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

All right. I think we'll get started. So welcome, everyone. Thanks for joining. My name is Terry Ma. I cover U.S. Consumer Finance at Barclays on the equity side. I'm pleased to be joined on stage with Mr. Cooper. With me today, I have Jay Bray, the CEO; Mike Weinbach, the President; and Kurt Johnson, the CFO. So welcome, gentlemen.

Thank you for having us. Really appreciate it.

Yes. And with that brief intro, let's just kind of jump right into it. Maybe just starting with the MSR market and what kind of opportunity looks like today. You reviewed a record number of deals a few quarters ago. But I think that quantity has decreased somewhat today. So maybe just kind of talk about what the pipeline looks like in the third quarter and what the market environment is like.

Yes. Look, I think to your point, Terry, the first part of the year was, well, we looked at a lot of deals. It was very active. There was a lot of supply. I'd say the summer was even pretty active, but there were a couple of aggressive buyers out there. So we kind of sit on the sidelines and let them bid aggressively. We didn't feel like they were at the levels that made sense for us. Now I think it's a normalized environment. I mean there's still supply out there. We think there's some seasonality slowdown which we expected. But we look for '25 to be a pretty robust year. If you think about it, nonbank originators, I think they're going to need to sell unless margins improve significantly. And then so the other thing for us, we obviously announced the Flagstar acquisition, which was a large $77 billion in MSRs and a considerable subservicing portfolio. That was a great deal for us. And so we've been pretty active with that one. But overall, I think the MSR market is kind of in a normalized environment right now.

Okay. Any particular factor that has driven this normalization or maybe the elevated deal activity seen earlier this year?

I think earlier this year, there were -- yes, look, there were banks that said they were going to come to market with portfolios, so we knew they were coming. There were some 9 banks that I think needed to sell, and we expected that as well. And I think people wanted to get out earlier in the year. So I think that's really what drove that. And now, I mean, look, originations aren't great. And so there's just not a lot of supply in the market. And so I think that's kind of what's driven the normalization.

Got it. That's helpful. And you touched on Flagstar a little bit. Maybe just -- it's a large acquisition or asset acquisition. Can you maybe just update us on how that's progressing? Maybe just to take a step back for those that are not familiar, maybe just talk about the rationale for the deal and what you found attractive in the assets.

Yes. I mean, look, it was right at the middle for us. If you think about it, the primary components of that deal are the MSR acquisition, which is our bread and butter. And it was a portfolio that was similar to ours, and the subservicing just gives us the opportunity to grow that capital-light business for us. And when you look at their clients, I mean there's -- some of their larger clients are existing clients of ours. And so that made a ton of sense for us to grow that business in a meaningful way. And so -- and look, that was a direct deal. I mean we worked with them on a direct basis. And if you think about who could actually execute on a transaction like that, there's really -- we're probably the only player that can do it because at the end of the day, we are the largest buyer of MSRs. We have a large subservicing business. We agreed to take their TPO business, which will absorb some of that into our correspondent business. And so I think it was a win-win for both parties. And we came out feeling really good about it. The integration is going great. We would expect to close it in the fourth quarter. And we're talking with their team members and excited about welcoming to the Cooper family.

Got it. And then maybe a question for Kurt. As I've been speaking to investors, I think there's a kind of wide range of what people expect for accretion. Is there maybe just a framework for investors to think about potential accretion from the deal?

Sure. And I'll just sort of lay out what the economics look like and people can kind of build it into their own models from an accretion and ROE standpoint. We've also said that based on this, we're comfortable moving towards the middle of our guidance of 14% to 18% in 2025. But the way to look at it is about $1.2 billion of the acquisition price was related to MSRs. We've always said and we report publicly that our MSRs yield about 11.5%. Our cost of funds blended is about 7.5% when you look at secured financing, which is SOFR-based and will be probably dropping over time. And then our unsecured financing, and we just raised unsecured in July at 6.25%. So call it, a 7.5% blended financing rate. So that's 4 percentage points on a $1.2 billion acquisition. So think of that as $48 million of contribution to earnings in 2025. And then on subservicing, we've always said from a pretax basis, on subservicing, we earn about 1 basis point to 2 basis points in pretax. So on, call it, $250 billion to $270 billion of subservicing at 1 to 2 basis points utilized midterm about $40 million of pretax earnings there as well.

