PHH Corporation Q2 2008 Earnings Call Transcript

PHH Corporation (PHH)

Q2 2008 Earnings Call Transcript

August 8, 2008 10:00 am ET

Executives

Nancy Kyle – VP, IR

Terry Edwards – President and CEO

George Kilroy – President and CEO of PHH Arval

Mark Dan – SVP and CFO of PHH Mortgage

Analysts

Bose George – KBW Investments

Louis Syke – Tennant Capital

Gabriel Kim [ph] – Wellington Management

Patrick Donnelly – Blackrock

Lee Matheson – KJ Harrison & Partners

Presentation

Operator

Good morning ladies and gentlemen. Welcome to the PHH Corporation 2008 second quarter earnings conference call. (Operator instructions)

At this time Nancy Kyle, Vice President of Investor Relations will proceed with the introduction.

Nancy Kyle

Thank you, Laurie. Good morning and welcome to the PHH second quarter 2008 earnings conference call. On the call today are Terry Edwards, President and Chief Executive Officer of PHH Corporation and PHH Mortgage, and George Kilroy, President and Chief Executive Officer of PHH Arval. After the prepared remarks by Terry and George, we will begin a question-and-answer session when other members of the senior management will be available. If you did not receive a copy of the earnings release we issued last night, you may access it from our website at www.phh.com, or you may call our investor hotline at 856-917-7405 and request a faxed or mailed copy.

Please note that this conference call will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Examples of forward-looking statements including our statements regarding our origination prospect list and the potential to increase market share, our expectations for achieving our origination target for the balance of the year, our belief about the economic value of our servicing assets, our expectations for continued pricing competition in our fleet segment, our expectation regarding continued success in retaining and signing new fleet clients and our comfort with our limited exposure to residual values for used vehicles.

Our actual results may differ materially from those discussed on this call. Please see the risk factors section in our 2007 Form 10-K and our quarterly reports for description of issues that may lead to different results. Please call our hotline if you would like paper copies of these filings or you may access them on our website and now I will turn the call over to Terry.

Terry Edwards

Good morning everyone. Thanks for joining us. I will start the call out by reviewing the last thing I said, so my quote from the end of our last call. I said we feel good about both our businesses and we believe we are in a good position for the future. That said there will be bumps in the road as we work through the credit crisis. This is far from over but hopefully the recent actions of the Fed will minimize volatility and we will not see another period like the last few quarters, especially March. That is what we said and obviously there have been more than bumps in the road. We have repeated March, in effect given what we went through in much of July and here early in August. So, with that said let us roll through the results.

Our originations business lost $18 million for the quarter versus an $8 million loss a year ago and $8 million loss in the first quarter. The servicing business made $34 million versus $17 million a year ago and the vehicle business made $16 million versus $30 million a year ago. As we have said, our vehicle business is feeling the impact of the increased cost of debt and also the impact of the less momentum we had – sales momentum we had last year while we were under the merger agreement. All told we had $32 million pretax.

Diving into the originations business in a little more detail, rising rates during the second quarter caused an $18 million loss in this segment as new application volume slowed significantly. Recall with the accounting changes implemented this year, expenses are no longer deferred and revenue is booked at application. Therefore as app slowed down in the month of June we lost that revenue that we had anticipated.

During the quarter the power [ph] mortgage coupon increased from 5.27% to 5.83%. On our last call we said we were seeing refi activity slow down as rates rose but the thought we could achieve our goal of $39 billion in origination loan volumes to break even in this segment with new outsourced signings to offset the slowing refinance activity. Obviously the rate increases has been more significant than anticipated and it has resulted in curtailing of both refinance activity and purchase activity. As a result, we now do not expect to break even for the originations segment this year. While we are signing new accounts as we mentioned in the press release and I am aware of three more close to the goal line that we hope to have implemented and rolling this quarter. We find ourselves in the position of once again having to rebalance our operating platform for slower volume. Good news is our prospect list remains strong, the market share has the potential to continue to increase as we mentioned in the press release. Of course, any rebalancing of the portfolio of the operating platform will include evaluating the pace of new signing. And given how much things have slowed down that pace could pick up.

Pricing margins while higher in the first – in the last few years are lower than we experienced in the first quarter. As we have all seen the market has consolidated further so we’d hope that those that have the pricing power recognize this and that perhaps margins can get better but we're not planning on that, but in theory if everyone looks at the overall performance of their mortgage segments people should be increasing the pricing. Another reason for increasing the pricing is the entire world has to document all loans in full detail. There are no longer limited documentation loans out there. Therefore all lenders face the expense associated with fully documenting loans.

Shifting to servicing, our expectations for servicing fell short. Last quarter I reported that hedge was structured so that in a 50 basis point decline we would lose $160 million and with 50 basis point rise we would benefit by $120 million. As you already know rates did rise by that amount and we did not see all of the $120 million benefit. This is largely a result of the flattening of the curve that occurred during June.

Our OAS valuation model use forward interest rates, the forward interest rate curve to predict the behavior of interest rates used in the valuation model. Since the yield curve flattened during the quarter, our model plus the effects of the performance of the hedge from the shape of the curve negatively impacted the valuation by approximately $97 million. In addition servicing was also hurt by an increase of $25 million in reserves during the quarter plus another $8 million in charge-offs. Given the decline in premium payment speeds that the entire industry has seen, we believe the economic value of our servicing has increased significantly. However, we have not adjusted our prepay speed models to reflect that. We also have allowed and get third party marks as we've discussed in the past and given the light activity in the third party mark for (inaudible) servicing the valuation will get capped there because third party – we are reporting our value at based on where we think the third party would pay for this servicing.

