First Financial Bancorp (FFBC) 2003 Q2 法說會逐字稿

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the Irwin Financial conference will begin shortly .

Good afternoon ladies and gentlemen and welcome to the Irwin Financial corporation announces second quarter earnings conference call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session. I will now turn the call over to Mr. Greg Ehlinger. Mr. Ehlinger, you may begin.

Thank you, Sandra. Thank you for joining our call. I am joined by our CEO, Will Miller and our Controller.

While making our presentation we will make statements forward looking statements of our plans, initiatives, expectations improvements, estimates. Expected results beliefs and similar expressions identifying forward looking information. These statements are not guarantees of future performance or events and are accomplishments of the plans we are going to discuss. Involving risks and uncertaintiess that are difficult to predict. Future events may differ materially from what we discuss here today. For an explanation of the factors that may affect our results rerefer you to our 10 k and 10 q and factors in our written press release.

I'll turn the call over to Will for a minute.

I think you covered the legal stuff pretty fast. I would like to start by reiterating the key points we made in the press release.

We were able to produce good results this quarter in spite of facing some tough issues. On a consolidated basis we reported second quarter net income of $13.2 million or 45 cents per diluted share. Significant increases in consumer credit costs were offset by strong origination volume in our mortgage banking operation. Resulting in a 61% increase in our net income per share versus the same quarter last year. We think this shows again the value of our balance revenue model. We we achieved another quarter net income. And in our commercial banking line of business where profits increased 45%. Total nonperforming assets declined since the end of the first quarter. We continue to see stability in the credit call the of -- quality of our 1.9 billion commercial banking portfolio.

However, reflecting a more pessimistic outlook for the continued employment weakness, we took significant residual impairment this quarter in our home equity line of business. Nonetheless, given the current condition of our mortgage pipeline, the growth in our mortgage servicing portfolio and our continued good result in commercial banking we feel we can au official our 2003 earnings guideline of at least $2.25 per share which would be a greater than -- at greater than 19% improvement over 2002 results.

Now I will turn the call over to Greg for a more detailed review of the quarter.

Thank you, Will.

Net revenues increased 55% year over year to 133 million dollars. Reflecting strong mortgage origination income and continued growth in our loan portfolio and prelated net interest income. Our loan and lease portfolio totaled $3 billion at quarter end up 2% from March 31 and reflecting strong mortgage origination our mortgage loaned held for sale totaled $1.7 billion on June 30. Deposits totalled 3.3 billion on June 30th, $300 million increase over the first quarter. And we had $385 million or $13.76 per share in common shareholder's equity as of June 30, a year over year per share increase of 16%. In our total risk base capital was 13 1/2% at the end of the quarter compared with 13.4% at the end of March.

We also announced after consultation with our regulators that begin with periods ending September 30 will begin to risk wait home equity assets described in our sub prime. At 200 percent for regulatory risk base capital purposes. These basis are described as sub prime due to the characteristics of the barrow credit history and the performance of the loans. They are largely comprised of home equity loan products we no longer originate for portfolio purposes. We anticipate this treatment would have the affect of lowering our risk base capital ratio from 13.75 if applied at June 30 by approximately 60 to 80 basis points. This change notwithstanding we remain well capitalized to meet our anticipated loan growth.

Consolidated nonperforming assets were $41 million or.74% of total assets at quarter end and this is down from $43 million or 81 basis points of total assets at March 31. Our on balance sheet au luns for loan and lease is June 30 and up from 54 million at the end of the first quarter. Net charge offs for the quarter rose to $10 million, up $4 million from the first quarter primarily reflecting losss in our home equity and broker sourced lease portfolios.

Now I'll turn to detail by segment starting with mortgage banking where will described a record quarter for us. Net income total 23.2 million dollars, another quarterly record. Net income increased 14.1 million or 153% over the second quarter of 2002. Loan originations tote tald 7.2 billion during the quarter, a year over year increase of 5.3 billion or 282% and an increase of 1.8 billion compared with the first quarter of this year. Refinances counted for 75% of production compared with 39% a year earlier and 70% during the first quarter. During the second quarter our new correspondant lending unit contributed approximately $2 billion or approximately 28% of all production. We anticipate this channel will continue to be a meaningful contributor to production and net income for the second half of 2003 and beyond.

