NetBank Q2 2006 Earnings Conference Call Transcript (NTBK)

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NetBank, Inc. (NTBK)

Q2 2006 Earnings Conference Call

August 8, 2006 10:00 am ET


Matthew Shepherd, Investor Relations

Douglas Freeman, Chairman, CEO

Steven Herbert, Chief Financial Executive


John Hecht – JMP Securities

Daniel Hayes – Thomas Weisel Partners

Sam Caldwell - KBW


Everyone, welcome to the second quarter 2006 conference call. (Operator Instructions) I’d now like to turn the call over to your host, Mr. Matthew Shepherd of NetBank. Sir, you may begin.

Matthew Shepherd

Hello, everyone. As you know, the purpose of today’s call is to discuss NetBank, Inc.’s financial results for the second quarter of 2006.

Please be aware our commentary or responses to questions may contain forward-looking statements. Forward-looking statements regarding the intent, belief or current expectations of NetBank, Inc. or its officers can be identified by the use of forward looking terms. Examples include may, will, should, believe, expect, anticipate, estimate, continue or any other comparable phrasing.

Information concerning risk factors that could cause actual results to differ materially from those contained in the forward-looking statements is available in our SEC filings. Along with this morning’s press release, we posted additional financial information directly to our website. This quarterly data provides statistics and further detail on the company’s financial performance by business segment. We may refer to this material during the course of this morning’s discussion. You may access the information on our web site at in the Investor Relations area. There is a link titled Financial Data.

We will take live questions following our summary of the results. Doug Freeman, our Chairman and Chief Executive Officer, and Steve Herbert, our Chief Financial Executive, will lead today’s call. We will begin with Doug Freeman.

Doug Freeman

Good morning. Thanks for taking time to join us. Since we really pre-announced our results two weeks ago as part of our June statistical report, I plan to vary the structure of today’s call from my normal approach. I’ll still give you a high-level summary of the consolidated results we detailed in the press release. Steve is also here to walk you through the numbers by business line and give you more detail on the various pressures we experienced.

But I want to spend the first part of the call on the big picture. I want to talk candidly about the strategy we have been executing and the changes we’re making to protect shareholder equity today, and to generate meaningful returns tomorrow.

Let’s talk first about operations. Our business is under pressure across the board. Market conditions are weighing on results within our retail banking and financial intermediary segments. These pressures have, in turn, impacted our ability to meaningfully grow our deposit base and invest in many of our transaction-processing initiatives.

For a complete understanding of our situation, I think it’s important to remember where we started a few years ago. Our goal has been to build out a diversified financial institution with multiple complimentary lines of business that could contribute to our bottom line and reduce our dependency on mortgage earnings.

When we began this effort, we had an online bank that offered a limited set of deposit accounts and was marginally profitable at best. We also had conforming and non conforming mortgage operations that completely dwarfed the bank.

We focused first on right-sizing the bank and moving it towards meaningful profitability, on par with other thrift institutions. We broaden the bank’s product set and introduced a number of asset classes so that we could better leverage the bank’s balance sheet and rationalize its cost structure.

We also set out to change the mix of our mortgage production. The majority of our production at that time consisted of conventional agency-eligible loans, a product that other, larger lenders in the industry could produce with great efficiency than we could.

We were also heavily dependent on re-financing activity since we originated loans mostly through independent mortgage brokers that frequently serve those types of borrowers.

Our strategy was to expand our retail mortgage franchise. We favored this business because it focused on first-time homebuyers and thus purchased mortgages, which are less sensitive to changes in the interest rate environment.

We also emphasized growth in our non conforming unit. Non conforming production has historically carried a higher revenue margins and ran countercyclical to conforming origination volumes.

Last, we decided to take the core banking and financial intermediary competencies and resell them to other institutions on a business to business basis, where we would acquire existing processing businesses that sold a service we needed within one of these segments to fully realize our long-term financial performance goals.

Directionally, our efforts have been correct. I don’t think the company as it was when we began could have continued. Diversification was and is the right answer.

But the fact of the matter is that the markets have changed dramatically over the past 18 months. Some of the businesses we chose to pursue look very different today. Given our current capital position, we must re-evaluate our commitment to them. We’ll not sit idly by and wait for the market to improve. We have an obligation as a management team and as investors in the company ourselves to make sure we are proactively protecting and building on shareholder equity by adjusting our strategy as needed.

