Mr. Cooper Group Inc.
Q4 2007 Earnings Call Transcript

Published: 18 Jan 2008

[Operator:]

Good afternoon and welcome to WaMu’s fourth quarter and full-year 2007 earnings conference call. All participants are in a listen-only mode. After the presentation, we will conduct a question and answer session. Today’s call is being recorded for replay purposes. The replay will be available approximately one hour after the call has ended. The toll free number to access the replay is 800-395-7443. This call is also being webcast live and will be archived for 30 days on the company’s website. Now I will turn the call over to Mr. Alan Magleby, Senior Vice President Investor Relations, to introduce today’s call.

[Alan Magleby:]

Good afternoon and thank you for joining us today. I would like to welcome you to WaMu’s fourth quarter and full-year 2007 earnings conference call. I want to remind you that our presentation today may contain forward-looking statements concerning our financial condition, results and expectations, and that there are a number of factors that may cause actual results in the future to be different from our current expectations. These factors include among other things, changes in general business, economic and market conditions; competitive pressures in the financial services industry; economic trends that negatively impact the real estate lending environment; or legislative and regulatory changes that may impact our business. For additional factors please see our press release and other documents filed with the SEC. With us today are Kerry Killinger, Chairman and Chief Executive Officer; Steve Rotella, President and Chief Operating Officer; and Tom Casey, Chief Financial Officer. At this time, I will turn the call over to Kerry.

[Kerry Killinger:]

Good afternoon, everyone. Thank you for joining us today as we review the results for the fourth quarter and full year of 2007. Joining me today on the call is Tom Casey, our CFO, who will discuss our quarterly performance in more detail and update our 2008 earnings drivers. Our President, Steve Rotella, will also be available to answer questions at the end of the remarks this afternoon. Earlier today, we announced our financial results for the fourth quarter and full-year of 2007. As you all know, the second half of 2007 has been a period of extreme stress and turmoil for the mortgage and credit markets. Our financial performance reflects that market impact, as well as proactive efforts on our part to better position the company for a difficult environment going into 2008. For the fourth quarter, we reported a net loss of $1.9 billion or $2.19 per share. As we announced in December, the loss was due to loan loss provisioning of $1.5 billion and a $1.6 billion after-tax non-cash write down of Home Loans segment goodwill. Due to the fourth quarter results, we also reported a net loss of $67 million or $0.12 per diluted share for the full year 2007. Clearly, these results are disappointing, and as CEO, I take responsibility. Yes, the environment was extraordinarily difficult, but we have to do better. It is also my responsibility, along with the management team, to take the necessary actions to return the company to strong profitability - and we will. We took the following significant steps in December to bolster the company’s capital and streamline our operations in anticipation of continued stress in the mortgage and credit markets

[Thomas Casey:]

Thank you, Kerry. The second half of 2007 was a period of unprecedented challenges in the mortgage and credit markets. The environment has been difficult for all financial institutions, and for Washington Mutual in particular, but I’m pleased with the steps we have taken to strengthen our capital and liquidity position during this period of uncertainty. My comments today will focus on four key areas

[Kerry Killinger:]

Thanks, Tom. There's no question that elevated provisioning will impact earnings in 2008. But it is also inevitable that provisioning will decrease with time. The key is to separate the cyclical effects from the secular earnings power of the company. Until 2007, this company had a 10-year average return on average assets of 1.09%, which is consistent with our long term target of earning high teens return on common equity. Until the environment improves, our senior leaders will be primarily focused on credit, capital management, liquidity and expense reduction. In addition, I hope it's clear that we will be uncompromising in our commitment to turn this company around. Performance is paramount. And to this end, I will not accept a cash bonus for 2007, and bonuses for the management team have been greatly reduced commensurate with our results. We all understand that we have to do better – and we will. We're now focused on 2008, which we know will be a challenging year. However, we will not lose sight of the fact that we have a powerful banking franchise that is at the center of our business strategy. Our retail and small business banking efforts are paying off. Our card services and commercial groups are vital and continue to do well. Our brand is valuable and strong. Our core businesses continue to perform, and we’re determined to leverage them to return WaMu to the level of profitability our shareholders expect and deserve. With that, Tom, Steve and I would be happy to take your questions.

[Operator:]

In consideration of the number of people who have joined us on the call today, we will accommodate one question per caller. We will get to as many questions as time permits. (Operator Instructions) Our first question comes from Paul Miller – FBR Capital Markets.

