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

Good afternoon, everyone. Thank you for joining us for this fireside chat with Mr. Cooper Group's team. We've got CEO Jay Bray. Prepared questions will be gone through. [Operator Instructions] We'll do our best to address it in the time we have today. We've also prepared a number of audience polling questions that we would encourage you to answer during the presentation, and we'll be publishing the results in our report summarizing the takeaways from the conference. With that out of the way, let's get to the discussion. Thank you all for joining us.

You guided to $18 billion to $20 billion in originations for 3Q '21. How did you perform relative to those expectations? Are they still the same today? And kind of what are your expectations for the mix between correspondent and direct-to-consumer?

Mark, yes, I'd start off by saying our -- that's what we shared as guidance at the end of the quarter. I think all the guidances remains in place. I think we feel very comfortable about the volume, the trend in margin, overall profitability both in the Servicing business and in Originations. I think we're going to end up having a quarter exactly as we expected. In terms of the split, it's going to be more of the same. There will not be a significant change. You'll remember in the second quarter correspondent volumes fell off a little bit, and we said we were going to be very disciplined about -- we'll stay active in the market, but we'll be disciplined around certain niches of the market where there was no margin whatsoever. And we'll continue to do that. So you shouldn't expect much change from us. But -- and you should expect our guidance to be pretty much on point.

Okay. Fair. Is it safe to assume then that from a competitive perspective, the market has been relatively stable in the weeks since we last heard from you?

Do you want to talk about...

Yes, I think so. I mean you're still seeing -- obviously, we're not in the broker channel. So we're not subject to really what's going on there. I think there, it's still very, very competitive. In correspondent, to Chris' point earlier, I think that still remains very competitive. And you've seen margins come back a little bit, but it -- still a very competitive marketplace. In our direct-to-consumer business, with rates coming down some, we -- that's actually helped margins a bit, and we've seen recapture kind of continue to improve slightly. So I think the direct-to-consumer channel is -- remains pretty consistent and very, very strong overall.

Got it. And so, I mean, you indicated guidance is still good. But how margins performed in 3Q? Did those -- and kind of your -- how do they compare to your view of more normalized margins?

Margins have compressed modestly. I think they'll continue to do so into the fourth quarter and perhaps in the first quarter. Eventually, we'll get to that 95 to 100 basis points of normal margin. Of course, that margin is somewhat dependent on the mix. And so if correspondent were to grow significantly, we'd expect margins to be lower and vice versa. But given where we are, I think getting back in that 95 to 100 basis points over the next couple of quarters seems still like the expectation. I think this quarter, overall margin should be a little better than it normally would be because of some onetime items. But overall, it should be -- we should report a margin that's right in line with our expectations.

Okay. You said margin is a little bit lower this quarter. Is that a mix issue? Or is it -- are you seeing a little bit of compression across kind of all your channels?

I mean in the correspondent channel, the market -- the margin is actually up a little bit so far in the quarter, but it's up off such a small number that it's really not meaningful. In the DTC channel, margins are down modestly, but I think there's still -- they're exactly as we predicted. If you look at our overall income, which we said our expectation would be -- will be somewhere between 200 and 225, I think we'll be -- we're very comfortable with that guidance. I'll leave it at that.

Okay. Very helpful. You recently announced a strategic goal of reaching $1 trillion in Servicing UPB. Can you just talk about what initiatives you've rolled out to reach that target? What role do you expect subservicing and bulk MSR acquisitions to play into that going -- can you remind us of kind of the time line to ultimately get to that target?

