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

Okay. Great. Good morning. Thank you all for joining us for the second day of the Barclays Financial Services Conference. Very pleased to be joined this morning by the team from Mr. Cooper Group, CEO Jay Bray, president Chris Marshall, and CFO Jaime Gow. We are going to be doing a fireside chat format. We have a number of prepared questions for the team. We're going to pause in the middle for some audience response questions. And then I'll open it up to the audience for any questions from you.

So just to lead it off, can you just discuss volume and margin trends you're seeing quarter-to-date?

Well, if you, think back to the second quarter, we said we expected volume to be relatively stable. And I think for a couple of quarters, we've expected margin to stay in the 90 to 100 basis points. I think last quarter, we were 103, that's exactly where we are. I think the correspondent volume maybe a little bit bigger. We are seeing margin in the corresponding channel start to come back as we had expected at some point in the year. So you will probably see a little bit more correspondent in the mix. Maybe the margin will be a little bit lower, but we're going to be right in that range.

Okay. Great. And any color on how kind of margins are trending across different channels? And I know you guys are no longer in the broker channel, but we saw some pretty aggressive competition by one lender responding to another lender's very aggressive move down in rate. Is that where you're seeing the most competition? How does it look across the different channels?

Yes, I think so. We are pretty close to one of those individuals. And I think they're -- they've stated what their mission is. They want to continue to capture market share. And when you talk to some of the other broker players, I think they're continuing to face that pressure. So that's probably the most competitive channel out there. To Chris' point, broker margins have gotten pretty thin, but now that's bouncing back. And our direct-to-consumer margins have -- they're still strong. So I think brokers are under the most pressure, for sure.

Got it.

And, Mark, though I wouldn't say that's an overall trend, I think some of the [Technical Difficulty] the haves and have-nots is sort of emerging. I think there are -- you're going to see some of the stronger players--not necessarily all the larger ones but some of the stronger ones who maybe have made investments in technology--they seem to be doing well in terms of protecting their margins. I think there are a lot of folks who are still struggling. So my comment on the corresponding channel is more the stronger players in that channel. And as Jay said in DTC, I think we're rock solid there.

Okay. Great. So with the 30-year fixed rate mortgage around 5% or a little bit above that, at that time, you issued 2Q and 3Q guidance, with the origination guidance of 5% to 6%, pretax income $50 million to $60 million. Mortgage rates have bounced around now at about 40 bps above those levels. What effect, if any, has that volatility had on kind of your near-term outlook?

Well, let me go back to what I said. We gave you guidance. I think we're pretty much spot on the guidance. Having said that, we've been whipsawed a few times. I mean, if you see that kind of volatility in the immediate week or 2 weeks, you definitely see an impact on new applications. If rates are going up, you see pull-through improving. It's netting out about the same place. But if rates continue to go up, there's no question it's going to have an impact on volumes. Having said that, most of our volume in the DTC channel is coming from cash out. And so if rates are at 5.25% or at 5.50% and someone needs cash to renovate their house or to pay for a wedding or whatever they may need, they're more likely they're going to take the cash out. They may wait a few weeks to see if rates stabilize. So long term, I don't think there's going to be a massive change to volume in our DTC channel. On the correspondent channel, most of our volume is now purchased. And so that's a home affordability question. Rates continue to go up, you'll see less volume overall.

Yes, it's a real benefit for us to have the 4 million customer portfolio, obviously, and that's where all the DTC volume is coming from Chris's point. Predominantly cash out refi is the product now. And those borrowers, in a lot of cases, they need the money for a variety of reasons, but they're not as sensitive to rates. And that's why having the balanced business model, I think, makes a ton of sense in this environment.

Okay. Sticking with the purchase market, how are you thinking about the kind of intermediate term outlook there? I mean, you've got different crosscurrents with obviously, I think, some strong secular trends, but obviously, affordability pressure just with the rates going. Kind of what are you looking for in the purchase?