When compared to other significant players in the market place like Wells Fargo and the JP Morgan Chase we increased our MSR by 15 basis points to 1.3% while Wells Fargo went up 29 basis points, almost twice what we went up to 1.37% and Chase went up 21 basis points again twice what we went up to 1.65%. So from a value perspective, we agree with these increases, which means our MSR is even more conservatively valued at the end of Q2 versus Q1.

I will now turn it over to George to dive into the vehicle results and to talk about the renewed momentum we have in this space.

George Kilroy

Thanks Terry. As Terry mentioned second quarter in 08, the fleet business reported $16 million of operating income versus $30 million in the same quarter in 07. Also as Terry said, the majority of that difference was from lost clients that happened during the pending merger period and for funding; and I will address both of those. Our client retention rates for those clients who elected to go out to bid in both the U.S. and Canada appeared to be back to pre-merger announcement levels. New sales in the U.S. and Canada have also increased and our pipeline is very strong. In challenging economic times like these, companies are looking for unique and dependable solutions for high cost items like fleet. And if we can continue to show market leadership in overall solutions as well as commitment to innovation, we expect to be – continue to be successful in retaining and signing new clients.

Our funding costs are in line with what we had announced earlier this year and while our industry is very competitive, clients who took their fleets out within the last few months have seen pricing that is more reflective of what the market realities are. I expect and hope to see this continue and suspect that we will be able to recover at least some of our additional funding costs. Remember too that the majority of our clients do more than just lease vehicles from us. We're fortunate to have multiple revenue streams from fee-based services. We take all of that into consideration when analyzing our client relationships. That being said, we fully believe we will continue to be able to adequately fund all of our leases and in fact that the current time have over $40 million excess capacity in Chesapeake.

I like address a couple of questions that we received over the past few months from some things that have happened external to PHH. One is the question about vehicle selection and do we see a change in the type of vehicles that our customers are using. Fuel costs, resale value, and remember resale value is a client responsibility but it is one of the key services that we provide for them. Production schedules, environmental issues, these are all considerations in our recommendations for our client’s eventual vehicle selection.

One thing to note in the vehicle it is more on a model year than a calendar year. The model year for ‘09 starts in just another month. So in this time in ‘07 was when customers and PHH together were making recommendations for model year ’08. And as a result what was going on in the marketplace was different last summer than it is this summer and we did not see a significant shift from model year ‘07 to model year ‘08. However, we do expect in our conversations and our recommendations for our clients for model year 09, we're going to see some changes not necessarily. Vehicles may be going from eight cylinder to six cylinder, six cylinder to four cylinder SUVs and the crossovers, midsize cars to compact that type of thing.

A couple of other things that customers are taking a very close look at are telematics, which is the optimal way to measure and control things like fuel and productivity; and another interesting thing that has happened is that customers that – clients that were reimbursing their drivers for the use of their personal car on business are taking a look at it and many are switching to company provided vehicles so they can have a greater control on that. So, we do expect some shift from model year ‘08 to model year 09, but it will have very little impact on PHH.

The second thing that has been going on in the marketplace has to do with the announcements that have come out from the motor companies. And that said we have a very close partnership with the vehicle manufacturers and they continue to support and depend on a commercial fleet business that it is an important part of their business. We have helped our clients with the motor companies work through some production schedule changes and we expect some more plant shutdowns early in the model year. We're working with the motor companies and our clients around those issues. One of the other announcement that the motor companies have made is the cutback on consumer leasing, and remember that is the important term in consumer leasing that you are seeing the announcements on. And that will have some impact on the overall market, which could in some ways be positive. That 50% to 20% in new sales with the motor companies are leased vehicles and if that dries up that could help the used vehicle market at least to get the used vehicle market right sized, which would be good for everyone.

The other part of that is PHH has a fairly small part of their portfolio in closed end leasing where we are responsible for that residual and it is a little bit less than 5%. The majority of those are not SUVs or trucks and they are actually lined up pretty well for what the used car market is buying right now. When we mark-to-market that on a quarterly basis and at this point we're very comfortable with our limited exposure in this area. Terry.

Terry Edwards

Thanks George. As we do each call, given that the company is a mortgage company and a vehicle company but because of the mortgage component of the business we traded at significant discount to book. As we do each call, we go through the key areas of risk related to the mortgage company on the balance sheet at quarter end. As I touched on the MSR at 1.3% our value was conservative. We do peer surveys that tells us we are at the low end of the pack and then based on the public data that I just mentioned we (inaudible) our MSR less aggressively than our main competitors. In addition as we said all along our prepay speed typically relative to the industry are 85% to 90% of the industry over time. So we will also see that value over time.

Shifting to captive insurance, we increased our reserves by $11 million during the quarter. We now have $50 million in reserves related to the captive. We currently project the present value of future premiums to be $14 million below the present value of future paid losses. This is a change from the past where we said those 2 numbers were basically netted to zero. That said take that 14 away from the 50, we have got $36 million of reserves that wind up making the overall look relative to the captive somewhat conservative.