Yes. We think we'll get there in about 3 years, and that's really just assuming a growth rate of about 15% a year. I wouldn't say there is a specific initiative we've rolled out. What we have been expecting for quite some time that we'd see more brokers selling their servicing. And that is starting to happen now. So we expect correspondent to remain a big part of it and co-issue to remain a big part of it. But I think the differentiator will be a more aggressive buyer of MSR pools that come to market. And while that's a higher level of growth than we had indicated at the beginning of this year, which is more 5% to 10%, now it's more like 15%, those are not really aggressive goals for us. If you think back pre-2019 when we intentionally took a pause on acquisitions to digest the 3 businesses we just acquired, we routinely grew at much faster levels than 15% a year. So I think there will be a -- there's a lot of pent-up servicing that will come to market, and we're going to put a lot of the capital that we've accumulated over the last few quarters to work by buying those pools when they make sense and at the right price, of course.

And I think, Mark, you're starting to see more activity already. I mean we're starting to see more pools come to market. And I think you'll -- as margins compress, you know this well in the Origination business, especially in your correspondent and wholesale channels, that they'll run in a cash flow negative manner, you're just going to see more servicing come to market naturally.

And of course, the one last part of that is, Mark, that we do expect over that 3-year time frame that CPRs are going to moderate considerably. I mean we've seen CPR speeds in the mid-20s, which are double what they normally would be. And so as that happens, we're not going to have to buy that much more, but we'll have that much less running off.

Got it. Are you still seeing a healthy number of lenders sitting on their servicing now hoping for rates to go higher and mortgage extends where they can get a fuller multiple on their MSRs? Has that constrained supply a little bit here?

There's still -- in relative terms, yes, but there are more people coming to market. If anything, there's still a fair number of them that have maybe slightly unrealistic views of the value of their servicing. But the fact remains that these folks have been able to operate on a cash flow-positive basis where margins were unusually wide margins, margins have tightened. They're not able to operate on a cash flow-positive basis anymore. They're going to have to sell their servicing. It just is a matter of price discovery at this point.

Yes. What is the competitive landscape like for acquiring servicing here? Certainly, a larger number of mortgage REITs that are out there looking to buy MSR. How does that compare to years past?

I don't think it's changed materially. There's always a number of new financial buyers that come in and out of the market. Right now, with funding costs unusually low, there might be somewhat more of those players. But they'll -- I think they will tend to be less aggressive buyers. If you think of us, number one, to buy large pools, you've got to have the approval of the agencies or the government to do that, to have those transfers made. There are only a few large buyers that are in a position to get that with certainty, and we're certainly one of them. The second thing is you've got to be able to service these pools at a reasonable price. We've got a very efficient platform. So we have some certain advantages. And the last one would be recapture. Everyone that buys a pool of MSR buys it with an assumption around recapture. And we've historically had recapture rates that are double the industry. So we have certain competitive advantages that should allow us -- I mean, people are going to -- we're not going to get every pool that we're interested in, but we do have certain competitive advantages that should make us very competitive across the board.

And really, if you think about the financial buyers, Mark, a lot of those are already subservicing clients, right? And for all the reasons Chris just cited, we're a subservicer of choice for the financial buyers, recapture platform being one of the greatest strengths there. So even as you have the financial buyers playing a role in the acquisitions, it's a high likelihood we'll get that subservicing or we'll certainly get our fair share.

Great. Jay, could you help us understand how in that situation, right, where you're a subservicer and there's a recapture opportunity, how the economics are shared between you and the owner of servicing?

It really varies by subservicing -- or by the financial buyer and the subservicing agreement. But in general, the gain-on-sale economics are retained by the subservicer, and the MSR is returned to the financial buyer.

Okay. Got it. And then what role do you see subservicing as playing in that in getting to that trillion-dollar UPB goal?

I think it will depend, right? Ultimately, when you look at our model today, our model is centered around a couple of large financial institutions and financial buyers. It's not really what you'd call your traditional originator-centric subservicing model. So I think depending on how servicing trades in the coming years, if there's a lot of financial buyers, I think subservicing will be a bigger part of the portfolio. If it's not, then I think it will be less, and we'll be buying more MSRs ourselves. So I think it somewhat depends on ultimately who the buyers are.

Okay. And then what type of investments will you need to make as you kind of leg your way into that $1 trillion portfolio?

