Impac Mortgage Holdings, Inc.
Q4 2017 Earnings Call Transcript

Published: 16 Mar 2018

[Operator:]

Good day, ladies and gentlemen, and welcome to the Impac Mortgage Holdings' 2017 Year-End Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. [Operator Instructions] As a reminder, this call is being recorded. I would now like to turn the conference over to Justin Moisio, Vice President of Investor Relations. Sir, you may begin.

[Justin Moisio:]

Good morning everyone. Thank you for joining Impac Mortgage Holdings' Year-End 2017 Earnings Conference Call. During this call, we will make projections or other forward-looking statements in regards to, but not limited to, GAAP and taxable earnings, cash flows, interest rate risk and market rate risk exposure, mortgage production and general business conditions. I would like to refer you to the business risk factors in our most recently filed form 10-K under the Securities and Exchange Act of 1934. These documents contain and identify important factors that could cause the actual results to differ materially from those contained in our projections or forward-looking statements. This presentation, including outlook and any guidance, is effective as of the date given, and we expressly disclaim any duty to update the information herein. I would like to get started by introducing Joe Tomkinson, Chairman and CEO of Impac Mortgage Holdings.

[Joe Tomkinson:]

Good morning everyone. Welcome and thank you for joining Impac's year-end 2017 earnings call. With me I have George Mangiaracina, our President; Todd Taylor, our Chief Financial Officer; Ron Morrison, our General Counsel; and Rian Furey, our Chief Operating Officer. We're going to begin with a brief review of the results in 2017. For the year ended December 31, 2017, GAAP net earnings was a loss of $31.5 million or $1.62 per diluted common share, and this is compared to net earnings of $46.7 million or $3.31 per diluted common share in 2016. In 2017, adjusted operating income decreased to a loss of $29 million or $1.49 per diluted common share as compared to income of $96.9 million or $6.52 per diluted common share in 2016. This loss was primarily due to a $174.9 million decline in gain on sale revenues. Origination volume declined 45% in 2017 to $7.1 billion as compared to $12.9 billion in 2016. Gain on sale margins declined to 191 basis points in 2017 from 241 basis points in 2016, resulting in gain on sale revenues declining 56% in 2017. Offsetting the decline in gain on sale of revenues included an increase in servicing fees, and a decrease in operating expenses. As we have been recently focused on retaining servicing, our servicing portfolio increased 32% to $16.3 billion at the end of 2017, from $12.4 billion at the end of 2016. The increase in the portfolio resulted in increase in net servicing fees of 132% to $31.9 million in 2017 from $13.7 million in 2016. Furthermore, although non-QM volume levels in 2017 were a little lower than anticipated, the non-QM originations increased to $891 million as compared to $289 million of non-QM reduction in 2016. In 2017, the combined non-QM in government insured originations represented approximately 41% of the total originations as compared to just 16% of the total originations in 2016. Additionally, we have been marketing our non-QM product as IQM, which more closely aligns with Impac's traditional product branding. As of December 31, 2017, CashCall Mortgage earn-out has been concluded with the final earn-out payment of $550,000 being made in February. Going forward we will retain a 100% of all the CashCall Mortgage earnings with no further earn-out payments. Contributing to the loss in 2017 was a number of non-cash items, including an increase in income tax expense and changes in the estimated fair value of mortgage servicing rights. With the new tax law significantly reducing corporate income tax rates we decreased the deferred tax asset on the balance sheet resulting in income tax expense increasing by $19 million in 2017 to $20 million from $1.1 million in 2016. The loss on mortgage servicing rights in 2017 includes a $38 million decline in the estimated fair value of mortgage servicing rights due to mark-to-market changes from changes in interest rates as well as changes associated with the ongoing runoff with the portfolio. With the rise in rates in 2018, the runoff has slowed, and the estimated fair value of the portfolio has increased. Lastly, in our earnings release yesterday I announced that, as of July 31st, I would be stepping down as CEO. When we took Impac public, in 1995, I could never have imagined what a tremendous journey we would all be embarking on. Through the good times and the difficult times, I've always tried to do what is in the best interest of our shareholders and our employees. Looking back, I can honestly say that I have given Impac all that I have, and I've very proud of what we've accomplished. When we hired George Mangiaracina in 2015 we began to prepare the company's succession plan. George had been a part of the Impac family since its inception. From being one of our bankers involved with taking the company back public in 1995, to providing the company with its first warehouse line of credit, and in helping the company to navigate the financial crisis of 2007. And finally, being one of the architects of the CashCall Mortgage transaction, George has been an integral part of the company for over 22 years. It gives me a lot of pride to turn the company over to George and so many of our talented, young leaders enabling them to grow the company into their vision. I will continue to provide leadership in whatever capacity is needed as I maintain my position on the Impac Board of Directors. I'd like to now turn the call over to our newly appointed president, George Mangiaracina. George?