Reflecting strong production and limited sales of servicing rights our first portfolio totalled 24.7 billion as of June 30, an increase of 83% from the prior year. We are carrying the first mortgage servicing asset at 194 million dollars or 79 basis points of the underling loan performance compared to our weighted average servicing fee of 34 basis points. We have continued to build the servicing portfolio in anticipation of rising interest rates and lower mortgage production. We expect an increase in the value of the servicing portfolio in a rising rate environment. We expect a slowing of loan production, but also anticipate we will capture a meaningful amount of servicing asset impairment through negative impairment or through servicing sales although the timing and amount of such recovery would be dependant on a number of factors we discussed in our 10 Q and these include potential loss on derivatives that we use to impact the falling interest rates.

Turning to our commercial banking line of business we earned $5.9 million in the second quarter. Quarterly record and increase of $1.8 million or 45% year over year. This is also a $700,000 increase from the first quarter of this year. Our commercial portfolio grew to 1.9 billion at quarter end and 11% year over year increase and a 3% increase from the first quarter of 2003. Included in second quarter net income was a provision of 1.3 million dollars for loan and lease losses and this is a year over year decrease of $1 million reflecting slower loan growth and an improved outlook for our commercial loan portfolio. Net charge also totalled $1.2 million during the second quarter or 25 basis points of average loans on an annualized basis, compared with an annualized rate of 21 basis points during the first quarter of 2003.

We ended the quarter with delinquencies of 32 basis points. This is down from 66 basis points at March 31. Net interest margin in the second quarter was 3.87% compared with 4.08% in the second quarter of 02 and 4.04% during the first quarter of 03. We have assumed a similar net interest margin for the second half of 2003 as what we experienced during the second quarter. Our average core deposits tote tald 1.6 billion during the quarter, an annual increase of 32.9% and up 6.6% over the prior quarter. Our home equity line of business lost 14.4 million during the quarter compared to its loss in the second quarter of 2002 of 4.5 million dollars. The higher loss was principally the result of credit related impairment to the carried value of residual assets comprised of loans with characteristics we no longer originate under the underwriting guidelines we have had in place since late 2002. The performance on home equity loans originated since the fourth quarter 2002 under these new tightened guidelines, continued to perform to our expectations.

The impairment of the residuals reflects our revised, less robust economic outlook as well as enhancements in modeling techniques for forecasting the level of post recessionary credit losses. Specifically we extended the period over which we believed the lingering affects of the recession and slow recovery -- slow recovery and employment would elevate losses in this portfolio from March 2004 extended now through December of 2004. In addition we revised our estimates of the base loss curves or the underlying level of losses expected as the portfolio seasons in a none recessionary environment in. total reincreased our loss reserves and recognized $33 million of residual impairment during the quarter to reflect our modified outlook.

Capitalized residual assets were $92.8 million as of June 30 compared with $183 million a year earlier and $132 million at March 31. At an undiscounted basis, this $93 million evaluation at June 30 includes $102 million of existing securityization over collateralization. And an additional 22 million in future net spread and prepayment penalties. Net charge offs on our balance sheet home equity portfolio was 2.58% on an annual basis up from 1.74% from the first quarter largely reflecting seasoning. Our allowance for loan and light of credit losses totalled $25 million or 3.45% of outstanding loans and lines. In our 30 day and greater law link wen see ratio for the on balance sheet portfolio increased marginally on a sequential basis to 2.7%, up from 2.66% as of March of 03. Loan origination volume was 299 million dollars during the quarter. A 12% year over year increase. And during the quarter we sold 242 million of whole loans for a net gain on sale of $8.3 million. Our commercial finance line of business broke even during the second quarter compared to income of $100,000 during the same period in 2002.

Earnings for the period were negatively affected by additional credit reserves for our U.S. sourced broker portfolio. Our U.S.-based broker portfolio and cost related to our decision to exit that distribution channel. Loan and lease fundings in this line of business totalled $66 million compared to 46 million a year ago and 58 million dollars in the first quarter. The portfolio now totals $399 million, a sequential quarter increase of 19.4 million. Our allowance totalled 10.3 million or 2.59% of outstanding loans and leases. And Irwin Ventures lost $100,000 during the second quarter compared with break even results a year ago. The investment portfolio now has a carrying value of $4 million which is about 1% of our consolidated equity.