We don't need to make any investments. We've made one final investment last year to bolster our -- the core of our platform. So we have the capacity to grow to $1 trillion and then quite a bit more actually. So just to be clear, we don't need to make investments for capacity. There are opportunities, though, to continue to automate some of the work and to drive more efficiency. And I think that's an area that we've been very successful. If you go back to the last few years, we've been able to drive down our unit cost considerably through those investments, and we'll continue to do it. An example would be the modification system that we automated. And we didn't do it planning on a pandemic, but we did make that investment expecting there will be periods when modification levels would be high. And the great thing now is that if we look at years past, compared to what we're going through today, 70% of the manual work has been fully automated. And so as we're now going through the last phase of exits through forbearance, we probably could not have gotten through this level of activity as smoothly as we have if we hadn't made that investment. We have a few areas in the Servicing platform specifically that would be in the claims function where some of our claims, the claims for certain investors, have been automated. We're still working on the balance. And so things like that. And then on the Origination side, we have taken the processing and underwriting functions and really broken them down into a couple of hundred small tasks and are about 20%, maybe 25% of the way through automating each of those tasks that don't need manual intervention. And so we'll continue to make those investments. And that'll take us probably through the end of next year before we're complete with that. But those are not things that need to get done. They're really efficiency investments.

Okay. Great. Well, I think it's a good segue to the next question around Servicing profitability. There have been, obviously, some headwinds here. Can you just remind us like what second half profitability should look like for Servicing? And then kind of longer term, as you look to automate more and more processes, where do you think the Servicing margin could ultimately get?

We think the Servicing margin -- the goal is to get it back to about 5 basis points. And I'm not sure that's a -- now that I said it, I'm not sure that's the goal. That's the expectation, it will get back to that level through a combination of investments and a combination of returning back to normal CPR speeds and...

Short-term.

Short-term rates returning to normal levels, so we're earning something on our float. Of course, that overall margin is dependent on -- again on the mix of subservicing and owned MSR. In the past, we had higher levels of profitability when the composition was more 60-40 owned subservicing. Now it's more like 50-50 subservicing. So that basis point number will change a little bit, but there's no reason why we won't get back to that level.

Okay. Great. Can you just talk briefly about the opportunity that you still may have around EBOs?

Yes. I think we said we expected EBOs to be lower but still meaningful this quarter, and they will be. We -- because the government has changed their -- the -- some of the options for resolving forbearance a little bit, we may have a small, incremental opportunity that'll probably show up in the fourth quarter. But it's another $10 million, $20 million, $30 million, in that range. It's not a big, big number. But after the fourth quarter, that opportunity pretty much have played out. If there's any opportunity in the first quarter, it will just be timing. Something will have slipped out of the fourth quarter, and it's not going to be meaningful.

Okay. And then what are your expectations for CPRs in the second half of the year? Is that going to be one of the biggest drivers to determine when you can get back closer to that 5 basis points of Servicing margin?

Yes. Well, CPR and short-term rates are equally important. But on one hand, we're not really that eager for CPRs to slow down because if CPRs slow down, that means Origination is slowing down. So the beauty of our business is it's pretty balanced. We're actually expecting -- well, we don't have any personal proprietary view on interest rates. But I think just given consensus, it looks as though rates will remain low for most of next year. And we should have moderating but pretty -- still pretty strong levels of origination. And I would expect CPRs to still remain elevated perhaps not in the 20s, maybe in the high teens. So I think it won't be until '23 until Servicing returns to a normal level. And that's going to be a combination of slowing down CPRs and, again, short-term rates rising.

Okay. That's helpful. So along those lines, could you update us on kind of the pool of borrowers with incentive to refinance in your Servicing book? And how have recapture rates trended in the quarter relative to 2Q a year ago?

So the number -- I don't think the numbers materially changed. I mean at the beginning of the quarter, as you know, rates rose fairly quickly, but they've come back down. So the number of people, I think we said at the end of last quarter, was 700,000 and change that could save $200 a month. That number is still probably approximately that. And I'm sorry, the second part of the question?

