Mr. Cooper Group Inc. (NASDAQ:COOP) Q3 2023 Earnings Call Transcript

Mr. Cooper Group Inc. (NASDAQ:COOP) Q3 2023 Earnings Call Transcript October 25, 2023

Mr. Cooper Group Inc. beats earnings expectations. Reported EPS is $2.79, expectations were $1.73.

Operator: Hello and welcome to Mr. Cooper's Third Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation there will be a question-and-answer session. [Operator Instructions] I would now like to hand the conference over to begin.

Ken Posner: Good morning and welcome to Mr. Cooper Group's Third Quarter Earnings call. My name is Ken Posner and I’m SVP of Strategic Planning and Investor Relations. With me today are Jay Bray, Chairman and CEO; Chris Marshall, Vice Chairman and President; and Kurt Johnson, Executive Vice President and CFO. As a quick reminder, this call is being recorded and you can find the slides on our Investor Relations webpage at investors.mrcoopergroup.com. During this call, we may refer to non-GAAP measures which are reconciled to GAAP results in the appendix to the slide deck. Also, we may make forward-looking statements, which you should understand could be affected by risk factors that we've identified in our 10-K and other SEC filings. We are not undertaking any commitment to update these statements if conditions change. I'll now turn the call over to Jay.

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Jay Bray: Thanks Ken, and good morning everyone, and welcome to our call. Let's start then with a review of our quarterly highlights on Slide 3. Starting with the financial performance, we were delighted with operating ROTCE of 13.8% which is back within our target range. And at this point in the cycle double digit return on equity is a powerful validation of our balanced business model and a major differentiator from our peers, whose results are much less consistent. Tangible book value was up nicely in the quarter to $62.78 and there is a lot of good news here. You're seeing the benefit of continued strong operating results, the gain from the trust collapse we mentioned last quarter and the accretion from closing the Home Point acquisition which came in consistent with our guidance.

Now turning to operations, the portfolio reached $937 billion and based on what we've seen from the disclosures it appears that Mr. Cooper is now the number one servicer in the country. This is an amazing accomplishment for the company, especially as I think back to our humble beginning in the 1990s. And I want to pause for a second and say thank you to our investors, our partners, clients and all of our other stakeholders for placing your trust in us. And especially to my fellow Coopers for your tireless work on behalf of our customers. Servicing generated $301 million in pretax income although bear in mind the gain from the trust collapse contributed $67 million and there were some other one-time items in there as well which Chris will elaborate on.

Originations reported EBT of $29 million which is excellent performance considering the rate environment, and Xome, saw strong sales momentum and generated a small profit this quarter as we guided you expect. Third quarter was a very busy period for us. In addition to Home Point, we closed the acquisition of Roosevelt Management, which provides us the professional team in the RA infrastructure for our asset management strategy. And I'm pleased to report we've already kicked off the capital raising process for our first MSR fund. Turning to Capital Management, we repurchased 1 million for $58 million and since the WMIH merger established Mr. Cooper as a fully independent public company, our stock price has tripled. But we still trade at a persistent discount to tangible book, which looks to us like a major disconnect given our consistent growth and our double digit ROTCE.

Despite growth and return of capital, we reported record liquidity and very strong capital ratios. This was partially due to the self-funding nature of the Home Point acquisition which we pointed out when we announced the deal and primarily due to our sound practices around capital and liquidity planning. As the markets lean servicer with 4.3 million customers, balance sheet strength is the foundation for all our strategic initiatives. Finally, I'd like to mention the well-deserved recognition we received from Fortune and A Great Place to Work Foundation, who ranked Mr. Cooper as one of the best workplaces in financial services and insurance. This is a positive reflection on our people and on the purposeful, inclusive work environment that we have created for them.

Now let's shift to Slide 4 and talk about a very important theme in the mortgage industry, namely the ongoing retreat of banks from the sector, which is creating a major growth opportunity for us. As most of you are aware, banks used to dominate the mortgage industry with close to 100% market share in both originations and servicing. Today, however, that share has fallen to around 40%. One of the drivers was the Basel III capital regime rolled out in the aftermath of the global financial crisis, which introduced higher capital standards for mortgages and MSRs. These standards came on top of severe operational challenges. As some of you will recall, Mr. Cooper's growth began to take off at this point when we acquired $200 billion plus portfolio from Bank of America.

