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

Good morning, and welcome. Thank you for joining us. My name is Terry Ma, I'm the new consumer finance analyst at Barclays. I'm pleased to be joined by the gentleman from Mr. Cooper. We have Jay Bray, the CEO; Kurt Johnson, the CFO; and Christopher Marshall, the Vice Chairman and President. Welcome, gentlemen.

I think we're just going to get right into it. Can we just start with an update on the servicing business. Your portfolio will be about $950 billion pro forma for Home Point. Can you just talk about the appetite and opportunity for additional bulk MSR purchases going forward?

Well, I think we've been very active in the ballpark. I'm sure maybe more than anyone else in the space this year. I think we're covering rather about $200 billion so quite a lot of activity. We expect that to continue. There's no sign of abating in fact I think as we get into the fourth quarter, you may see some of the regional banks start to sell some of their portfolios, just given the recent capital changes and the fact that they hold that more to retain their customers than they do to make money. So we expect it to be a buyer's market for quite some time.

Yes and I think if you look at our platform, we really feel like we have a competitive advantage when you think about it from a cost standpoint, customer standpoint, et cetera. And you look at our track record on being able to acquire portfolios and transfer them and they've gone extremely well. The ones we've executed on this year couldn't have gone better. So I think as you think about the regulatory and sellers, they weren't a trusted adviser, and I think we're #1 on that list.

Yes. And I would say, in addition to that, we've done over the last decade, about 700 services. And so we know all of the sales. We know performance. We've got detailed information on them. And I think it allows us to be competitive on our bids and on the pricing scenario, we're still seeing really attractive yields in the marketplace.

Got it. That's helpful. So maybe you can just speak to the competitive market for MSR purchases. Is it more of a buying market, a selling market and what positions key to with some of these purchases?

Definitely a buyer's market, especially as you get beyond the small pool $1 billion to $3 billion to $4 billion, $5 billion. If you exceed, say, $20 million, there may be a couple of active virus. Now we're in a great position because we've got historically high liquidity. And we've planned over the last few years for this to occur, anyone who's been listening to our conference calls over the last couple of years, we've been saying this is -- this will happen. People will start selling their portfolios. It started with the originators that retained MSRs during the refi boom, but now it's extending into the banks. So it's definitely a buyer's market, returns are very good, but there are limited buyers out there.

And look, if you look at -- and Chris alluded to, but if you look at the new proposed capital rule for the banks, where 700 billion assets more banks were always held a 10% limit on MSRs before dollar for dollar capital to Basel III, that's been expanded now in the billion dollar bank. So there are a few hundred billion dollar bank where the MSRs are approaching that 10% already. So they're going to get dollar-for- dollar treatment. And frankly, they have [indiscernible] natures $1.3 billion in servicing. They're not going to be efficient from a scale perspective. So we do -- there's going to be some more opportunity going into next year.

Yes, I've never been more excited about look at the kind of the last financial crisis, we were -- we acquired more portfolios then than anybody. And I think now it's even a bigger opportunity. We think it's going to be probably $1.4 trillion in the next 24 months to 36 months, it's going to transact, and we expect to be sure our fair share of that. So, I think there's a massive opportunity in the market right now.

Kurt, I'll tell you if you look at the regional business, I don't think any would ever claim that they make any money off of servicing. One of the advantages we have is we're the buyer of choice. But those banks that don't want to pay a higher capital charge on a non-earning asset. We're also a big subsurface. And unlike I think it's about anyone else in the industry, we provide white label subservicing. We've done that for many years. It's a big differentiator. If you're going to subservice someone, you still want your customer to think that you're being handled by your bank. But we're now investing a lot of money into creating a white label originations channel as well. So, I can see in the very near future, banks will be looking at us not just to handle their MSR but perhaps outsource all of their mortgage function to us because, as we all know, banks really don't make any money off of mortgage but we do.

Got it. Helpful. So maybe you can just touch on your expectations to sort profitability in the second half? And also maybe additionally, just where is the mark to market today?

Yes. So we guided to over $700 million in profit for the servicing at our last part of the earnings. I think we're very comfortable with that. I think servicing results have continued to be strong. Prepayment rates are low. Your short-term interest rates are higher, which helps your float income. So I think it's a good market for servicing right now. And I think we continue to see strong and improving earnings on the service side, and we did roughly $180 million last quarter. I think you'll see it up from there.

