摩根士丹利 (MS) 2005 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Saxon Capital second quarter 2005 earnings call.

At this point all the participant lines are in a listen-only mode.

However, there will be an opportunity for your questions and instructions will be given at that time.

If you need any assistance please press star then zero and an operator will assist you off line and as a reminder today's call is being recorded.

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

Please go ahead.

Thank you, John.

Good morning and welcome to Saxon Capital's second quarter 2005 earnings conference call.

Joining me this morning is Michael Sawyer, our Chief Executive Officer and Robert Eastep, our Chief Financial Officer.

We issued a Press Release yesterday evening, 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 risks and uncertainty, which could affect our future plans.

Saxon's actual results and the timing and the occurrence of expected events could differ materially from our plans and expectations due to a number of factors.

We refer you to the Press Release issued yesterday as well as our Annual Report on Form 10K for the 7ear ended December 31st, 2004 for more information about factors that could affect our business and results.

You should be aware that all of this discussion is as of August 9, 2005 and we undertake no duty to update any forward-looking statements.

I'd like to now turn the call over to Michael Sawyer.

Thank you, Bobbi, and good morning everyone.

Before I speak to the Press Release we issued and the results from Saxon, I wanted to take a few minutes during the call to discuss our perspective of the general landscape of the industry and then discuss what we are doing to address the current market conditions.

Words like bubble, boom, conundrum, maybe even perfect storm scenario have been used to depict the current state of our industry.

We continue to see a rise in one month LIBOR.

Since March 31st of this year one month LIBOR has increased 47 basis points and has increased 197 basis points since June 30th of last year.

However, the two to three year swap curve is lowered, which has resulted in an intense flattening of the yield curve.

Regardless, we continue to see aggressive pricing from our competitors along with indications of limited underwriting and due diligence discipline, which is reducing overall margins.

However, the recent moves from some of our peers in the pricing arena may bode well for the entire sector.

Finally, prepayment speeds have remained at the same levels as 2004.

One year ago Saxon's prepayment speeds were around 39%.

For the second quarter of this year they were approximately 38%.

For Saxon this scenario I just laid out for you has had a disparate impact upon us due to the maturity of our portfolio that we have been building since 2001.

The average life of our portfolio today is just north of two years with a high percentage of two and three-year hybrid loans.

With prepayment speeds remaining strong, slower portfolio growth and a more seasoned portfolio, the impact of the margin compression is not diluted by high production.

Competition and interest rate cycles will always exist and it is our responsibility to manage through these times, control our costs and continue to create a value for our customers, our shareholders and our employees.

To counter the implications of the market conditions at hand we have continued to focus on increasing our efficiencies and lowering our overall net cost to produce.

We recognize our hard cost structure and understand that we have made a cognizant decision to invest more in the front end of our loan processing and underwriting.

However, that does not remove our accountability and the necessity for us to operate an efficient business model.

We have taken many steps to improve our processes through automation and are continuing down the path of realigning and refining our processing workflows to create efficiencies without sacrificing our commitment to quality.

As we previously disclosed in our second quarter announcement regarding the divestiture of the retail branches, Saxon has moved to a more centralized retail-lending platform.

We now operate three main origination platforms in Virginia, Texas and California along with a small number of strategically placed branches that can be expanded reflecting the market opportunity provided within those selected geographies.

The new retail lending platform allows us to streamline our processes, increase efficiencies and productivity and improve especially the training and our employee development and leverage marketing efficiency and scale while reducing the overall cost to produce in retail.

We have also refined our back end operations to complement our production platforms.

This realignment now provides a scalability necessary for cost effective production growth.

Our integrated front end and back end platforms provide us with geographic presence and the efficiency to leverage market opportunities while allowing us to serve our customers faster and more efficiently.

Yesterday we rolled out our ideals, automated underwriting and pricing engine.

This new engine integrates pricing and underwriting into one streamlined decision tree that will provide the best loan options and counter offers to our customers.

Not only does ideals improve efficiency and expand functionality, it improves for us the flexibility to dynamically introduce new programs and products into the marketplace.

Backing efficiency is only half of the question, however.

Increasing productivity levels must complement improvements in operational efficiency so that the economics can be fully recognized.

The introduction of ideals will allow us to deploy another phase of our strategic plan by expanding the breadth of our product offerings.

Historically Saxon's origination strategy has been very portfolio oriented founded on solid credit an underwriting discipline.