In summary, we had an EPS increase of 61% over the second quarter of 02. We are pleased to have achieved these results in a difficult environment. It is a reflection of our diversified revenue model. We had another record quart neither banking and commercial banking as well and both those lines of business have performed well the first half of this year. Our total nonperforming assets declined sequentially since the end of March. We have modified our assumptions for future cash flows in our residual models and recognized impairment on our home equity line of business. But nonetheless we can relay official our earnings forecast for 2003, EPS of $2.25 per share.

Sandra, Will, Jody and I would like to open up the call to questions. Thank you.

We will now begin the question and answer session. If you have a question you would need to press the 1 on your touch phone keypad. You will hear an acknowledgment you have been placed in queue. If you wish to be removed from the queue, please press the pound sign. Your questions will be queued in the order they were received. If you are using a speaker phone police pick up the happened set before pressing the numbers. Once again Fthere are any questions, please press the 1 on your touch tone phone. Our first question is from Joe Sieber. Please state your question.

Hi, guys. Two questions here. First of all, your correspondant group in your mortgage banking practice is doing better than we have expected. Can you tell us what feeling -- obviously the mortgage feeling, but the whole group has done better than expected whachlt is helping you there? That's number one. And number 2, can you talk about the amount that your mortgage servicing rilts -- rights have been written down and what would the potential recapture be and up 50 basis point and up 100 basis point on Ginny Mae rates. Thanks and good quarter.

Your first question was, I think essentially your first question is, are we surprised our correspondant group is doing better than expected? I think our short answer is, no, given the environment. You pointed out, obviously it has been a good environment for mortgage originations and we fully expect that group to add meaning flee to volume in the type of environment we have had in the last six months. But I don't think we are surprised. Add meaning flee to volume in the type of environment we have had in the last six months. But I don't think we are and we are not surprised because of the history of that group.

As we described when we announced nine months ago that we were going get into the correspondant lending group while it was a new distribution channel for us, our new colleagues in Louisiana have been together for 15 or 20 years and have had a very good track record profitability with their former employers and an ability to generate good volumes of loans in both good environments we have had with them, but also going back into the into the 99 and 2000 period. They have demonstrated their ability to keep margins in that business attractive, even in tougher origination environments. So the second part of your question has to do with mortgage servicing rights, the amount of impairment that we have, how much write up we would expect. The impairment allowance today is about $200 million. The amount we would be able to write it up over the next 50 basis points as your question asked, Will said you asked about 100 basis points?

No, I said 50 and 100. Could I give you a few more numbers too, but I'll try those two.

The dollar value of a basis point in the part of the evaluation that we're in right now is about a million dollars. Now, that million dollars though is before -- it would be the amount of the reverse on the impairment and wouldn't -- does not take into account, but ought to be adjusted by an estimate made by analysts with regard to the amount of hedge loss we would have. We described our hedge strategies in previous calls and in our queue, we use a combination of treasury-based in Euro dollars and swaptions and depending on the time of the market, depending on consolidated income forecast, consolidated capital levels, amount of time to the end of the quarter from new production to come in, we adjust those hedge ratios pretty dynamicly. But we do try to leave sufficient room in the hedge ratio in terms of the way we designed especially the swaption portion of our derivative book, so we can have an opportunity to write up the servicing asset on a net basis by spreading the swaptions out and allowing for a good portion of that dollar value of a basis points that, as I said, about a million dollars right now, to be able to flow into impairment reversal.

Okay. Thanks, Greg.

Our next question is from Fred Couplings from McDonalds Investment. Please state your question.

Good afternoon. A couple questions, Greg. First, can you provide us -- I don't think I saw the managed net charge off ratio for the home equity portfolio for the quarter. Looks like you broke it out between on balance sheet and secure tiesed. Hello.

Yeah. We're trying to look up that figure.

And related to that, Greg, I also wanted to get a sense for some static pool data there in terms of what year of originations is causing you the most problems in this home equity portfolio. If you looked at the portfolio, the problem comprised what percentage of the total book?