Oh, just how are your recapture rates trending relative to recent experience and to last year?

I think you should expect recapture to move up gradually, though it will not be -- it's not going to return to the mid-50s overnight, but it will move gradually up just like we expect another shift is you'll see cash-out become a bigger and bigger part of our refinance activity. And I don't have those figures at the tip of my fingers for the quarter, but I expect they'll continue to improve.

Okay. Since you mentioned cash-out, how are those efforts going? Has it been kind of a shift from an origination perspective to get people to focus on trying to leverage the equity opportunity to generate new refinance volume?

We have a big marketing initiative pushing cash-out and sort of educating our customers on what their opportunity is to consolidate debts and use cash-out as a way to lower their overall debt cost. And it's been -- I think it's been very successful. I don't have the number, but I'm going to guess that cash-out is 40% of our refi activity this month. So you should see that continue to grow.

Yes, I think the sales force has done a great job of shifting to that, which is more of a needs-based sale. But I think Chris is right. I think even in the second quarter of the refis, I think 40% were cash-out refi, and we continue to see that kind of gradually go up. So there's a real demand for it, and we clearly are helping our customers understand the benefits of it.

Do you have any sense for how much of that is kind of additive to the refi opportunity? I guess what I'm asking is, how many of these emerged who might have refinanced not that long ago and are using it as an opportunity to consolidate? And how many have emerged who maybe haven't refinanced, but they're using this opportunity to take cash out and consolidate that? Because I think the interesting story is like you get to the refi wave and then you realize all these people have home equity. You can effectively refinance them again as a means to kind of leverage some of that equity they've been delivering in the last couple of years.

It's a great question. I don't have a statistic.

We can get that for you, but we -- I don't know that off the top of my head.

Okay. Let's see.

But I do think you -- you're right. I think people are -- they refinanced previously. We all know what home price appreciation has done, and so there's a massive opportunity there. So we'll -- we can get those numbers.

I definitely think we'll see that grow significantly as rates go up because today, we're still -- the majority of our marketing are to customers we already know are in the money just from a rate/term refi. And we're also now marketing to them with the opportunity to do that plus a cash-out on top of it. As the opportunity for rate/term refi begins to shrink, that's when we'll also be marketing just to another segment of our customers to do debt consolidation.

Okay. Great. Could you talk about whether there are any initiatives you're kind of focusing on right now to improve your recapture rates?

Well, the project I talked about on the Origination side, which we call Project Flash, is intended to promote efficiency but also to improve the customer experience and to significantly reduce our turn times. And we think part of the fallout we have when we market to a customer and we lock a loan, there are times when they -- during that process, they fall out. They may decide to pursue a different option. They may just get flustered with the process. And so customer delight -- driving customer delight is one of our big initiatives. So I'd say there isn't any specific initiative just around recapture. It's over -- our initiatives are designed to either lower our cost to originate a loan or to improve the experience for the customer.

Which naturally is going to, I think, improve recapture, right? At the end of the day, the more we can delight our customers, I think it's -- that's automatically going to increase recapture. I really believe that. If you look at the customers that have originated or refinanced with us previously, the -- our recapture on those customers is 65%, 70%, 75%. I mean it's very high. So the delight aspect is extremely important.

Okay. Is there anything you can do to more effectively market to customers who may be in the money in your Servicing portfolio? Or does it feel like you're as far along as you need to be there and that it's more like the delighting levels on the process and making it easier to convert them, that, that's the bigger focus here?

I think we can get better at the marketing piece as well. Look, I mean, from my seat, I think, Mark, there's always room for improvement, right? And so we are taking a hard look at kind of our current marketing tools and programs today, and I think there's room to improve there as well. So you should -- look, we want to be at a 60% recapture rate, right, at the end of the day. And we want to drive towards that, and then we'll get there gradually, but it's going to take efforts in the marketing, in the process, customer delight, really throughout the channel. We're going to be looking at all that to continuously improve it.