Got it. That's helpful. And then is there a way to think about some of the areas you think kind of outearned kind of like the framework you kind of just went through?

Sorry?

Is there a way to think about certain areas where you can kind of outearn [indiscernible] the framework?

Yes. So I think everything that we said there was sort of what our averages are. And obviously, we've become a far more efficient servicing shop. And so again, because this is largely a servicing acquisition, I think -- over time, I think the marginal efficiencies will increase the returns on both the MSR and the subservicing. So I think both of those frameworks are where to think about from an average return, but I think from a marginal basis. Again, you have to kind of layer in the fact, as Jay said, we're welcoming all the employees into the Cooper family. And so there will be attrition. So it will probably be sort of -- cost will sort of go down over time. But I think, yes, you can see some improvements in those returns in the back half of 2025, probably.

Especially if you look at like we're making investments as we speak, that are driving -- that will drive cost per loan down. So I think that's going to -- in the beginning of '25 and throughout '25. So I think that's another opportunity for us to outperform there.

Got it. That's helpful. And you touched on the TPO platform. Maybe just talk about what you see there and what that brings to your business, your origination business?

Yes. I think the TPO platform has a couple of different components. When we look at the correspondent piece, it's actually a great story. I mean there's about 150 clients that are not existing clients of Mr. Cooper. So we're going to welcome that team, welcome those clients to the Mr. Cooper family, and that's going to result, we think, in incremental volume profits for the correspondent channel. And then for the other channels, the broker channel, et cetera, I think there, we'll absorb those team members and we'll kind of wait and see how that performs and observe it over time, but could present a lot of opportunity, but we're going to be kind of measured and thoughtful about how we think about that business kind of medium term.

Got it. Is there like an origination footprint that investors are kind of anchored to, like when we kind of combine those pieces?

Look, I think we are -- in the correspondent channel, we're going to continue to grow that channel. I mean this quarter has been a phenomenal quarter, and we think there's -- if you're the lowest cost servicer, which we think we are, if you have the highest retention in the industry or among the highest retention in the industry, it's just logical that you are going to be the right buyer for the correspondent business. And so that we're very bullish on. We're growing it as we speak. I think Flagstar will add to that. Our co-issue business is extremely strong as well, probably a top 3 player there. And then our direct-to-consumer channel is, again, we expect that to grow, it's having a phenomenal quarter, which we'll touch on here in just a second. But that channel will continue to grow, we'll continue to invest in, add capacity. And then yes, with the remaining TPO channel, again, I think that's kind of, we'll wait and see how that evolves. But that's how to think about the origination footprint today.

Okay. Got it. That's helpful. Maybe just to turn to servicing. You ended the first half with about $1.2 trillion UPB and you guided to a third quarter servicing EBT to remain relatively flat into $80 million to $300 million range. I guess maybe just to get a mark-to-market so far, does that guide still hold? And what's the outlook for profitability in servicing going forward?

Yes. It's -- this is a quarter where the balanced business model once again kind of is proven. We would expect to hit the high end of that guidance, if not exceed it. Servicing is performing very well. And candidly, in some areas, better than we expected. So it's a very strong quarter from a servicing standpoint.

Got it. Any more color on what's driving the outperformance? Is it more just operating leverage or like any color you can give there?

It's operating leverage. I mean at the end of the day, that team has done a remarkable job of taking costs out, automating the investments we've made there, have continued to make us a more efficient platform. So it's ultimately -- it's been all about execution.

Got it. That's helpful. Maybe I just want to touch on credit and maybe ask about the credit trends you're seeing in your portfolio. Delinquencies are at cyclical lows, but we've had mixed results. Unemployment numbers were higher last month, a little bit better this past month. So what's the outlook on credit?

Kurt, you want to?