Well, I think you saw it recently that the volume numbers keep coming down for the year, right? If they can be further reduced their overall volume for the year, I think purchase is really challenged right now. If you look at where rates are at, if you look at just kind of the overall affordability equation and when you look at -- I think -- there's a lot of people that are on the sidelines now that are nervous about recession and what's next. So I think you're going to continue to see a slowdown there. Home price appreciation, that's clearly -- that's going to come down at a reasonable pace as well, I think. So a lot of macro factors to your point that are going to impact that market, overall, undoubtedly.

Great. What impact, if any, do you think student debt forgiveness could have on stimulating housing activity?

We took a quick look at that. I think if you looked at our portfolio, about 16% of our customers have student loan debt. And then when you kind of double-click on that, they're probably other ones that have student loan debt, 30% of those are more delinquent than kind of the average portfolio. But the delinquencies are so low that it's kind of insignificant at this point. It's not making a huge difference. And then if you fast forward to this forgiveness plan, of that 60%, we think somewhere between, call it, 30% and 40% are going to get their debt completely wiped out. So I don't know. I think, for us, it's going to be pretty minimal at the end of the day. And I think we're probably representing since we are among the largest servicer in the country, we're among the largest servicers. We're probably representative of what's going on in the space.

Okay. Great. Could you talk a little bit more about how you expect share -- your share among the different origination channels to shift as the market adapts to kind of minimal refi demand?

While there's definitely a significant reduction in refi, refi is sort of a secondary thought right now, but cash out refinance is strong. And I think as rates stabilize and consumer confidence starts to build, we'll see more volume there. Purchase is not something we've had a big market share in previously, but we have a big purchase initiative going on at the company, and we'll talk more about that probably in a couple of quarters as we see some evidence. But I wouldn't make a long-term forecast on what that's going to be because of all the macro factors that Jay mentioned. I mean as -- he just commented on, we've got 4 million customers. We will be the largest servicer in the country this time next year just based on the trends of the other large players. And having that customer base gives us an opportunity to serve them in a lot of ways. But when refi was hot, we pivoted to that. As purchase starts to grow, as inventories start to build, as customers -- our customers are more interested in purchase, we intend to be there.

Just given the nature of the seller base, when you participate in correspondent, does that tend to be a little bit more skewed to purchase than the DTC?

You should think of the correspondent as indicative of what's going on in the overall market, right? So it's definitely a much higher purchase in that channel than you would see in DTC.

So should we think about you potentially leaning into that a little more as refi gets more challenged? Or is it all just margin dependent here?

Pretty focused on the margin.

At the end of the day.

We try to maintain a lot of discipline around that. And I mean it's going to, I think, very dependent on quarter-by-quarter and what margins are really doing in those channels. Like, right now, we increased correspondent, to Chris' point earlier, slightly because we're really starting to see margins come back there. But if that people behave irrationally or that kind of goes away, then we'll back off. We get through every quarter pretty -- and frankly, every week, almost disciplined capital deployment routine to determine, all right, where do we want to invest, what are margins looking like and what's going on in the bulk market, et cetera, et cetera.

Great. Looking through my questions. I don't think I had anything about cash out, but something you've talked about twice. Can you talk a little bit more about what you're seeing there, kind of, what the opportunity is, what the demand is that you're seeing from customers on that front?

I think you think -- you should think of virtually all of our volume in DTC is cash out. Now we are very experienced in that product. We've got very sophisticated models to predict which of our customers are in need to cash out. We market fairly aggressively to them. And we expect that volume to stay relatively stable from where it was in the second quarter. I'm not sure there's much more to say to that. But I think the message or theme in your questions are what happens now that rates are up and we think where we are is relatively where we're going to be going forward? If margin in correspondent gets much wider, we'll allocate more capital there. But the backdrop to all that is our servicing business is going to be on fire, right? Speeds are very low. Amortization is down. I think in the second quarter, we said you should expect our earnings from servicing, which have been so depressed because of high CPRs, they will double in the quarter, and then they will double again in the fourth quarter. And I think you'll see them continue to grow to -- they're not going to double forever, but servicing is going to come back in a big way. And as the soon to be largest servicer in the country with the most efficient platform, we're going to make a lot of money off of servicing. So Jay mentioned the balanced business model, if rates stay high, services, which has always been a crown jewel is going to shine, and if rates start to come down again, then refi will start to come back into the mix to a certain extent. But I think the one thing we want to leave everyone with is of all of the independent mortgage companies in the country, we're the one that really has that balance.

