Impac Mortgage Holdings, Inc.
Q2 2016 Earnings Call Transcript

Published: 31 Jul 2016

[Operator:]

Good day, ladies and gentlemen, and welcome to the Impac Mortgage Holdings Second Quarter 2016 Earnings Conference Call. At this time all participants are in a listen-only mode. Later we'll conduct a question-and-answer session, and instructions will follow at that time. [Operator Instructions] I would now like to introduce your host for today's conference, Vice President of Investor Relations, Mr. Justin Moisio,. Sir, you may begin.

[Justin Moisio:]

Thank you. Good morning everyone. Thank you for joining Impac Mortgage Holdings Second Quarter 2016 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, market risk exposure and mortgage production, as well as general market 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, 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 Bill Ashmore, President of Impac Mortgage Holdings.

[William Ashmore:]

Thanks, Justin. Good morning. Welcome and thank you for joining Impac's second quarter 2016 earnings call. On the line with me, Joe Tomkinson, our Chairman and CEO, Todd Taylor, our Chief Financial Officer, and Ron Morrison, our General Counsel. I will begin with a brief review of the results for the second quarter of 2016. Consistent with our previous earnings releases, management believes it is more useful to discuss operating income excluding changes in the contingent consideration to get a better understanding of operating results. Therefore, in the second quarter of 2016, operating income, excluding contingent consideration changes, increased to $18.6 million, as compared to $7 million in the first quarter of 2016. GAAP net earnings in the second quarter of 2016 were $12.3 million, or $0.92 per diluted common share, as compared to net earnings of $981,000 or $0.08 per diluted common share in the first quarter of 2016. In the first second of 2016, origination volume increased 38% to $3.2 billion, as compared to $2.3 billion in the first quarter of 2016. During the second quarter, retail originations through the CashCall Mortgage channel continued to be the main driver of total originations, representing approximately 77%, or $2.5 billion of the total originations. The brand recognition of CashCall Mortgage as a consumer-direct best priced option which closes loans on an average of 15 days has allowed originations to surge in the first half of 2016. The increased originations for the second quarter, like in the first quarter put the company ahead of its business projections for 2016. Gain on sale margins increased by 14 basis points to 243 basis points in the second quarter of 2016, as compared to 229 basis points in the first quarter of 2016, an increase of 57 basis points over the second quarter of 2015. The continued low interest environment allowed us to grow our pipeline during the second quarter without having to reduce margins. Consistent with the increase in originations in the quarter, personnel expenses and business promotion increased by 26% in the second quarter of 2016, as compared to the first quarter of 2016. This was primarily a result of an effort to capture an increased amount of refinance volume during the first quarter of 2016. As of June 30, 2016 the company’s mortgage servicing portfolio increased to a record $6.6 billion, a 29% increase from March 31, 2016, which increased the value of our retained MSRs to $54.7 million at June 30, 2016, as compared to $44.3 million at March 31, 2016. This also resulted in a 34% increase in servicing income in the second quarter over the first quarter. During the second quarter of 2016, we sold only $850 million of our servicing portfolio, much less than we have in prior quarters. Increase in the servicing portfolio and therefore resulting in higher than expected mark-to-market losses because of declining mortgage rates during the quarter. Furthermore, instead of selling MSRs at depressed pricing levels, we focused on recapturing run-offs. During the second quarter, prepayment increased to $894.5 million as compared to $413.4 million in the first quarter. However, during the second quarter, we successfully recaptured 81% of these prepayments, an improvement over the 77% retention rate for the first quarter. Our retention efforts have been extremely successful and we believe we can sustain our retained – it can be sustained on a retained MSR portfolio. However, going forward, we may selectively sell certain portions of our retained MSR portfolio as we manage our cash position. In recent quarters, the company has strategically moved higher amounts of MSRs on its balance sheet and focused on recapturing the run-off in this low interest rate environment. The successful retention program, we have more options to not only retain MSRs but also to opportunistically sell certain portions of our servicing portfolio. We believe this to be a successful strategy for the company and its overall financial performance even if and when interest rates move higher. With the strong retention capability, we are able to both take advantage of a low interest rate environment with strong origination volumes and create a low weighted average coupon portfolio that will increase in value during a rising rate environment. Furthermore, we have been able to increase our MSR assets while at the same time increasing our cash position during the second quarter. As previously discussed, in December 2015, the company entered into equity distribution agreements to sell common stock through an aftermarket transaction or ATM. We set up the ATM to have the opportunity to raise capital in a way to mitigate downward pressure of stock price, while adding capital in an accretive manner to existing shareholders. In the first quarter we began to issue shares to the ATM primarily to ensure the process will work smoothly. During the second quarter of 2016, the company sold approximately 200,000 of its common shares, providing net proceeds to the company of approximately $2.8 million, net of sales commissions at an average price above our book value per share which also increased 10% during the quarter. The net proceeds were used basically to retain more MSR assets. The ATM gives the company another tool which it can raise capital incrementally, without putting downward pressure on the stock price. In the future, we will utilize the ATM to support selective retention of MSRs to improve our cost of funds as well as support any acquisition opportunities that may present themselves. With regard to the overall loan originations, we have seen our locked pipeline increase from the end of the second quarter and into the third quarter. At June 30, 2016 our locked pipeline was $1 billion and currently our locked pipeline is growing 20% to $1.2 billion. We have seen that locked pipeline growth has translated into increased mortgage origination volumes that are continuing into the third quarter. In closing, I would like to comment that second quarter origination volumes and operating income gives the company significant momentum on track for a great 2016. We are especially pleased by our performance in MSR retention, reaching an 81% recapture rate last quarter allowing the company to retain record levels of low weighted average coupon MSRs on the balance sheet. Indications are that we should be able to maintain these percentages in a low interest rate refinance market as we are now in. Now I would like to close my prepared remarks, and respond to questions received via email, and open the call for questions.

