Mr. Cooper Group Inc. (COOP) Earnings Call Transcript & Summary

Great. Thanks for joining us today. Happy to welcome Mr. Cooper Group back to the Crédit Suisse Financial Services Conference. Joining us from the company is Chairman and CEO, Jay Bray; Vice Chairman and CFO, Chris Marshall; and also various other members of management there to kind of help to kind of as needed.

Jay or Chris, so just to get it started, as we were talking a little bit before. Clearly, interest rates have been moving, and I think kind of people want to top of mind is kind of how you view this impacting originations. And kind of how you're viewing the origination environment in light of this large move in rates we've seen.

Well, so far, I think it's going to be very minor. If you remember on our earnings conference slides, we shared that we had, I think it was 811,000 customers that could save $200 a month or 35% of their mortgage payment by refinancing and another 500 could save $100. We actually ran that in the middle of the month, and I think the change in rates which overall is about 40 basis points. But for us, from the point we ran that data, I think it was 21 basis points as of last night. So there's probably 100,000 customers that no longer could save $200 a month, they save $150. I think it's -- in the short term, it's definitely a mild impact. But obviously, rates and originations are correlated. We'll have to see how it plays out. For now, we've got an enormous pipeline of customers to refinance. And unless we see a massive spike in interest rates, I would think we're going to have a pretty strong 2021. Question would be, how long does that continue into '22? With 1 million customers, even with another 50 basis points, even 75, there's still hundreds of thousands of people there. And then of course, we'll start to pivot to cash out and other products. So there will be an impact at a certain point, but the rate movement so far is going to have a very, very minor impact on us.

And I guess if you could talk about the -- mortgage rates have gone up less than the move in treasury, so definitely seen compression in the primary-secondary spread. Just talk about kind of how that has impacted the profitability for your origination volume?

Sure. Well, the -- obviously, this quarter and into next quarter, the pipeline is hedged. And so there's no -- there's not going to be an impact. As we go through the year, we've expected compression in the margin. And the overall margin last quarter, I think, was 186 basis points. So we expect it to normalize and at a certain point, that normal level is going to be somewhere between, say, the low 90s and maybe 105 basis points. And if you look back over 2005 to -- I mean, 2015 to 2019, that's pretty much where we averaged. We've done a lot to automate and take cost out. So maybe it will be a little bit better than that. The question is how fast is it going to normalize? And so far, where we don't see much compression in the margin. Now we have a little more elasticity with our customers than the typical mortgage broker who's selling through a correspondent channel. But we'll definitely see it. I hate to forecast when we'll see it because there'll be some impact today. New locks that we're putting on will be slightly less profitable than the one we had yesterday. But I think there's going to have to be a little more compression before it starts to become a meaningful impact on us. We do expect it, though, and we've been forecasting it now for the last 12 months or so, and we've been wrong. So we'll see where the compression goes and how fast it happens.

And I guess getting back to the pipeline of potential borrowers. Obviously, rates have been low for a while now, kind of what gets those borrowers who hadn't refinanced yet kind of off the sidelines? What is your comfort that you're actually able to convert those potential customers into actual refinance volume?

Well, let me start. As Jay has been in this business a lot longer than I have, but I'll tell you one thing that I've always seen happen, there are some customers that may have very, very low loan balances and they have absolutely fixed in their mind that they're going to pay off their loan and they're not going to refinance. That's a small fraction of the portfolio. But there's another fraction that -- or a larger fraction that thinks, well, I'm going to refinance, but I'm not going to get to it today. And as rates start to move, you'll see that -- you will see a surge of people that want to lock it in before they lose their opportunity. I want to go back and just make one other comment, Doug, which I should have added to my answer to your last question, which is, of course, as originations see that impact and as compression happens and rates do start to tick up, we're going to see positive marks on our portfolio. So -- and we already have. I mean if we ended the quarter today, we'd have a healthy positive mark on that portfolio. And that's not going to offset every dollar for dollar. But I think when you look at us compared to some of our more origination-centric peers, we've got more of -- much more balance in our business. So we took over $1 billion in impairments as rates went down. We expect to recover an awful lot of that when rates go back up. And so that's an important thing to think about when you look at our company. But Jay, do you want to...

Yes. I mean I would just say that tactically, if you look at how we've managed portfolio in the past year, frankly, there's pockets of the portfolio we have not marketed to, right, that we normally -- just because we've been capacity constrained, et cetera. And so I think we would, in ordinary course, if things do slow down, we would tap into all the marketing tools that we've used previously to get the folks to respond and get our customers respond because it's still a good thing for them. The savings is still certainly worthwhile, and we would be, I think, more aggressive in that -- along those lines. So it's -- candidly, we've been -- there's been so many inbounds, if you will, that there's really not -- it hasn't required any real marketing effort. And I think we would just go back to what we've been doing for 20 years, right? And use some of the marketing tools that we're really good at to get that response.