The calculations for these reserves are done using industry data. So, we would hope and expect our portfolio to outperform the industry as it has over time.

Shifting to recourse, loans we have sold but hold a recourse total $453 million at June 30, down from $460 million at the end of the first quarter, 5.77% of the loans are 90 days delinquent, 60% of these loans were originated in 2003 or before, 16% in 2004. So the remaining ‘05, ‘06, ‘07 exposure represent 24% of this portfolio.

Shifting to the retained credit risk related to our recourse program that we talk about each quarter; this was down to $1.4 billion at June 30 down from $2.4 billion at year-end. Recall we have exposure for the first 18 months of the loan and the loan that goes to 120 days delinquent we must buy back. Based on when we halted this program, we expect that this will wind down to zero – close to zero exposure by June 2009, dropping by about $160 million of exposure each month.

Last call we said we would expect to add reserves. All credit reserves including those related to our captive insurance are now $118 million versus $81 million at year-end and $93 million versus the first quarter. So the $118 million is made up of $50 million for Atrium and $68 million for every recourse positions just discussed plus REO [ph].

Last with regard to mortgage loans held for sale, it is shown on one of the tables in the press release 79% are conforming. Early in July we sold $142 million of nonconforming. So the adjusted mix of conforming held for sale would be 85% and as we said all along we do not have a held for investment portfolio. The entire balance sheet related to the mortgage company is marked.

Liquidity as of June 30 is shown on the last page of the press release. We had $162 million in unsecured capacity via our bank lines, $1.4 billion in warehouse capacity and $450 million of vehicle capacity as George mentioned earlier. As we said we're working to move the maturities out on our debt as demonstrated with our $1.5 billion RBS 2-year funding for the mortgage warehouse and will continue to try to expand liquidity when practical.

Our liquidity for those who follow us closely is down from the last quarter as increasing rates caused cash losses on the hedge instruments. In addition we were holding jumbo loans at quarter end that I just mentioned. Once the $142 million I mentioned was sold and settled in July an additional $68 million of unsecured funding capacity became available. Overall, our tangible debt to equity is 4.8:1, which is conservative for us historically and conservative for a company like ours.

At the end of the day we still believe the long-term prospects for our businesses are good although the short-term results will be less than desirable. Once the market turns we expect great possibilities given the consolidation that has occurred within the mortgage industry. We have already increased market share from 1.5% to 2.3% over the past twelve months according to inside mortgage finance and hope to continue to do that by signing new relationships.

As a fleet management company, we are addressing the challenges of increased funding costs while assuming they are not temporary. We're excited about the sales momentum that is building as the market recognizes our expertise and welcomes us back with open arms.

So at this point Laurie, we will be happy to open up the lines to take questions.

Question and Answer Session

Operator

Certainly. (Operator instructions) And our first question comes from Bose George with KBW Investments.

Bose George – KBW Investments

Guys good morning.

Terry Edwards

Good morning Bose.

Bose George – KBW Investments

I had a couple of questions on the mortgage production business. First your fee-based closings are up pretty well. And can you just discuss the drivers of that and the economics of the fee-based business versus originating loans for sale and also given that your total production is up quarter-over-quarter and $20 billion, why you are revisiting the $39 billion guidance number?

Terry Edwards

Okay, fees, the fee-based services that is up because one of the things that we had to halt was doing jumbo loans for sale in the secondary market. From the first quarter to the second quarter that mark-to-market has basically dried up and is limited – and almost is still dry at this point. If you reverse engineer where AAA prime securities, obviously AAA and prime they go together – securities we trade in the marketplace if you reverse engineer the execution you would get that would mean a coupon rate to a new originating customer of about 8% and that is just not going to fly in the mortgage market today. So as a result our large clients are portfolio [ph] jumbo loans and because of the increased portfolio activity for this business that drives the fee-based business up. The fee based business is good business in that we don't take the risk but because you don't take the risk the return isn't as great as it would be if we sold the loan on a gain on sale basis in the secondary market. That said we don't have any appetite for the risk of taking on jumbo loans and holding onto them and hoping that we can get execution in the market place. With regard to the overall $39 billion target, you are right Bose, we were at the $20 billion through the first half. So everything was on track but as I indicated our June results were hurt by the fact that new application volume started to come down in June as rates were up basically 50 basis points from where they were in the first quarter. Rates have continued higher and while I don't want to make a trend out of a week and a half of August activity, volume is very, very slow and it is slow for every single business source we have. So isn't a function of one particular business source or a couple of business sources slowing down. So it is our expectation that the $4 gas, the fact that every month everyone gets to read how much housing prices are dropping, the amount of credit card debt has now increased with that data that is out there. Consumers are tightening their belt and, you know, one of the things that is going to slow down is obviously new home acquisition. People think that houses are going to be cheaper you know further out from here. So as a result volume is very slow. Now I don't want to call August a trend. Typically August slows down anyway but it has slowed down dramatically. So as we move towards September – so just based on that August slowdown we're not going to do $20 billion almost $20 billion in the second half of the year. So we are as I said rebalancing what our expectations are. Hopefully, getting those additional three clients that I talked about plus others over the goal line with that information we will assess how much additional costs we have to take out of the business, recognize that market-wise the world is going our way. More and more are going to outsource. So we have to balance cutting our platform cost and making sure we don't cut into muscle. We want to have the muscle available for new client signings and to the extent that if there is any lift in the housing market we want to be there for it. Now I would expect that the lift in the housing market would to have to come from some kind of drop in interest rates, a compounding factor associated with rates is the fact that spreads of Fannie and Freddie agency securities are close to their lives of all time as we speak. So that in itself those spreads trading the swaps at a number like 135 basis points relative to our traditional spread of 75 or 80 that in itself has added 50 basis points to the cost that the consumer pays.