[Paul Miller:]

I know you are going to get a ton of questions on credit, I want to start it off here on the Pay Option ARMs. You talk about the Pay Option ARMs resets, the bulk of them are in the 2010 to 2012 time period, but you do have – correct me if I am wrong – 10% loan caps on these loans. I was wondering if you can talk about how many loans have a neg-am balance and so some of these will probably hit their loan cap balances in 2008, probably in the latter half of 2008. Have we seen any of the defaults coming from that, and can you just address that issue?

[Thomas Casey:]

We really have not seen that issue become a problem. As I mentioned in my comments, the fact that treasuries are coming down so fast is actually reducing the amount of neg-am and those reset dates may actually get extended. We will have to continue to watch that but that is what we are seeing already, as the index comes down, those payments become less.

[Operator:]

Our next question comes from Brad Ball – Citigroup.

[Brad Ball:]

I wonder if you could describe in more detail your revised guidance for credit card net chargeoffs - 8.5% to 9.5% seems a bit extreme. What kind of economic scenario underlies that and could you talk about the composition of your card portfolio; I know you said 37% of new account came through retail in the quarter, what is it for the entire book? And, just to clarify Tom, you said the provision may have to go higher, depending on securitizations. Does that mean the $1.8 to $2 billion guidance per quarter is not inclusive of credit card provisioning or increased credit card provisioning as per the new guidance?

[Thomas Casey:]

I’ll try to take you through all of those. The first one, we saw a very good performance of receivable growth in the quarter, up about 37% of total origination. That is probably running at about a third, we’ve been talking about for quite some time, so we just indicated that we are seeing more penetration as we are deemphasizing some of the national brand. But overall that portfolio is growing as a total percentage; probably at this point it has to be ranging about 20% of the total managed receivables. With regard to the level of net credit losses, we did give an indication last quarter that we were seeing NCLs go up; we were obviously surprised by the unemployment report as I am sure many of you were - a rather significant increase to 5%. What we are trying to do is capture the outlook on unemployment in that range. Obviously we are not predicting the unemployment rate in our drivers, but we are trying to be cautious that if the unemployment rate was to continue that we would expect to see higher NCLs. Lastly on your point about 1.8 to 2, we have been running at about a 65% securitization of total managed receivables, and I was trying to indicate there that there is timing and levels of securitization depending on pricing and liquidity that could move that number around from quarter to quarter, and I was trying to capture that. If the total credit card securitization percentage was to decline, that would put some upward pressure on the provision, but that is not in our outlook right now that’s included in our range for now, but if it was to change significantly I just wanted to make sure everybody understood the sensitivity around the accounting for securitization of credit cards.

[Operator:]

Our next question comes from Bob Napoli - Piper Jaffray.

[Bob Napoli:]

Just wondering if you could give a little more color on your commercial portfolio and outlook for credit in that business?

[Thomas Casey:]

We are really not seeing much activity in that area on the commercial side at all, the whole portfolio. Net chargeoffs were about $30 million for the whole portfolio. Non-accrual loans were only at $24 million; it’s a pretty high-quality portfolio and we have not seen any issues there at all. That portfolio has been tightly managed and we are not seeing any deterioration to speak of.

[Stephen Rotella:]

I just want to jump in on that. Remember that over $30 billion of that $40 billion portfolio multi-family loans and we have actually seen some positive trends around rentals around the country. I would tell you that proactively since we have seen this credit issue roll through different asset classes, we are expecting to take our new origination volume down in 2008, with some particular emphasis around the piece of our business – smaller piece nonetheless – where we are lending on commercial real estate.

[Operator:]

Our next question comes from Kenneth Bruce – Merrill Lynch.

[Kenneth Bruce:]

Hoping you would shed some light within your Pay Option ARM portfolio it looks like your average current over 80% LTV is about 25%. Can you give us some sense as to how much second liens may be behind these first liens? Do you have any sense of that? And, if you do, are you seeing any different performance out of those with seconds versus those that don’t?

[Thomas Casey:]

First on the increase in loans greater than 80%

[Operator:]

Our next question comes from Howard Shapiro - Fox-Pitt Kelton.

[Howard Shapiro:]

I am going to join the list of people asking credit related questions. I am wondering if you could tell us on the loans that are charging off in your first lien and home equity portfolios, what is the loss severity that you are experiencing and how is that changed versus a year ago? And on your credit card portfolio, can you tell us what percentage of your portfolio is newer vintages and what percentage is California? I am sure you know that all the other large issuers are saying that the former high-hump appreciation states are seeing elevated loss rates. And let me just squeeze one more question on credit in if I could. I noticed that there was a fairly dramatic pay down in your subprime portfolio – about 26% annualized – given the lack of refinancing alternatives I was a little surprised by that. Just wondering if you could just tell us what’s going on there.