Earlier this year we talked openly about the challenges facing our company, and our primary objectives in mitigating them. We pointed out that we could see operating losses continue given current exposure, continued exposure to mortgage and servicing asset earnings volatility. Our goal has always been to limit the downside risk on our tangible book value without sacrificing the parts of the business that carry the most strategic benefit over time.

To make sure we are ready to execute smart, timely decisions if market conditions deteriorated further, we undertook a disciplined review of our performance by business line so that we could redirect scarce capital from underperforming areas to better performing ones. You saw us apply this discipline when we decided to move forward with the sale of our mortgage servicing platform and servicing asset. The sale will improve our operating profile and free up capital that we can use to further customer and asset growth at the bank.

This is not all we’re doing. We and others in the industry were hopeful that we would see some rationalization in market conditions that would relieve some of our earnings pressure. Unfortunately this has not been the case, and the operating losses we are currently experiencing have gone beyond an acceptable tolerance level.

During the second quarter, we continued our disciplined approach to optimizing our capital allocation and turned our attention to our non conforming operating. We have examined our product mix and recent loss trends to determine where we had the best opportunity to compete and earn a meaningful profit. We redirected the business accordingly and cut our expenses dramatically.

These changes are beginning to provide benefit, but we remain concerned with the direction of the non conforming industry as a whole. We’ve seen several institutions voice similar concerns. National City and T Bank have said they are now exploring alternatives for their non conforming units. We announced back in March at our investor analysts meeting that we’re putting all of the options on the table for our non conforming business, and that we would be ready to pursue different paths based on our perception of market trends.

For the sake of clarity, allow me to frame the issue as we see it. Over the long run, we believe there may be value in having a sizeable non-conforming presence. We think the non conforming market is likely to correct from current margin levels, but it is impossible for us to say to what degree and how soon. If you hold on and the market stays depressed for several more quarters, you’ve made a bad short-term call. If you move off the business and it comes roaring back in a few quarters, you’ve made a bad long-term call. This is a balancing act that we believe is critical to manage for our shareholders.

With all that said, I’ll go back to my point that short-term losses are now past a reasonable tolerance level and correcting that situation becomes our top priority.

We are also addressing the lack of performance within our recreational vehicle, boat and aircraft financing business. We’re in the process of reorganizing it under our auto lending operation. The integration of management between these businesses should help us achieve better sales and operating performance. Our auto lending operation has deeper industry contacts and a retail side that we can bring to bear in marketing our RV, boat and aircraft financing.

I want to reiterate that we think this business has real strategic appeal over the long run since its borrowers have exceptional credit profiles and a high propensity to use our other banking services, however, we’ll continue to monitor performance and consider other options if this reorganization does not generate the improvement we expect in the near term.

We truly believe these steps and others will help us mitigate the current market pressures and move back towards profitability. It’ll likely take a couple of quarters to fully execute these actions so we remain susceptible to additional operating losses over the back half of the year as we move into the slower mortgage season.

Let me summarize by saying management is making the adjustments we feel are necessary and in our best interest over the long run. Our process is disciplined and deliberate. Although we understand quick, decisive action is crucial at this stage, we think it would be short-sighted to fund short-term gains at the expense of greater long-term value.

Let me talk about second quarter earnings. I’m now going to transition to our second quarter results in detail. As we reported in the press release, we recorded a loss of $0.68 per share, which was in line with the revised guidance we gave you in July. As we said then, our results were impacted by a number of unusually large charges, chief among them the $15 million write-down in the value of our servicing asset and the $6.4 million impairment to goodwill on our recreational, boat and aircraft financing business. I think we have articulated the rationale for each pretty well so I’ll not go into further detail here, plus Steve will touch on these points in his commentary shortly.

I do want to spend a few minutes on the trends we’re seeing within the retail banking and financial intermediary segment. The flat yield curve is impacting performance within both segments, as net interest margins have compressed. In spite of this challenge and our inability to meaningfully grow our asset base right now, the retail bank segment has performed well. All of the primary lines of business within that segment are profitable. Our business financing unit continues to outperform as it posted pre-tax earnings this quarter of $3.3 million.