In addition all the other additional fees and charges that have been put in place by investors in order to make up for past losses, couple that with the dialing back of all the underwriting scoring engines that has occurred across the industry has really impacted the overall demand for housing. So long and winded question to a simple answer but that is why we're concerned about the – long-winded answer to a simple question that is why we're concerned about our ability to hit $39 billion, Bose.

Bose George – KBW Investments

Okay it makes sense. And just switching to the turmoil that is sort of continuing in the market. Are there any other potential impacts in your business especially in terms of hedging costs some things like that?

Terry Edwards

Hedging costs can always be volatile. So that is something that is always out there. And then there is always the new wrinkle that we haven't seen yet and we're not going to forecast based on what everyone has seen making forecast that says outside of this data the other thing, everything will be fine would just be too dangerous.

Bose George – KBW Investments

Okay then just switching to a question on the fleet business, I was just wondering the operating expense line item jumped (inaudible) materially in your segment breakout. I was just wondering what that line item was driven by?

Terry Edwards

Yes, the operating expense line has to do with increase syndications and as the cost of goods through our truck business, the actual cost of the trucks that we acquire before we syndicate and run through that line.

Bose George – KBW Investments

Okay, so it is just a – is that kind of a temporary bump given that it was just flowing through this quarter?

Terry Edwards

There is an offset in lease revenues for that number.

Bose George – KBW Investments

Okay, great thanks very much.

Operator

We will go next to Louis Syke with Tennant Capital.

Louis Syke – Tennant Capital

Welcome to (inaudible).

Terry Edwards

Hi, Louis. Can't quite hear you.

Louis Syke – Tennant Capital

Is this better?

Terry Edwards

Getting better.

Louis Syke – Tennant Capital

I have a number of questions actually on the – could you just clarify the –

Terry Edwards

Do me a favor Louis given them to one at a time. I can't walk and chew gum.

Louis Syke – Tennant Capital

I will. On the production side, the $18 million pretax loss and you explained it a little bit. This issue under the interest rate lock commitments. Can you explain that a little more – fundamentally I'm looking at volumes up but the explanation in the press release sounds like the lower gains were due to lower volumes and I lost you a little bit there?

Terry Edwards

As I mentioned in – I will go through it again because it is complicated. With the change in accounting this year expenses are no longer deferred, but you do recognize the revenue immediately when you get an interest rate lock. So that benefited the first quarter by $30 million. As we shifted to the second quarter with interest rate locks being below what we had anticipated in June we don't get the benefit of that revenue. So as soon as the revenue turns off you are still incurring the expense so you don't get the benefit. So it winds up being a negative timing issue if you will. The expense is all there ready to handle the loans and then the loans don't come in. So you expense it. So there's a chart in the Q that will show you that puts the expenses apples to apples and shows that expenses are actually down in the second quarter when you adjust for that accounting change.

Louis Syke – Tennant Capital

And so what was the revenue headwind associated with that in the second quarter?

Terry Edwards

If we're talking about another billion dollars of loss application volume, that number would be $10 to $15 million of revenue that we would have gotten in that quarter and that would have gotten originations much closer to our break even target.

Louis Syke – Tennant Capital

Okay, and the $20 million hedging loss that you disclosed in the separate table, is that the same thing or is that in addition to that?

Terry Edwards

No, that could be rolled up in gain on sale.

Louis Syke – Tennant Capital

Right, but – so are these, the hedging and warehouse losses, right? Towards the end of the press release you have this $4 million decline valuation of jumbo loans and $16 million loss on the other economic hedge results for a total of 20. So does that reflect some of this interest rate lock commitment issue or is that a –

Terry Edwards

No that is not there – that would not be there. That could be in the revenue line. Those impacts are from continued volatility to hedge. The overall cost to hedge remained high. If we called it, it was $26 million in the first quarter. So it came down some in the second quarter but not as much as we would expect in a stable environment.

Louis Syke – Tennant Capital

And some of the impact there is still from widening spreads and to the extent that spreads can't widen forever that expense would disappear.

Terry Edwards

Yes, it should come down to a much lower run rate in a normal environment.

George Kilroy

Louis this is George. Let me come back to you on the revenue question that Terry was talking to and looking at 2 particular numbers. We did a little over $17 billion in applications and not all those applications are closed. There is some fallout associated with that and that was in the first quarter. In the second quarter the application volume fell to around $12 billion and that is really just of the revenue drivers now under the new accounting. So a lot of the loans that were – that we took an application for in the first quarter would have closed in the second quarter. So your closing numbers look pretty good quarter-over-quarter but the application volumes are down and that is part of the reason for the revenue decline.

Louis Syke – Tennant Capital

Okay, understood and the – but all the volume metrics that you disclosed are so more lag – the closed loans and sold loans are basically not tied to the revenues anymore. Can you disclose these?

Terry Edwards

They are in the Q.

Louis Syke – Tennant Capital

The $17 billion and the 12.