[Operator:]

[Operator Instructions] And our first question comes from the line of Trevor Cranston from JMP Securities. Your line is now open.

[Trevor Cranston:]

Hi, thanks. First question is related to the non-QM product. Can you just give us an update of, kind of how that developed over the course of the second quarter and what the pipeline currently looks like?

[William Ashmore:]

Yes, we have approximately $115 million pipeline on our non-QM that is consistent with the first quarter. We were hoping to have a significant increase, but we – some changes in – relative to the – the overall market has surged product in the agency originations and really has taken some of the – some of our eyes off the ball here relative to non-QM. However, we still have a commitment here to get that volume up to a significant level. As it is right now, the fundings are less than $50 million. But we believe that going forward, we are going to have a big push on this and there has been some significant changes relative from the process and programs. So, right now, it is not a significant amount of the overall production, but we hope that we will fill in over the next six months.

[Trevor Cranston:]

Okay and we've seen a couple of securitizations of non-QM products announced, I think, from Caliber and Deephaven recently. If you guys have looked at those, can you comment on, if they are types of products that are in those deals that are similar to what you guys are originating and if you think securitization is potentially becoming a more viable outlook for those loans? Thanks.

[Joseph Tomkinson:]

Trevor, this is Joe Tomkinson. It’s a different product. Ours is a much higher quality borrower, high cycles than what the Caliber has out and we think that the securitization market is viable. Yes, the securitization market is viable, but, we are not interested. We are holding it in a lot of that we are selling off is whole loans right now.

[Trevor Cranston:]

Okay. Thank you. I appreciate the comments.

[Operator:]

Thank you. And our next question comes from the line of Michael Salzhauer with Benjamin Partners. Your line is now open.

[Michael Salzhauer:]

Hi, good quarter. I have a few questions for you. One is, are there any other acquisitions that might fit with the company like a CashCall type operation? Or do you think that's unnecessary because CashCall is scalable?

[Joseph Tomkinson:]

Well, we don’t normally comment on acquisitions, but there are a couple of things that we are looking at. But I am not going to – I am not going to go into any detail on it.

[Michael Salzhauer:]

Okay, and then, the other is a question about when you might take another look at your DTA and could you remind us how big it is?

[William Ashmore:]

Okay, Todd, why don’t you just take that?

