摩根士丹利 (MS) 2005 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the Saxon Capital Incorporated first quarter earnings call, at this time all participants are in a listen-only mode.

Later we will conduct a question and answer session, giving instructions at that time.

If you should require assistance during the call, please press star, then zero.

And as a reminder today's conference is being recorded.

I would now like to turn the conference over to Vice President of Investor Relations Bobbi Roberts.

Please go ahead.

Thank you and good morning and welcome to Saxon Capital's first quarter 2005 earnings conference call.

I have with me this morning, Mike Sawyer our CEO and Rob Eastep our CFO.

We issued a press release yesterday which is available along with our summary of financial data on our web page at www.SaxonCapitalInc.com.

As is customary I would like to begin with the following information on forward-looking statements.

Statements in this discussion reflecting our future plans and strategies are forward-looking statements that are based on current expectations and assumptions.

These expectations and assumptions are subject to risk and uncertainty which could affect our future plans.

Saxon's actual results and the timing and occurrences of expected events, could differ materially from our plans and expectations due to a number of factors, such as changes in overall economic conditions, and interest rates, and changes in the applicable legal and regulatory environments.

You should also be aware that all information in this discussion is as of May 6, 2005.

We undertake no duty to update any forward-looking statement to conform the statement to actual results or changes in the company's expectations.

With that I would like to turn the call over to Mike Sawyer.

Thank you Bobbi and good morning everyone.

We are pleased to announce during the first quarter of 2005 we earned net income of $31.7 million or $0.63 cents per share on a diluted basis.

This is a 61% increase compared to first quarter of 2004 net income and a 5% increase from the fourth quarter of 2004 net income.

For the first quarter total production was 805.2 million a 25% increase compared to the first quarter of 2004 and a 16% decrease from our fourth quarter of 2004.

Our retail production was 202 million an increase of 2% over the first quarter of 2004 and a decrease of 21% from fourth quarter 2004.

Wholesale production for the first quarter 2005 totaled 342.5 million, an increase of 14% from prior year first quarter and a decrease of 10% from fourth quarter 2004.

Correspondent flow production was 222.8 million for the first quarter an increase of 101% over the prior year's first quarter and a 15% decrease compared to the fourth quarter of 2004.

Correspondent bulk production 37.9 million an increase of 16%, compared to the first quarter of 2004 and a decrease of 41% compared to fourth quarter 2004.

At March 31st, 2005 our net mortgage loan portfolio grew to $6.1 billion an increase of 24% from March 31st, 2004.

The serious delinquency ratio in our net mortgage loan portfolio decreased to 5.7% compared to 7.0% one year ago.

On a static pool basis our 2003 and 2004 vintage production is performing substantially better than our 2001 and 2002 vintages, I would like to refer you to our first quarter presentation slides, which are located on our website for detailed graphs of our static pool delinquency curves.

We also purchased third party servicing rights for approximately $3.1 billion of mortgage loans.

As of March 31st, 2005 our total servicing portfolio was grown to 21.5 billion an increase of 112% from March 31, 2004.

I'm going to discuss briefly our announcement on May 4th regarding the divesture of some of our retail branches to Bravo Credit Corporation.

Over the course of last year our management team has devoted significant amount of resources to evaluating our long-term business model.

In order for our company to compete at the highest level we must operate from a platform that provides efficiency, flexibility, optimal productivity and scale.

The transaction announced on Wednesday will expedite our evolution process and the development of our new retail lending platform.

We will focus our energy and resources on growing our retail originations through a more efficient network of strategically located retail mortgage centers and our three centralized call centers located in Virginia, Texas and California.

This platform will allow us to streamline our processes, increase efficiently and productivity and enhance our training efforts while reducing our overall production costs.

The existing retail mortgage centers and three centralized call centers are the future for our retail business and we will invest significantly in their growth.

With that overview I will turn the call over to Rob Eastep our Chief Financial Officer for a review of the financial results.