Fast forward to today and a new set of regulations is on the horizon called Basel III endgame. These regulations once again include tighter requirements for mortgages and MSRs at the same time that rising rates are pressuring profitability and operations. We expect to see banks see more share in the mortgage sector creating attractive growth opportunities for best in class operators like Mr. Cooper. Moving to Slide 5, while banks were dialing back, Mr. Cooper made a commitment to serving mortgage borrowers and to continue making the necessary technology investments to do so efficiently. And the result as I mentioned already is we are now the industry's largest servicer. We're also the most efficient. The annual MBA benchmarking survey is the authoritative study of mortgage industry performance and as you can see, we've steadily brought down our servicing costs over the last few years to the point where we are now 33% more efficient than the large banks in the survey and nearly 50% more efficient than midsized banks.

If you consider our scale, cost advantage, industry-leading retention and the depth of our expertise, there's really no one in the industry who can compete with us in servicing. Now let's move to Slide 6 and talk about where we're going from here. Given the attractive yields available in the bulk market, as well as new subservicing agreements in place, we will exceed our $1 trillion strategic target in the first quarter of next year, at which point we'll return to update to you with a new set of strategic targets and a comprehensive plan to achieve them. For now, I'd remind you that we have several strategic initiatives underway, many of which are focused on technology investment and cost leadership, both in servicing and originations as well as winning new subservicing clients.

In closing, I'd like to highlight once again the disconnect between a dominant platform of strong growth prospects and double digit returns and a stock that trades at a discount. If we continue to execute, there should be meaningful upside in both our stock and our high yield notes. And before I turn it over to Chris, let me address something that you no doubt noticed in the press release. Chris has shared with us his intention to retire by year end 2024. Chris joined us in January 2019 as Vice Chairman and CFO and quickly enhanced the finance function implementing bank like processes as well as pushing for efficiency gains and deleveraging. This served us extremely well when the pandemic hit a year later, being well prepared for adverse scenarios, we were able to substantially expand our liquidity.

In 2021, we promoted Chris to President and gave him a mandate to oversee operations where he took our process discipline to the next level, leading to higher profitability across the enterprise and improvements to the customer experience as well as architecting some new directions within our technology strategy, including the investment in [indiscernible]. In his remaining time with us, Chris will continue to lead operations with the goal of driving continued strong portfolio growth and return on equity in addition to overseeing the capital raise for our first MSR fund. As I look back on these five years, Chris has brought to Mr. Cooper a special kind of energy and intense focus on the needs of our customers, our team members and investors and a real sense of urgency to deliver results.

Chris, the improvements you made at Mr. Cooper will endure and we know you will continue to make a big impact on the company ahead of your retirement. I'll add that we put in place a process to identify a successor and while no one can replace Chris, the initial feedback indicates a very high level interest from some exceptionally talented candidates, which shouldn't be a surprise given how well the company is performing. So more on this in due course. Chris?

Christopher Marshall: Thanks, Jay. I appreciate those comments. And before I start, I'm going to take just a second to share with my teammates how much I appreciate your commitment and your hard work over the past five years. I really couldn't be any more proud of what we've done together for our customers and for the excellent financial results we've produced for our investors. You all know Mr. Cooper has been and continues to be a very special experience for me and the capstone to a long career, but I'm not done quite yet, so you should all expect me to continue pushing us to do more and to do it faster until I am done. So with that, let's talk about what we all care about, which is the company's outstanding third quarter results.

I'm going to start on Slide 7 and talk about servicing where we generated a record $301 million in pretax operating income this quarter. Now as Jay just mentioned, this included the one-time $67 million from the trust collapse and I'd also call out $13 million in deboarding fees from a subservicing client that took their portfolio in-house which we called out last quarter. And as you look ahead to the fourth quarter, I remind you that there is some seasonality in net interest income. So I project servicing EBT to be roughly flat quarter-over-quarter at $210 million to $220 million after which we should expect to see excellent growth in 2024. We put this in terms of our prior guidance of $700 million in servicing EBT for full year 2023, which as a reminder does not include the gain from the trust collapse.

It looks like we'll close out the year with at least $775 million. Now, as you know, servicing income is affected by interest rates and we're in the camp of expecting rates to stay higher for longer, which is an ideal environment for servicing. But that's not how we run the company. We're completely agnostic about rates since they're not in our control and instead we focus on those things we can control, namely process improvement, cost leadership and operating leverage. We've talked in prior quarters about some of our current efficiency projects, which include driving down call volumes through chat technology, digital tools, enhancements to our IVR, as well as implementing AI for the call center, all of which provide a much better experience for our customers as well as lower costs for us and we're making outstanding progress with these initiatives.