Okay. Great.

And Mark, it's just -- if you think about cash out, just the amount of equity our customers have, it's a staggering number, right? Because you've seen what home price appreciation has done in the last decade. And so to Chris' point, there's tremendous opportunity there.

Okay. And are you focused -- when it comes to helping borrowers extract that equity, are you focused primarily on just a full cash out refi? Or are you thinking about, if you don't already have it, broadening into seconds, whether it's a HELOC or just a close end, so they don't have to refinance their whole balance?

Yes. We're -- we spend most of the time looking at second lien products and have the availability to do that. So ultimately, you want the right thing for the customer. Now everybody wants to move out of that first lien. But I mean, again, when they have consumer debt that's 4x their current rate, there's a lot of savings there. So it just depends on the individual borrower situation.

We've gotten a lot of questions from investors really on that topic. Do people really want to refinance a 3.5% loan and go to 5.5%? And the answer is, if you're sitting there and you've got $40,000 of revolving debt or you have some other emerging, that 2% doesn't really slow that decision down. So if you think of our portfolio sort of being middle America, there are a lot of people carrying a lot of debt and the cash out helps them clean up their balance sheet. They may be paying a little bit more in the long term, but the cash flow improvement they get is immediate, and that's really what they're solving for.

Yes. I assume part of the problem they're also facing is just supply. Like, for example, my mortgage lender is Chase and they don't yet -- I mean they've talked about it, but they don't offer a second, right? And so right now, my only option, if I want to extract equity is to refinance. Is that -- I mean is it -- are you just seeing a lot of lenders really be reluctant and slow to kind of ramp up the second?

The big banks that went through the home equity crisis in 2009 and '10, unfortunately, I was one of them. I -- that's a hard memory to get past. So I think Chase has -- was early about saying they didn't want to increase their exposure. But that doesn't mean they won't participate in some way and syndicate and sell off that product. I'm not suggesting they will. I'm just saying, I think the big banks are going to be very slow to jump back in with both feet.

Yes. Okay. Shifting to your $1 trillion servicing target. Is anything about kind of the evolving origination environment affected the goal there and the timing?

No. I think we're probably slightly ahead of schedule. If you look at the activity we had at the end of the fourth quarter and the first quarter of this year, and frankly, some subservicing wins, probably ahead of schedule there. But nothing actually impacting that.

Okay. And how is the bulk MSR market shaping up? You would assume that some of the potential sellers, more of them may be, feeling more and more distressed and looking for liquidity for sales. Is that -- you started to see that continue to unfold?

We are. We're starting to see a lot more supply than, I would say, they're our buyers, to be honest. That's a good place to be. We're remaining patient. I would say, we have not been as active as we were kind of, again, back to the fourth and first quarter because we think there's more coming and probably more size. And so as we think about last half of the year, we think there will be more opportunities, for sure.

Okay. Great. Can you talk a little bit more about your expectations for servicing profitability in the second half of the year and into 2023?

Well, we spent most of 2019, a lot of 2020 as well, making big investments in that platform. So today, I think it's acknowledged we have the most efficient, profitable platform. But going from where we are, which we ended the quarter just over $800 billion to $1 trillion, there's a very small amount of expense we have to add to service that incremental volume. So that's why we're focused. The $1 trillion is a number to get everyone's attention. I think we'll get there. As Jay just said, I think we're a year ahead of schedule. So we're not going to stop there. We intend to continue to add to the platform for that very reason. So rather than forecasting a basis point, I think you should just think about that incremental volume is probably 3 to 4x as profitable as the core and that's going to continue.

That's helpful. You talked about kind of what you're seeing from realized servicing speeds compared to your expectations that drove the $100 million pretax servicing income expectation.

Yes. Speeds, which 18 months ago were in the mid-20s, are high-single digits now. I want to say, they're 8.5 or somewhere in that range. I've seen a variety of forecasts where they will be at the end of the year, some kind of hard to believe and some are in the mid-single digits. I'm not quite sure we expect to hit that, may be they will. I don't think they will stay there. But I think staying in the high-single digits through the end of the year and into next year in the current rate environment is probably a good estimate.