Okay. Great. Changing tracks to Xome. I think, Jay, historically, you talked about the value of that being north of $1 billion. And you've already extracted over half of that just through the sale of your title business. Do you see additional opportunities to extract more value from what remains in that platform?

Absolutely. I mean a couple of updates on that. We -- you might have seen the announcement. We sold our valuations business, our appraisal business. I think that was a very tiny sale but, from a strategic standpoint, was a win in that we were able to place all our team members with another -- with the buyer, and it just is not a distraction for us. And it wasn't making much money. I think we're working on a field services transaction as well. We'll see if -- how that unfolds. And so then you're left with the exchange business, which I think is extremely valuable. And once the moratorium lifts, you're going to start to see the power of that business. It's a business today that is 80%, I think, third-party business. And no longer is it really dependent on Mr. Cooper's volume, it's all third -- predominantly third-party business. When you look at the cash flow and the earnings from that business, probably second half of next year, you're going to start to see really meaningful profit come from that business, again, once the courts get opened and once kind of the foreclosure process starts to unfold. And then in '23, I think the profitability will be back to historic highs. And so I think ultimately, we think there's no book value in the business. We're not really getting the full value, we don't think, reflected in our share price. So I think monetization makes sense. And I think we sold the title business for $500 million, and I think we can absolutely sell the auction business for more than that.

Great. It was very helpful. And turning to capital deployment. You've achieved your previously set 15% capital ratio target. Can you talk about how to think about cash flow you're generating and the uses of that? Is deleveraging the balance sheet something you're still prioritizing?

I'd say we don't have any plans today to delever, and we don't have any debt that's callable until January next year and even that under premium. We'll look at it then. Our priorities are to use our capital to grow the portfolio, both to have more servicing, more profitable servicing, and to provide more customers for the Originations business. And the capital we have today, we feel, is sufficient to let us get to $1 trillion. Now if we proceed with the -- and also, we still have some room left in our repurchase authorization, which you should assume will be used in a normal course of things, nothing significant like the KKR transaction. But when we're at a point where we monetize the auction platform, that will provide us a lot of capital. We don't have that earmarked. And I think we'll talk a little bit more about what we're going to do at that point. But the message to our shareholders really should be, as large shareholders ourselves, if we can't use the capital to expand the business and provide the right level of return, then we'll return the capital to the shareholders. We do not want to sit on excess capital. There's no value in doing that.

Okay. Got it. Just briefly on buybacks. Can you just discuss the impact of the additional buyback flexibility you have now, now that you've passed kind of the 3-year anniversary of the WMIH merger?

Yes. It's -- I'll say it's very, very significant and for 2 reasons. One, when you get through that 3-year anniversary, you can have, I think, up to a -- you start back at almost 0 and you can have up to 50% change in your 5% owners. So it's -- it provides you a lot of flexibility. But the other part of it is our DTA, which could have been at risk had we breached that level prior to the anniversary. It's no longer a DTA made up of NOLs, it's almost -- by the end of this year, it'd be almost entirely timing difference. And so it's a different type of DTA. And so I think you should take away from that, that we have a significant flexibility to buy back shares as well as the DTA is no longer a captive DTA that you could lose or you can lose it if you breach the rule or if you weren't able to use it to offset your taxes. The timing difference is a permanent asset. And we can use it, or if the company is ever sold, the buyer could use it.

And it has no expiration.

Great. Could you just discuss your appetite for buying back shares at this valuation?

I think you should think of us as being opportunistic, just like we were with the opportunity we had to buy back KKR's stake. At the right price, we'll buy back shares, and we'll see how the stock continues to perform. We think we're going to have a strong quarter. We think tangible book will continue to increase through organic earnings. We also think there's upside if and when there is a change in the corporate tax rate that would add $250 million or so to our tangible book, maybe $3 a share. So I think the stock price should continue -- I mean, the tangible book per share should continue to grow. If the stock price doesn't follow suit, then we would be -- we would have a big appetite. And if the stock price performs the way we expect it to do, maybe we'd have a more modest appetite. We don't -- we're not going to chase the stock price. But beyond that, I think you should expect us to continue to look for opportunities like the one we just took advantage of.