Yes, I can take that. So I think that in general, we're still seeing the credit performance on our portfolio hold on. I think -- and perform really well. Do I think Q3 will be our, whatever it is, eighth consecutive quarter of declining delinquencies? Maybe not. But I think it's holding flat. I think the composition of our portfolio has been pretty carefully constructed. We've got the average LTV in the low 50s. We've got FICOs on average at around 740. We've been buying a healthy mix of agency versus Ginnie. So I think for our portfolio, in particular, the credit mix has been really, really good, and that's great because it provides us some opportunity, as Jay said, to take advantage of the correspondent market. and it's here as well because we've got such strength in the existing portfolio right now.

Got it. That's helpful. And then maybe just touching on technology. You've spoken frequently about your investments in technology. Can you maybe just talk about where you stand with your tech initiatives today? And as it relates to servicing, how much more operating efficiencies can you extract?

Yes. I mean it's -- yes, I'm happy to jump in here. In many ways, it's the same story that it's been. We relentlessly talk about perfecting the platform, and that means investing in technology, in the servicing space. We've been at it for a while. We started in partnership with Google, building out our Pyro AI platform. We continue to make investments in AI as we're moving from where we started with documents into the call centers, and it's resulted in a best-in-class efficiency from a servicing standpoint, which produces the opportunity to generate cash flow, which we can reinvest in the platform, which we've been doing. So we feel really good about the ability to continue to generate operating leverage. As Jay indicated earlier, we feel like the direction of travel and costs is going to continue to be down, and we plan to continue to relentlessly invest in the platform.

Yes, I don't think people realize the power of AI, and Mike's given this example a couple of times. But just right now, we're taking the customers' call, and before, the agent would have to summarize that call. And that could take anywhere from 40 seconds to 1.5 minutes. Now we're deploying AI to do that. And if you think about that, if you take that amount of time off of the number of calls we receive, it's extremely powerful and reduces cost significantly. If you were to look at kind of our goals and the cost per loan, I mean I think we can take cost down another 25% to 30% from a cost per loan standpoint. So a lot of runway there. Obviously, we have to execute and continue to make investments, but very, very excited about the opportunity.

Yes. I mean that example, the customer experience has improved also because the agent isn't focused on documenting the system. The agent is focused solely on the customer. And so whereas there was distraction before, there's no longer distraction. And going forward, I think it will be even better because the AI will actually pop the right screens at the right time, anticipating the next question the customers can ask. So I think -- but it's not only an efficiency play, it is a great customer experience play as well.

Great point. Got it. Yes, 20% down seems like a lot of runway. I guess, what else do you need to achieve or implement to actually get there?

Look, I think we have a number of initiatives, a lot of them are AI-centric. It's really execution at the end of the day. We've identified we're -- like if you take the calls, for example, what -- the amount of time it takes for each piece of that call and how can we streamline that process. We've also identified why our customers are calling us, and they're calling us for the top 10 reasons. How can we help that customer get the right digital tool in their hands so that they can self-serve, they can get the answer they want in a more efficient manner, and frankly, to Kurt's point, a better customer experience. So when you look at just those 2 pieces alone, there's a lot of opportunity there.

And it requires continued investment. And not to be a broken record on it, but you take the -- and we've been at it for some time, but you take -- a typical call takes 10 to 11 minutes to resolve a customer issue. We've shared in some of our past earnings presentations, our number of calls has fallen in half over the last 3 years. So part of it is new digital technology that lets customers self-serve. Within that 10 to 11 minute call, Jay talked about the 30 seconds to a minute that we saved in the after-call summary, as Kurt alluded to, the ability to have AI listening to the call and serving up the information our agents need to be able to help customers. If you've ever had the experience of being on a customer service call with any company where the agent says, "I'm going to put you on a brief hold," they're probably looking up information from other systems. Having that information readily available for the agent saves that hold time, which could be 2 minutes on a 10-minute call, so another 20% reduction right there.

Got it. That's helpful color. So maybe just turning to originations. You guided to a pretax profit of about $35 million to $45 million for the third quarter. On the last earnings call, we've had a bit of a rate rally this quarter. So can we maybe just give a mark-to-market there on how volumes and margins are trending quarter-to-date?

Yes, quite strong. I mean I think the way we think about it is we're definitely going to be in the high end of that range, if not exceed that range. When you look at our lot volume, you look at our funding volume, they're both exceptionally strong, and it's going to be a really, really strong quarter. And we have a lot of momentum there. I mean our correspondent channel, like I said earlier, has really got a lot of tailwinds at their back and feel great about it. And DTC, given the rates, the customers, we're helping a lot more customers. So it's going to be a good quarter.