And that -- and those expectations are consistent with that guidance?

Yes.

Okay. Great. And then maybe looking out a little far, but what are your expectations for speeds in 2023?

I just said, right now, I would assume they're going to be right around that level. They could go from 8% to 9% to 10%, maybe, but I don't see anything creeping back up in the double digits.

Yes. Fair enough. Can you discuss sticking with some of the investments you've made, with the impact of your prior investments in originating servicing technology now that we're in a much different environment than a year ago?

Well, not to bring everyone down into the weeds, but if you think of things like loan modifications, well, we have an automated loan modification platform now. If you think about our customer contact centers, we made an investment in the most bleeding edge, state-of-the-art telephone system. We've seen call volumes on a like-to-like period are now reduced, I guess, 30%, just because of advances in the IVR that we've implemented. And IVR, that's not a sexy thing. They've been around forever, but the ability to reprogram on the fly because something came up this morning and be able to have an option for a customer to come on and hear, "Oh, if you are calling because of the wildfire, just push 7." The idea that you can have a customer self-serve, get a quick answer to something rather than get on the phone that costs $7 or $8 or $9 for a phone call, we continue to see things like that decline. But virtually every part of our platform has gone through significant investment in automation. That's why we were able to sell the IP for the bulk of that servicing platform for $0.25 billion. It is the best servicing platform in the industry right now. So I'm not sure if I'm answering your question, but I think the proof of that is in the efficiency that we have. We can service loans cheaper than anyone else largely because of that technology.

And I think, Mark, it's just -- we're probably still in the early innings of what's possible. I mean this is something as simple as you look at the number of calls we get for customers that just want to make a payment. Well, you should be able to make a payment within the IVR, not have to talk to an individual, et cetera. But some people, they really want to talk to an individual, so you set up a special process for just those customers. We know who they are. It takes a call from 8 minutes to 3 minutes, and that's real money. It saves you a lot. And so Chris is the engineer of this, but we are driving still a significant process improvement and automation in the servicing platform. So pretty excited about being able to continue to take that cost per loan down.

The same thing applies to the originations platform. The reason our margins have stayed as high as they have is directly related to the amount of automation that we've invested in. And an example of that, we've talked in the past about Project Flash, and it sounds sexy, it's kind of boring when you get down into the 300 little manual tasks, you've got to do the process alone. But we now process a loan at about 1/3 of the expense of what we did 2 years ago. If you think about that, this is the same thing. This is a commodity product that's been done in the same way for 50 years. Well, we now do it in an automated way and quality, the speed, everything has improved dramatically. Now we're going through the underwriting process right now and doing the same thing. So it's not just servicing, although that was the place we started. We'll continue to invest there, but it's also on the origination side.

Yes. I think we even really want to come out of this cycle, whenever that will be. And with the best factory -- we already, in our opinion, have the best factory in the servicing business. And to Chris' point, I think, we really want to be ready on the origination side with continued efficiency, better customer service, lower cost, et cetera, and that's where we're making the investment.

Okay. That's helpful. It sounds like you think there's still a lot that you can do. Is there anything you want to preview in terms of like what some of your next priorities might be around process innovation?

One, we're going through a complete overhaul of our website. Everyone here knows -- everyone has a website. So what's the magic there? Well, we've been studying our customer behavior on the website, the patterns, where they go, what attracts them, what doesn't. Our website provides about 42% of the leads that turn into loans, funded loans, whether that was through refi or it's cash out, we have -- like most people, we have tools that our customers can use when they go online to figure out what they can save and figure out what loan works best for them. But there's definitely improvements we can make to make it simpler. We can see where customers drop out and pick up the phone or where they drop out, they're just in the process. And so there is a lot of science behind how you keep them engaged. When you introduce a chat function to help them, when you -- just stepping back and redesigning that whole process with the analysis we produced over the last, say, 18 months has been a big initiative for us right now.

Okay. Great. I'm going to pause here for the audience response section. [Operator Instructions] The first one, what do you view is the biggest catalyst for Mr. Cooper over the next 12 months? One, better-than-expected origination volume; two, better than expected gain on sale margin; three, capital returns; four, monetization of Xome assets; or five, other?