Got it. And Chris, you mentioned that if the quarter ended today, you'd have a positive MSR mark. I guess that's one piece of the servicing. I guess, when -- how do you think it plays through in terms of kind of your regular way profitability kind of ex the mark, when you might see kind of a slowdown in amortization and kind of an improvement in profitability?

I think you'll see the amortization slowdown as rates go up. And I think that correlation is going to be tight. I think the -- quite honestly, I think the recovery of float income may be much slower. It's -- I hate predicting what rates are going to do or what the shape of the curve is going to look like, but I can certainly see a scenario where inflationary pressures push the long end up, but near-term rates really stay pinned to 0, at least for some period of time until the economy is back on its feet. So we may see the recovery from amortization, but that's about half. I mean, the makeup of the profitability is almost 50-50. We need both of those things to happen to get back to that normal, let's say, 5, 5.5 basis points of profitability outside any other recoveries or -- that's the real core profitability of the book. And I don't know how long that will happen, but I suspect the short end of the curve is going to stay low for quite some time.

But I think you will see, Doug, as we talked about on the call -- on our earnings call, servicing profitability will improve, right? And with the EBO activity, with slower prepayments. So I think you'll -- we'll start to see it gradually get better. To Chris' point, do we think it will get to the full level of profitability without getting float income? No. So that's going to take more time.

Got it. I guess that kind of leads into kind of with earnings, you guys updated your kind of view of kind of normalized return on equity. Can you just kind of talk about -- just kind of talk about kind of where you're seeing kind of normalized returns on equity? And kind of how to frame kind of the near-term environment as to kind of where you might fall in that range?

Well, in the near term, as we pointed out yesterday, we expect to be above that range and comfortably above it. So we mentioned that for '21, we expect return on equity to be at 25% or higher. And we've been fairly conservative about the guidance we've given in the past. So we're comfortable with that number. In really any scenario, we expect originations to remain very profitable this year. We expect servicing to rebound, as Jay said. The guidance we initially provided on EBO revenue this year of $250 million, it's probably at least $100 million light. And some of that may move into '22, but as Jay said, that's going to turn profitability around, at least in the short term in servicing. And Xome is going to have another solid year unless modernization happens. Either one of those things is good for us. So in the short term, we expect to be above that range. But I think the 12% to 20% is when rates normalize. And what do we think we can do, and we're very comfortable saying normalized earnings will be in that range. They'll be higher when -- once we pivot back to a rate of cash out refis and start to run that model. It may take us a quarter or 2 to rightsize the workforce and other things that go along with those cycles. But consistently over the long term, we're very comfortable being in that range.

Got it. And I guess, if you could -- I think your prior commentary, I guess, more focused just on kind of the 12% level. Is that -- I guess, just if you could contrast the new range, which, obviously, 12% to 20% is higher than just kind of 12% just kind of contrast kind of that new range versus kind of what you had been previously talking about as kind of the 12%?

Well, we never really talked about 12% as guidance. We said we're committing to -- among other things, to improving the consistency of our earnings. And the 12% was a minimum a target that the company would shoot for consistently year in and year out. So that's still the floor in that range. Now that doesn't mean there's going to be a point where in some changes in some cycles, something could occur where we might fall below that range, but we don't expect to. And we would -- if that were ever to occur, we would think we would immediately return, and we -- again, 12% was always the minimum, and 20% is right now, we think we're -- that's a responsible range that we can forecast the company for as long out as we can. I mean this is a business that it's hard to predict timing of cycles, it's hard to predict the -- how quickly things spike. But we don't feel any discomfort in saying that range is appropriate for us, and you can pick any point in the mid and -- for your own guidance, but don't think of 12% as our legacy guidance. That was always the floor.

Got it.

And I think, Doug, if you structurally look at the business, right, if you look at our capital structure and what we've been able to do on the debt side, both paying down debt and refinancing debt, clearly, that is at much more attractive levels than we had previously. So that gives you some confidence in your -- that cost going forward. When we look at our productivity really in originations through this cycle, based on the investments we've made over the last, call it, 3 years, productivity is significantly better. So I think to Chris' point, the 12% was kind of the floor of legacy guidance, but when you step back and look at the structural pieces of the business, I think we're just in a better position today than perhaps we've ever been, so.