[George Mangiaracina:]

Good morning everyone. Joe, I'd like to start by thanking you for your commitment and dedication to the Impac family. I'm pleased to have earned the Board of Directors' and your confidence to lead the company in the future. In this endeavor, I will be guided by the core principles you've instilled in the organization, integrity, indomitable spirit, respect for employees and counterparties, and creation of shareholder value. On a personal note, what will endure is our friendship. For over two decades I've benefited from your counsel and wisdom and have gained measurable lessons in life as well as in business. For this I am forever grateful. We have already begun to take significant steps to change the trajectory of the company, which I will now review. In December of 2017, Rian Furey joined the company as President, CashCall Mortgage, our direct-to-consumer channel. Effective today, we've decided to expand Rian's role in the organization to include that of Chief Operating Officer Impac Mortgage Holdings. Together, Rian and I will focus on reengineering the company's origination activities across all of our channels. Particular attention will be given to future technology initiatives and attribution of our marketing spend with the goal of improving metrics on customer acquisition and operating efficiencies. In February, the first stage of that reengineering was implemented in our business-to-business channel. We restructured our operations and sales organizations, eliminated layers of redundant management and sales cost overrides, and empowered the account executives and relationship managers with a revised compensation plan that's more aligned with our origination objectives. We estimate that this first stage coupled with natural workforce attrition will result in $6 million to $8 million in annual cost savings to the company. More importantly, we expect these changes to improve the B2B's operating efficiencies and competitive positioning for loan origination and acquisition. With respect to the CashCall Mortgage platform, several developments since the third quarter earnings call are noteworthy. The company had been operating CashCall Mortgage under three year earn-out provision since its acquisition in January of 2016. That earn-out provision expired on December 31st 2017. Final earn-out payment in the amount of $550 was made in February. Effective January 1st 2018, Impac Mortgage Holdings will be the beneficiary of all and any future operating income derived from CashCall Mortgage. As previously noted, Rian Furey joined the company in December 2107 as president of CashCall Mortgage. Rian's additional role as COO of Impac will enable the company to provide integrated and consistent operations, technology, marketing, and other traditional foundational support services across all of our origination channels. In his limited tenure at the company, Rian has already instituted a number of changes to the operating model at CashCall. These initiatives are consistent with our goal of repositioning the platform from a California refinance centric business model to one that is more geographically diverse by state and loan type. Refinance versus purchase Fannie and Freddie versus government and of course our proprietary iQM product. Balanced origination volumes should on an aggregate basis have a positive effect in reducing the company's prepay speeds on our MSR portfolio and result in more advantageous execution levels on our loan deliveries to the agencies and other capital market participants. I will now turn the discussion over to Rian Furey for some of the specifics.

[Rian Furey:]

Thanks, George, and good morning. As we mentioned, CashCall Mortgage platform traditionally originated almost exclusively refinance confirming agency product California, and did so in most cases while paying third party closing cost for its borrowers. That pricing and the positioning of the CashCall Mortgage contributed not only to the platforms impressive credit performance but also its problematic repayment speeds. In the fourth quarter and continuing in 2018, we focused our commission loan agents on new customer acquisition with lead traffic driven primarily by our TV and radio marketing campaigns and to a smaller extent purchased online leads, organic web traffic and customer referrals. For existing portfolios, we have also maintained servicing defense group made of salaried originators skilled at capturing transactions from barrowers who have indicated their intent prepay. To reduce prepayment speeds, company has previously expressed its desire to expand and diverse its product mix in the geography of the barrowers that it serves. To that end, we have increased our non-California marketing spend by testing and targeting additional states and specific markets. Today approximately 40% of our new origination come from outside California. We are also evolving in the positioning the CashCall Mortgage marketing to introduce messages that emphasize (NYSE

[George Mangiaracina:]