Terry Edwards

Yes.

Louis Syke – Tennant Capital

Oh, they are in the Q.

Terry Edwards

The application volumes that drive revenues are in the Q.

Louis Syke – Tennant Capital

Okay and then –

George Kilroy

Just to give you a little more detail. Straight locks in the first quarter were $7.6 billion. Locks in the second quarter were $4.7 billion. So you can see there's significant revenue shortfall driven by that slowdown in the locks to the extent that locks pick up we will start to see that benefit again but as I said that is not happening in August.

Louis Syke – Tennant Capital

And then moving on to servicing, you explained that typically you would have seen $100 million plus gain on the 50 basis point upward move in rates and obviously you came in at $37 million and you said that had to do with the flattening of the yield curve.

Terry Edwards

Yes.

Louis Syke – Tennant Capital

Could you explain that a little more?

Terry Edwards

Yes, the shape of the curve is one of the inputs. The shape of the forward interest rate curve is one of the inputs in our OAS, option adjusted spread, model that is used to calculate the present value of the service date the cash flows associated with the servicing and obviously that is how you arrive at the value of the servicing. Because the curve flattened, recall that the Fed started to talk pretty hawkishly in June about raising rates and concern about inflation. And the world was feeling of the whole lot better about itself early in June before things started to take a turn for the worse. As the curve flattened out or as the curve flattens, when the curve is steep the expectation is the model is that rates will continue to increase. When the curve flattens out it takes away that increased rates over the life of the increased factors associated with the rising rates. Therefore, the value of the loan from the model standpoint comes down because it doesn't anticipate rates going up as much anymore. So that –

Louis Syke – Tennant Capital

In the near term?

Terry Edwards

So well present value – in the near term, in the long term, over the life of the loans. Therefore, those rising rates would also expect loans to stick around longer and therefore as the curve flattens out if it's okay with them the model says okay, rates aren't going to go up. Some of these loans are going to pay off more rapidly and therefore the value comes down. That said the point I made on the call and that is I am emphasizing we watched others take their value up way more than we did. If we took our value up another 15 basis points in line with what Wells Fargo did and what Chase did that number is about $90 million. So the curve took it away but other participants in the market either didn't use the curve or they adjusted their prepay speeds and more likely the latter. They adjusted their prepay speeds to reflect market conditions. Our portfolio was going to be much more stable as we go forward just like others in the industry because of all the product elimination, all the product restrictions on those that remain. So at the end of the day our valuation is as conservative as it has ever been against the peers that we track in one of the surveys that we participate in. So at least $100 million of value will come in over time because of our – these slower prepay speeds but it is not reflected on the books today.

Louis Syke – Tennant Capital

Okay, and also in the servicing business on the credit reserve, the $25 million, can you give us a sense for how you would expect that to develop going forward assuming a further price decline in all of that.

Terry Edwards

Yes, I mean, unfortunately it is hard to predict but at this point I wouldn't want to predict any kind of slowdown. We are seeing loss severity pick up. While we are not seeing the rate of delinquencies and foreclosures that others have as you can see from the information provided our book continues to look stellar relative to the rest of the world but as loss severity increases we continue to take those adjustments. What will benefit us a year from now that total $1.4 billion of exposure that we still have that goes to zero. So in some respects there are positives. We're not putting any more recourse loans on. We're dialing back that program. The positives associated with Atrium are is we are using industry information and as we indicated we are building reserves but to industry metrics and our metrics we’d hope would be better over time. But at the end of the day predicting that the loan rate for those expenses to come down at any point in time would just be dangerous. At the end of the day the way – you have heard several procrastinators out there talk about what aiming we are in this ball game and based on just what we have seen happen in the last 5 or 6 weeks we don't think we're (inaudible), but as we jokingly said earlier today hopefully we playing little league baseball and it is only a 16-year [ph] game and so we do over the hump it matures itself rapidly.

Louis Syke – Tennant Capital

Okay, and how much was associated with the non-recourse and the limit your credit enhancement stuff that will disappear sort of within the next year or so I guess?

Terry Edwards

We don’t have that number handy. We will have to break that out for you.

George Kilroy

And we will come back to you with that Louis.

Louis Syke – Tennant Capital

And then on the fleet side, the results were basically down $14 million year-over-year and some of that is obviously the spreads and you mentioned the other factor I guess was the slightly lower volumes, can you break those two out?

Terry Edwards

I would say the spreads are 70% plus of that $14 million and the rest of it is some shortfalls in volume which are reflected in the Q, and then there is kind of always maybe $1 or $2 million of one-time events either up or down from last year, but the majority of it is the fund.

Louis Syke – Tennant Capital

So, when you previously talked about the $30 to $35 million increase in funding costs, how was that put through about $10 million, which you are saying is 70% of $14 million?

Terry Edwards

While remember our funding mismatch was not as evident in the first quarter as it will be – as it was in the second quarter or will be through the next 2 quarters. Just because of the timing of the renewals of Chesapeake and when the increased fees kicked in. So, we are –

Louis Syke – Tennant Capital

So that 30 to 35 is not in annual run rate but it was an expectation for ’08?

Terry Edwards

That is a ’08 number.

Louis Syke – Tennant Capital

Okay, and how much production are you getting in passing these through to customers. You mentioned that when people go out for bid they see this reality reflected in the market?