[Thomas Casey:]

I missed the last question, I apologize – 26% annualized decline in?

[Howard Shapiro:]

In your subprime portfolio – you went from 19 – something like that.

[Thomas Casey:]

Let me get that one first. First off, we have stopped doing any subprime lending; that portfolio is in runoff mode and that is obviously going to drive down that portfolio as that portfolio runs down. With regard to severities that we are seeing on prime and home equity, clearly severity rates are clearly up year-over-year; we weren’t even talking about severity rates a year ago. Given home price declines in key states like California and Florida, the severity rates for home equity can approach 100% for example. In the prime space, those are more like 25 to 30% type range, and that obviously depends on the underlying collateral, how much equity is in the home, and how the individual area has performed in the environment. With regard to your questions about Card, just to give you some perspective, at the end of year, about 19% of our total outstandings are in California. We haven’t seen any differentiation as far as chargeoffs as a percent of our (?) portfolio, it’s pretty consistent based on the weighting in California.

[Operator:]

Our next question comes from Fred Cannon – KBW.

[Fred Cannon:]

Kerry, just a bit broader question perhaps. If I look back, you haven’t really achieved an ROE above 15% since 2003; your stock is down 70%. You seem to have some plans in place to move forward, but I am just thinking, you also have scaled back a lot of your origination capacity and obviously the company is going to struggle through 2008. Could you give us some feel for security that you do have a plan in place that as we emerge we can get back to reasonable levels of profitability?

[Kerry Killinger:]

Fred, certainly the top priority for myself and the entire management team, and certainly with the support of the Board of Directors is to get the company back to an earnings power that we believe it is capable of achieving. We think there are a number of parts of our business that are operating very well and right in line with the long-term targets we have and that’s why we keep harking back to the growth that is going on in our retail bank, the key income growth, the expense management, the growth in the managed receivables in the card business, the growth in our commercial business. Certainly the most challenging thing we’ve had to deal with here is the unprecedented conditions in the housing markets, which have both impacted the ongoing business activities of our Home Loans group and has required us to retool that business in a fairly significant way. And the second factor, which is certainly quite meaningful, is the impact that that environment has had on the credit costs of the company. Our credit costs are significantly elevated from what we think would be normal. What we are working very hard to do is first be sure we have the appropriate level of capital in place, and then be sure we have the right amount of liquidity to work our way through very diligently the plans that we have in place and to work through the credit challenges as methodically and as aggressively frankly as we possibly can. Again, it’s a very difficult market condition, but we are just taking it head on, we’re rolling up our sleeves, working around the clock and a very determined team to get us back to a satisfactory level of profitability as soon as we possibly can. I think one of the messages to investors is to keep an eye on the profitability from our continuing operations before credit costs and see how that is progressing over time and then these credit costs which are at a highly elevated level right now, we are going to work as diligently as we can to get those down as quickly as we can. The Board of Directors has been highly engaged in the processes; we are certainly in constant dialogue with the plans that we have in place to get this turnaround completed and they are certainly supportive of the initiatives that we are executing right now.

[Operator:]

Our next question comes from Peter (?) – Stonehill.

[Peter (?):]

I was actually hoping you could help me in two areas. One is, you talk about a lot of growth in the retail banking area, but I see the deposits have declined significantly in the last two quarters; I think it’s about 13 or 14%. I was wondering, given that you have CD rates high in the competitive scale, why that is, and also, how are you continuing to grow fees given that. Also, I was wondering in the credit card portfolio, both your managed receivables and your delinquency rates in credit losses have grown significantly in the past year, but your quarterly provisioning for loan losses has stayed flat. I was wondering if you could help me with that as well.

[Thomas Casey:]

Clearly, in the retail bank deposits have obviously become more competitive but we have not seen the reduction that you said. From June of this year, we’ve been just slightly down, about $2 billion in retail deposits as the balance sheet has come down, and consumers have been reaching for higher cost deposits. Most of the deposit reductions have been in the wholesale area - institutional CDs and commercial deposits. We had one large customer pull their deposits as a result of an acquisition – A.G. Edwards and Wachovia – so that was some impact. And we are also being quite disciplined in our pricing of our platinum checking. All of those things we feel very good about our deposit profile in the retail bank and I think the team has done a very good job. With regard to the fee income, we are seeing yet another year of double digit growth and projecting one for next year. That is again on the back of generating new checking accounts; 1.1 million new checking accounts this year and that is obviously the key driver of our fee income. Then finally, on the managed credit losses, as we probably indicated all year, net credit losses were at historical lows; they were even further reduced because of some of the bankruptcy law changes going back into previous quarters, and we’re expecting credit losses to continue to increase as unemployment starts to increase. That is the view that we have and I will continue to keep you up to speed on it but no unique story in any of those real line items.