Got it. I guess one of the other things that you said with earnings is that you kind of now expect servicing balances to kind of grow 5% to 10% this year and then would expect that for next year as well kind of after taking a couple of year kind of pause. Can you just talk about what you're seeing in the environment that kind of makes you -- or within your own company that kind of makes you more excited about the growth prospects for servicing balances?

Well, I think the -- I'd start with what we've been saying for maybe 5 or 6 quarters that there hasn't been much bulk product that's come to market. I mean it's far below normal levels. And that's just because pricing, along with low rates, we've been at historically low values for MSR. And so to the extent people could operate in the cash flow positive way and hold on to that MSR, they have, right? They've been waiting for higher prices. That's starting to change. It started in the third quarter. So there's -- it's still at low levels, but we're seeing steady small pools come to market. And you have to really step back and remember, Mr. Cooper over the last 10 or 12 years grew at 38%, 39%, 40% CAGR. We bought more pools than anybody. And so we are very experienced, we're very efficient. I think the agencies, Ginnie Mae, view us as a buyer of choice. And so we'll buy these small pools, but we also are looking for larger and larger pools. And there has been a shift where the banks have been selling off certain product and maybe buying different product. You've seen a lot of the banks move away from Ginnie Mae. And we're happy to talk about any size portfolio. There is no one that has our ability to take on very, very large bulk portfolios. And that's what we've done in the past. We've now developed new technology we talked about on our call the other day that just -- even with these small portfolios, the ability, it's very expensive and time-consuming to take in the massive amount of data that goes along with portfolio purchases and translate it accurately. That's always been a very, very difficult task. We've always been among the very best at it. But we've now developed this, which I hate to even call, OCR technology, it's -- because it's not just recognizing text, it can recognize any kind of mortgage document. When you think about the kinds of things that you have to ingest that have tech stamps from every county in the country, our system uses AI to learn all of those things and can ingest data with greater accuracy, far greater accuracy and at 4x the speed of the tech -- what it has been considered the best technology available. So we've made a lot of investments, bring down servicing costs, but also that extends to what you'd call the boarding process in anticipation of this flow starting. So we're hopeful. We fully expect to see levels continue to rise, and we're very experienced, and we have all the liquidity we need to be a voracious acquirer.

Can you -- I guess, just as you look at the opportunity set out there between Fannie, Freddie, Ginnie and subservicing, I guess, how do you see the opportunity set as to kind of what might be the most likely growth channels?

Yes. I mean, I think, Doug, it's -- we'll see where the market goes, right? But clearly, there is, I think, still some large Ginnie-trade opportunities out there with real meaningful size. And so we're definitely focused on that. And then I think when you look at the normal kind of on the run, what's coming to market now? It's a blend of both Fannie, Freddie and Ginnie. And then -- and we'll take our share of that, but it's probably indicative of what's going on in the overall market. If you think about the next phase of this, if the nonbanks, let's assume this plays out like we talked about earlier, rates rise and margins get depressed, whether that's later this year or next year, I think a lot of the nonbanks will start to sell servicing because to Chris's point, they've been able to retain it, just given where their margins have been, and that product is probably, I'd say, more Ginnie-centric than Fannie and Freddie. And -- which, again, is clearly in our wheelhouse and something we're very interested in. So I think it's going to evolve over time. But we'll be active in all the different spaces. From a subservicing standpoint, we announced we boarded a new client, one of the largest financial firms in the world. And we expect that relationship to grow and then we also expect our existing relationships to kind of grow consistent with the overall market. And so if you look at one of our clients, in particular, they're predominantly purchase-money. All their originations are purchase-money or the majority of it, and so I think we'll benefit from that going forward as well.

Yes. I'll make one last comment and that is when you ask why should that start to change? You're probably aware, Doug, that up until -- virtually right now Ginnie Mae had put a moratorium on any portfolios transferring from banks to nonbanks. And that goes back to the beginning of the pandemic when they wanted to just make sure everyone had appropriate liquidity. And Ginnie Mae is now going through the process of evaluating firms and deciding which ones are sort of free to buy portfolios. And I don't know how many firms have been through. I know we were among the first to get approval to go ahead and do that now. So those moratoriums are being lifted as we speak. But of course, it's not just -- all firms are not created equal. But Ginnie Mae will look at any portfolio that would be transferred and evaluate the firm's ability to take on those kind of things. As you know, the last thing they want us to have to step in and take something back. So we feel very good that they're comfortable that those transfers can occur and feel even better that they view us as totally prepared to do that.