Terry Edwards

Yes, that is right Louis. We are encouraged by what we have seen in the market place when our customers have elected to go out to bid and the responses from the market place have really reflected some different kind of interest indexes and spreads that we have seen in the past. But it is important to note that that is only a portion of what our say financial relationship with our customers is, and we have detailed plans for each one of our top 50 clients as to how we are going to deal with that relationship going forward. So, it isn’t just a one-time event of raising rates, it is a fairly detailed conversation with each one of our clients as to what we can do with them to further the relationship.

Louis Syke – Tennant Capital

And what is the timing of that?

Terry Edwards

We hope to have all the plans communicated and have discussions with our clients by the end of the third quarter and any actions that we are going to take would certainly be done by the end of the year we would hope.

Louis Syke – Tennant Capital

Okay, and then final question on Terry, on the new client wins especially UBS, can you give us a sense for how big that might be, I mean, at least order of magnitude?

Terry Edwards

Yes, we would hope that on a normalized basis that our UBS would be $500 million a year or more, obviously it has got much more potential than that over time, but for now we will stay in a number like $500 million. The new accounts that we have close to the goal line represent between $600 million and $900 million in new volume on a run rate basis.

Louis Syke – Tennant Capital

The UBS is – it sounds like they don’t offer much in the way of mortgages to their wealth management clients at this point?

Terry Edwards

No, they do. They are active, but I want to be cautious about how much I commit that account to.

Louis Syke – Tennant Capital

Okay, how big is that wealth management business relative to Merrill for example?

Terry Edwards

In terms of financial advisors they have several thousand whereas Merrill is 14000, 15000.

Louis Syke – Tennant Capital

Great, I will let someone else get on. Thank you.

Terry Edwards

You are welcome Louis. Thanks for your questions and for all your support.

Operator

We will go next to Gabriel Kim [ph] with Wellington Management.

Gabriel Kim – Wellington Management

Hi, good morning.

Terry Edwards

Good morning.

Gabriel Kim – Wellington Management

Hi, guys. My question is on the new production guidance, in the past you sort of said that this could get to break-even and I wasn’t quite sure how you are thinking about that goal lately?

Terry Edwards

Getting it to break-even this year will be difficult because we have – we got to rebalance, you know, we already behind (inaudible) as we said this year. So, getting it to break-even is just not going to happen. So, what we are going to do over the next few weeks is the management team at the mortgage company is going to brainstorm on what new accounts do we have coming on, what is the sales momentum, what do we think the run rate is for all of our existing clients, what does that look like in terms of volume and in order to be break-even what do we have to take out of the cost structure in order to get there. So that is the extra size to we will go to get that thing back on track to break-even and then as we win more market share over time to the extent that we remain in a stable rate environment new volume beyond that break-even point would mean we would get ahead of the game.

Gabriel Kim – Wellington Management

Okay, and then just on the UBS, I mean how long does it take to win a customer like that?

Terry Edwards

Far longer than we would like it to take. As we have talked about, in many respects our competitors are not such much others that offer the outsourced program but it is the bank, the financial institution itself and making the decision to finally make the outsource decision.

Gabriel Kim – Wellington Management

So that what is happening. Is this replacing sort of an in-house capability that they had?

Terry Edwards

While in this case UBS had been actually using another provider?

Gabriel Kim – Wellington Management

Who were they using?

Terry Edwards

They were using a company called LenderLive [ph].

Gabriel Kim – Wellington Management

Okay and so what –

Terry Edwards

And prior to that they had been with a very large financial institution that has a stagecoach as a logo.

Gabriel Kim – Wellington Management

Okay, of course, and then the – are they – is this now sort of an exclusives are they trailing, how is that?

George Kilroy

Now we have an exclusive arrangement.

Gabriel Kim – Wellington Management

Okay, for how long.

George Kilroy

We don’t want to get into the terms Gab because we wind up telling our competitors when they should know on the door.

Gabriel Kim – Wellington Management

That is fine. Okay, very good. Thank you.

Operator

We will go next to Patrick Donnelly with Blackrock.

Patrick Donnelly – Blackrock

Good morning guys.

Terry Edwards

Good morning.

Patrick Donnelly – Blackrock

I have got 2 questions Let us start with the amount of noncomforming mortgages that you hold currently and it looks like sequentially we were way down here, over $600 million last quarter on the $388 million if my math is correct. Currently, how much of that was sales and how much of that was runoff in terms of the sequential decline?

Terry Edwards

As I mentioned we settled $142 million in early July. That is not reflected in the numbers yet. There were sales in early in the – it was a similar sale early in the second quarter. So for the most part it is almost all runoff associated with sale and we stopped. We are not taking on any new jumbo commitments without having a pay gap if you will. So, running a mass book from that perspective.

Patrick Donnelly – Blackrock

And then going forward do you just plan on letting these loans runoff or do you want to actively go to the market, seek out a potential buyer or buyers and just get these off your book, what is your thought process there?

Terry Edwards

We are actively looking at moving those loans.

Patrick Donnelly – Blackrock

Okay, and you reserve for that.

Terry Edwards

Yes.

Patrick Donnelly – Blackrock

Is that the $25 million.

Terry Edwards

No, the $25 million is all related to credit losses. The reserve associated with fair value on those marks runs right through the gain on sale.

George Kilroy

Hey, Patrick remember, we don’t have any held for investment product, everything is held for sale and it is all mark-to-market.