Our retail banking segment numbers have been somewhat skewed in the past quarters to the casual observer due to QuickPost expenses. We have been booking these expenses in the online bank since that’s where we incubated QuickPost. We intend to move it to our transaction processing segment in the foreseeable future, but we thought it was important to provide greater transparency at this stage so you could see banking performance outside of our ongoing investments in QuickPost. You’ll now find an additional line in our banking segment financials that breaks out QuickPost’s net performance.

We continue to believe in QuickPost’s potential over the long run. We think its expenses will begin to level off over the next couple of quarters. As we explained in the press release, the primary driver to QuickPost expenses is the number of UPS stores sending packages in each day. About two-thirds of the stores are now generating packages on a daily basis. The cost for these packages remains the same, whether there is one deposit in a package or 20. The key is now to increase the number of deposits or payments contained in the packages. We believe we will make inroads on this front over the rest of the year as U.S.A.A. continues to build momentum in promoting the service to its customers and we bring Native Federal Credit Union, First Horizon, Dime Community Bank and other institutional partners online.

Within our financial intermediary segment we continue to see significant pricing pressures, but repurchase activity emerged as our biggest challenge. Repurchase demands spiked in both our indirect conforming and non conforming channels. Our provision expense in the quarter was more than $13 million higher than last quarter due to the volume of requests we received.

We believe this issue is somewhat market driven as other lenders have recently reported higher occurrences of early payment defaults, or EPDs, and borrower fraud.

We as a management team, however, cannot pass the blame entirely and say it was simply the market. We have to ensure that we are doing everything we can do internally to exceed underwriting standards and produce the highest quality loan possible. This is the surest way to mitigate repurchase risk.

We’ve been actively reviewing the primary reasons for legitimate returns and adjusting our internal procedures to correct any deficiencies. We’ve also analyzed the repurchases from a product perspective to determine if there are certain loan types that carry too much repurchase risk for the associated return. The strategic changes we made in our non conforming operating that I mentioned earlier were based on this effort. The non-conforming products we discontinued accounted for more than half of the non-conforming repurchases we were seeing. We think these modifications and continued diligence on our part will reduce our exposure to repurchase risk in the future.

Before I turn it over to Steve for his business line review, I want to give you an update on the Commercial Money Center litigation. The judge in the multidistrict litigation published an updated pre-trial calendar.

The good news is she declined to reopen fact discovery barring any extraordinary circumstances. Fact discovery in this case ended in August 2004. We believe the sureties would have used this process to delay the case further, had the judge been willing to reopen it. The judge also set a deadline for the completion of expert witness discovery which had been postponed until this year.

The bad news is the judge’s decision to delay acceptance of any motion on summary judgment until January 2007. As you may know, we’ve been waiting to submit a motion for summary judgment since we believe it will allow us to address the real issues at hand. These issues could not be covered in a motion for judgment on the pleadings as a matter of procedure. Given the new timeframe, we’re unlikely to see any meaningful movement in the CMC case until next year.

Obviously, we’re disappointed and extremely frustrated over the time it has taken for this case to work its way through the court system. January 2007 will mark five years since the litigation started. Due process in this instance has completely favored the larger, well-capitalized insurance companies. They’ve known it all along and that’s why they’ve been reluctant to follow through on their contractual obligation to pay us.

You heard me talk earlier about the market challenges facing our business. The $130 million at stake in this case is pivotal for a company our size. We’ve been able to play this waiting game only because of the changes we made to our business over the past few years. I don’t think the company as it existed when we began to diversify into other lines of business could have survived.

The sureties are hoping market or internal pressures will force the banks, including ours, into giving up or settling for less than they’re owed. It is completely disgusting in my book and a shame that the sureties and large, well-funded conglomerates can manipulate the legal system in such a way for over five years and potentially harm small businesses that are at the heart of our economy.

Now let me turn the call over to Steve, who’ll give you his business line update.

Steve Herbert

Thanks, Doug. Okay, well I guess I think I’ll start out with the adjustments for quarter two. Certainly, we’ve pretty much covered those, I think, already in the pre release and in the various conversations that we’ve had post pre-release. It’s also covered in the press release, but probably still adding a little bit of color on this call might make some sense.