Got it. And then I guess just 1 last one on that kind of 5% to 10% growth. I mean is that kind of assuming kind of regular way business? Does that kind of assume any of these larger Ginnie Mae opportunities hit? Just to kind of gauge the sizing around that.

Yes. I think you should -- 5% to 10% is a good target for this year. And it's probably a good target over the next 5 years. Now we may do a very large transaction, and the average may be up a little bit, but I think you should think that as the target we operate the firm for, we allocate capital for certain bulk purchases every year. And so 5% to 10% is the -- that's just the standard operating mode. If we had an opportunity to go out and buy a massive portfolio tomorrow, that would be outside of that normal growth.

Got it. And just sticking with servicing, just talk about kind of what trends you're seeing in the portfolio in terms of forbearance and kind of how you expect the next several months to kind of play out as forbearance plans end and foreclosure moratoriums eventually end and kind of how you're thinking planning for that eventuality?

Yes. I think if you look at the forbearance plans today, they're about half of what they were at their peak. And so we've had about 50% of the customers kind of come off their forbearance plans already. And so the ones that remain, if you look at them in their composition, they're going to roll off with this most recent extension. They're going to roll off in the, call it, May, June, July. A big percentage will roll off during that time frame. And look, I think we've proven with our -- if you look at our digital tools that we've rolled out for the forbearance plans, a significant amount of customers are signing up for forbearance via digitally and then a significant amount of them are coming off from a digital standpoint. So the process itself is actually very customer-friendly and very customer-centric. And then I think what will the ultimate outcome be? I mean, right now, we're seeing a significant amount of the Ginnie portfolio is selecting the modification to come off. So they want to stream on mod because effectively that lowers the rate. And it's almost like a no-cost refinance for them. And so I think that's what we'll -- we would expect to continue to see in the Ginnie portfolio because I think it is the best thing for the customer. And then on the Fannie/Freddie side, we've got -- there are menu of tools there. And so I think nothing really surprising that we're seeing right now. And ultimately, we will be left with customers that just can't -- they can't get back on their feet, right? The good news, I think, if you think about the overall housing market and you think about the equity that we have today, to me, I think this is going to be well managed, right? And it's going to be -- it's not going to be anything like we've seen in the past. And I think we'll be able to manage through the folks that can get back on their feet and some type of other liquidation and hopefully, it works well for them. So I think that's how we're thinking about it.

Got it. And I guess taking that to the next step, I guess, how does that impact Xome? And kind of what are the outlooks for Xome in the REO sale piece of the business, in particular?

Yes. As you heard us say on the call that we are really not expecting the exchange business, the REO sale business to generate really anything in 2021. And now that could change, right, if they stick to their current moratorium dates, you might see a little bit of income. But I mean, all we're doing that, I guess, just creating this big backlog that's going to have to get through the system once the moratorium is lifted. So when you look at the overall pipeline and you look at the overall inventory, it's going to grow. It has grown. And when you look at our new clients that we're adding, I think we're very close to announcing a new very big client. I think it's going to -- it all speaks to strong, strong earnings for the exchange business once we get through this moratorium. You recall, I think pre-COVID, the exchange business was earning $55 million, $60 million a year, and there's no reason whatsoever that it can't go back to that and more. And so -- but we got to get through this, again, which I think will take the majority of the year. But when you sit and look at, again, the inventory and you look at the clients that we've added and the clients we've maintained through this, I think it's -- I'm very bullish when we come out of this.

In fact, when we first come out of it in the first year or 18 months, we would expect to be well north of the normal profitability, the $55 million to $60 million was what we were doing right up until the moratorium hit. But given the backlog -- and again, it all depends on when that happens and it takes a few months for the courts to ramp back up, but there's a lot of backlog that -- for us to tackle.

Yes. And then I guess just sticking with Xome, what update can you give us about the strategic review that you announced, I guess, a quarter ago?

Well, we'd rather give you an update when we have something concrete to say as opposed to we're in the process, but that's where we are. We're in the process. Obviously, as we're talking about the exchange business, there needs to be more clarity. I'm not saying we've got to wait until the exchange business is back to normal profit level, but there has to be clarity on when the moratorium is going to be lifted to have serious discussion with buyers about that part of the company. Other parts of Xome are not as -- not in that same situation, and we're in discussions now on those. And I'd say, hopefully, by our next earnings call, we'll be able to say something a little more meaningful. So I hate to evade the question, but I'd rather not.

Understood. I guess on kind of thinking about your capital levels, your liquidity levels. As you mentioned earlier that in 2020, you made kind of significant progress on kind of refinancing and pushing out your debt maturities. I guess, how do you think about your current levels of leverage?