It's a great -- I mean, Terry, you know this, but it's -- our model is very balanced, right? We have strong origination business and the servicing business is perhaps the strongest in the industry. And we're in an environment where interest rates are high. So origination is obviously slower. But the servicing business is killing it. And I think the other thing that we kind of view we're in the early to middle innings of the efficiency and costs continuing to take out of the servicing business. So my view is profitability is going to continue to improve there. I mean we've got several initiatives that we're investing in this year that are going to really drive down and we think make the customer experience better. So serve tools, a lot of digital tools, et cetera. So very, very bullish on kind of the outlook for servicing in quarters to come.

But if you go back -- for those of you who haven't followed us for many years, if you went back to end of 2018, 2019, we made massive investments in the servicing platform. In fact, Kurt managed all those investments. And now we're seeing the full monetization of some of those, as Jay said, we'll continue obviously, to continue to invest in that. But our call center is state-of-the-art. I think we are probably approaching 50% of the head count we had a couple of years ago, and yet we've grown our UPB by 1/3. So there's a lot of room to go, but right now, we're the only company that has invested heavily in their servicing platform.

And then in terms of mark, we announced in the first quarter that we had increased our hedge from historically about 25% to about a 75% sell-to hedge ratio. I think that's really important. So we've seen obviously a sell-off and increase in the servicing value is going to go up as a result of that. We're offsetting that increase about 75%. So where the market is today, it is up even net of the hedge, but it's not all that dramatically, but I think it positions us really, really well for a rally in rates, not only do we have the originations income, but we're going to have cash flow from a hedge perspective as well.

Got it. That's helpful color. So just turning to credit for a moment. Can you just talk about the credit spend you're seeing in the servicing book? So what's the outlook? And is there any impact from student loan for buying and selling?

You want me to start?

Yes.

So look, there will come a time when credit obviously will hit the mortgage space. It's not right now. We're seeing our delinquencies. We reported at June quarter end that our delinquencies were down from pre-pandemic level even in pre-pandemic were at historic lows. So our servicing portfolio right now has the lowest level of delinquencies that we've ever seen in our 20 years of existence. And if you look at July and August, Ginnie Mae statistics and those -- the Ginnie Mae public also sort of July and August are out there, our delinquencies have continued to decline in July and August. So we're not really seeing a credit crunch in the mortgage space right now. We are monitoring our customers' other consumer accounts. You mentioned student loans. We have about 16% of our mortgages have a student loan. The average balance on is about $43,000 versus a $200 of mortgage. So we are looking at that as student loan payments resume. And we are seeing a little bit of delinquency noise in credit cards and autos for our customers as well. So we are paying close attention to it. We have not only the monitoring tools, but we do outbound calls based on kind of the credit characteristics of the customers. So we're pretty proactive in reaching out and making sure that we're making those payments.

Fundamentally, it's like Chris said delinquencies are an all-time low for the company. And when you look at the health of the customer from a housing standpoint, significant equity in their homes, much, much more than what we've seen back in 2008, et cetera. And so I kind of view it as a very, very healthy portfolio. And if you look at some of the recent acquisitions we've made, we acquired Rushmore, which is one of the best specialty servicers in the industry. We acquired babies special servicer a year or so ago. So we really have a lot of capacity in dry powder. If you were to see a turn from a delinquency standpoint, we certainly have the capability and the capacity to handle that. And we think we're going to grow those business. If you look at the sort of landscape, A let's just say a bit of chaos and I'm so happy Mr. Cooper and Rushmore are partnering together, that's a very powerful statement to the market. And so we think we're going to grow special services in a meaningful way, and it will be kind of a thing to the stool from an earnings standpoint.

Of course, if you look at our overall portfolio, roughly 40% of its subserviced we don't bear any credit risk. In fact, we get paid higher servicing fees as loans do become delinquent. So the combination of all those things is we're not just well positioned if things do turn, but it may be a growth sector for us.

Got it. Helpful. So turning to originations. Can you maybe just give a quick update on how volumes and margins have been trending quarter to date?

I'd say volume is exactly where you'd expect it, given rates have pierced the 7% mark. So our -- I mean, the guidance we gave was $20 million to $30 million. I think we had a little bit more in terms of [indiscernible] but of course, that's the high watermark for the year. So we expect it to be 20% to 30%. We're very comfortable with that guidance. But it's -- if anyone were asked why is it down is there's the cycle, but of course, rates and rates have a big impact on originations, but we more than offset it on the servicing side. So our business is designed to have that balanced business model, and you should expect that to show up when we report earnings.

And I'd say the other thing in the origination business is we're definitely investing for the next cycle. We've made some significant investments in the platform to improve the efficiency, again, improve the customer experience, so we expect when and if rates do come down, that we'll be more than ready from a capacity standpoint to take advantage of that opportunity. So that's really a challenge to the team at the end of the day is how to handle this in a much more efficient manner and be able to kind of see when rates do shift.

