New PHH Chief Rethinks Funding, Costs

Jerome J. Selitto, the newly installed chief executive at PHH Corp., has far-reaching plans to resuscitate the mortgage outsourcer, starting with its funding sources and cost structure.

Selitto, a longtime mortgage executive who was hired this week to head the industry's eighth-largest originator in the second quarter (and the largest nonbank one), said he plans to expand PHH's warehouse lines by going to nontraditional providers like hedge funds. And he is taking a hard look at all of the Mt. Laurel, N.J., company's businesses.

"The old business models are not going to work in this market," Selitto said. "We're entering into a reassessment, looking at our processes and how we deliver our products. The idea is to create efficiencies in such a way that we can be more agile to respond to rapidly changing conditions."

Though it is not a household name, PHH originates mortgages behind the scenes for a wide range of financial companies, including Allstate Corp., Comerica Inc., Charles Schwab Corp., Northern Trust Corp. and UBS AG. Like many mortgage lenders, PHH has had to grapple with significant losses during the housing downturn. In the first quarter its mortgage production unit reported its first profit in 11 quarters, helped by an increase in refinancings. (PHH also runs a fleet management business and, as of June 30, serviced $149.2 billion of mortgages.)

In June, Pennant Capital Management LLC, a hedge fund that owns roughly 10% of PHH, started a proxy fight that ended in the ouster of Selitto's predecessor, Terry Edwards, and of former nonexecutive chairman Alvin Krongard.

The hedge fund claimed that PHH did not understand the profitability of its customer relationships and was slow to cut costs during the mortgage downturn.

"This is an opportunity for the company because, when you have a management change, you can revisit everything," said Bose George, an analyst at KBW Inc.'s Keefe, Bruyette & Woods, Inc. "They're going to look a lot closer at costs because the whole [proxy] fight was about the company looking at controlling their costs, because these are businesses with a lot of volatility."

(Edwards was hired by Fannie Mae in September for the newly created post of executive vice president for credit portfolio management.) Paul Miller, a managing director at Friedman, Billings, Ramsey & Co., said PHH's mortgage origination unit has a "very high cost structure," though he maintains an "outperform" rating on the company's stock because the management change offers hope for improvement.

Like the other nonbanks in the field, PHH has had to grapple this year with a growing scarcity of warehouse financing.

Selitto emphasized that PHH has $4.4 billion in warehouse capacity — enough to fund its mortgage production for at least a year — from two lenders, Fannie Mae (which began providing this kind of financing this year to aid lenders) and Royal Bank of Scotland Group PLC.

Still, he said, he wants to "broaden and stabilize" PHH's funding sources at a time when liquidity remains a challenge."I, personally, have been a warehouse lender and a warehouse borrower, so part of our strategy is talking to firms coming into warehouse lending, as well as starting a dialogue with nontraditional hedge funds and others."

Selitto is a former vice chairman of Amerin Corp., a mortgage insurer that shook up that sector in the 1990s by introducing such products as lender-paid policies and captive reinsurance. (Amerin merged with CMAC Investment Corp. in 1999 to form Radian Group Inc. in Philadelphia.) In 2000 he started DeepGreen Financial, an online bank and home equity lender.

Jim Egan, a PHH director who succeeded Krongard as the nonexecutive chairman, described the three-month search for a new CEO: "We didn't want somebody who had been involved in the bad decisions that had been made in the industry in recent years that led to toxic assets on their books," he said. "That narrowed the field down considerably."

The executive search firm Heidrick & Struggles whittled down an initial search field of 200 candidates to 80, then to 18. PHH's board interviewed eight potential CEOs.

"Jerry was the first person we interviewed, so everyone else had to measure up," Egan said.

Selitto said he told the board that the company needed to start "from a clean slate."

"I said we need to look at it as if we were going to build the company from scratch. What would we do?" he said.

PHH has not yet specified a date to report its third-quarter results, but it reported a second-quarter profit of $106 million, or $1.91 a share, up from $76 million, or 30 cents a share, a year earlier. Revenues rose 16% in the second quarter, to $768 million.

The mortgage production arm swung to a profit of $82 million in the second quarter, from a loss of $17 million a year earlier.

In addition to reviewing the company's mortgage and fleet management businesses, Selitto said, PHH will look at its client relationships and build a return-on-equity model tailored to the current environment.

He dismissed the suggestion that, as a nonbank, PHH operates at a disadvantage to its large-bank competitors. (The two top originators, Wells Fargo & Co. and Bank of America Corp., originated 44% of all home loans written during the second quarter, up from 28.6% a year earlier.)

"The advantage they have is funding," Selitto said. "They're large organizations, so I don't know how focused they are at improving processes. We're very, very focused on improving the process so we do become a much more efficient operation."