We will begin introducing expanded product offerings to better align ourselves with the mainstream market allowing our sales force the ability to be more competitive with a full product basket.

Our portfolio discipline, however, will not change.

We will leverage the strong hold on sale market as an exit strategy for non-portfolio assets.

Saxon's disciplined pricing and underwriting culture, our industry leading service standards and talented sales and delivery teams with the expanded origination strategy I just mentioned will make quantifiable impact to our production levels, portfolio growth and continue to reduce the cost of our net cost to produce.

With that introduction I'd like to briefly discuss the quarter.

Saxon reported net income of 19.4 million or $0.38 per share on a diluted basis.

For the second quarter total production decreased 2% compared to the first quarter of 2005 and 17% compared to the first quarter of 2004.

Year-to-date production is flat at 1.6 billion compared to the same period a year ago.

Our net mortgage loan portfolio increased 1.1% since March 31st, 3% since December 31st, 2004 and 17% since June 30th of 2004.

We continue to see a consistent and stable level of serious delinquent loans.

This quarter serious delinquencies were 6% versus 6.5% one year ago.

Our portfolio continues to perform as expected and in line with historical seasonal trends.

Also during the quarter we purchased third party servicing rights to approximately 4.6 billion of mortgage loans.

As of June 30th, 2005 our total servicing portfolio has grown to 24.7 billion, an increase of 118% from the same period a year ago.

With that overview I would like to turn the call over to Robert Eastep to discuss the financial results in more detail.

Thanks, Michael.

As Michael mentioned earlier, one-month LIBOR continues to increase, in turn increasing our borrowing costs but the market has not raised rates on the mortgage assets accordingly with the rise in funding cost.

Approximately 40% of our portfolio consists of loans originated after July of 2004, which is when the Federal Reserve Board began raising short-term interest rates.

In addition we saw total delinquencies increase 103 million during the quarter, which is consistent with the seasonal trends.

Of to 103 million 81 million of the increase was in the 30-day bucket, which is more subject to seasonality.

Excluding the first quarter of 2005, our serious delinquent and total delinquency rates are still at their historical lowest levels.

However, the combination of these events along with the flat portfolio growth and increase of prepayments fees, which accelerated our amortization and deferred loan costs, we saw a decrease in our net interest margin before and after provision for loan losses.

During the second quarter our hedges provided approximately 3.2 million or 23 basis points of benefit in the form of reduced interest expense.

The flattening of the back end of the curve did negatively impact the fair value of our hedges as this reflected in a lower balance of other contents [ph] of income at June 30th, 2005 as compared to March 31st, 2005.

Our portfolio continues to perform well within our credit expectations.

We expect to see lowered projected losses on our 2003 through 2005 vintage portfolios when compared to our 2001 and 2002 portfolios.

Our allowance as a percentage of total delinquencies and serious delinquencies continue to remain stable in the range of 5.5% to 6.5% and 11% to 12% respectively.

The investment in third party servicing generated a gross servicing revenue for the quarter-- for the second quarter of 2005 of 28.5 million or net of amortization and impairments of 17.2 million.

The net amount is an increase of 27% from the first quarter of 2005 and 148% increase from the second quarter of 2004.

During the second quarter with the growth in our mortgage servicing rates balance, we didn't [ph] experience an increase in amortization expense of the MSRs.

The second quarter amortization was approximately 5% higher than the first quarter 2005.

We expect amortization expense to continue to increase as we continue to grow our third party servicing portfolio and as the portfolio seasons.

Let me now turn our attention to G&A expenses.

We saw an $8 million decrease in total expenses in the second quarter of 2005 compared to the first quarter of 2005.

As Michael mentioned before, we are aggressively analyzing our cost structure and work flow within the organization.

We saw our overall costs, net cost to produce decrease to 2.84% as compared to 3.27% in the first quarter, which is a 13% reduction in net cost to produce even as our volume was down 2%.

This highlights that our declining net cost to produce is numerator driven, not denominator driven.

In our servicing channel costs to service decreased 3 basis points or 15% from the first quarter of 2005, primarily due to the absorption of capacity and increased operating efficiency.

We do expect to see continued improvements in our costs to service in 2005.

And with that I'd like I'd like to turn the call back over to Michael.

Thank you, Robert.

Before we open up the call to Q and A from our listeners I would like to say that in today's environment we are now operating in a lower margin business.