So first of all I’ll talk about the $15 million provision or loss adjustment that we recorded in the quarter. That was evenly split between the conforming and non conforming operations, $7.5 million to each. But the story in each is just a little bit different.

On the non conforming side, what we saw was a spike in EPDs from the latter part – that’s early payment defaults, let me not use letters on you. Early payment default frequencies for the latter part of last year appear to have run considerably higher than what they had run historically, especially in the areas you probably would look: stated documentation, one doc products, higher LTV and lower credit score nodes from what we’ve been looking at seem to be where these higher frequencies showed up from.

Those EPDs reappeared in the current quarter, having been higher than what we had seen in the past. It had a double impact of needing to provide for the volume of EPDs we saw in the current quarter and needing to provide for higher frequencies of repurchase with respect to the future. So that resulted in about a $7.5 million adjustment and at risk of oversimplification, we would say it was primarily a frequency issue with early payment defaults on certain non conforming products.

On the conforming side, although frequencies were and the volumes of repurchases were on the higher end of the range, in general they were within the types of levels that we had been seeing for the past several quarters. The real headline issue, I think, there is not a frequency issue but is probably more so a severity issue. We resolved an unusually high volume of loans during the current quarter of three scratch and dent sales, and scratch and dent executions were substantially lower than we had seen historically, close to about 10 points lower than the types of executions we’d seen previously.

So that had the impact with respect to those, the high volume of loans which we resolved in the current quarter, we saw larger losses than we had been predicting because of an erosion in scratch and dent pricing behaviors and had the additional impact of higher severities on those loans translating into an expectation of higher severity related to future loans that we would repurchase, and those loans currently on the balance sheet that remain to be resolved.

So again, at risk of oversimplification, we would say on the conforming side the issue was more one of severity impact than of frequency. A little bit different from the non conforming side, and the adjustment there intended to provide for the current experience that we’ve had in the future risks was $7.5 million.

I also made a $15 million servicing adjustment. Basically, we’ve been working on a marketing package in various formats for awhile and as we crossed over and were closing the books for June 30, additional market intelligence was available to us that probably would not ordinarily be available to us, and that market intelligence seemed to suggest that sales values and marketing ranges were generally lower than what our carrying value was at June 30. So we analyzed that information and determined to make an adjustment to bring the value down, more in line with the information that we were then seeing. That was a $15 million adjustment.

The final item is the $6.4 million goodwill write-off on the boat, RV and aircraft operation. Their busy season, really for them, is in the second quarter. We did see good volumes in the second quarter and hope to see higher profitabilities and better margins, but the margins remain pretty weak and the operation after this adjustment reported slightly better than breakeven results.

As we look at rationalizing the existence of goodwill under GAAP accounting practices, it is in many respects a price to earnings multiple basis for rationalization and without earnings in the busy season, we felt like we had reached a point where GAAP would require that we make an adjustment to the goodwill because we couldn’t support it off breakeven earnings in the busy season for that operation and it’s unclear when margins will normalize or improve. So we felt like this was the appropriate time to go ahead and resolve that issue through a goodwill charge.

Turning now to the quarter two results versus what we had kind of expected the last time we talked on the first quarter conference call, conforming production, we saw two major impacts that were occurring at that time.

We expected slower production because rates had just increased towards the end of the quarter and into the early part of the second quarter. So we saw production off the higher rate environment, but higher production off the normal seasonal impact. Purchases tend to accelerate into the summer.

I think we’ve all read a lot of articles that suggest that the purchase side of the business is probably weaker than it’s been historically, although still pretty good. So what we really saw on balance, where we expected some modest improvement potentially in production volumes and margins and movement towards breakeven operations for the conforming segment, we saw slightly lower volumes as the impact of higher rates seemed to offset the seasonal pickup that we expected to see.

But it’s pretty modest. We went from $2.2 billion of production to $2.1 billion of production. So volumes were just slightly lower. Margins did in fact, after you adjust for the $7.5 million, come in higher at around a 135 versus a 101 for the prior quarter. If not for the adjustment that we made to the conforming segment of $7.5 million we would have been at overall breakeven performance, so conforming production was still a bit disappointing to us where we hoped to do better than that. But it moved back towards breakeven before the adjustment.