Got it. And what are you seeing with respect to competition from the other originators and players in this space?

For us, it's -- in the correspondent channel, I would say, there's less irrational behavior there. And so you've seen a few folks that were extremely active a few months ago or even a couple of months ago are not as active. And so I think margins are improving. Our profitability is improving. And again, some of the things that we've done internally have also improved our ability to drive those results. So competitively, I think it's a more rational environment today than it was perhaps a little bit earlier in the year.

If I could just add on the direct-to-consumer space, we're helping customers that we service and have a relationship already. So it's a little bit less of a competitive dynamic than you see in the correspondent space. But we have been investing in the platform, on the DTC side as well, in order to be able to create and have more capacity. So over the last couple of years, where it's been a really challenging environment for most originators, we've still been profitable. We've been investing back in the platform to be in a position to scale rapidly when the market opportunity comes. And I think we shared in the commentary on our second quarter earnings call that we hired about 100 loan officers in the second quarter and we're continuing to add capacity. So we've been in a good position to take great care of customers with what's come so far, and we're ready if the rate rally continues.

Got it. And the things you've been doing internally, is it just from a capacity standpoint? Or are there more kind of tech initiatives you're rolling out on the origination side?

Well, yes and yes. The tech initiatives have been to drive capacity. So we've talked in the past about what we call Project Flash, which is componentizing the elements of processing and underwriting, both to simplify them for our employees, but also to automate them where we're able to, so it can be straight through. We're continuing to invest in our front-end digital application, so we can pre-fill it with everything that we know about customers and give customers the opportunity to share information with us. So by the time they're talking to one of our mortgage professionals, our loan officers, they're getting right to the heart of the matter and, at the end, to be able to help them. So that translates into a greater number of loans that we're able to handle per employee on the origination side, and we're seeing some of the benefit of those investments in terms of the ability to scale. In addition -- yes.

I mean, another area that we're investing in is what we call it, front office modernization, which is really all around the loan officer. So it gives them the ability -- today, they work in, call it, 2, 3, 4 systems. This is consolidating that into 1 system. So when they get that customer on the phone, it's already prepopulated with everything we know about the customer, everything the customer has done from a digital perspective and it immediately takes them to the solution for that customer and gives them what's the best product and price match for that customer, which makes it just a much, much more efficient process. And then capacity-wise, I mean, we, today, we have probably 25% to 30% additional capacity. We've been very intentional about adding capacity over the last few quarters. We're still adding capacity because, again, we think originations is going to be extremely strong. It's what happens -- it's what people are predicting is going to happen to rates, actually happens. And that's the beauty of the balanced business model, right? I mean really, we're somewhat agnostic to rates, but at the end of the day, if that does present itself, our origination team is going to be more than ready to help our customers.

Got it. Helpful. So on that point, I mean, you mentioned you're agnostic to rates, but I assume you have some sort of view of what the rest of '24, maybe '25 kind of looks like. If I look at industry expectations, I think Fannie and MBA are calling for $1.7 trillion for this year and just over $2 trillion for 2025. I guess, first, do you share that view? And two, if that higher amount of volume doesn't materialize, I guess, you talked to your capacity point that, I guess, maybe just speak to your ability to kind of recapture in your portfolio?

Mike, you want to start?

Yes. So at a high level, we think the second half of this year is going to be a bigger market than the first half of the year has been. And we think, similar to the Fannie forecast, next year is going to be bigger than this year. If you take a part of the Fannie forecast, that increased from $1.7 trillion to $2.1 trillion, the $400 billion increase is mostly refinanced. And so if you take the percentage increase in the refinance market that that implies, that's about a 60% to 78% increase. And as Jay talked about, we've got 25% to 30% capacity now, and we're continuing to add to be ready for that or more.

Got it. In terms of the potential refi, I guess there's the traditional rule of thumb of having a 50 basis point incentive still hold. I think there are a couple of the mortgage companies here at the conference that have kind of pointed to 100 basis points of incentive is probably the more right incentive to be?