I believe that we have outlined how we intend to compete in this environment and operate the Company from a long-term strategic standpoint.

While our financial results have not met the Street's expectations, both Robert and I are focused on the revenue and cost side of the income statement.

We are focused on our portfolio growth and we are pleased with the realignment of the back end operations to complement the new retail lending platform and the existing wholesale platform.

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

[Operator Instructions] And we'll go to Richard Shane with Jeffries and Company.

Sort of a detailed question and then some bigger picture stuff, what was the amortization rate on the MSR during the quarter or what was the amortization cost during the quarter because you show it on a net basis?

Yes, Robert is figuring it out right now.

Richard, why don't you get on the next question and let me get that number for you?

And in conjunction with that is there an impairment that you guys took during the quarter or was it just through the amortization line?

Just amortization.

Yes, Richard, there was no impairment but as the larger the portfolio gets obviously the amortization of the receivable increases.

Got it and you say in the Press Release that there was a billion of MSRs purchased during the quarter with approximately 50 basis points of fees associated with them.

I'm assuming that that's net of amortization.

Yes.

The bigger question is this.

The question I'm driving at is sort of directionally sustainability of dividend but I want to talk about it in context maybe of the loss provision and the loss rate and see perhaps what the taxable number for the second quarter was.

If I take the difference between the actual losses of 9.2 million during the quarter and the provision of 13.5, that adds back 4.3 million for me, which is about $0.09. $0.09 takes you to roughly $0.47 for the quarter with a normalized-- you know with a provision equivalent to the charge-off rate?

That is approximately correct, Richard, and we do have-- is it in the Q?

Yes, Richard, in the 10Q this time we're going to have a reconciliation of GAAP tax, which will go into elaborate on the differences that you were dead on in your analysis of the allowance.

The other impact is the difference between Inter-Trust [ph] and Remicks [ph], which has a positive impact as far as GAAP versus taxable income.

There was taxable income for the quarter equivalent to the $0.55 dividend?

Yes, for the quarter taxable income is $29.7 million.

29.7?

Yes.

That's correct.

Versus GAAP of 21.7.

Now do you expect that over time the difference that-- they'll converge and so that tax will come down?

Yes, over time.

There's a difference between the two, yes.

There's one other thing I think, Richard that was a negative impact to us.

As you know, we've hedged quite a bit of our portfolio and our interest rate exposure but our hedges are generally out of money hedges and we also expect to see a reversal in the effect of the hedge on our earnings in the third quarter.

Just two dates since June 30th the value of our hedge portfolio is out in excess of $15 million.

Since June 30th?

Since June 30th.

And where does that run through on the P&L?

That's in other contents [ph] of income of income.

Yes, it goes in other contents [ph] of income and gets amortized or accreted into the P&L as a reduction of interest expense.

Okay and that happens over sort of a two-year life?

Correct.

That's correct.

And so I mean not to try to put too fine a point on this but let's talk about dividend.

Where do you think dividend is going given you know, you guys have been very frank about lower margin business--

Right.

-- timing differential--

While we don't give forward-looking statements, Richard, what I would say is that we are comfortable right now with the level of the dividend today and I don't expect to see any changes negative to that, at least as far as I can see going forward.

The dividend, and I should remind everyone.

The dividend that was paid out today was a percentage of our taxable income and we were cash flow positive with that.

Got it.

Okay, well I've asked a lot of questions.

If I have anything else I'll come back into queue.

Thank you guys for your frankness.

Hey Richard, real quick here your question on the amortization is approximately 29 basis points.

All right, thanks Robert.

Next question please.

Next we'll go to Scott Valentin with FBR.

Thanks for taking my question.

I also appreciate your color on the industry.

As far as the margin goes you guys mentioned that I guess there was a 23 basis point benefit to the margin this quarter from the hedging.

Could you talk about maybe-- you mentioned in the Press Release that your deferred amortization costs, the amortization of that was up 94% in the quarter probably had something to do with prepays but I imagine it also had an adverse impact on your--

Yes, I mean if you listen to most of the earnings calls, Scott, over the quarter, just about everybody has been impacted by the same thing.

As you know under FAS91 you defer some portion of your origination costs and when prepayment speeds accelerate you also have to accelerate that amortization.

Robert, if you want to address the numerical piece of that?

Yes, and Scott the amortization was about a 44 basis point increase at amortization quarter-over-quarter, first quarter versus second quarter.

The hedge I guess would not be designed to offset that?