The biggest catalyst is what we expect to see catalyst...

Well, this is for them, so [indiscernible] reaction to their responses. So they're looking for...

Okay. Well, I think our gain on sale margins remain pretty strong compared to everybody else in the industry. Our DTC margins are rock solid. I think correspondent is going to be whatever the market provides. You've seen us cut back and our margin, our overall margin, which, of course, is driven by gain on sale, has expanded, and it may contract a little bit. If you separate mix, I don't see gain on sale changing that much going forward. So if that's the biggest catalyst, I'd ask the audience, if we sell Xome, if you look at our stock right now, well, some may question the ongoing profitability of the independent mortgage banks as a whole. If you look at us, there's nothing that's going to prevent us from remaining profitable. Like, servicing is going to increase right on line with what we said. Our profitability and originations is right on top of our guidance. Our stock is trading at about 30% below book value, and that gives you exactly 0 for Xome. So I personally think if we get to the finish line and we're not there and sell Xome, I would suspect that's going to drive our stock significantly.

Okay. Great. Next question, please. What's the biggest risk to shares, weaker-than-expected origination volume, weaker-than-expected gain on sale margin, weaker-than-expected servicing growth and profitability, less-than-expected capital returns? Five, other? So 15-odd percent indicated weaker-than-expected servicing growth and profitability. Next question, do you want to respond?

Well, I think look, the servicing business to Chris' point is doing exactly what we expected. I mean, if you look at where we thought we'd be in the third quarter, where we think we're going to be in the fourth, and it's not that complicated. I mean, at the end of the day, when you see speeds coming down to, call it, high single digits that impacts your amortization expense, right? And when you see interest rates increasing, that impacts our ability to earn interest income, and so I think those are going to happen. And so I think you will see strong servicing profitability going forward. I mean if something else happens with rates or if you see something unexpected, that could change. But I'm highly confident in where we're going to end the year.

Okay. Great. Next question, please. What is the best use of excess cash flow? One, increased buybacks; two, purchase bulk MSR; three, dividends; four, delever the balance sheet; five, other? To delever the balance sheet. How does that line up with your priorities?

A lot of fixed income investors out there. How does it line up? I think our leverage is healthy right now. I joined the company in 2019. The first thing I said is, "I want to delever, more to show people we could that we had more ammunition than people were giving us credit for." I'm a little surprised by the question, but we're certainly -- we have no appetite to get aggressive with leverage. I think, right now, our debt is very serviceable. We have tons of liquidity, more than we've ever had. So I have to think about that. I think...

And frankly, Chris, if you look at our unsecured stack, if you will, we don't have anything maturing in, what, 4, 5 years?

4, 5 years.

It will be difficult to do that in a material way on that piece of it, but...

[indiscernible] buyback loans.

Buyback loans.

We might. I mean it's just capital allocation where do we see the best returns. Quite honestly, what's the lowest purchase bulk MSR, I guess, isn't the lowest. But at the returns, in today's market, when you're sitting with a lot of liquidity, given certain size pools that we expect to come to market, we may be the only potential buyer. So being able to buy those bulk pools at extremely attractive rates to us seems like a good use of cash. We are sensitive to buybacks. We have enough capital to do both. And so I think for the foreseeable future, we expect to do both. If we had to choose, I think the returns would be continue to buy at those prices. When prices contract a little bit, then we've proven to be very disciplined, we sat on our hands through a quarter or 2 before. But in the last couple of quarters, we've increased our buying just because we see the opportunity and it maybe the opportunity of a lifetime. So if that unfolds, you'll see us do more there. Again, we haven't really thought about delevering. But if we were at the point where we didn't see any opportunity to put our cash to work buying assets, we might look at buying back some of our bonds in the open market. We haven't done that to date.

Okay. I've got one more question for the audience if you could pull that up. Over the next year, would you expect your position in Q2: one, increase; two, decrease; three, remain the same? A lot of increase, great, 50%. All right. That does it for the IRS. Happy to open it up to questions from the audience, if there are any more. We have 2 over here.