Fred, let me tell you in your first question. Were you looking for managed portfolio net charge offs. We actually tried to get a little bit more detailed this quarter and split charge offs in the press release between charge offs in the resitedule -- in the residual asset and charge offs in the on balance sheet port -- loan portfolio. And unfortunately I don't have right in front of me the amalgamated number we used to report and I apologize for that. we'll get that into the queue. But I can tell you if you look at the second or third page of the press release you will see that on a disaggregate basis.

We -- yes.

We do have the managed portfolio delinquency ratio. It closed the first quarter at 5.55% and it closed the second quarter at 5.68%. So we had about 13 basis point sequential quarter creep on the delinquency ratio. Your second question was on a static pool basis, what type of -- maybe you said what year vintage is causing us some trouble, Fred, let me answer that slightly differently. It is generally the high loan to value product that is causing us the most amount of trouble. That would correspond into originations in the 99 to 2001 time frame. The originations prior to that time were more so Senegal traited in the 100% loan to value portfolio.

I think a more important way of separating it though is one that we have studied a lot here and now discuss a lot and review a lot of statistics on, and that is what we call inside current credit policy and that which is outside current credit policy. We have talked quite a bit about the credit underwriting changes we made in late 2002 with a focus on significantly increasing our barrows -- barrow betters disposable income and moving the barrow profile up on a fico score basis. That seems to have been fairly successful for us. What we have been able to do with the data that we have for the portfolio going back to 1995 is separate the entire portfolio into a portfolio that would qualify under today's credit policies or what we refer to as inside current credit policy and that portion of the portfolio -- that wouldn't satisfy today's underwriting criteria and the vast majority of the credit difficulties we have had and therefore the bulk of the reason for the residual impairment is coming from that product that we originated in that 97 through maybe mid 02 time period. That is in what we call the outside current credit policy bucket. In the area of about 75% of all that residual impairment we took came from that now outside current credit policy bucket.

And, Greg, just to clarify, what are your loss expectations for the current home equity originations that you are holding on balance sheets. I see it rolls from 174 to 258. Where do you see that number stabilize sning -- stabilized.

Fred, the number has risen in the last quarter. It will see some fluctuation on a quarter to quarter basis, depending on whether we sell current production or not and whether the remaining portfolio is an older vintage, seasoned portfolio. We have an allowance on that book today of about 3 1/2%, 3.45%. Obviously, you know, that allowance is a good estimation of what we think is potential losss in the portfolio. But we would be glad if it was lower than that.

Okay and one last question on moving to the mortgage business. And looking at your spreads on loan sales, I don't think you guys provide us -- you give us the originations. You don't give us the volume of actually loans. So can you talk about the outlook for spreads in secondary marketing of sales. And also, somewhat related to Joe's question, servicing margins. You are losing money in servicing today and rates continue to go up. What's the outlook for -- how much money can you make in the servicing side of the business? Or if you can talk about your spreads on that business?

Yeah. I think your first question was asking to differentiate between our originations and our shipments. Our shipments were below our originations of 7.2 billion. They were just shy of $7 billion. Our outlook on secondary market,s that not one that I think we have any better vision on than anybody else. That will depend a lot on what competitive conditions are in the market. And the degree to which folks are willing to pay for market share which we have seen folks do in the past. Obviously we have looked for a profitable --

what rates rise.

Right. What rates rise. We look for an all in profitable relationship including the value of the servicing, but we are not going to be giving away loan rates in order simply to keep market share. It has not been our practice in the past. But I don't have and I will let Will speak up, but we don't have an ability to predict what competitive conditions are going to be like if rates p continue to rise or rise from here.

The only thing I would add to that is the -- apart from confirming that my crystal ball is not any clearer than anybody else's on how competitive spreads will change, but our current mortgage rates are back into the range that they were in at the end of the first quarter. While people have been focusing on the fact that interest rates have risen significantly from a troughs that we hit actually going backwards. The round trip has brought us back to about where we were at the end of the first quarter. So that plays out in terms of people's actual pipelines and their need to begin to buy business by narrowing spreads versus whether we're going to continue in a mode where there is plenty of business for everybody is hard to predict. I did note that some industry analysts recently have said that even in the current range with mortgage rates in the 5 and 3 quarters to 6%, they believe half the consumers out there still have an economic incentive to refinance. We don't know that, buts that what some analysts are saying.

Then, Greg, the margin and servicing business.