The non-conforming production was a substantial disappointment for us. We had expected sluggish but still similar overall volume levels and margin improvement with some movement back towards breakeven. That just didn’t materialize. What we actually saw was not slightly lower volumes but significantly lower volumes. Volume moved from $605 million to $478 million. That’s down 19% on production. We had hoped for improved margins, but even after adjusting out the $7.5 million the margins came in lower at a 102 versus a 115, down another 11% from off the low first quarter levels, and the lower volumes also – even though we did cut expenses, we went from $9 of absolutely expense load to $7.8 million, which is a significant improvement as we’ve been making changes in that operation – the loss in volumes, we actually lost leverage. The operating expense ration went from a 149 to a 164. So it doesn’t take long to do the math on that. Lower volumes with lower revenue margins with higher expense margins translated into a loss that moved from $1 million to $2.3 million after excluding the $7.5 million item. So performance there was very disappointing. We had anticipated movement back towards breakeven and beyond and it just didn’t materialize.

Our retail bank, we expected continued moderation of balance sheet size. That is what we saw. Balance sheet moderated from $4.6 billion to $4.3 billion. The flat yield curve is going to continue to create an overall trend towards narrowing margins. That didn’t materialize in the current quarter, but most because of a gain on sale on some HELOC product that we sold generated between provision reversal and pure gain about $2.3 million of current quarter income. If you adjust that out, adjust the HELOC transaction out, the retail bank produced about $1.6 million of pre-tax profitability, down a little bit from third and fourth quarter run rates.

The headline really inside the retail bank is the QuickPost, PowerPost and NetServe expenses which we pulled out to enhance people’s ability to sort of see the numbers, or this additional detail, I think, adds some color to what’s really going on there. That operation has a heavy initial marginal fixed cost structure, so those marginal fixed costs are front-loaded as volumes come on board. So we’ve seen a significant uptick in the expense structure, and that’s what accounts for the increase that we’ve seen in the next expense from QuickPost, PowerPost and NetServe as we continue to make an investment in those initiatives.

Transaction processing, we expected long-term continuing trends towards improvement, but there is a scale issue there. At just $1.5 million of pre-tax profitability, it’s not really a needle mover at this point. We did show some decrease there primarily due to the write-off of about $640,000 of past-due receivables related to our ATM operations. You adjust that out, things were relatively neutral quarter to quarter.

Servicing, always volatile so we always warn about the volatility of the net hedge results. Our goal is generally to see a net hedge result that approaches breakeven. If you adjust out $15 million, we accomplished that. We really had a positive net hedge result of about $700,000. That was really great performance out of a net hedging operation for the quarter before the adjustment anyway. Operating results continued an improving trend, as we see lower prepays, resulting in lower amortization expenses and plus, you know, we made some management changes there and operating expenses on a pure basis have been managed lower by the new fellow we’ve got over there. So the combination of those two things has resulted in operating results which improved from $2.7 to $2.4 million loss before the net hedge results.

Turning now to look at the quarter three expectations. Conforming production, really non conforming production, we think, is likely to be range-bound for the foreseeable future anyway. No major dynamics to move the needle too much in any direction. We expect conforming production on volume and margins to sort of operate within a range. The issue there for us is really going to be to stabilize the repurchase activities and to have a more normalized reserve outcome than what we saw in the second quarter. That can make a big difference as we look at Q2.

Non-conforming production, same thing. We expect volume and margins to stay pretty much in an operating range of what we’ve seen and absent any surprises, quarter three probably is going to look not too much different from quarter two.

The retail bank, excluding the QuickPost, PowerPost and NetServe initiatives posted about a $1.6 million operating profit after taking out the HELOC gain on sale and overall, obviously, we got leverage long-term and a flat yield curve that’s going to probably slowly grind against those numbers or work against improving it, so we’re slightly negative on the outcome that we would probably see there after adjusting.

QuickPost, PowerPost, NetServe, most of the fixed costs are probably in the numbers that you’re looking at in the current quarter. They probably will get a little bit worse before it gets better. We are, I guess, optimistic that it won’t get too much worse before we get to the volume levels that will start to result and it’ll move back towards breakeven or profitability for those investments.

Transaction processing, not really a needle mover; slow, long-term improvement over the long haul is what we think we are going to try and get accomplished. That, of course, excludes any impact that a servicing sale might have on the portion of the segment that relates to the sub-servicing of the servicing asset.