Thanks, Mike for the first quarter our pre tax income was $0.55 cents per share versus $0.33 cents per share in the fourth quarter of 2004.

Representing a 67% increase.

During the quarter we have seen our pre-provision net interest margin on our portfolio decline slightly compared to the fourth quarter of 2004.

The approximate 10 basis point decline for the quarter compared to the fourth quarter of 2004 was substantially less than the approximately 60 basis points decline in the fourth quarter 2004 as compared to the third quarter of 2004.

On an after provision basis our net interest margin increased approximately 30 basis points for the first quarter of 2005 from the fourth quarter of 2004.

We saw a decline in our provision for loan losses in the first quarter, which was a direct result of a $68 million drop in delinquencies at March 31, 2005.

Let me review our allowance method again.

As required by Generally Accepted Accounting Principles, we reserve only for assets that are impaired which we define as assets that are 30 days past due.

And our delinquencies decreased by 98 million in one quarter.

Our allowance for loan loss and related provisions for loan losses will also decline.

Let me go over in some detail what we are seeing with our interest margin, primarily our first quarter borrowing cost and related hedge activity.

For the first quarter we experienced an approximately 50 basis points increase in one month LIBOR.

Approximately 75% of our long-term securitizations are variable rate bonds that are indexed to one month LIBOR.

In addition, our warehouse financing facilities are indexed to one month LIBOR.

This has impacted our borrowing costs as we saw our borrowing cost rise to 3.7% from 3.5 % in the fourth quarter.

This would be a good time for me to remind everyone again that we do hedge our variable rate financing costs over the life of the debt in order to protect our interest margin.

Because of the P&L recognition requirements under FAS 133 there may be an immediate impact on our net interest margin in either direction due to changes in one month LIBOR, compared to the impact of anticipated changes in cash flows for the hedges that are included in other comprehensive income and shareholder's equity on our balance sheet.

These changes in the hedges are recognized into earnings over the expected life the of the variable rate bonds.

This is an important point, because there may be short-term mismatches and changes in our borrowing costs and the effect of our hedges, but over the term of our debt, the hedges effectively protect the interest margin.

This mismatch tends to be magnified in the transition period of a rate cycle change which we have seen in the later half of 2004 and into the first quarter 2005.

As I stated in our fourth quarter call, we expected based on the first quarter rate environment that our cash flow hedges would positively impact our net interest margin.

We did experience a positive impact of 255,000 in this quarter compared to a negative impact of 2.1 million in the fourth quarter of 2004.

This provided a swing of approximately 14 basis points, which helped offset the increase in one month LIBOR.

We also recognized an unrealized hedge gain of 22.1 million on a pre-tax base, which is reflected as a competitive shareholder's equity in the accumulated other operation income on the consolidated condensed balance sheet as of March 31st, 2005.

We expect this unrealized gain will have a positive impact to earnings as it's accreted into the P&L in future periods.

I mentioned before we have seen an improvement in our portfolio's credit quality and we are pleased with the performance in the portfolio as we saw a $98 million drop in delinquency and a 2.1 million drop in charge offs compared fourth quarter and a $4.5 million drop in charge offs from the first quarter of 2004 while our own balance sheet grew 25% year-over-year.

In addition, we continue to expect to see lower projected losses on our 2003 and 2004 vintage portfolios when compared 2001 and 2002 portfolios.

As Mike previously said this information can be seen graphically on our first quarter presentation, located on our website.

We continue to expect the performance of our later vintage portfolios to have a positive effect on our net interest margin after loan loss provision in the future.

With the improvement we saw our allowances as a percentage of the net interest loan portfolio decrease to .55% at March 31st compared to .69% March 31, 2004.

This decline is due to the aging and run off of the '01 and '02 portfolio and the strong credit performance of our '03 and '04 portfolio and the decline in Q1 delinquencies.