Yes, I can take that. So we're seeing a minimum of 50 basis points, but we're seeing probably more like 75 to 100 basis points the way we look at it, and we base this on response rates. It's really the payback months in terms of cost to originate. So between 24- and 36-month payback is when our customers are really responding well to refinance options. And that's, call it, 75 basis points.

Yes. And one thing, Terry, that I forgot to mention earlier on the servicing side of the business I want to go back to is -- because I don't know that a lot of people are aware, but when you look at our MSR portfolio today, it's about 75% hedged, right? And that's intentional because we think with our DTC channel and the ability to recapture, that 75% makes sense. And we then, as Kurt, at that level for what, probably 8 quarters now?

Yes, close to 8 quarters and have performed consistently and the results, have been, call it, plus or minus 7.5% to that 75% range consistently.

Yes. And I think that's an important point from an overall value standpoint that I didn't mention in the servicing comments, but I want to make sure that we go back to that.

Okay. Got it. That's helpful. Maybe it's a good time to just pause and go through the 2 ARS questions that we have. So the audience can use the controllers and just respond. Question one, relative to Fannie and MBA, for mortgage originations of $1.7 trillion in '24 and $2.1 trillion in 2025, what do you expect 2025 total market -- total mortgage originations to be? So fairly evenly split between $1.8 trillion to $2 trillion and $2 trillion to $2.2 trillion, 36% each. So next question, please. And over the next year, would you expect your positioning to increase, to decrease or to stay the same? Yes, yes, 67% increase, 17% stay the same. Okay. So maybe let's just switch gears and touch on some of the other parts of the business. So maybe can you just give an update on Rushmore and Xome? And also maybe just talk about how these businesses fit in to keep strategy?

Yes. Look, I think Rushmore is a fantastic special servicer. When we acquired that, we felt like we were getting a platform that had some strong capabilities. And if you think about, if we are going to enter into a credit cycle, there's no better answer than Rushmore as a special servicer. And there's been some consolidation in that industry if you look at SLS, SPS, et cetera. And through that, Rushmore has been able to grow. And we've been able to add clients. I think we've got a strong pipeline of clients that we're going to continue to add. And we look at that as a real opportunity. And then from a Cooper standpoint, clearly, if necessary, we could certainly leverage their capabilities there as well. Rushmore has exceeded our expectations, honestly. When we underwrite that deal, they performed exceptionally well. The capabilities there are extremely strong, and we're growing clients as we speak. Xome is, right now, the way to think about Xome is that, the only thing really left in Xome is the auction business. So it's, we call it our exchange business, and it's very default centric. It's focused on the CWCOT or the FHA program where you auction off properties, and there's no foreclosures. So since there's no foreclosures, the Xome activity has been pretty minimal. Having said that, we've continued to invest in Xome. The platforms continue to get stronger. We've grown market share there as well. So if you look at the clients that we've added throughout the last couple of years, that's increased. And both those businesses are, again, kind of a hedge, if you will, if we get into a more difficult credit cycle. And they're both fee-for-service businesses and we love that about both of them. So Xome's capabilities have never gone away. Once foreclosures do return, it will return to a strong profitability level and strong cash flow level.

Got it. Helpful. And a question for Kurt. You guided to 14%, 18% ROE range for 2025, and you indicated you should firmly be at the midpoint of that. Can you maybe just talk or speak to your confidence, what gives you confidence in that? And maybe just talk about what type of operating environment gets you to the high end versus the low end of that range?

Yes. So I mean I think that we are very confident about it, and we're confident about it because of the balanced business model in a wide range of rate scenarios. And we do run kind of different scenario modeling through and looking kind of at our recapture rates and some sensitivities around that, and we land fairly consistently in that range regardless. And I think that there's some upside because in a rate rally environment, what you usually see is margin expansion, right? And we've started to see, as Jay pointed out, a little bit of margin expansion this quarter. So if you see that continuing, I think you could go up from there in terms of what our ROTCE looks like. And then I think compounding, as Jay talked, to hedge, right, we are 75% hedged. And so in a rate rally environment like this, that hedge actually generates a ton of cash. And the actual mark is a noncash event. So it gives us a lot of flexibility in terms of what we do with things. So I think we're very confident in terms of where our returns are going to be. And I think we've got a lot of capital to potentially repurchase stock to buy more assets as they become -- as the target prices are in our range as well.