Got it. So if I look at industry [indiscernible] MBA and Fannie forecast anywhere from $1.9 trillion to $2 trillion of total originations in 2024. Mr. Cooper have an outlook from what '24 looks like?

I mean, I think we'll stay consistent with Fannie and Freddie. They've been on consistently. Our general view, I think as interest rates are going to stay higher for and you could see some downward price numbers. But overall, I think it's in the range of what we would expect. Again, with our model, it is a very bad business model. So from a servicing standpoint, again, we have a lot of visibility in the quarters to come, and we think that's going to be incredibly strong. And if you think about where kind of current coupons are at like the vintages, there's a significant number of customers that are still in the 3% range. And so it would take a significant move to get a real slight increase in volume, at least in the refi side.

Yes. And look, I would say that everything Jay said, I asked but from the servicing origination interplant for our company, right? If rates do value you see in market, it's more than the $1.9 billion to $2 billion. We do 80% recapture on our refinance business. We're in double digits on purchase recapture and moving more towards 15%. All of those are factored in. So to Chris' point earlier, if the market is $1.5 trillion to $1 trillion instead $1.92 billion, you're going to see servicing earnings come in really strong, your CPRs are going to be slow, and it comes faster, you're going to see originations earnings really pick up. So I think the balance is really key.

Adding one line to that is we're obviously focused on volume. Volume is that -- I mean we're at the trough now. So it sounds a little silly to be talking about margins, but the investments we're making are to protect and even expand our margins and just not to bore anyone, but a lot of people talk about making investments in technology. We've taken every single individual step in the origination process and the servicing process and that every single step, thousands of steps. And our effort has all been focused on what could be automated, what could be outsourced, I mean not outsourced, but offshore. And then what just is the process itself to be streamlined. We've gotten about 40% to 50% of the way through on the origination side. We save more than half of being in the labor. The cost -- direct cost per loan is down more than half. And so when volumes do come back, we will have our fair share and more. But our margins, which have always been the highest in the industry should be even stronger. So we're prepared for that. In the meantime, though, we're killing it on the servicing side. We've done the same exact thing. We've gone through every step. We've automated quite a bit, but we have further to go. And so our margin establishing over time should be even stronger.

Got it. Maybe just touch on what you're seeing in the correspondent channel. Would you expect the competition?

I don't know. There's been a lot of discussion about correspondent margins bouncing back. We don't really see that. We're a big player in correspondent. They're okay, but there's still a lot of competition there. We're focused on margin, as I just said. So we're indifferent to where we get our business. It could be through correspondent. It could be through a co-issue. It could be through bulk. Right now, with a fair amount of correspondent relative to the market, but I don't think margins are what people are expecting them to be just yet.

Yes, margins overall is still very thin. I think when you think about allocating capital, we're looking at working we get the highest return. So right now, we still feel like that's in the bulk market, the co-issue, we're certainly going to be participant in the correspondent market. And to Chris's point, we see margins coming back here in a strong way.

Got it. So you've talked in the past about expanding the scale with your DTC platform. Can you maybe just speak to the investments you've made there?

I didn't hear the firm, is what platform?

DTC platform...

DTC...

Investment.

We're going through a whole series of investments now. The first is modernizing the front office, basically with MLOCs distribute inline that and also that the customer has to go through. That's part of it. The second part is what I just talked about. We call it Project Flash, where we've taken processing of the application that is completely now automated or the processes have been streamlined. We've taken out half the cost -- more than half the cost. We're now doing the same thing through underwriting, we're half way through that, and then we'll get to funding in post close. I'd say it will take us through the end of next year. We shouldn't have underwriting finished by the first quarter. So those are the things we're doing for our internal processes. But standing up a white label capability and a white label recapture capability is the way we think we're going to capture more revenue into the company. So we'll bring it in, but we've got to be efficient back office. And I think we are more than halfway there.

Got it. You spoke a little bit about this. But you did -- the origination segment did $38 million in pretax last quarter, you guided to $20 million to $30 million. Can you maybe just talk about what the outlook is in the near term?