Our 2003, '04, and '05 vintages make up approximately 83% of our March 31, '05 portfolio and on a static pool basis the expected losses are projected to be substantially lower than our '01 and '02 vintages.

Our allowance as a percent of both delinquency and serious delinquency increased slightly at March 31st compared to year-end 2004.

Saxon's third party servicing portfolio grew to 15.5 billion at March 31st as compared to 5.2 billion at March 31, 2004 and $14.2 December 31, 2005.

This investment is generating gross servicing revenue for the company's third party portfolio 24.3 million for the first quarter of 2005, an increase of 10% over of the fourth quarter 2004 and 98% over the first quarter 2004.

During the first quarter with the growth in our mortgage servicing rates balance we did experience increased amortization expense on the MSRs.

The first quarter was 2004 amortization was approximately 25% higher than the fourth quarter 2004 and 89% higher than first quarter 2004.

We expect amortization expense to continue to increase with the growth in the MSR asset balance as we continue to grow our third-party servicing portfolio.

Now let me turn our attention to G&A expenses.

We did see a $2 million decrease in gross operating expenses in the first quarter of 2005 compared to the fourth quarter of 2004.

On an after FAS 91 deferral basis net G&A declined 400,000.

We did incur 300,000 of non recurring expenses related to the closing of four retail branches in the first quarter.

As Mike outlined our change in the retail strategy we do expect a reduction in operating expenses with the retail business with increased efficiency and a lower cost produce.

In our servicing channel cost to service decreased 4 basis points or 17% from the fourth quarter of 2004, primarily due to the absorption of capacity, and increased operating efficiencies.

We do expect to see continued improvement in our cost to service in 2005.

On the origination business, on a year-over-year basis we continue to see improvement in our efficiencies and the G&A component of our net cost to produce.

This cost was 293 basis points for the first quarter of 2005 as compared to 332 basis points for the first quarter of 2004.

Please note this metric does includes premium paid and represents a 12% improvement.

With our continued investment in technology and our production platform and the announced reorganization of our retail channel, we do expect to see continued improvements in G&A efficiency in the loan production in the second half of 2005.

In addition, to the tax impact of the REIT items, such as dividends paid reduction,GAAP requires that the impact of intercompany transactions, such as the sale of loans from the TRS to the QRS must be eliminated.

The net tax affect of eliminating these transactions contributed to the additional tax benefit in the first quarter.

As we have stated in prior calls, the company is undertaking steps to reduce the difference between GAAP and tax earnings.

In April the company began table funding loans in the REIT which will help us achieve this goal.

With that I would like to turn the call back over to Mike.

We are once again pleased with our overall performance this quarter in a very tough competitive environment.

Our goal is to be increasing our efficiency, improving our customer service, and growing shareholder returns.

We look forward to an equally successful second quarter in the reminder of 2005.

I would now like to turn the call over to our operator so we can take any questions from our listeners.

Ladies and gentlemen of the jury, if you wish to ask a question please press star and then 1 at this time.

You will hear a tone indicating you have been placed in queue and you may remove yourself by pressing the pound key.

If you are using the speaker phone please pick up the handset before pressing the numbers.

Once again if you have a question please press star and then one at this time and please hold for first question.

We have a question from the David West, Davenport and Company.

Please, go ahead.

Good morning.

Good morning, David.

Mike I just wondered if you would talk little bit about the competitive environment out there.

I know in the past, the last call, I know that you particularly cited that certain competitors were doing some disruptive things.

Could you kind of update us on your feelings about that now?

One of the two major players has backed off and sort of come back with the pack in terms of pricing.

However, the market leader continues to price at what we believe is an uneconomic origination rate.

We have seen some players come in and out of the market in terms of doing special rate programs, but the thing that concerns me the most right now, at least what my competitors are doing, not Saxon, is that we are starting to see and in past cycles this has run the cycle, but since the competition has found that they're pricing at break even to a loss, pressure has eased slightly on margins, but they're now starting to compete on credit quality.