Got it. We have about 6 or 7 minutes left. I'll just open up the open it up to the audience for Q&A. Questions, anyone? Okay, we'll keep going. Maybe just, is there an update on the MSR fund, kind of where does that stand right now?

Yes. We actually have had some strong progress there. We have a couple of anchor investors that have gotten through their investment committee process, which always takes a significant amount of time. And now we're in the documentation phase. And so we would look to complete that, call it, by year-end and be ready to deploy capital in the early part of 2025. So it's taking a little bit longer than we expected, but we're ending up in a good place with some very strong counterparties and investors there, and we will certainly grow that over time. But again, look to start deploying capital in the first part of the year.

Got it. And then maybe another question for Kurt or anyone. How do you think about capital allocation? Your tangible network in total assets will be 26% pro forma for Flagstar. I think you indicated your target range is 25% to 30%. So how should investors think about that? And in terms of the buyback, you have over $250 million remaining, but the shares are trading both tangible book. So how sensitive are you to, I guess, valuation?

Yes. So we agree with your audience. We think we're also going to increase our ownership stake in Mr. Cooper and continue to invest in the stock repurchase. We do think, look, 16% ROTCE even trading above book is kind of a 7x to 8x forward price to earnings ratio. I think there's a lot of value in our stock right now. And as I said, with the capital generation, with the cash generation, with the hedge, we think we're in a good position to continue to buy, and we are going to be buyers of our stock. And then the target ratio, so correct you -- not meaning to correct you, but we guide to 20% to 25%. So we're right now above the top end of that range. So we think we've got some flexibility there as well. And again, as we see MSR assets becoming available where we think the returns are great, we still have some flexibility to do that. We're focused on the Flagstar acquisition and closing that, making sure that the customers are really taken care of. But we are going to be looking for opportunities to continue to grow the MSR portfolio as well.

And Terry, you mentioned the valuation relative to book, and book is a relevant way to look at the valuation as it pertains to our MSR portfolio. But as Jay talked about, it maybe is underappreciating some of the businesses we have that don't require capital. Some of the fee-based businesses like subservicing, like special servicing and then obviously, the origination opportunity that our direct-to-consumer channel represents.

Got it. Okay. Any questions from the audience? We have about 2 to 3 minutes left. Okay. Maybe just going back to credit. We've had a few mortgage companies present here this week, and they kind of pointed out mod programs from the GSEs, helping borrowers stay in their homes. Do you think these programs maybe present a new norm for mortgage credit on delinquency trends?

Yes. I do. I mean, Kurt, you're closer to it, so go ahead.

Yes, I do. I mean I think that we, as an industry, and I mean the entire mortgage ecosystem, learned a lot coming out of the great financial crisis. And I think we learned what worked, and I think we learned what didn't. And I think we learned to collaborate a lot better. And I'll give the agencies a ton of credit. I think that they've developed a framework that really makes sense for the customer and makes sense for the servicer and actually makes sense for them as the investor insurer as well. And so I think the FHA program that just rolled out, utilizing the partial claim to do a payment supplement, so the customer can make a 75% P&I payment for a 3-year period of time really starts to kind of incorporate what happens if one customer has -- loses some form of income. And so I think that they've been really effective programs and will continue to be really effective programs. And then FHA has built an insurance fund of $120 billion. And FHA is supposed to be a bridge loan. FHA is supposed to be kind of your entry into the system, where you keep an FHA loan for 3 years and then you graduate to a Fannie, Freddie loan. And what's really happened, because of those interest rates that are sub-4%, those customers are now in an FHA loan for much longer. They're not risking customers at all because they're now equitized. They have 40% value in their homes. So they're staying in that 3.5% rate FHA loan and continuing to pay the mortgage insurance premium, which is self-fulfilling then the new customers to be able to be off in these modification programs when they enter an unfortunate life event. So I think, generally, I think the programs have been super successful.

Okay. Great. We have about 1 minute left. And if there are no further questions or any questions from the audience, I think we'll just wrap it up there. All right. I think we can go. Thank you, everyone. Thank you.