[Todd Taylor:]

Okay, okay so, for the DTA, we actually analyze this every quarter and take a look at it. We did recognize some as everybody knows, last year, when we completed the acquisition of CashCall for about $24 million. Since then, we constantly look at it to see if we can recognize more. The DTA, as a reminder driven off of projected taxable income, not necessarily GAAP income. So when you have a strong GAAP quarter in earnings as we have and operating income that not necessarily indicative of future taxable income per se, and so until we – really the driver is the mortgage servicing rates portfolio, the MSR portfolio. To the extent you are retaining more servicing, it is going to actually create what we call a DTL, deferred tax liability, which actually is the opposite of creating a DTA. So in other words, you are not producing taxable income, you are producing a deduction if you will. So, to the extent we continue to retain MSRs, most likely the DTA is not going to change dramatically or as far as the $24 million assets. If we get to the point in time that we haven’t spoke about actually selling the – more servicing that will create an opportunity for us to release more valuation and increase the DTA. I wanted to just clarify with that, that doesn’t, the fact that we aren’t releasing more DTA is not indicative of - and issuing our earnings projections that we don’t normally speak to, but obviously, the CashCall division is driving a lot of their earnings and our projections, as you can look at in analyzing our contingent consideration, the projections remains strong. And why do I say it? Because the contingent consideration at the end of the year was about $48 million and today it’s $50 million. But in the first half of the year, we paid out about $12 million in payments. So the fact that that’s remaining at that level is indicative that the projection has remained strong for that division.

[Michael Salzhauer:]

Thank you.

[Operator:]

Thank you. And our next question comes from Brock Vandervliet from Nomura Securities. Your line is now open.

[Joseph Tomkinson:]

We were speaking, Brock. We can’t hear what you are saying if you are asking a question. It sounds like you have the mute button on.

[Brock Vandervliet:]

Can you hear me now?

[Joseph Tomkinson:]

Now, we can hear you.

[Brock Vandervliet:]

Okay, great. Sorry about that. In terms of these volumes that you are seeing, how – in respect to those volumes, how aggressive can you be in terms of pushing origination margins?

[Joseph Tomkinson:]

I am not sure, what you mean, how aggressive can we be in pushing origination margins. You mean, increasing the margins?

[Brock Vandervliet:]

Yes, it seems like they've moved up pretty materially in the second quarter. Could that continue or should we expect them to kind of run where they are?

[William Ashmore:]

There is a two basic component that we’ve seen in those margins for the first half of this year. On a sustained level of low interest rate, you are not having to compression margins in order to keep your volumes up, number one. And since they have the rates have continued to be – right now let’s say the predominant 30 year conventional rate that we are showing which has had no cost to our borrower is around three and three eight and that’s been pretty consistent and it creates a 3.5 first half of the year. So because there is some sustained periods of time, we have these low interest rates. We have not had to compress our margins. So that was one factor in terms of wider margins. The second factor is that, we do have a higher percentage of CashCall which generates a wider margin. When you start seeing larger percentage of business-to-business and if you start seeing, rates start climbing, you will see these margins starting to compress, one, because this is the business has lesser margins and number two, in order to drive, keep those pipeline full and drive production you are going to have start showing some compression on the margins. So those would be the two main factors.

[Joseph Tomkinson:]

You know, Brock, there is something else that, notwithstanding the margin, but I don’t think people fully understand the significance of recapturing so much of the run-off on the servicing portfolio. So many people are having to write-down their servicing portfolio in huge numbers, but when you talk about the cost of origination, the expense side originations notwithstanding the margins, and that that product is falling in naturally back into it, that’s a huge savings right there. And that alone, you can look at is a pick up in margins. The other thing that we’ve seen in the pick up in margins also building – is we had a big pick up in the non-QM or all-QM product as far as our margins are concerned. So we are going to be concentrating a lot on all-QM in the last half of the year. That helps?

[Brock Vandervliet:]

Yes, yes, that's very helpful. I guess, yes, I am accustomed to seeing recapture rates more in the 30%, 30%-ish maybe 40% level. What's the distinction with your platform that produces such a high rate of recapture?

[William Ashmore:]

Can’t tell you.

[Joseph Tomkinson:]

Yes.