We don't support this and we will not follow it.

However, this is not the first time this has happened and I believe it will run fairly shortly, strictly because the ability of the bond markets to finance this debt has gotten much greater with their ability to model risk and to do due diligence and I think it will be a fairly short time before discipline is re-inserted in the market.

And you sold about 20% of our production this time, this quarter, would you kind of anticipate that level of activity currently going forward?

Actually, no.

I don't anticipate that we will sell that much of our production.

We have seen an improvement in our margins.

And our credit quality continues to remain stable to slightly better.

There was, -- the pressure in the early first quarter production on margins was such that while they were profitability loans, as could be seen by our one 1% net premiere gain when we sold them, they were not such that they exceeded our desired return on investment threshold.

So by selling those loans I was able to spread the cost of origination over a larger base, while still earning a point in profit, however that is not our long-term goal.

Our long-term goal is to grow the portfolio over the long-term.

So I don't expect that we'll see loan sales of that degree on a regular basis, but it all depends on where the market goes.

Is the market for loan sales pretty active?

It seems like, from what we have heard on some other calls the market remains fairly robust in terms of demand.

Absolutely it is, but again remember our primary goal is not to sell in the market, but to originate and hold to term in the portfolio.

So that is really where we are focused.

Okay.

My last question and then I'll get off.

Rob you mentioned towards the end of your comments that starting in April you began doing some funding within the REIT, that would reduce the difference between GAAP and tax.

Could you go into a little more detail on that please.

Sure.

What happens now currently or what happened prior to the table funding and the table funding let me just reiterate, we are doing in the retail channel and is only on 25% of our production.

As we get licensed in the REIT and other states we'll increase that.

But currently what happens is that the loan is originated in the TRS.

The TRS sells that loan to the REIT, which creates a premium at the TRS basis.

When the QRS originates the loan there is not a premium paid and the REIT is able to take a deduction of taxable income, the cost to originate that loan.

So that better matches how that is accounted for from a GAAP standpoint and will reduce the difference between GAAP and tax.

Thank you very much.

Thank you David.

Our next question comes from Scott Valentin, FBR.

Please go ahead.

Thanks for taking my question.

You guys touched on this in the comments;

I was hoping you could get a little more specific.

On the cost to originate I think it ran about 3 1/4 for the quarter.

It down from last year, but up from last quarter and I know you guys are taking steps to try and improve that and increase efficiency.

And could you talk about where you see it going and some of the things you are doing to improve efficiency.

Well, there are several things Scott.

First of all, we have had a continual quarter-over-quarter decrease in our cost to produce and it's been very consistent over the last three years.

The transaction conversion to the REIT kind of upset that last year in that we had expenses that were related to the deal.

However just this quarter we closed four, of the retail branches, and also sold another several branches to Encore Corporation.

And the reason for that is that we have looked at the business and we feel that having a smaller geographic footprint with larger centers that can be managed by more experienced and higher level people is a more efficient way to go in the retail business.

We tried the branch, the large fixed cost branch network and we just couldn't get it to work with the quality of the business we want to do.

So we took probably, Rob -- what would you say was the charge in the first quarter?

300,000.

300,000 and we are expecting cost-savings over the reminder of the year after the deal with Encore of $1.9 million per month in reduced G&A.

I guess with the closure of the branches and centralized retail platform is that more? of a call center type of operation?

Yes, it is.

And we have done very well on that environment in our Fort Worth retention unit, which is in our servicing center and we feel that we can lever off that experience and how well they have done expanding that and creating the same here in Richmond and out in California.

Scott, this is Rob too on the $1.9 million per month savings, keep in mind that we are going to grow those centralized units in Virginia, Fort Worth and California.

So approximately $900,000 of that $1.9 million is payroll savings of the branch network.

That we would expect --

Over time.