The hedge is more of just a--

Yes, the hedge is not related to the prepayments.

Okay, and also could you talk more-- I know you went through a lot of detail on the back office and the consolidation of the retail platform but, and congratulations on lowering your costs originating as you said through the numerator, not through the denominator.

How much, that being said you guys, the market is still probably below you for most of the players and if we're in kind of this environment people taking lower returns I imagine a lower cost to originate allows them to sell loans at a cheaper price and can you address where maybe you see costs originating going to?

How much more do you see being able to cut that number?

Yes, well I think that the savings that we have incurred over the last nine months, actually-- I mean if you recall we began this in the third quarter of last year-- have not been fully realized and I think that you'll see a continuing decrease in our cost to produce.

I think the other thing is that we are pretty well done with reductions and restructuring of the platform and the management team and that we are returning to a growth mode.

But just to give you some raw numbers, since January 1st of this year while keeping volume relatively flat we have reduced 152 positions in all areas, approximately 130 in retail, about 18 in wholesale, 3 in correspondent, while adding 50 people to the servicing operation as that portfolio continues to grow.

If you're talking about total run rate per year, we are estimating and you've seen some of it at least $17 million a year in reduced operating expenses while maintaining not just the volume but having a platform that is leverageable and leverageable on an increasing efficiency basis.

I have to tell you that we are quite aware of the need to increase our originations as compared to the runoff in our portfolio.

However, we chose cognizantly as the compression began last year to focus on the growth of the servicing business and to take this period of time where the assets that are available in the marketplace at the price today are not as attractive an investment for the portfolio as we have had in the past so we are continuing to apply our capital for the growth of the servicing business.

We have reduced very much the cost to produce without affecting our quality and we are in the process and beginning to retool the growth engine in our origination channels and we are seeing that today.

Okay and then just one housekeeping question, restricted cash looked like it increased quite a bit in the quarter.

Can you just explain what that's related to?

Yes, that's just a timing issue relating to securitization.

Robert, do you want to--?

Yes, that's-- Michael is exactly right.

We get our 2005-2 securitization close to the end of the quarter and, as you know, we've pre-funding strategy where not all the loans are securitized at that point in time so that cash that comes off the securitization is put into a basically an escrow account and it's restricted cash until the pre-funding part of the securitization structure is completely filled.

Okay, I'll get back in the queue for more questions.

Bose George with KBW.

I had a couple of questions.

Your book value fell by about $0.50 in the quarter and the dividend difference was about $0.17 so what-- could you comment on what else was driving that?

Was that the--

The retained earnings from the taxable subs.

Robert, do you want to give him--?

Yes, and Bose, the other difference is the decline in other contents [ph] of income quarter-over-quarter had a negative impact and that's primarily the fair value of the hedges.

Okay the other thing was just your reserving policy going forward.

Is it going to be more or less in line with the charge offs?

Do you think you're going to increase reserves--

One of the issues with the GAAP accounting is simply the timing of charge-offs versus reserves.

Our reserve policy has not changed since before we were a public company and we have remained consistent through that.

One of the things about our industry not just on the production side is the seasonality of repayment behavior of our customers.

When you have them at a relatively mature portfolio you see the seasonality much more than if you have a rapidly expanding new portfolio where growth tends to hide true delinquency behavior.

If you go back over several years you'll see that generally delinquencies are lost between December and March of every year.

They begin to flatten out and then they start to rise from June till September and then in September they start to decline with generally a seasonal spike in December that's rapidly recovered in January.

This pattern has been in the industry for as long as I've been in it and if you compare us year-on-year in percentages, we're actually doing better than we ever have historically.

Right thanks; if you just one more, on the origination outlook when do you think some of the retooling will start showing?

We are already seeing that today.

We have seen pickups in our pipelines for across all three channels but specifically in the retail channel as we begin to build up the call centers in the three main hubs.

David West with Davenport.

Actually you just hit on what was going to be my first question and wondering if you'd add a little color as to July production?

You say you've seen a pickup in the pipeline.

Any further color you care to put on that?

I would say that without giving out numbers that we are pleased with the progress that we have made given all the reorganization and reductions that we have done.

I think that in the call a lot of people have missed something that's very strategic for us.

For years and years Saxon only originated loans that we intended to keep and put in our portfolio.