I'm not sure what your question is Fred. We have not seen a deterioration in margins in the servicing business. The single period profitability of servicing has gone down in recent quarters as prepayment speeds have picked up. Amortization this quarter cause owed a single quarter ascribing no future value to the msrs that being originate owed the production side of servicing. To the servicing end. But as we see increases in interest rates and declines in prepayment speeds, we will see a evened out decline in our amortization rate. I think our amortization was up to $33 million which is a $6 million increase just from the first quarter.

Ands that what I'm asking. I'm asking in a normalized prepayment environment, the $24 billion of servicing, we earned 20 basis points on that and servicing fees. Is it 25 or 30? s that what I meant by the margin there's. -- that's what I meant by the margins there. You are booking with 37 basis points and are offseting that with the amortization expense. I'm trying to get a feel for what the net spread might look like, or what has it been in the past?

Fred, the difficulty in trying to give you a meaningful answer to that is I'm not sure with the volatile interest rates we have seen in the past couple quarters there is a normal servicing environment. The servicing fee is pretty stable. And the expenses of the human beings is pretty stable. But those are swapped by changes in the amortization expense which go up and down in the accounting treatment with interest rates and they are swapped by write up and write downs in the MSR's and all that involves interest rate forecast that we are not I believe we are not able to do. It is very difficult to give you a normalized meaningful number because of -- because it involves an interest rate forecast.

Okay. That was assuming with rates going up. And we get a slow down in prepayments, what would you expect? Well, it all gets into the how much does it slow down? You know, where is that rate at the end of the quarter when we have to do the MSR mark to market.

It is too complicated to give you a meaningful answer. Hypothetically. All right. Thanks.

Our next question is from Sy Jacobs from Jan partners. Please state your question.

Hi. When you first guided down your expectations for second quarter results a few weeks ago or a month ago or so, you stated the mortgage banking prospects were so strong that you were still comfortable with the 225 for the full year which implys a much better second half than first half. Since then 10 year rates have gone up 100 basis points and yet you still guide toward the 225 plus. Would I be wrong in assuming that it is a stretch to say that mortgage banking earnings in the second half are going to be higher than in the first half? With higher interest rates and 75% of your volume coming from refinances? Or is your implicit forecast of higher earnings in the second half than the first half based on some other line of business other than mortgage banking.

You would not be wrong in thinking that the mortgage bank is unlikely to double its performance or equal its first half performance on the production side certainly. The basis of our confidence in giving guidance at this point, given what we see right now is as we explained in the press release, a combination of current pipeline which on -- obviously does have trailing affect coming from the dip we saw in rates in June and likely would not be sustained at rates that we have today, but there is that piece of it. The second piece as we talked about an awful lot is the reason we built the servicing portfolio from 10 to 12 billion dollars, just 18, 24 months ago to $25 billion today is to prepare for this point when interest rates start going back up. And, our results over the last two years have been impaired by servicing impairment.

And certainly part of our strategy is to be on both sides of the mortgage business and expect that kind of opportunity to realize some value on the servicing side as interest rates go up. The third thing we mentioned in the earnings release is that our commercial bank has been performing very, very well for a number of quarters now, going back more than a quarter several years now. And we are starting -- and over the last year we have begun to see the benefits of having built that portfolio in the late 90s and early parts of this decade. And their credit quality has been very strong throughout. I think lastly, probably the most single significant thing is that we have now taken over $50 million of impairment to our residual. And on one hand you can say this guy has been good about valuing their residuals because it is an environment that continues to deteriorate and there is production offset to that.

But on the other hand we do feel we have the residual, have I fairly valued realty to the underling cash flows and underlying collateralization we have. And if you were to back out the impairment we needed to take in the home equity market segment this time and look at the core earnings of the home equity company on the core business and their portfolio business that mixes portfolio and sale, it is the combination of that strength with the other three factors that gives us the confidence to make the earnings forecast for 03.

I see 13.4 million of impairment net of servicing as of net of derivative gain.

Sy, I'm sorry, when I was saying 15 million I was focusing on the home equity segment and the amount of impairment we have taken over the course of two quarters. It was 33 million this quarter. The 12 million dollars that you made reference to a minute ago is the amount of first mortgage servicing impairment we took in the mortgage bank.