-- over time to invest in the centralized units, but you are looking at about $1 million of fixed cost, you know true brick and mortar cost that would be pulled out of the retail branch structure.

Okay and then one final question, before I let someone else asks.

On origination volumes you guys had 25% increase year-over-year, is the change in the retail going to affect your origination growth and it will be less than you thought?

Yes, over the short-term, we are looking at about a 35-40% drop in the retail from the branches that were closed and sold.

However, we expect that very shortly we'll be able to recover that volume as we get into -- because we are going to use some of the savings to expand marketing and leads coming into these centralized centers so we are very confident that we’re going to hit our yearly goals and we just think this is a better way to do business.

Thank you.

and our next question comes from Richard Shane, Jefferies and Company, please, go ahead.

Hi Rich.

You there Rick?

Thank you Mr. Shane, please, go ahead.

Can you hear me?

Now we got you.

Sorry about that.

Rob, you mentioned sort of the reserve policies and the reduction of the reserve this quarter and that makes sense given how much losses came down.

The question I have for you is this though, my understanding of reserve policies is that it's supposed to be based upon 12 months anticipated forward losses.

And when I look at your numbers now, you are showing a $33.5 million reserve and if I annualized the charge offs, the absolute dollar charge off in the first quarter, that gives about $35 million.

Are you expecting the absolute charge offs on a dollar basis are going to continue to go down as sharply as they have the last couple of quarters, and can you factor in sort of the seasoning of the portfolio as we look into that?

I mean I understand the credit quality is improving, but I'm wondering as the portfolio seasons as you add new loans, if that is really a realistic assumption and can you talk through that?

Okay well first of all, Rich, this is Mike and the short answer to your question is yes, we expect fewer losses as the portfolio continues to age and the '01 and '02 continues to pay off.

As Rob had said of March 31st, 83% of our portfolio is 2003-2005 volume.

Now that is a simplified way of looking at reserve policy.

Our reserve policy hasn't changed since before we were a public company, and what you have to remember is you can only reserve against loans that are delinquent and even though the portfolio grew over $100 million our delinquencies total deliquencies dropped by $98 million.

So the way that the reserve works when you take the charge off, it goes charged against the reserves and then you put reserves up against new delinquent loans.

When you have fewer delinquents loans your reserve goes down and unfortunately as our good friends at Freddie Mac found out you can't reserve against loans that are not delinquent.

So we feel very comfortable with not only where the reserves are, but if you do take a look at our static pool delinquencies and compare year-over-year from '01 to '05 you will see it makes very much sense.

And, in fact, our percent of reserves against serious delinquent loans was actually slightly higher from year-end.

It's just we had so much fewer seriously delinquent loans

Got it, I guess another way to help us understand this, Mike, is that when you look at older vintages, and I know that within your securitizations you will these assumptions imbedded.

What were the old cumulative lifetime loss assumptions, based on the credit quality versus the type of stuff?

Yes; for 01 and '02 -- and again you never know when these things are go going to be called, but assuming 72-month life of the trust just on average, we are looking about just under 5% losses on '01 and for '02 somewhere in the neighborhood of 3.5 , whereas, with '03, '04, and '05 we are looking significantly under 3% after seven years out.

So you can see and if you track the losses and then look at the delinquencies in the pools -- and these are all just model and anything can affect those changes -- but if you look at delinquencies, the delinquencies static pool to date are performing actually better than what we had originally modeled out

Okay and so you really are anticipating that the loss rate, the cumulative loss rate could be down 40% from '01 to '04.

Should economic conditions stay the way that they are and delinquencies continue the way they are, that would be an accurate assumption.

Great, thank you.

Rick, one other point on the '01 and '02 we have actually hit the peak of losses on those and losses are coming down.

And on the '03 and '04 securitization, the rise up towards the peak is not anywhere near what the '01- '02 slope was.

Okay.

Makes sense.

Thank you guys.