That has artificially handicapped our sales force because of the types of products that are being originated today in the pursuit of ever increasing growth in order for a broker to give you what we consider to be core product, you have to be out there with the higher FICO, higher LTV stated income programs that we've never been comfortable owning.

We have, however-- there is, however, a marketplace for that product.

It's been demonstrated.

It is deep and it's broad and Saxon has negotiated with third parties who are willing to purchase these with advanced pricing and underwriting guidelines and with the introduction of our new underwriting system yesterday we will by the end of the quarter be able to pretty well match about 90% of the market underwriting guidelines for non-prime and prime loans and we will then take those loans from that production that does not fit our investment parameters for the portfolio and we will sell them for a profit to help generate additional capital.

And to make sure I understood that then you're thinking about roughly maybe 10% of your typical production you'd be selling?

I would say that of our typical production we won't be selling any of it but we expect to grow it by offering additional product menus to our customers.

Given it was a very good quarter on the G&A side, do-- could a little more color there in the second half as far as you identified you obviously have some, about 1.9 million of kind of non-reoccurring costs in the third quarter--

That's primarily due to the two senior executives that departed the Company.

As Robert had mentioned we have been going through the organization in detail not just at the front end or the back end but throughout the management ranks and we found what we believe to be an unnecessary level of management.

We had good supervision above it.

We had tremendous talent and dedicated people with experience with below them and so in the world of today, which is 300 basis points of spread, not 500, we just couldn't afford that extra level of management and they decided to leave.

Do think in absolute dollar terms that G&A can remain flat or decline versus the second quarter?

My expectations are that G&A will continue to decline in raw dollar terms in the third quarter, yes.

Okay.

Thank you.

And, I guess, last question, in you're introductory remarks Michael you mentioned that recently maybe some competitors has done some pricing to make things a little easier.

Could you try provide a little color on that?

Yes, there's two things I think that's important.

First of all, when everybody is looking at pricing and spreads I don't think they're taking into account the credit quality that's involved and by credit quality I don't just mean FICO scores.

One of the characteristics that's always made Saxon different is that 75% of our loans are full documentation income loans, which-- you can ask anybody in the business-- perform much better and more stably than stated income products.

However, everyone in the industry charges an average of 50 to 75 basis points more for a stated income loan simply because you're going to have higher variability of delinquency, higher expected losses.

Because most of my competitors that's a complete opposite, they average between 70%/75% of their business limited and stated income loans.

They generally might show a higher coupon than we have but they have a much more unstable product quality in their portfolio base.

Now that was important, but repeat your question because I got off track.

Just some color on your comment about competitor's prices.

That's what I was getting to, okay.

Well, it's no secret here and I'm not going to repeat everybody's names who the two companies are that dominate the market and have been driving prices lower.

We would argue based on some recent earnings calls that driven the margins to what would be called uneconomic spreads and so that having been acknowledged both in the marketplace and by the management in those companies, we have seen them raise their pricing across the board several times in the last couple of months.

But I don't think and it's never-- it has not been my contention now for almost six months that this business will ever return to the 400 plus basis point spread days.

It's my opinion from observation over the last year that this business can still be a 20% return on equity business at the level of spreads that are there today and that capital will continue to flow to the business, which will keep competition.

I think that there's going to be consolidation in the business and I expect that Saxon's going to be one of the companies that's going survive and prosper in this arena because we keep our disciplines and we can keep control of our portfolio, but until something happens that changes the economics, which would be driven primarily by demands of the bond markets I don't see margins moving much wider than they are today.

Matt Howlett with Fox-Pitt, Kelton.

Thanks, for taking my question.

Just in terms of what was sold this quarter, was it primarily second liens?

Yes.

Entirely second liens, I think we had a small non-performing asset sale where we just clean up aged.

Okay and going forward you mentioned there could be some more first lien sales of the whole on market?

Oh, we all-- well, we also- we have an ongoing selling program for Fannie Mae where on our retention unit the customer cleans up his credit and qualifies for Fannie Mae we make the loan; then we sell it off to them and that's a small portion of our business.

Okay, but going forward and in terms of the non-prime products.

Yes.

Just to give you an example, we're not looking to go deeper into credit with what we do, but right now and in many of the markets, especially California, Florida, Maryland what you see is a higher loan to value allowed with higher FICO customers on the stated income programs.

Okay.

The definition-- Saxon is the only player I know in the business, at least that's public, that defines full income documentation by Fannie, Freddie underwriting standards.

Right.