Okay. Great. We had a question coming in from the audience. "Can you talk about how some of the investments you've been making could help drive purchase volume in the DTC channel?"

Yes. Well, I'd say the biggest one now, I mentioned Project Flash, which is an investment to automate a lot of the workflow. Our previous investments have been in proprietary technology to automate things like document disclosures to customers or our pricing engine that allows us to provide customers -- Jay mentioned needs-based selling. That's how we sell to our customers. So we're able to run thousands of calculations instantaneously to show a customer while we're live with them in a conversation. This is an investment in something we call sales desk to ship all their options right on their screen as we're talking to them. So the investments themselves have been powerful, and it's a reason that even though our recapture rate has come down, you got to keep in mind it's still double the industry average. And it's because of that technology. Now the next step will be to automate the front end. We're going to be integrating Blend in as our point-of-sale system. So that, along with the proprietary technology we built and a more automated workflow, I think, will eventually lead to a sales process with much less friction for the consumer.

Got it. Got it. Some of the bigger direct-to-consumer competitors have actually invested in a national brand. Is that something you can see yourself advertising? Do you see yourself doing more of that, Jay? Should we expect the next name on Cowboys Stadium to be Mr. Cooper Group Stadium?

No. Look, I think we -- to Chris' point, when you look at the investments we're making now, they are going to go a long way to continue to improve our recapture rate, and they're going to go a long way to delighting our customers. But my personal view has always been if -- until we get to that 60% recapture, until we are delighting our existing customers, because we have so much opportunity there, and it's so profitable, right, because the customer acquisition is basically nothing, we're going to keep our focus there. And then when you look at the correspondent channel, the way we've grown that and the way we've been able to acquire customers through that, we think there's a lot of opportunity there as well. And that's where we're acquiring a lot of purchase money business. So I think staying the course is where we are going to be for the next 2 to 3 years. After that, sure, we will certainly think about new customer acquisition via direct-to-consumer channel, but I just feel like there's so much opportunity in front of us that we got to stay focused.

Okay. Is -- you clearly in the past made a constitution to back away from the broker channel. Is that something you'd ever consider getting back into if you're able to find the right opportunity?

Yes. I think we would. And we -- the market is -- it's an interesting time in the market because I do think you're starting to see, like I said, a, more pools come to market. You're also seeing more companies pursuing potentially a sales strategy or an acquisition strategy. And so I think, yes, we're going to look at platforms. We would definitely look at a broker platform if we thought it made sense. But we're very selective there. If you look a couple of years ago when we acquired Pacific Union, that was a very nice acquisition for us. It came with a decent-size servicing portfolio, came with a lot of talent from a correspondent standpoint and really allowed us to kind of leapfrog in the correspondent business. So we would definitely consider a strong broker platform if we could identify one.

Okay. Just one last question for me. Is there anything that's winding its way through the halls of Congress that you guys are particularly focused on that could impact your business?

Yes. I think, Mark, what's the -- most of the discussion this year has been around the forbearance plans, right, and the exit out of the forbearance plans. I think it's a good example, frankly, where the government and industry have worked really well together. And I think there's a lot of tools and a lot of programs to allow customers to exit forbearance and retain their home. So a lot of energy has been spent around that. I think now it is low- to moderate-income lending, right, and looking for ways to really help the underserved. And as I think about FHFA, FHA, HUD, where their focus is going to be, I think you're going to see a lot of focus in those areas. And that's what the talk in the halls is today, is how can we help with that, new programs, new products, et cetera. I think there'll be a tremendous focus on that.

Okay. Great. Well, now I think we've run out of time. I'd like to thank all of you for your time and insights today. We really appreciate it.

Thank you, Mark.

Thank you, Mark.

Really appreciate it.