I think we feel very, very comfortable with them. We feel good that we have brought the company back to actually below the level that the company operated on a ratio basis before the WMIH merger, nominally more on a dollar basis. I think we feel very, very comfortable, especially given the fact that we're -- we expect to earn a lot of money this year, and our equity is going to expand. So -- I mean, that's a simple answer. We feel comfortable with it. If we hadn't, we would have paid down more debt before we completed the refinancings.

And so then, I guess, given that comment, right, of continuing to generate a lot of earnings this year, very strong return on equity, I guess how are you balancing and thinking about the amount of capital that kind of goes into kind of growing the business versus the ability to possibly return -- continue returning some capital to shareholders?

Well, I think all our shareholders would say, if you can grow the business at attractive returns, then spend every dollar on that. But if you can't, then -- and you really believe that the stock is not reflecting all the value because we do feel comfortable earning 12% to 20% a year. We do think being valued on book value ignores a lot of value that's in Xome. So if you believe those things, you'd be a very active buyer of your own stock. And so again, we have certain limitations on what we can do up until August of this year. We'll still have some limitations, but we could be much more aggressive about that. And I think short of us finding an ability to put all of this cash to work that we'll do both. There's not a formula. It would be return dependent on the opportunities that the market presents us. But our stock is -- and we feel our stock is considerably undervalued. And one thing you can do about that is to buy it.

Great. And I guess if we could just pivot now to your thoughts on kind of any changes in regulation that might be coming. CFPB kind of has a new administration, new head of the CFPB. Kind of your thoughts around the CFPB kind of in the coming years?

Yes. I think, Doug, you know us pretty well. I mean we have, over the last 10 years, invested a significant amount of money in our compliance management system, our risk management system, et cetera. We've gone through multiple state exams. We go through multiple state exams every year. We've gone through multiple CFPB exams in the last 3 years, and I'm happy to say those results have been outstanding. And so I think when you look at the core infrastructure of the business, the way we run the business, the way we manage it, I think it's a very -- it's from a regulatory mindset. And then the other thing I always look at is customer complaints. And our customer complaints are at all-time lows. And I always want to get them to 0, but we haven't quite reached that goal, but they're definitely -- they've trended down, they continue to trend down. And so I feel good about that. And I think, look, we, frankly, want to work with CFPB. I mean we think organization like ourselves, as important as we are and a leader in the industry, we want to work with the regulators to get it right and to make sure that we are doing everything we can to treat our customers the right way and have a customer-centric mindset. So we spent a lot of time and money and frankly, we've got a lot of experience in this area. So even with the change in administration, I don't feel like it's something that's going to hurt Mr. Cooper. We'll work with the new administration, work with the new directors, and I think it will be -- it will work out in an exceptional way.

And then I guess the other piece of it would be the FSOC has definitely, in their annual reports, talk more about kind of the growth of nonbank originators, servicers and the potential need for some sort of federal regulation. Obviously, you guys are regulated, but kind of thoughts on kind of dealing with the FSOC and potential for a different form of regulation there?

Yes. Look, again, I think we are heavily regulated already, as you said, regulated by CFPB, all the states. We have -- when you look at the capital requirements, we have capital requirements from FHFA, from Ginnie, et cetera. And so I wouldn't say we're light on regulation. And then on -- from a federal standpoint, it just depends on what shape that would take. But again, we've been able to navigate once -- if you go back to the last crisis and you look at all the changes that happened post that with new standards coming from everybody and a tremendous amount of change, we navigated through that I think really well, and we will react to whatever comes. I don't think -- I mean, ultimately, if we could wave a magic wand and have one federal regulator, I don't think that would be a bad thing. Because today, like I said, we are dealing with a number of different constituents. So I think we would be in favor of that.

The FSOC's concerns about nonbank servicers primarily, while it's understandable that they have some questions, I think, in light of what's happened through this crisis, I wouldn't be surprised if those concerns were greatly diminished. If you think about the position we were in, in March, where no one knew how dire the situation was going to be, we went out and we -- in 60 days, we're able to secure billions of dollars of secured financing at very attractive rates. At the same time, we were refinancing our corporate debt. The first tranche was at the lowest spread in history for a B-rated firm in any industry. I mean the market was not in any way concerned about us. So I think that's instructive to the FSOC that while they might have had a concern, they just saw us get tested, and we came out a much stronger company. So I hope they would take that into consideration.

Right. Makes sense. And I think with that, we're out of time. So Jay, Chris and the rest of the Mr. Cooper team, thank you guys for joining us again this year.

Thank you, Doug.

Thank you. Appreciate it, Doug.

Thank you.