Most of our competitors say, if you have 12 months bank statements they call that a full doc loan.

Right.

They report it that way and they price it that way and there are people that will buy these higher LTV, higher FICO products and you can earn a premium on them.

Unfortunately, in order to get the broker to sell you his core product you've got to be an outlet for this type of product too because that's the only way he can sell it.

So our sales force for over a year now has been handicapped and it is our intention to erase that handicap as quickly as possible and to add incremental additional production that we will sell in order to help grow the core business.

Great, so we could see a pickup on that gain on sale?

Absolutely.

And in terms of an operating margin in the banking, are we to be given guidance of what we can look at maybe net of carry or something, so forth based on the--

Well, Robert, why don't you talk about what you saw as non-recurring impacts and/or season impacts versus where the margin is today?

I mean you have the amortization, the hedge.

Yes, right.

Well, there's basically three things I think that you would say would be non-reoccurring.

One was the spike up in delinquencies, $103 million.

I think that's more seasonal driven and I wouldn't expect in the third quarter and fourth quarter to see that level of increase probably flat to [indiscernible] delinquencies as Michael said.

Also, the hedging, that's going to be impacted by the shape of the yield curve and today as Michael said we're-- our hedge value is up over $15 million post June 30th.

Assuming that continues you would expect to see a positive impact on our margin in the third and fourth quarter.

And then the third thing is the level of amortization, which we had a 44 basis point impact in the second quarter versus first quarter.

What we're seeing based on prepayments because I don't necessarily seeing anything slowing down on the prepayments so I would say probably second quarter is more relative to what you would expect to see in the third and fourth quarter from loan amortization expenses.

Okay, great and just one last question in terms of the return hernel [ph] at the QRS, is that still-- can you still achieve that, the 15 plus, 20 plus percent return on capital?

I think 15% is fully achievable.

Okay.

And what I would say -- and that's off current originations-- what I would say is we have always in the past felt that 20% was the minimum return that we would put in the portfolio and that's pretty aggressive where spreads are today and so we are working on the other parts of the corporation in terms of reducing costs, increasing efficiencies and building the fee for service third party servicing business to accommodate and compensate for the reduced margin available in the market today for the assets that we portfolio.

We're not and we never will reduce our commitment to our credit quality and so growing the third party servicing business in this time of compressed margins where the returns are in excess of 20 plus percent ROE after tax is what we think a prudent place to put our capital while these economic conditions continue.

Great, thanks a lot.

John Massonick [ph] with Wasatch Advisors

Could you give a little bit more color on where expenses are running at quarter end or maybe in July and August?

I mean I'm assuming expenses came down during the quarter and so--

Yes.

I mean, John, the expenses have come down quarter-over-quarter.

I think what our expectation would be is and we're in the middle of closing our July books, so I can't really tell you what the number is, but I think our expectation would be, as Michael said, from a run rate standpoint at the end of the first quarter we expect to reduce our G&A approximately $17 million per year.

We did sell or close most of the retail branches in the second quarter, so I would expect in the third quarter to see continued efficiencies out of that, so I think my expectation for the third quarter would be that total expenses will be down and into the fourth quarter as we continue to grow back our retail I would expect the G&A expenses in the fourth quarter would probably be flat compared to the third quarter.

Can you-- okay, that's helpful.

Can you kind of say maybe what they were in June versus what was the trend in March, April, June or do you not have that granularity?

I don't have that granularity at my fingertips.

But, I mean we can get it to you John.

Okay.

That's just something that didn't-- we don't have that number in front of us.

Going on to the mortgage servicing business, what-- so you bought $4.6 billion of servicing rights.

What was the price paid for those?

Approximately 65 basis points.

Okay.

And we have also committed to purchase, but have not yet delivered 5.2 billion as of June 30th, of additional servicing.

And what's the market like for the servicing?

Is it robust right now because people originally--

It's very economic for us right now.

We have not had any issues in acquiring as much servicing as we wish to acquire.

As with everything we do we keep it under control because the economic advantage that we get is directly attributable to our performance and the performance of what we have in the house and so we've been growing it very rapidly but under a lot of control.

Just two weeks ago we opened up the second servicing center here in Richmond, which gives us full backup capacity on both front end and backend systems and expanded our capacity from 30 billion to 50 billion, which we hope to fill in the next couple of years.

And what's the CPR that you're seeing on your servicing portfolio?

It's about 3% a month, which is about 36, 38.