Servicing, same story. It’s volatile. Our goal will be to breakeven on the net hedge performance and we are still engaged in a process to sell some, all and/or most of the servicing asset. Reasonably optimistic that hopefully we’ll be able to get something done on that in the foreseeable future.

So really that kind of, to sum that all up, in the quarter three expectations in general, if you take out the three major adjustments that we talked about from Q2, Q3 we’re really kind of relatively neutral on Q3’s performance relative to Q2.

That really concludes my comments, and I’ll turn it back over to Doug.

Doug Freeman

Thanks, Steve. I know we’re over the normal amount of time we take for our commentary so I’m going to limit my wrap-up to just a few seconds. If you take away a few points from our discussion today, I want it to be these:

Number one, our top priority is to protect shareholder equity from further erosion to the extent possible. We’ll continue to balance this effort with an eye towards preserving the parts of our business that have the most strategic relevance and the ability to generate the greatest amount of return when the market conditions inevitably improve.

We’re doing this through a series of disciplined, deliberate actions. Our company has significant hidden value that we believe is being discounted or largely overlooked today. Our online banking operation has a solid deposit base built around multi-product, transaction-oriented customer relationships. Our direct and indirect conforming mortgage operations have tremendous upside earnings potential over the full economic cycle. We’re also making investments in a few promising initiatives like QuickPost that have the potential to contribute to the bottom line over time.

Then last, we have a talented base of associates who believe in what we’re doing and are actively engaged in optimizing our performance across the enterprise.

With that, we will now open it up for questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from John Hecht with JMP Securities.

John Hecht – JMP Securities

Yes, two quick questions here. One’s related to this servicing asset write-down. You’ve taken a write-down at a time where you’re slow on prepayments, you know the factors have upward pressure on the asset values. So real quick, what was the variance between your internal assessment where the third party came out, given the amortization rate changes?

Doug Freeman

John I’m a little, I think, confused on exactly – can I get you to give me that question one more time?

John Hecht – JMP Securities

Sure. You wrote down the – you took a charge against the valuation of the MSR base and elsewhere in the industry when prepayments slow and cash flow durations extend, typically there’s an improvement in the perceived value of the assets. Yet you guys took a charge, and you said that was related to some third-party – discussions with third parties and some reassessments of the base there. I’m just wondering, what was the variance between your own internal values and the third-party values and what types of data were you looking at that caused you to take the charge against that asset?

Steve Herbert

Well, I’ll do the best I can to answer that question. We’re doing some work, analytical work, right now to specifically diagnose which specific assumptions between the market views that we’re currently being provided and our internal model views, where those differences lie. Is it in prepay speed or cost of service or, you know, earnings on escrow deposits or option-adjusted spreads that market participants are demanding. We periodically do that recalibration process so this is not anything, you know, really unusual for us to periodically have to dial those adjustments back in.

What I would tell you that I believe anecdotally to some degree, anyway, probably occurred during the second quarter, interest rates did go up about 40 basis points on the ten-year, which is probably the most relevant thing to look at. That’s a pretty big market move for one quarter, and what I believe that we’ve seen is that market participants are not factoring in the lower prepay speeds that would be modelled given the changing economic condition, as the convexity issues are beginning to materialize.

In other words, in some sense I think maybe market mentality may be shifting. The next move is going to be lower on the ten year and prepay speeds are not, over the long-term, going to be as low as the model is currently projecting.

So I don’t know if that answers your question, but that’s some of what we’re hearing, is that the major participants in the market didn’t give credit for all the value increase that you would have expected as a result of higher rates. They only gave credit for a portion of that and so you can describe that as a model risk, so to speak.

John Hecht – JMP Securities

Okay. That explains maybe the increase in value was overshooting the slowdown in amortization savings over time. I understand that.

Second question is, looking at the credits, the non performing assets’ changes over the last couple of quarters, it looks like everything seems normal within seasonal trends. Is there anything that you guys are seeing that’s causing you to stay awake at night with respect to credit across any of your asset classes?

Steve Herbert

At this juncture, you know, really, no. I mean, the vast majority of our exposure is centered in first mortgages. You know, so any [inaudible] we’re seeing, you know, fairly stable overall charge-off percentages and profile on the HFI side.