Thank you, Rian, for that update. I'll now spend some time discussing the company's activities and what we believe to be our most promising ongoing initiative, Impac's iQM origination business. Impac in early 2014 was one of the first mortgage companies to anticipate and actively pursue the revival of an alternative non-qualified mortgage market. Since the company's founding in 1995, we have been recognized a leader in providing creative loan products borrower's need of alternatives to traditional Fannie, Freddie and government offerings. The design, underwrite, origination, securitization and master servicing these products have historically been a core competency of the company. We consider this to be part of our DNA. After the financial crisis of 2006 and 2008, the company consciously maintained resources across these disciplines to manage our pre-crisis legacy all-date portfolio. The company naturally extended this existing franchise intact to the reemerging IQM market, providing us with significant competitive advantages over any new entrant. We have steadily increased IQM production from $130 million in 2015 to over $900 million in 2017. Along the way we have achieved proof of concept expanding our investor base and successfully working with rating agencies to enable securitization of our loans. We expect one of our key investor partners to issue a deal backed solely by Impac collateral no later than the end of the second quarter of 2018. While we are pleased with our accomplishments to date, achieving scale in the IQM business is our next focus and key strategic initiative for the company. Resources have been committed across several areas. With respect to customer acquisition, we now conduct on-site IQM training programs across the country to educate our clients as to the nuances and successful origination of these products. With respect to loan processing and pipeline management, we've created an internal IQM sales support team to ensure data and documentation quality to clear underwriting conditions and to improve application to close times and pull-through percentages. And with respect to technology, we've concentrated our efforts on automating our underwriting process, initially credit conditioning and ultimately credit positioning. These collective efforts should enable the company to scale the IQM franchise and capture market share in the expanding alternative market segment. I will now shift to the last topic for discussion before opening the call for questions. The company's mortgage servicing rights, or MSRs, as of December 31, 2017 were approximately $16.3 billion in notional, and carried at a fair value of $154 million. Conventional wisdom holds than an MSR portfolio in a rising rate environment is a natural offset to a reduction in origination volume, margin, and profitability. Market sentiment calls for continued higher rates in 2018. Treasury has traded this year in a range as wide as 40 to 60 basis points above 2017 year-end levels. These market conditions have resulted in a year-to-date mark-to-market gain on the company's MSR's of approximately $12 million, the positive contribution to early 2018 GAAP earnings. In terms of liquidity, the MSR portfolio contributed approximately $32 million of net service in cash flows to the company in 2017. As of December 31, 2017, the company had borrowed approximately $35 million against the MSRs with flexibility to borrow approximately an additional $30 million. We intend to continue to accumulate MSRs as long as the economic value of this asset satisfies the company's return profile and strategic objectives. The company has been successful in recapturing loans that would otherwise prepay the critical defense against portfolio runoff. Additionally, the credit quality of our MSRs remain strong, with a weighted average coupon of approximately three and three quarters percent weighted average LTV in the mid sixties, and the weighted average FICO above 730 as of December 31, 2017. In summary, the MSRs should provide the company with liquidity and GAAP earnings resilience if faced with a difficult origination environment in 2018. That concludes our prepared remarks. We will now open up the call for questions.

[Operator:]

Thank you. [Operator Instructions] Our first question comes from Trevor Cranston of JMP Securities. Your line is open.

[Trevor Cranston:]

Hi, thanks. Good morning. First question, on the MSR write-down in the fourth quarter, can you give us some additional details on what exactly drove that write-down and particularly the magnitude of it? It was a little surprising I guess given that interest rates increased marginally in the quarter. So just any additional color you can give around that would be useful. Thank you.

[Todd Taylor:]

Hi, Trevor, this is Todd Taylor. Yes, it's -- half of that is really due to runoff amortization charges. The other half is due to a true, sort of mark-to-market associated with the changes in interest rates. I think at the end of the year we actually took a look at the assumptions, and we ended up scrubbing the assumptions, and it ended up aligning some of our prepay assumptions to things that we've seen more recently in our experience. And so that's probably attributed to that. So today, going forward, we feel very comfortable about those items. And as a result, we've seen some good pickup, as George mentioned, in the first part of 2018.

[George Mangiaracina:]

Yes, and I'll also just add that correctly noting that rates have gapped up, but our portfolios primarily focused in California, we've had some very health housing market here. And there's been some HPI gains. And so we're seeing home sale activity that's increased our paid-in-fulls on the servicing. We've also seen refinance activity that's not rate-in-term [Ph] refinance, which you'd see in a low rate environment, but is actually cash-out refinance which you'd see in an up-rate positive housing appreciation environment.