It's very consistent with what we have.

Depending on the product it tends to be a little faster because it's generally higher credit with lower prepayment penalty.

Okay and in terms of-- I think you've talked about this in the past, but I just don't have the number is how much equity capital do you need to run that business?

Robert.

Right now we actually build on an unlevered basis, so basically the mass capital that we've deployed to that business is value of the mortgage servicing rates.

We do have the ability to leverage up to $0.50 on the dollar on our MSR valuation, so we do have the ability to grow that business substantially without additional equity capital.

Do you probably have 100 I don't know $130, $150 million of equity capital on those?

Yes.

Okay.

What-- and then so looking at your overall capital structure, Michael, what are you going to think-- what are you going to do with the excess capital that you have if it continues to be tough to grow the portfolio from here?

Right.

Well, that's the long-term strategic question that we're always looking at and we get questions from some of our shareholders all of the time.

At this point in time we recently addressed that we intend to continue to grow the servicing business as rapidly as we can.

We also intend to invest in growing the origination business and we are very much aware that we need to increase the growth rate of the origination business and we are looking at all possible options to do that and we are actively looking at that and that's all that I'm going to say on that, regard.

Okay, thanks.

Anna Weinrick [ph] with Basswood Partners [ph].

Yes, I guess, help me out.

One thing I'm confused about is relative to the difficulty in growing a portfolio so far this year you're blaming on competitive pressures, but yet volume this year is probably tracking at a rate above last year.

I mean I can only expect that volume down somewhat next year, but I mean what could possibly change that would allow there to be more loans at prices available to you?

Do you need some-- do you need bond investors to stop buying the lower rated traunches [ph] of securitizations?

I mean what can possibly happen at this point to make things get--

To make things more economic, which would make us make more be more aggressive in marketing?

Yes.

What-- the same thing that's happened about every four to five years in this business since 1980, rapid growth with improperly priced product and too much risk taken on has invariably led over the years to what's called credit event.

Given where the economy is today with interest rates rising some of the of the margins and some of the products that are being originated while-- there's two things I think that the analyst or the casual observer to our business I don't think they've put enough value or paid enough attention to.

Much of the volume from some of my larger customers comes from refinancing their own customers and they just refinance them from one product to another product to another product and they continue to increase the LTV.

They continue to take more risk.

Just because that volume is getting done does not mean that that's something that a prudent investor should do or put into his portfolio.

However, if you're going to be competitive in a third party business, which is 70% of my business and 80 plus percent of the marketplace, you have to have a product basket that the customer is demanding and that the market is willing to provide.

We have competed without that full product basket for many years and been able to grow the business.

We feel very strongly that having an outlet for those products that we do not desire, but for whatever reasons higher leverage, greater economic value, lower cost of funding.

There are people there that have an appetite to purchase these products and we are in the process of and have completed already, just as we do with our second mortgage product, establishing conduits to originate that product and deliver it and that will allow us to get back into broker houses and correspondent houses that we have never-- that we have pretty much walked away from simply because we refused to do the extended risk product.

Right.

And that's why I see our ability to do so and at the point in time when the credit event comes and it will, we will be very well placed with both, our capital structure, our servicing operation and our more efficient platform to take advantage of what happens next.

Do you judge the competition from the big banks to be any different now than it was in years past?

I mean when that event does come do you think the appetite for-- from HSPC and Citibank and National City who presumably have lower cost structures and lower cost of funding than say a-- is there competition or their presence in the markets now that different than it was at the other points in the cycle?

They're really not much competition to us.

Long beach, which is owned by Lonaliz [ph], but HSPC, which is Household and CitiFinancial, which is The Associates, really operate at a different credit traunch with a different type of customer than we do.

Where I see the opportunities happening that would cause this, there's-- we have two very large competitors who dominate the marketplace today.

My hope is that nothing happens but I'm a little concerned about what's in their portfolios as compared to the level of capital that they have and their ability to service the bonds as those portfolios age.

Hopefully they'll be able to continue to refinance those but at the LTVs that are being put out there with the stated income levels and the margins that are there should real estate in the West Coast of Florida happen to flatten out and/or decrease over a short period of time, then I would be worried about a credit event which would cause margins to rise.

In that type of an environment Saxon has always prospered.

We are very, very confident in our portfolio and the credit quality contained therein and our ability to withstand stressful economic times.

Thank you.

My last question if you don't mind, relates to that interest margin, which that I just pointed out declined quite a bit in the quarter.