To be fair, though, I think intuitively, the market as a whole and we in general do have some concerns about a consumer under additional stress and when or whether that will translate into credit issues. If it is going to translate into credit issues, you’d probably more so rather be secured by a first mortgage than an auto loan.

We have some residual concerns, but we’re not currently seeing anything that we could point to, other than the high EPD frequency that we saw on the non conforming side in those specific products. Again, from some of the folks we’re talking to, we’re hearing that other people have seen unusually high frequencies for early payment defaults as well out of production from late last year and very early this year, and a lot of people made product changes. But again, that could point to some issues with credit beginning to show up a little bit.

John Hecht – JMP Securities

Okay. Thanks very much.

Steve Herbert

Okay, John.


Thank you. Our next question comes from Mark Sproule with Thomas Weisel Partners.

Daniel Hayes – Thomas Weisel Partners

Hi, guys. Yes. Daniel Hayes in for Mark Sproule. Is there any way for you to quantify the benefit of the QuickPost contribution – sorry if you’ve already mentioned this – to earnings growth, to the earnings asset growth, and maybe quantify more of the expenses surrounding QuickPost?

Doug Freeman

Yeah, I think – this is Doug, Daniel. We have started to breakout the expense stream so that you all can start getting a handle on the expenses associated with it.

Secondarily, a couple of months ago we began to break out QuickPost volume back 12 months historically.

So with that being said, at some point in time you all are going to be able to get your hands around the marginal costs, marginal revenue associated with that. But as of today, the only metrics that we give you are the total expenses and then the volume.

Daniel Hayes – Thomas Weisel Partners

Okay, great. Secondly, given the weakness and, as you’ve said, the historic lows in the recreational vehicle, boat and aircraft lending segment, is there any interest or any thoughts of divesting that segment?

Doug Freeman

We are looking at everything, Daniel, on a very disciplined basis. As I have said in the press release and in my talking points, I really like the customers that we get out of those three product lines. We like their profile. We like their credit profile, and we like their marginal propensity to consume Internet banking services. What we don’t like is the profitability, or lack thereof, of the origination function of those products.

So we’re integrating them with the car business. We hope to get some sales synergies but more importantly, operating synergies and, with that being said, as we said to everybody, we are going to aggressively evaluate how much of those synergies can come to fruition. I will tell you that a flat yield curve doesn’t do a lot to make that business look very attractive easy, when there’s no return for the carry trade.

Daniel Hayes – Thomas Weisel Partners

Okay, great. Thanks, guys.


Thank you. Our next question comes from Sam Caldwell with KBW.

Sam Caldwell - KBW

Good morning.

Doug Freeman

Good morning, Sam.

Sam Caldwell - KBW

Steve, could you walk me through the $15 million re-evaluation of the servicing asset and how that shows up in the results? Because I guess I’m looking at the, kind of, the impairment showing up in the servicing assets results as $9.5 million and I’m just trying to see what else I’m missing there.

Steve Herbert

Okay. Are you looking at the web page data? The servicing --?

Sam Caldwell - KBW

I guess not, probably. That’s probably my problem. I’m looking at the press release.

Steve Herbert

Well, the – yeah, okay. Well, let me just, let me see if I can explain it to you by getting you to look at the web page and what you’re going to see on the web page is that there was a gain or loss on the hedges of $4.8 million, and at risk again of oversimplifying a little bit, if our hedge worked perfectly, we would have seen a recovery of value on the servicing side of $4.7 million and then booked the $15 million valuation adjustment to the impairment or recovery account, which is why that amount is netting to $9.5 million.

In other words, we did, as one of the earlier callers say, “write up” the servicing value by $5 million probably during the quarter because of higher rates being modelled by the, you know, being modelled out? Then we took a $15 million write-down.

Sam Caldwell - KBW

Okay. Okay. Thanks.

Steve Herbert

Thanks, Sam.


Thank you. (Operator instructions) Gentlemen, I show no further questions at this time.

Doug Freeman

Okay, well let me end again by thanking you all for your time this morning and I look forward to chatting with you all about the third quarter results. Thank you.


Thank you. This concludes today’s teleconference. Thank you for your participation, and have a great day. Please disconnect at this time. Thank you.

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