[Trevor Cranston:]

Okay. So as a follow-up to that, I guess if around half of the write-down was sort of amortization/runoff and half of mark-to-market that would put -- the amortization would basically offset the net servicing fees for the quarter so it'd be sort of a zero net line item. You guys anticipating that sort of pace of runoff in amortization to slow down at all over the next couple of quarters or do you think that's going to sort of continue as long as the California housing market is reasonably strong?

[Todd Taylor:]

In general it is going to slow down, and that's what we have seen in the first part of 2018. And so the rate of amortization, if you will, has slowed down slightly. But George is right; there is a factor in there that's relative to what's going on with the housing market. But I can tell you what we have seen in the first two months is it's slower than what we saw in the fourth quarter and all of '17.

[Trevor Cranston:]

Okay. And then on the expenses, so the commentary about the changes you guys have made so far this year were helpful. And I think the number you gave was $6 million to $8 million in annual expense savings. So question related to that, looking at the income statement for this quarter, if you add back the mark-to-market impact of the servicing the total revenue number was still meaningfully lower than what the total expense level was. So when you guys are thinking about that going forward this year and trying to return to the state of profitability, are there sort of incremental areas where you guys think there's room to improve on the expense side in addition to the adjustments you've made so far this year or sort of how are you guys thinking about getting that back to a more profitable level?

[George Mangiaracina:]

Well, the $6 million to $8 million simply in the third-party origination channel. There have also been reductions in force and in cost savings over the CashCall platform, which we did not highlight here. And I think you'll see us continue to refine the overhead supporting the businesses. And I think you'll continue to see us rightsizing the infrastructure for the volume. This first stage was a very early, quick decision to head in that direction, but there's more work to be done there, and I don't have specific numbers on that yet.

[Trevor Cranston:]

Okay, that's fair enough. And just on the market -- the gain on sale margins, it looked like there was some compression in the fourth quarter just based on the amount of decline in the gain-on-sale revenue relative to the decline in origination volume. Can you share sort of how those have been trending so far in the first quarter? And if you guys anticipate any further compression in margins given the increase in rate so far this year and presumably incrementally lower volumes and increased competition?

[Rian Furey:]

Yes. Hi, it's Rian Furey. We have seen with a backup in rate increased competition and competitors accepting lower margins in the direct lending channel in particular. And that tends to happen as there is capacity available widely in industry and volumes start to decline, tends to even out as folks reduce their capacity which we have already seen has started to happen. But we did definitely go through an inflection in the fourth quarter where margin compression was noticeable. And I would anticipate again as folks reduce their capacity, we'll start to see that as well.

[Trevor Cranston:]

Got it. Okay. And then a question on the -- you guys mentioned that one of the investors in your non-QM products is anticipating completing a securitization backed by your loans by the end of the second quarter. Just to clarify are those going to be -- is there any retention from that securitization deal for Impac's balance sheet or it looks -- completely sold and off the books by that point?

[Joe Tomkinson:]

We've sold -- all these loans that we have sold to this particular this investor was sold and service released basis. And we have no retention requirements as a result of that activity.

[Trevor Cranston:]

Okay. And as you look forward strategically for 2018, is there any sort of thought or planning around potentially completing securitization on your own balance sheet and retaining subordinate investments, or do you guys anticipate continuing to pursue the gain on sale approach with the non-QM loans?

[Joe Tomkinson:]

Trevor, our product is out for competitive bid. And the way we measure best decks [Ph], the whole loan service release that is superior to any securitization that we develop. And again, there are others who associated with our securitizing due to aggregate product for a period of times, not easy product to hedge from a credit perspective. It would require a lot of liquidity to hold that product. And then on securitization, we have the retention requirements. We think currently best decks whole loan sale is superior to anything we would do in securitization space. At the same time having gone through the rating agency reviews where we are positioned to be able to securitize is just not economically beneficial at the moment for us.

[Trevor Cranston:]

Okay. That makes sense. Appreciate the comments. Thank you.

[Operator:]

[Operator Instructions] And I am showing no further phone questions at this time. I would like to turn the call back to Impac for closing remarks.

[Joe Tomkinson:]

Well, if there are no other calls, then this concludes our 2017 earnings call. And I appreciate everyone's participation, and next call will be through the first quarter. So, thank you very much.

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program, and you may all disconnect. Everyone have a great day.