Okay.

You have to use the word impairment to refer to two different things because that's the accounting literature. Impairment of residual and impairment of servicing rights are separate issues.

So just focusing on mortgage banking now, I understand the commercial is commercial bank is strong. Are you still saying that the servicing affect will out weigh the drop in origination volumes and margins?

No. We are not making an estimate whereas they earned $43 million year to date. We are not making an estimate they will earn 86 million dollars in that segment.

For the full year.

For the full year. But what we are saying as production declines there we will have -- we believe we will have a fairly significant offset in the reversal of servicing impairment in that segment and then added to that the other three aspects I talked about.

So in the other three aspects, what change since you gave that second quarter guidance to at that time you were expecting stropinger mortgage banking in the second half. You are no longer expecting stronger mortgage banking, but you are still saying you are going to earn more than 225.

The perception that there will be a decline in production in the second half if rates stay at these levels offset by the increased value in service in portfolio.

So you're saying that the servicing value increase will be greater than --.

No we're not. In both cases we said we thought we would earn at least $2.25. We didn't say exactly $2.25. So we didn't define a set to cause you have a one for one offset.

Also, the other thing we should acknowledge that changed from the preannouncement to today's announcement is that in the preannouncement we said we expected earnings to be significantly below the first quarter which was 41 cents. We came in above the first quarter. So in the process of closing the books and reviewing all of the precise elements of the residual -- new residual models and also getting more up-to-date information on secondary marketing gains in the first mortgage business, there was a shift in the actual second quarter results that also plays into the -- at least 225 manage. -- figure.

Okay. Thanks.

Our next question is from Darius Brown. Please go ahead.

Good morning, gentlemen. Just keeping in tradition with the other questioners, a couple questions with respect to the servicing asset.

Sure.

Can you -- can you sort of break down for me what percent of that is 30 year fixed paper and what might be hybrid arm paper? The 24 billion underling?

Darius I don't have those numbers in front of me. We traditionally have not been an as strong an arm originator as we have been a fixed rate originator. Historically that number is in the 75, 25, 80, 20% range in terms of fixed versus arm. We have been, just like we have been anticipating higher interest rates and doing the servicing portfolio we have been working at the mortgage company to develop additional arm products and we would expect those to pick up in a percentage of current production if rates stay up at these levels, especially with the curve.

Can you comment in terms of the age of the portfolio. For example, 50% is x months old. Give us an idea how new it is?

We can give you a high level. I don't have the numbers in front of me. But I know we looked a couple quarters ago at how many -- what percentage of our loan has been originated within the last two years. And it was the preponderance of it. It is actually a remarkably young portfolio.

Okay. And the underling barrow betters, are they mostly higher fica scores.

We sell all those off to Fannie Mae. So it is people who meet their guidelines. Either in the -- there is some expanded approval. So it is all under written --

it is all conforming paper. And the next question I had had to do with the write down to the residual. That pertained to the off balance sheet loans under written to old guidelines. What percent of those ol balance sheet loans was written to guidelines. It was all of them?

All of the loans were under written to all the 850 million dollars worth of principal balance loans that underlie the residual were written to quote unquote old guidelines.

Okay.

But the distinction I was trying to make earlier, by definition, they were the guidelines that were in place at that time. But the distinction I was trying to make was the distinction between the loans that we have made since the 4th quarter of 02 and our ability to analyze and make judgment busy their expected performance of those loans because there were some of those $850 million of the loans we made between 95 and 02 that would have made it under today's scoring. I think it is roughly half.

Okay. And then the comfort you expressed, I guess, with your on balance sheet portfolio since November of 02, you know, those lines are -- those loans are kind of -- well, they are quite young. Can you comment on what is giving you comfort?

Maybe Will can take a shot at this. Because my answer will be for the third time the same one, that I tried to explain with the regard to the sense of our ability to analyze loans that have been in our portfolio since 1995 that would have met today's underwriting criteria. So maybe Will can give as you third try.

Imagine if you will going back in time only lit clear and saying, here is a group of loans that have the same characteristics as our new guidelines currently in place. Let's look at how they performed over this period. There are some old loans that don't meet the characteristics of what we do today. But we just look at the subsets that do. s that what we call inside current policy. And -- that's what we call inside current policy. We are basing it on what we do today on the behavior of loans that have similar characteristics to what we are producing today as they have behaved over the past several years.