And we have a follow-up from Scott Valentin with FBR, please, go ahead.

The growth of the REIT portfolio it looks like -- and servicing portfolio looks like pre-payments were exceptionally high this quarter, could you comment on that?

Yeah, I will let Rob give details, but we had one – on the third-party servicing we had one deal we bought in 2003 that has had an unbelievable amount of pre-payments.

So we took an MSR adjustment against that; and Rob do you want to talk to that?

Yes, Scott on the deal that Mike is talking about, obviously a substantial increase in pre-payments on that portfolio, but in general, speeds were slightly slower than the fourth quarter on average they were 35% CPR speeds for fourth quarter of '04 compared to 34%.

So just a little bit slower, but there are pockets of the portfolio, for example, 2003-1 had almost 51% CPR speeds as some of those loans hit the reset dates on that.

Okay.

And Mike, you mentioned earlier about people, you know, you are starting to see some irrational things in the market.

I also noticed that -- not that IO's are irrational, but your IO production is going up dramatically and is that a response to the market or is there any thing your doing differently from ?

No, I think it's a good product.

I know that rating agencies aren't comfortable with it yet, but the criticisms I hear of the product, though, don't make a lot of sense to me, especially how we underwrite the loans.

And the structure of our loan is slightly different also in that the customer has a reset on the interest rate and payment only three years into the deal and then it resets again and re-amortizes five years out over the remaining term.

But if you take a look at pre-payment behavior in this business, you would see that by the time you get five years out in the trust, there is very few of these type of loans left in the portfolio, because of what our customer does.

Our customer has a constant need for cash and they historically have refinanced.

There is no negative amortization in our IO product.

It has a significantly higher average FICO and lower LTV than our other products.

So overall we are very comfortable with the IO.

Now, the things that I'm seeing and I can't name the competitors, but we see it in the marketplace.

I have sales people bringing me stuff all the time is that they are doing credit specialize like I have one very large competitor that's currently got a flier out that states they will do a 580 FICO 100% Stated LTV loan with one times thirty on the mortgage in the last 12 months.

Well if you want to do that, that's fine, but Saxon is not going to do that business.

So we'll see what happens.

And they can hide it in t their portfolio for a certain amount of time, but sooner or later it's going to get them.

And then just a REIT structure question, actually two questions.

One, you guys had another tax benefit this quarter.

Does that reflect just a loss?

That is directly attributable to the transfer pricing deductions we get within the REIT when TRS sells the loans to the QRS, the REIT.

And that is when we began to table funding our retail business in April, which will help reduce that, and we expect by the end of the year any loans that we're not holding for sale will probably be table funded out of the REIT to line up GAAP income and taxable income.

Okay.

And so that tax benefit, then, will diminish over time?

We expect so, yes.

And then a second question on the structure.

As far as cash flow goes, was cash flow sufficient to pay a dividend or was there a little bit of repayment of capital?

And did the REIT earn the dividend for the quarter?

The REIT definitely earned that dividend for the quarter and from a cash standpoint the cash generated from the business was more than sufficient to pay the dividend.

Thank you.

Thank you.

And our next question comes from Alan Fournier, Pennant Capital, please go ahead

Good morning.

Mike, first question I had was regarding the retail channel and it sounds like you have a plan to improve.

I guess I would like to understand what it was that failed in the model that you had implemented?

A couple of things.

First of all, the management that we had out in the branches tended to be rather young, and if you are familiar with non-prime mortgage branch networks, that tends to be the case.

We found a high level of turnover as, if we get anybody who was any good who sold our discipline, then people would come and raid and take them away and they'd walk out with several of their good loan officers with them.

And so we had a turnover issue.

The second thing was given where margins continue to go in the market, I don't think we're going to have a squeeze as bad as it was in the last quarter.

I think rationality and profitability requirements will return, but I do see that over time margins will be compressed, just as we've talked about for a couple of years now.