Yes. I think -- look, as Chris said, we're very comfortable with the $20 million to $30 million. We think Q2 is the high watermark. We book revenue at the time of lock and a lot typically come in for most of the summer in the late second quarter. So as a result of it, you'll see higher funding volume and maybe slightly higher and elevated prepayment speeds on the servicing side, although not much. And rates, as Chris have increased. And so our lock volume is probably a bit low than what this margins seem to be holding in pretty well, and we're comfortable in the $20 million to $30 million space, but I think, as Chris said, the high watermark was Q2. But again, going to be completely offset with increased servicing income on a go-forward basis. I also do think that we're doing a nice job now on really kind of expanding products. Second liens, I think are going to be a continued focus for us. We do see a lot of customers with rates in 7%, we have a 3% mortgage and the second lien is attractive for them. And we took Chris' point earlier, we put in a lot of automation around things to make sure that we can have a second -- a profitable second lien program. And what that does is that raises the effect of refinance rate from a customer, right? So they're in a 3% right now, but now they've got a 10% second. That combined refinance rate is now 5% to 5.5%. And so it's a little bit less to be in the money to kind of refi and combine the 2 of them.

But fundamentally, the origination business is profitable. We expect to continue to be profitable. Kind of when you look across the origination landscape, that's not always the case. Originators are facing tremendous pressure but again, with the balanced business model, we're really focused on origination business in the more medium and long term and making the right investments so that when the opportunity presents itself, we're going to be more efficient, more effective, we're going to have to hire 1,000 people, 2,000 people, we're really building, I think, a factory that is going to be well prepared for what to come. And the servicing business, again, is going to continue to kind of carry the day and offset anything we would expect it.

Okay. Got it. That's helpful. So when we look at the entire business, you generated an ROTCE of 1.7% last quarter. It's expanded in each of the last 4 quarters. What's the outlook going forward? And just based on the trends that you've seen present?

Well, we've always said we would earn 12% to 20%. That's our target over the long term. Of course, in refi we've made multiples of that. And as rates shocked, those returns fell. But we're -- we should be back in that zone. I think this is still a tough time for the mortgage industry, but I don't know how many companies can say we're still earning 12-plus-percent ROTCE. Although over time, you should see us stay in that zone. As things pick up, yes, we'll move more to the top of that. But right now, I think we feel confident that we can continue to generate returns at or around this level but moving up as we get into next year.

Not only saying that they can earn 12% ROTCE in the trading below book also, so...

That's right.

Pretty unique in that aspect.

Got it. Maybe you can just dig in and maybe talk about some of the drivers that get you to the top end of that 20% range.

I think a little bit more originations. We don't ever have to get back into a refi boom like we just saw. We don't ever expect that to happen again. But to get back to its come down a little bit, you'll see a little bit more refi. If you go into more of a recession, and that's your -- everyone can make their own bet on what's going to happen. But if that happens, we will see more pressure on the consumer. We'll see more people refine certainly more people tapping the second liens that we offer. So I think it's likely, even if that doesn't occur, over time, the book that we've been generating over the last couple of years will be in the money even with minor drops in rates. So I think we're still at the beginning of a transition for most of the industry. We're doing extremely well and always see as upside. So I'm not sure which path the economy is going to take, but either way, we should see upside.

And I think the -- if you look at the assets we're acquiring now, they are at very, very attractive yields. And so even with a slight downturn, we expect that to perform in those levels. And then when you look at the initiatives we have underway, I mean we are maniacal about taking cost out. We're going to continue to invest where it makes sense to reduce costs. We've got, I don't know, 5 or 6 key initiatives for the quarter that we hope to take in another $50 million plus in cost. And so I think it's a combination of those things that drive that.

And then as the costs come out of course, we've got fee-based businesses that are now generating income without assets, right? So we've got the subservicing business. And if we're the most efficient in the industry, people are going to look to us to subservice more and more assets. And I think you're starting to see that already. But we're starting to see people come to us and want us to be in subservices with them, not just because we're expensive in the industry, which we are, but because we are also really, really good at what we do and we have retention capabilities as well. And so we acquired Rushmore and Roosevelt as of the end of July. We're looking at potentially starting a fund with Rushmore, the formal Rushmore spinning out as a licensed entity and able to acquire MSRs. We'd be the logical choice to subservice those as well. That's even furthering our fee-based business. And look, the white label, colabel that Chris talked about in terms of the origination side, there's a new fee generation earnings stream for us as well. And so all of that without assets, I think, can add to that 12% OTC. Last thing, the driver is we had a lot of successful cost reduction initiatives this year. This will all be annualized next year. We had a tremendous amount of growth that will all be annualized next year. So it's not like we need a new driver to help improve our returns, it's just seeing some of the things we've done recently get annualized. But we expect growth to continue. We expect our subservicing business to continue. As Kurt said, we are considered the best in the industry. At the same time, where some of the more logical or traditionally logical subservicing choices are really into this array. I mean the 2 largest independents are -- they have a lot of challenges in front of them without there declining very rapidly, and we are a beneficiary of that.