Patrick Donnelly – Blackrock

Okay.

Terry Edwards

That is marked down (inaudible) of the mortgage business.

Patrick Donnelly – Blackrock

Okay great. And in a kind of more big picture in terms of the mortgage production obviously is not where you want it to be, but obviously you get benefits on the mortgage servicing side. So, just sequentially how should we think about the progression, positively, negatively for the next couple of quarters? Will the servicing side offset the weakness on the production side and just again in an aggregate sense how is that mortgage unit going to look sequentially and then year-over-year?

Terry Edwards

Patrick we are going to avoid any kind of guidance because it is just a recipe for diaster. I think the guidance that we have said indirectly here is the originations business is not going to break-even and the run rate is significantly below what it had been. Therefore the originations business will throw off losses. The servicing business is going to be burdened by credit losses. So, ideally servicing would offset the mortgage originations business but I don’t want to be so bold as to say that that will happen because we still have the risk of more credit losses. In addition to the extent that interest rates were to move down some of those hedging gains that we had in effect would be given back, but to the extent that rates moves down a little bit, hopefully that means the originations business picks up. So the two kind of run in tandem and there is always timing differences. So, at the end of the day, we felt great about life at the end of the first quarter related to the mortgage business. As we sit here right now, we feel great long-term but we don’t feel good about what the next six months might bring.

Patrick Donnelly – Blackrock

But are you still comfortable that the mortgage servicing side provides that natural hedge that you have discussed in the past?

Terry Edwards

It should absent more significant credit loss.

Patrick Donnelly – Blackrock

Got you, okay. And just on the production side what is curious, I am of the opinion that there seems to be a willingness to transact on behalf of buyers and maybe that is – and that is being borne on some of the numbers and maybe that is more for closure activity than anything else, but I am trying to get a sense as to going forward are we going to have a lack of production because there is a lack of willingness of behalf of lenders to lend or ability or is this more the consumer pulling back and again as you mentioned watching the deterioration before they step into the housing market?

Terry Edwards

It is a combination of the two and what I mean is lenders still want to lend but the underwriting box is for the Fannies and Freddies of the world has tightened up dramatically. The underwriting box is for the MI [ph] providers who are now the only game in town because people aren’t providing second loans anymore to replace mortgage insurance. So those boxes have tightened up dramatically. As a result, we have a lot of leads that come into our call center here, a far greater percentage of those leads – a far less percentage of those leads qualify now because the box the scores engines have been dialed back so significantly. So, lenders want to lend but lenders want to lend much more prudently then they have in the past. So that is one driver. The other driver to the originations business is that rates have gone up so significantly. It is significantly turned off refi activity. So, refi activity was pretty robust in the first three or four months of the year but now that has really dialed back.

Patrick Donnelly – Blackrock

And the new legislation and how it is written is – I mean there are positives and negatives, where do you guys come out in that?

Terry Edwards

At the end of the day it is directionally it is positive but it is not like it is manor from heaven or something like that. No easy fix. It basically set the ratings, Fannie and Freddie are still going to be here because the government got more explicit about the backup, but interestingly – it is interesting to note that spreads have widened on those the offerings for those mortgage-backed securities since the housing legislation was passed out. That is kind of odd. One would hope it is because it is August and the buyers aren’t here right now, but one would think that buyers being the arbitrageurs that they are would recognize that spreads are almost as wide as they have ever been and they will be bringing those spreads down and that has driven up the rates for consumers also.

Patrick Donnelly – Blackrock

All right great. Thanks guys.

Terry Edwards

You are welcome. Thank you for the questions.

Operator

We will go next to Lee Matheson with KJ Harrison & Partners.

Lee Matheson – KJ Harrison & Partners

I have a few things. I want to start on the fleet side for George. When I look at the numbers in terms of the number of fuel cards and maintenance cards, one is there is obviously a large diversion in terms of the reduction in the number of (inaudible) gas cards relative to maintenance cards and all of the card business relative to the number of the reduction in the number of leased vehicles. Can you sort of explain, I think you talked last call about there were some people who were able to get out of their card program before their vehicle lease deals ended and some uncertainty around the GE Capital that people trying to get away to some extent but, you know, I guess why that number is still coming down in terms of those averages and will we see that tick back up?

Terry Edwards

Let me see if I can do one at a time. Remember when our clients signed up with PHH, the leases roll off as the leases expire. It very rarely happens that a lease that is in the first or second year, if they elect to leave PHH and go to somebody else that lease will be bought out by the new lessor. So they will runoff over a period of time. That is why the lease vehicles show a much less slower drop off than the services that are attached to it. And the drop off in fuel specifically is due to some very large fuel only clients. We do have some clients that don’t lease from us or do maintenance with us, but they will do fuel and we had maybe three major accounts that had the majority of those large fuel cards. Some of the large fuel cards with clients who also lease with us, but the big difference there is clients that only used us for our fuel cards program.

Lee Matheson – KJ Harrison & Partners

Okay, so that when I look at the revenue line, the fleet management fees revenue line which is only down a million bucks year-over-year in a quarter versus the number of cards, does that imply pretty substantial price increase across the board?

Terry Edwards

I wouldn’t say price increase no, I think it is just kind of the way we mange the supplier network and some of the things that we are doing.