I actually have 2, but I'll only ask 1 for now. What's the logic behind the opportunity of a lifetime. Could you just touch on that comment you just made and offer some logic behind why you would say that?

Sure. Well, there are several origination-centric companies that can't turn a profit right now. Their liquidity is drying up. They're still holding MSR and they need to sell them as Jay's point before was that there have been times over the last 2 quarters where there's much more paper in the market than buyers to absorb it. And when that happens, obviously, yields go through the roof. I think there have been opportunities to buy pools of MSR, smaller pools, had returns that are almost double what they were a year ago. So unlevered returns in the high teens. That's not going to -- that's not the norm. So maybe that's a little high probability to say opportunity of a lifetime, but certainly opportunity we haven't seen for the last few years.

I get the -- I get what you just said, but one of the things that's happened is rates have gone up a lot. And so I'm trying to square that opportunity against closer to cyclical, and we'll see where we get to in terms of cyclical highs for mortgage rates, but we're definitely closer to the higher than the low, right? So with that said, how does that square with?

Well, I think the way -- for us, the way it squares is, we've built a highly scalable digital servicing platform. The more assets we can buy at good returns, to feed through that platform with large incremental profitability, to us, that's a great opportunity.

And frankly, given the -- to your point, if we're at the highs and you're going to see rates come down in the next 18 months, 2 years, it's a great thing for us. I mean, just look at 2020 and '21. With our ability to recapture those loans, the origination business is -- and frankly, that's why we're making some of the investments we are like Flash, et cetera. So we can be even more ready for that opportunity. So I love that because I think there will be a chance for us to -- where we're capturing today -- and you guys correct me if I'm wrong, but on the refi side, close to 72%. If you look at customers that had refinanced with us previously, it's closer to 100%. So we really -- I think the machine is working very, very well. And if we do see a downturn in rates that will be a really good thing for us on that side of the business.

[indiscernible]

We're hedging more today than we ever have. I think it's over 25% of the portfolio, but we're comfortable at that level. Because when you think about the recapture, even if you look in '20 and '21, when you had speeds that were significantly in the 20s, right, the recapture of profitability alone would offset any more from the MSR, et cetera. So I think our current thinking is consistent with what we said in the last couple of quarters.

So you've talked on here and on conference calls about potentially monetizing more of Xome. If you were to do that, could you talk about sort of what the priorities of capital allocation are? You talked about MSR buying. You talked about stock at 70% of book. And then finally, after Xome is monetized, is there a new leverage target? Or do you repeat the same leverage targets you have now?

Let's see. I don't like to avoid giving you a specific answer on all those things because we're not at that point where we're going to talk definitively about the time line for Xome other than we're prepared to sell the business when we think there is a demonstrated ramp to profitability -- I mean, significant profitability. I think the business is right about breakeven. Maybe we'll make a little bit of money in the fourth quarter. There's been -- and we've talked about this in the past, so I won't repeat it, ad nauseam here. But the moratorium was slow to get lifted. The CFPB was very focused on examining everyone to make sure that the CARES Act was implemented correctly. So there's been a hesitancy to really speed up the inventory through foreclosure. That's changing as we speak. The courts are still opening slowly, but Xome is progressing exactly as we expected. So I don't know if it will be the first quarter, second quarter, third quarter, but selling it is a near-term decision that's already been made. We're going to do that. And it will be market dependent when we get there as to what we're going to do with the proceeds from that sale. Having said that, as a shareholder in the company, myself and obviously we all are, it's very hard for me to look at our shares and being totally objective in saying, "Why on the earth do they sell for less 70% of book value? Why do you question about the value of the assets?" We buy and sell MSR all the time, and we sell them at where they're marked. So to me, I feel the stock is significantly undervalued. And if we had the proceeds today, at least I would be one voice in the boardroom saying, "We should be buying back our shares in mass."

[indiscernible].

Yes. I think our leverage target is a responsible target. I mean if we had debt that was maturing today and the price of new debt was where it is today, maybe we would delever to some degree. But I don't see any compelling need for the company to do that today. That could change in a couple of quarters.

Great. I believe we're going to need to end on that note, but please join me in thanking them all for their time.

Thank you.

Thank you.