Got it. Helpful. So I'm going to pause right here and just gather 2 audience response questions that I have. Can you just queue up the first one? The question is relative to any and MBA forecast of total originations of $1.6 billion to $1.8 trillion in 2023 and $1.9 billion to $2 trillion in 2024. Do you expect 2024 total mortgage originations to look like $1 billion, $1.5 billion to $1.6 -- to $1.61 billion to $1.83 billion, $1.1 billion to $2.0 billion or greater than $2 trillion?

Yes, so it will end.

So next question, please. Over the next year, would you expect your position in Mr. Cooper to, one, increase; two, decrease; or three, stay the same?

Be bullish now. I can't wait for the answer here.

That's bullish now, yes.

We'll take that.

I'll open the floor to Q&A if there are any questions. Anyone?

Maybe just talk about -- a little bit more about the second lien business. Just you don't normally take credit risk so how is that getting funded? And then kind of separately, if you could just talk about rating aspirations and optimization around what kind of -- what rate do you think you're the most efficient at?

I heard a second line is the rating, where we think rating aspirations, where are we comfortable, yes. Kurt is, the CFO and [indiscernible]. So my ambition has always been to at least be BB. Let's see, second liens, we rate every customer, we score every customer every day. So we know the customers that may have some challenges. We know the ones that have the most equity. And we know the ones who it makes more sense to do a second lien than a refi is a large majority of our customers today. We originated in our balance sheet. We sell them to a couple of different large banks on a regular basis. Funding is -- we're funding things for less than 30 days generally. So that at our current level is sustainable through the long term. So we're not taking any credit risk, we're basically selling the credit risk away on a flow basis or kind of a, call it, a minimal basis gold not sell to them. We have a stable of investors. That market has come back in a pretty meaningful way, and we have some large money-centered banks as well as some other buyers.

Yes, I was the CFO of a couple of banks during the true financial crisis. Home Equity was not -- did not fare in that cycle. So I will never forget that. So we're selling what our customers need, but we're not taking the risk. Do you want to comment on ratings?

I will. And look, we talked about efficiency. Our turn times on those are very good but also for that. We don't have a lot of lost volume, that's uncommitted, the return times are great, as Chris said. On the rating agency perspective, look, I think our bonds are trading like we're 2 notches above where we are. So if you look at some of our industry pairs, we're trading kind of at that BB minus level. I think that's where our aspirations are, and I think that's where you'll see us kind of having some really good dialogue with the rating agencies over the next 3 to 6 months around getting there because I think the market already thinks we do.

And if you just look at the balance sheet and you look at the capital liquidity and the overall levels, we should -- we're working -- actively working with the agencies to address that.

I think we have a little bit of time. Maybe you can just start on capital levels, what's your target capital levels longer term?

Yes. So we're at 30% right now. So obviously, a really rock solid balance sheet. I think our liquidity is at a record level. We commented that there was about $2.4 billion as of the end of the quarter. I think that's pretty stable, consistent growing at the end of this quarter. And so I think we have some room. And I think as there's opportunity to invest capital, we certainly will. As I said, we're trading below book. So I think we'll continue to buy back shares as well. But we're never going to be -- we probably aren't going to come down to the 18% that was in our presentation, but you can see it kind of coming down a little bit from the 30% because right now, we think there's still some opportunity and that will increase returns, which I think are positive or the company in the stock right now.

Any more questions from the audience?

Sorry, you mentioned earlier that you thought the correspondent business still had weaker margins and like our then makes it attractive. I guess where would you expect originations -- corresponding originations to get to in order to have margins that were sustainable and/or how much capacity would need to come out of the market before margins were minimal?

I'm sorry, I didn't get the whole question.

I mean on correspondent just kind of where we think margins would have to be more stable, attractive for us. So I think like the correspondent business has always been a little volatile, and we've been somewhat opportunistic there. I think margins today, we are a profitable correspond. But for us, more about where can we get the highest return on the invested capital. So we don't think that's a corresponded channel today. We find we're [indiscernible] more attractive again, the vaults, even lower vaults are more attractive. So I think we would want to see kind of sustained profitability correct me, but 30, 35 basis points in that channel for us to probably invest more capital. And again, just with the amount of supply on the bulk side, it just -- it makes a lot more sense for us to focus on that at the moment.

Yes. And then I would say the other thing as Fannie and Freddie are influencing the margins a lot with their duty to serve goals right now, right? You have to -- they have a certain percentage that everyone has to hit in terms of lower purchase and very low income purchase, which frankly isn't representative of where the market is right now. So in order to be competitive, you have to lower your margins and that is -- and so that is probably depressing margins overall as well.

Okay. Great. I think that does it for us. Thank you.

Thank you.

Appreciate it, thanks.