Lee Matheson – KJ Harrison & Partners

Okay, when again looking at the fleet business on the income statement we are talking about this, the increased spread funding through Chesapeake and yet the actual number on, excuse me, on fleet interest expense in the quarter was down over last year. Can you kind of explain why the absolute number is down?

Terry Edwards

Yes, the absolute number includes the actual interest rate. So, I think last year LIBOR was 4%, 5%, and now it is 2.5%.

Lee Matheson – KJ Harrison & Partners

It is okay, and when you guys are doing these renegotiation on the lease, my understanding is that is the Chesapeake is priced off the H-15 index, is that correct? Or is it LIBOR based?

Terry Edwards

It is priced off of LIBOR.

Lee Matheson – KJ Harrison & Partners

It is priced off of LIBOR.

Terry Edwards

Commercial paper issued by the conduits that provide the financing.

Lee Matheson – KJ Harrison & Partners

So, whether or not there was some issue with the commercial paper index moving away from LIBOR and there being some mismatch, I am just wondering if when you rewrite the lease deals, you are able to go in and more perfectly match the funding to the lease agreement.

Terry Edwards

And that is what we are trying to do. Where we would have in the past used the LIBOR as the index for pricing to our customers, we are now using something closer to what the actual asset backed commercial paper rate is.

Lee Matheson – KJ Harrison & Partners

Okay, great. And then to follow up on Louis earlier so that the number you gave us $30 million increased funding cost for 2008, if we assume that none of the impact was felt in Q1 and $10 million was felt in Q2 that would imply sort of a $10 million run rate per quarter for the remainder of the year and I get on an annualized basis it will be more like a – on a 12-month basis will be like a $40 million impact to funding cost, is that correct?

Terry Edwards

I mean that is not far off. I mean – there is a whole lot of other moving pieces in there but if that was basically they stayed at a 100 basis points penalty on $4 billion dollars it is $40 million a year but that is the going in number. That is not where we plan to end up.

George Kilroy

Of course, we are repricing as we go.

Lee Matheson – KJ Harrison & Partners

Okay, on the, excuse me, on the servicing side, where do you sit, you gave a market share in ranking number on the origination side, where does that sit on the servicing side?

Terry Edwards

I think we are the 11th largest player in servicing.

Lee Matheson – KJ Harrison & Partners

Okay, so 11th largest in both servicing and origination.

Terry Edwards

Yes, we might be moving up too.

Lee Matheson – KJ Harrison & Partners

I think that IndyMac is not going to be above you for much longer. And the other question that I had was I have somewhere here in my nose and I apologize I don’t know where I came with this number exactly, but the large portion of the restricted cash in the balance sheet relates to Atrium? Is that correct?

Terry Edwards

There is a large portion related to Atrium and there is large portion related to the funding of the vehicle business.

Lee Matheson – KJ Harrison & Partners

Okay, so when I look at – we start to look at Atrium which you don’t disclose in terms of segmented information, when I – my notes imply decent sized asset number particularly from restricted cash for that unit and I am wondering if the number that I have is correct. I would expect it is large on the absolute and so what is the ROE or ROA of that business and presumably if it has the asset level that my notes say it should have, it should have sort of segmented disclosure. I am wondering what your view is there?

Terry Edwards

To help you with your notes, the restricted cash primarily for us related to Atrium is $246 million.

Lee Matheson – KJ Harrison & Partners

246, okay.

Terry Edwards

On a normalized ROE basis this is 15 percent return, but that is in a normal. It has been a great business since 1994 and now we got a few years to slug though. Mark Dan, do you want to add something to that?

Mark Dan

The restricted cash is you know, is established under insurance rules as we satisfied a portion of the premium receipts by paying future claims. So it is all income generated through restricted cash.

Lee Matheson – KJ Harrison & Partners

So, it is an effective investment portfolio that has an typical insurance company model. Okay, when I look at that business it is actually net income generative and generating positive cash flow?

Terry Edwards

It is. That cash flow actually trapped in the trust and released at the sunset period and it has been generating income, we are establishing greater reserves in anticipation of paying some claims in the future, and we will see how the market will obviously drive the kind of overall level of those claims.

Lee Matheson – KJ Harrison & Partners

Okay, and then I think – just to follow up are you guys going to – playing a lot of attack here with Nancy regarding some sort of investor day or meeting, are you guys going to – can you talk about your willingness to start to have people come down to New Jersey and see you again?

Terry Edwards

Yes, we are planning those dates.

Lee Matheson – KJ Harrison & Partners

Great, so it is going ahead.

Nancy Kyle

Probably – it will probably be late September.

Lee Matheson – KJ Harrison & Partners

Late September.

Nancy Kyle

Yes.

Lee Matheson – KJ Harrison & Partners

Okay, thanks guys.

Terry Edwards

Thank you Lee.

Operator

(Operator instructions) And there are no other questions in queue. Mr. Edwards, I will turn it back to you for any closing remarks you may want to make.

Terry Edwards

Thanks, Laurie. Thanks everyone for listening to our call this morning. Have a great rest of the summer and we will speak to you soon. Thank you.

Operator

This concludes the PHH 2008 second quarter earnings conference call. Once again ladies and gentlemen the replay will be available in approximately 2 hours at the company’s website at www.phh.com or by dialing 1-888-203-1112 or 1-719-4579-0820 using pass code 3889457. It will be archived until August 23, 2008. You may now disconnect.

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