And the fixed cost of having a bunch of branches out there, just in my mind, I cannot rationalize that unlike the Citi Financial and HSBC models, we do not do high-cost loans, and we don't sell credit insurance.

So not having those methods of generating higher margins and profits, we just felt we could not justify all of that fixed cost.

Now on the other hand we have been very successful in our centralized operations and there is a whole bunch to it.

When you got somebody managing 50 or 100 people, you can go out and afford to get an experienced high-quality, big player.

You have better opportunity for pricing discipline.

You have quicker turnaround and response for underwriting and you have much greater opportunity to train people and in a larger environment they see more opportunity for career enhancement.

And so we think that the plan that we have and Mr. Smith is in the process of executing is at least for the way Saxon does business, in terms of pricing discipline and credit quality discipline, we think this is a better way to go than what we with were doing in the past.

And we have been working on this for a year.

Could I ask a question?

What is it that competitors could offer these successful, young managers that Saxon was unwilling to offer?

Less discipline in both pricing and credit quality, which means easier way to get loans and make more money.

I see.

And you know, I don't hide from that.

If you want to work here, you have to have the discipline.

Okay.

Did I hear you say in your comments that the savings from these branch sales would be $1 million per quarter or per month?

Approximately over the remainder of the year, there's about $1 million a month in fixed costs that we sold off and have closed.

And then there's about $900,000 a month in payroll-related expenses that we will see over a shorter period, but as we staff up the call centers, some of that will then get added back into G&A as we grow the business.

Okay.

But a million is a good number.

Okay.

Now in terms of your comment on the marketplace and saying that you are seeing competitors move into, I guess, worsening credits.

Let me -- not so much worsening credit, Alan, but taking more risk for the price they are getting?

How do you see that?

Because in the FICO scores your competitors are producing you don't see any real change in FICO scores?

Right, well you won't see that now.

Okay, but what you are seeing is look at the average LTV by FICO band when you look at their numbers and then you look at ours.

That is where you will see it, because basically what we would have called a "B loan" or an "A- loan" at best and maybe done 90% LTV on, I have a competitor out there going 100% LTV and doing it at an A rate.

Okay.

(Multiple speakers.) Don't actually see it in the numbers, but where you want to look is look in the production broken by FICO bands and watch what is happening to the LTV and that will tell you if they are pushing credit band or not.

Thank you.

Two other quick ones.

In terms of your comment about uneconomic rate in terms of the current marketplace, how does your cost to originate versus your competitor's factor into that?

Because --.

It's not so much the cost to originate, because that is a small thing.

What I was talking about is just especially for the current market leader, just the gross IO that is left after securitization of the loan and/or originating loans and selling at a premium that is less than his reported cost to originate -- and that is fine.

They can do that.

I have a different message for my shareholders, which is over the long-term grow the business approximately 20% a year.

Keep leverage under 15-1 and achieve at least 18% to 20 % after tax return and do that consistently quarter-over-quarter-over-quarter.

And for four years that is what we are doing and continue to do that.

Now in a short period of time like the last 90 days, did I sell off some loans that I could have put in the portfolio?

Yes, I did, but those assets maybe would have returned us 12-15% after tax.

And I would much rather put assets that return me in excess of 20% after tax.

So my last question actually was on our leverage which I guess is around 10-1?

We're about 10-1 now .

Up from about 7-1 at the deal time.

I guess it's sort of a challenging environment to get to you know, a more optimal level of leverage.

That is correct.

However, if you think about it, in terms of a long-term view, versus short-term view, I have a couple of pretty large competitors that the market seems to favor right now, that are going to need to raise capital fairly soon.

And their stock prices are all fairly depressed.

Why are they going to have to raise capital.

Look just at their growth rate.

They can't continue to lever.

If you start levering up past 16-17 to 1, not only do you bring tremendous instability into your balance sheet and your ability to service your debt, but you also start pushing up against a liquidity covenants with your lenders.