And those older pools this early in their lost curves, was the performance similar to the other loanss you originated?

We built a seasoning curve that takes into account the way the losses come in over time as the portfolio seasons.

And the current pools are consistent with the pools from 99?

Yes.

Okay. Thank you.

Our next question is from Eric Feld. Please state your question.

Yeah, I was just curious if you could help me understand a little bit what changed from when you guided down -- when you said you had earned less than in the previous quarter and you actually earned more. Did you end up writing down the residuals less than you anticipated writing them down?

Yeah, Eric, we earned 4 cents more in the second quarter than we did in the first quarter. When we safe guidance in early July we gave it long before we had the books closed, long before we typically have the book closed. But at a time that we knew that changing our forward outlook on losss in the home equity loans will have a significant impact on impairment for the quarter. Giving guidance is not our normal practice. But we did it because it appeared to us that frankly the market was not incorporating guidance that we had provided in our ak filing in early June that talked about the likely residual impairment we were taking. We did come out above the first quarter. That's that not where we were expecting to, in early July, but we came out 4 cents above the first quarter. But frankly we thought given the fact that the market didn't appear to be listening to the guidance we provided in middle of June, we thought it better to give directional guidance rather than no guidance.

The guidance in early June specifically was, we will take significant residual impairment. It was in an analyst presentation and we put it out.. There we became concerned that it was not being factored in so we wanted to signal that. As we closed the books, we did refine the estimate of exactly how much residual impairment we needed to take. And we also got more information on the secondary marketing gains in the first mortgage business which changed the numbers between what we knew at the time we made the first release and what we released today.

Those were the two primary factors.

Was one more of a factor than the other?

Yeah, but --

they were both significant.

Okay. Thanks.

Joe Sieber is back on-line with a question. Please go ahead.

Greg, I want to go back to the residual for a second. I want to do some math. The residual now is now valued at 903 million -- 93 million. But if you break that out between the credit enhanced io strip and the noncredit enhanced io strip and basically the irregular laterss say the credit enhanced strip is what they are, quote unquote, more concerned with. Is it fair for me to take the percentage that you use in the following sentences because I calculate that actual your credit enhanced part is not on only 17 million dollars of the 93 million dollar current evaluation, am I doing that math correctly?

Joe, looks like you are going down the right path. We have the residuals valued at 93 million dollars.

Right.

That's a discounted value because we use discount rates that range between 18 and 25%. So the underling undiscounted cash flows as we point out in the release are 124 million dollars. And of those 124 million dollars there is about 102 of over collateralization. Already collected excess in the SOC. Another 22 million dollars, here is your ceios and another 22 million dollars undiscounted cash flow that we expect to collect on a go forward basis. So, we -- in that one portion of the release we do mix discounted figures which is the caring value because we have to discount it and we use the 18 and 25% discount rates and undiscounted figures to give some sense of the underling cash flows and as we break those down, that 22 million dollars is what we have to collect. The 102 has been collected through excess spread. When you take the sum of those two and get 124 million and discount those back you get the 93 million. You used 17 million dollars ands that pretty darn close.

So I am in the right neighborhood.

Absolutely.

Sos that -- so that really becomes the risk -- I don't want to say the only risk because in theory the whole residual is at risk on a pretax basis. But if you look at the credit portion, the 17 is the credit risk portion of the puzzle right now.

Depends on what you mean by risk. We have the fair market value of the entire -- residual exactly.

Personally I think of it is a 92 million dollar asset we have to value fairly every quarter.

Every quarter. Okay.

The split we make is intentional that of the numbers that we quote in there the over collateralization is represented of excess sprid that we have collected over time -- excess spread that we have collected over time.

It is already in the bank in some respect.

It is in escrow account. That's how to think of it.

I wanted to get that distinction and make sure I was doing the right math. Okay.

Is there any additional questions, please press the 1 on your touch tone phone. There are no more questions at this time.

Sandra, thank you very much. We appreciate everybody's attendance this quarter and we look forward to talking to you after the third quarter results.

Thank you, ladies and gentlemen. That does congress clued today's teleconference. Thank you for participating and you may now disconnect.