I mean we expect the funding cost will continue to tick upwards as short-term rates go up and then hopefully you would be able to get the interest income line or your margin to go up eventually once competition slows down, but as for that happening further compression seems to be likely as that ticks upwards?

Yes.

Except for the fact that-- I mean the-- I don't know unless the forward curve actually inverts, which who knows?

It may happen.

I don't see how we could get much more compression.

Our hedges because of the way we've structured the protection, are significantly rising at value at this time and that in and of itself will be a significant contrary move towards the compression of the margin.

Okay.

Thank you, very much.

Allen Fornier [ph] Pennant Capital

Could you touch upon these growth initiatives?

I mean am I hearing you correctly in that you intend to get into the whole loan sale business?

Yes.

I'll give you an example.

Our stated income we stop at 90 LTV but there are people out there that will purchase 100% stated income loans at a certain FICO level.

We don't have that product.

We don't believe in it.

We like the stated income borrower to actually have some skin in the game, as we say, so by expanding our guidelines to that with our new origination system we opened up today products like that, higher LTVs, higher FICOs, but not necessarily the price risk reward that we like, we can now originate those and deliver them on a forward flow basis with committed pricing and guidelines and our system can tell them apart so that at origination the loans are priced and they are designated either portfolio or non-portfolio.

And it also is an opportunity to increase our servicing because many of the people that will be selling home loans to are also people that we buy servicing from and so I expect that we'll probably have additional servicing opportunities there.

And how much are you investing in this effort?

It's not really investing additional money, Allen.

It's just widening the product basket, so the investment is only how much more product that we want to keep comes in the door due to our ability to deliver a full product menu to our customers.

But it kind of sounds like to me like it's an almost if I can't beat them I'm going to join them strategy, yet you describe the environment as being--

If you agree that you're going to keep those loans then I would agree with you, but we have no intention of putting those loans in the portfolio.

We're going to just pass them through to other investors who have an appetite for them.

And you think that's a good strategy, given the perfect storm environment that you're describing?

I think that as long the market's willing to provide that credit and, as you know, the wholesale broker and correspondent sub prime it's-- they attempt to deliver the customer as much cash in his hand as possible with the least amount of investigation or effort.

That's what drives our customer and in order to get into those shops to get the customers that we want, which we feel are properly priced for the risk, we need to be able to offer those products and we have not been able to for reasons that we chose not to.

Right and that's what I guess I'm struggling with is that you've been since I've known you very bearish on the industry, yet it seems as if you're suffering more, at least if we looked at sort of stock price to book value.

I would agree with you on the short-term that you're correct, Allen.

And--

And now you're essentially saying that I want to be more like these people that you've said offer these products that are unsustainable, so I'm struggling with that.

The only differential being is I don't intend to put them into my portfolio and the day that the markets say this is too much risk and the price has to go up I'm going to change it and the day that I can't sell them I'll stop offering them.

Last question is, when did this become apparent to you in terms of the deterioration of the marketplace over the recent history?

Well, to be honest with you if you've listened to me on our discussions over the last year, the additional capital that came into the marketplace over the last two years has extended the period of the cycle but the cycle is following classical, absolutely classical, behavior patterns.

Growth requirements and earnings expectations drive irrational behavior.

Margins come down as pricing competition accelerates.

The market gets scarcer and eventually the bondholders rebel.

That happened in March and April, which since then you've seen the pricing, the coupons stop going down.

So what happens then is in pursuit of additional growth credit starts getting stretched and we have never participated in that before.

Well, we're willing to deliver those stretched credit products to people that want to buy them if it allows us to continue to play in the game but I'm not going to put them into my portfolio.

But you've been talking about this playing out, yet it seems as if your strategies to mitigate, which included large purchases of servicing, have done little to position the Company to thrive in this environment.

I would beg to differ, Allen.

I think our servicing-- I think our efforts on servicing side and the financial results of that subsidiary are extremely contributive and are everything that we've looked for and our return in equity there is still in excess of 20% after tax.

All right, I guess the issue was on the still remaining business.

That's correct.

Okay.

Thank you.

With that we will end the call for today.

I would just like to thank everybody for being here.

Again, we are committed to increasing our volume and reducing our cost to produce and getting back on track to meeting the expectations of our investors, our shareholders and our employees.

Thank you, again.

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

Thank you, for your participation and you may now disconnect.