So if you look at their current rates of growth and their ability to generate capital, they are going to have to go out and raise some capital pretty soon or slow their growth rate, one or the other.

Or just sell more loans.

Right, that is true, which will slow down their growth rate.

Grow their balance sheet, you mean?

Right, so what we did, is we went out and raised capital at a time when we thought it was the most efficient time to raise it.

We said right up in front when we want to raise the capital this is enough to last us the next two and a half to three years and that we don't want to go out and have to dilute the capital again.

That is why we are currently under-levered.

However, I do see in the quarter we had annualized about 19.8% after tax return, even at a 9-1 leverage ratio.

And I think that as we continue to do and stick to our disciplines and grow the business, that we will be able to lever that up within the time period that we first committed to when we raised the money.

However, the one thing I don't want to do is should there be any kind of a liquidity crunch in my marketplace, I don't want to have to slow my consistent growth down, because raising equity at that point in time would be too dilutive and I would have to sell stock too cheaply.

Right.

So I guess that answers my last questions, which is, is there a price to book level at which you'd consider buying back stock to increase leverage?

And it sounds like your preference would be to hold capital for a better environment?

My preference at this point in time is, however, you know, like I said Alan, I never know whether the board may make that decision in the future;

I don't know.

But right now our commitment is to continue to grow the business and we are doing so.

Okay, Thank you.

And ladies and gentlemen, we do have time for one more question.

We have a question from Andy Wagsap [ph] TouchStone Investments.

Hey Mike how are you doing?

I wanted to ask you just on this credit issue.

One of the benefits of your third-party servicing business is that you get an opportunity to audit the files of the other sub prime originators.

And I just wanted to get a sense as the credit mix has changed in terms of what some competitors are doing out there, have you seen any change in the level of fraud, be it appraisal fraud or credit fraud or whatever in the files that you are seeing with the third-party servicing piece?

I haven't seen much of an increase in fraud.

We get, well, I don't know the reverse of adversely selected on the servicing pieces because the loans we are servicing have been sold and gone through due diligence through the street because we are primarily are servicing for investment bankers and they tend to be a much higher FICO score than our own portfolio.

But what I would say is the comments I made in the marketplace, you are not going to see for a while for two reasons.

Generally, given the additional OC level that they would need, with a large pool of this stuff, these loans would not be securitized.

They would be sold off (inaudible) if they could, even if it's at a loss, to help do business.

Right.

So we would not generally see those loans, but if we do see them, you know me.

I will let people know I am seeing.

Right.

In California is there any, obviously California --big piece of puzzle.

And are you seeing any disproportionate trends there?

Or no?

The only thing we have seen in California is that there has been a slow down of appreciation.

It has not stopped.

We have not had any softness in the California market in terms of days on markets to sell REOs, but the days of 5 to 10% appreciation per month have begun to stop.

Right.

And as it relates to your IO business, over the entire portfolio, if you had to basically give me a number for California, I mean California I would guess is a disproportionate share of that IO business?

Is that safe to say?

It's a greater proportion of it than it is a proportion of our total business in California, yes.

But that makes sense.

The product is tailored towards the larger-balance loans to help people afford to get into their homes.

What percent of the California business is being done IO?

I don't have that number in front of me, but we can get back to you with it.

Okay sounds great.

Thanks, Mike.

With that folks, that is all the time we have for questions.

Again we would invite you to call Bobbi Roberts our Vice President of Investor Relations, should you have any additional questions and she'll put you in the touch with the person that will have the answer.

I would again, like to thank everybody for being with us.

It was a very competitive quarter, however we feel that we came through it very well.

We continue to focus on making our business more efficient and on growing the portfolio.

And we are very, very confident in the future of Saxon.

Thank you all and have a good day.

Ladies and gentlemen, that does conclude our conference for today.

Thank you for your participation and for using executive teleconference.

You may now disconnect