[Operator:]

Our next question comes from Ron Mandel – GIC.

[Ron Mandel:]

Kerry, I was wondering beyond a cash bonus if you are taking any bonus this year. And then, more broadly, if you could elaborate a little bit about cash and non-cash bonuses at the most senior level other than you and what level you will be paying for any type of bonus.

[Kerry Killinger:]

Ron, for the pay programs this year, again the primary bonus we have is a cash bonus and again I asked the Board not to consider me, so I refused any kind of a bonus there. I would say that for our executives, compared to last year, the reductions were probably in the neighborhood of two thirds to 75%.

[Operator:]

Our next question comes from Thomas Mitchell – Miller Tabak.

[Thomas Mitchell:]

Recognizing that setting an appropriate level of loss reserve is more of an art than a science, I can’t help but note that your reserves at the end of 2006 were 59% of your non-performing assets and that despite growing your reserves aggressively during 2007, you ended the year with reserves at 36% of non-performing assets. I could understand if the mix of business had change or the mix of non-performing assets had changed, that the expected ultimate losses on the change in mix might arrive at a lower level for setting reserves, but it’s a little difficult for an outsider to understand in a period where apparently the severity of losses being taken and the frequency is rising – the severity is rising rapidly – why it would be appropriate to reduce the relationship of reserves to non-performing assets. So I am just wondering if you could explain to me the thought process you used in deciding to reduce your reserve relative to your non-performers?

[Thomas Casey:]

Tom, thanks, obviously loan loss provisioning is a challenge for anyone. Let me give you some perspective on it. First, we are taking into account all the non-performing assets and losses and chargeoffs that we are seeing in our calculations so please be aware of that. That is an incurred loss type of construct under GAAP. Couple perspectives that may help you understand it a little bit. I mentioned in my prepared remarks the significant increase in real estate owned and also (?) that we have done, and so keep in mind that on the real estate owned side, as that portfolio grows, that gets put into the NPA number but there is no ALLL associated with it because we’ve already written that down to net realizable value. So that is one thing that you have to factor in. The other thing is with regard to the loans that we transferred into the held-for-investment portfolio you may recall our comments back in the third quarter and the fourth quarter where we transferred loans that we were previously going to be selling, we brought them back in the portfolio, those were all brought in at market value. As a result of that, we have approximately $500 million of additional discounts if you will. So some of the normal relationships that you may be trying to trend are impacted by those types of dynamics and it makes it difficult. What I would point you to is that when we look at our allowance for loans held in the portfolio, it’s actually grown quite a bit from a year ago. December of 2006, our allowance as a percent of loans held in the portfolio was about 72 basis points and that number now is at 1.05. So you can see that the ALLL is growing as the risk profile is increasing, although you do have some of these unique set of circumstances that really weren’t in place last year, particularly the REO that sits in the NPA.

[Operator:]

Our last question comes from Louise Pitt – Goldman Sachs.

[Louise Pitt:]

I just have a very quick question for you. With respect to credit ratings, clearly (?) your rating from the other agencies already in the triple-B category, I just wondered if you had any comments about the fact that your competitive position vis-à-vis your large U.S. domestic peers in retail and commercial banking is clearly becoming a disadvantage in terms of rating. Can you comment a little further on that?

[Thomas Casey:]

Clearly the credit rating is an important part of our business, although a lot of our funding is at the bank level, and that is profoundly focused on retail deposits; as I mentioned, about 50% of our funding comes from retail deposits and then we have a very large capability with the Federal Home Loan Banks so our need to go to the public market is quite limited and in fact, in my prepared comments, we don’t see any need to go to the public markets for our holding company as well. So, while the credit ratings are down, we don’t really depend on the secondary markets for funding purposes in any large extent. We really positioned ourselves from a liquidity standpoint at the holding company; we’ve got cash available there through 2010. The cash position of the bank is predominately retail deposits. We don’t rely on any kind of asset backed CP programs or the issuance of CP in any way. So our dependency on the secondary market is quite limited.

[Kerry Killinger:]

With that, I think we’ll draw it to a close. Thank you all for joining us today. If you have any follow-up questions, be sure to contact Investor Relations. Thank you all very much.