[William Ashmore:]

Basically, what we have is we’ve refined the ability for us to, number one, contact the customer or more importantly for the customer to contact us. The name brand recognition is the fact that number one, they do offer ultimately the lowest rate in town around that that borrowers can shop to, so that entices the borrower to come back to us. And the second thing is the fact that we are extremely fast at closing those lines. In California or in dry state, wet states aside, it’s a little bit longer to close. On average, it’s 15 days or less. So, if you combine the fact that you do at the fastest, and you also have the lowest price in town, you are going to attract people to come back to you. So, the viewpoint here is a lot of these borrowers come back to us not necessarily because we contact them, they come back to us because they know they are going to get the actual best deal in town.

[Joseph Tomkinson:]

And then the, the other thing that I want to stress is, is the service level in the east and you have to remember that CashCall, I don’t know how many billions and billions of dollars we have done with the same customers, but those customers have had a unique good experience and you know as well as anyone, we have a good experience, are you going to go to somewhere else or are you going to go to the individual and had a good experience.

[Brock Vandervliet:]

Got it, okay. Thank you. That's very helpful.

[Operator:]

Thank you. And our next question comes from the line of Chase Basta with AWH Capital. Your line is now open.

[Chase Basta:]

Hi, good morning guys. I just want to follow-up on the gain on sale margin and trying to understand this a little better. So, I just kind of want to understand how to think about this. Kind of as a point of reference, Wells had a production margin of less than 170 basis points this year and you guys seem to track them last year? So it seems like something has really changed for the better with this gain on sale margin and I kind of want to understand has there been a change or what's driving that?

[William Ashmore:]

Well, I think the change has been that, relative to us approaching these retention rates, I think that’s a big plus that we have, that’s why strategically we are – and we have the cash ability to do this to retain more of those MSRs. I think that as Joe alluded to earlier, that’s a big plus. I think that is something that is fairly unique to us as you alluded to. I believe we have industry best retention rates out there for CashCall directly originated loans for over 90% and we are over around a 50% retention on the business-to-business. So, whether you blend them or you take it individually or by themselves you are going to see that from a retention standpoint, we do an excellent job with that and I think that is going to be a differentiating portion of where Impac Mortgages is going to be going forward with some higher levels of the retention of these MSRs at these historical low rates. Our WAC on our MSR portfolio today is a little three and three quarters, predominantly at agency third year fixed rate which is extremely low from a historical standpoint. So that the value of these MSRs that we are retaining at these levels is going to be huge on a go-forward basis allowing us to have more optionality to have current servicing income. Number one, as you saw, we had a huge surge in servicing income, but also have the ability here to marry that with the retention model when and if the – there was a time when this stuff was running off. So I think, we are just doing a better job in this year we did last year relative to managing our origination.

[Joseph Tomkinson:]

And there is – there are a number of – there has been a number of operational initiatives that we’ve taken on to improve the efficiencies. So, the combination of both has improved our seed and our margins.

[Chase Basta:]

Okay and maybe this is a naïve question, I am just trying to understand, what's the connection between the high retention rates and the high gain on sale margin?

[Joseph Tomkinson:]

Well, as I alluded to earlier, I don’t have the numbers in front of me, but, let’s just say 30% of your originations is coming with no expense from the standpoint of advertising – cost of sourcing it. That’s going and it comes in to you free.

[Chase Basta:]

Okay. I follow you, now. I follow you, now. That makes sense.

[Joseph Tomkinson:]

Yes, okay.

[Chase Basta:]

Okay, okay. And my next question is, can you guys give us an idea on the cash earn-out payment you've made or will make to CashCall for the second quarter performance?

[Joseph Tomkinson:]

I don’t have that right now, but we will – if you call back, we’ll give it to you.

[Chase Basta:]

Okay, okay. All right. Thanks guys.

[Operator:]

Thank you. [Operator Instructions] At this time, I am showing no further questions. I would like to turn the call back over to Mr. Ashmore for closing remarks.

[William Ashmore:]

I have no further closing remarks. Appreciate everybody on the phone call and we’ll see you again next quarter. Thank you.

[Operator:]

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