In fact, we've been able to add nearly 140,000 customers year-to-date without increasing headcount, which I hope you all agree is a very impressive example of positive operating leverage and you're going to see a lot more of that in 2024. On a separate note, I'll add that we're very pleased with our progress in special servicing. The combination of Rushmore plus RightPath, which was our existing platform generated EBT of nearly $20 million in the quarter. And if the credit cycle were to turn more adverse, special servicing could become a very meaningful contributor to our bottom line. Now let's turn to Slide 8 and talk about portfolio growth, which was very strong this quarter, thanks to the Home Point acquisition and the other polls we acquired which more than offset deboarding the subservicing client I mentioned.

At quarter end, the portfolio reached $937 billion up 10% year-over-year which is a very comfortable growth rate for us to manage operationally. And it is a pretty safe bet we'll grow at least that fast in 2024 given that we already have well over $100 billion of deals scheduled to close and onboard well into the first quarter. We continue to see very attractive returns in the bulk market. This reflects the backlog of MSRs retained by originators during the refi boom, which they're now under pressure to sell due to very tight margins and limited liquidity. Also, we're starting to see banks bringing MSR pools to market as they prepare for the Basel III endgame regulations. With a limited set of buyers, this supply is creating very attractive conditions for the growth.

At the same time, we also see great opportunities in subservicing. If you stack us up against the competition, there's really no comparison. Were the clear scale leader and not only do we offer excellent customer service and industry-leading recapture, we're also a blue chip counterparty with a very strong balance sheet and an extremely strong compliance function, which is very important for clients seeking to partner with a stable, reliable institution. No one matches our depth of capabilities and quite frankly, no one even comes close. By the way, on this point, I'm delighted to share that we've just signed a new subservicing client and we'll begin onboarding their $80 billion portfolio in the first quarter. Later in 2024, our MSR funds should become a source of additional subservicing growth.

We're talking with institutional investors about opportunities to achieve double digit returns from an uncorrelated strategy with very limited exposure to interest rates or macro shocks. And while we're still very early in the process, so far the feedback we've received is very encouraging. Now let's shift gears to Slide 9 and talk about originations, where we turned in another outstanding quarter with $29 million in EBT which is at the high end of our guidance. Our recapture performance remains best in class with refinance recapture reaching 83% in the quarter, which is nearly four times the industry average. We've also been able to drive and sustain higher purchase recapture following a series of operational enhancements and new marketing campaigns.

Now looking ahead, as you know, fourth quarter is the seasonally weakest quarter of the year with a shorter day count and other distractions of the holidays and with mortgage rates well above 7% our customers are more likely to take advantage of second lien products, which is the right solution for them, but it's a smaller margin product. Also we're seeing pricing pressure return in the correspondent channel due to higher mortgage rates pressuring originations volumes. So as such we guide you to a range of $10 million to $20 million for fourth quarter. Now if you turn to Slide 10, I'll provide an update on Xome, which continues to do an excellent job executing and gaining market share. Sales grew 17% sequentially and the unit generated a profit of roughly $2 million, which is in line with our guidance and a step in the right direction, although nowhere close to Xomes ultimate potential.

Looking ahead, we guide you to flat results in the fourth quarter as we'll begin to incur some expenses associated with continued investment in the platform. As you know, the FHA foreclosure market remains well below what we consider a normal level and we can't give you an estimate as to precisely when activity will normalize. Nonetheless, we're investing now because we intend for Xome to be the dominant competitor in this space whenever the market normalizes, at which point you'll see its full earnings and monetization potential. On that point, let me take a step back and comment on the company's overall performance. At this moment, servicing is producing terrific results, thanks in large part to the investment we made over many years to perfect the platform with innovative technology and a strong process discipline.

In contrast, originations and Xome are operating well below potential due to where we are in their respective cycles. But you know how well they performed in the past and right now we're investing in these platforms too, just like we did in servicing. When originations and credit cycles turn, I'm confident they'll generate spectacular results. So with that, I'll now turn it over to Kurt.

Kurt Johnson: Thanks, Chris. Good morning. I'll start on Slide 11, which gives you a summary of the financials. I'd like to highlight four items. First, let me give you some color on the adjustments. On the Home Point transaction, we recorded a bargain purchase gain of $96 million and incurred $5 million in deal costs, which together added $1.47 to tangible book value. Obviously this was stronger than our guidance dollar and accretion reflects very favorably on the performance of the MSRs we acquired as well as limited exposure to contingent liabilities after extensive diligence. Other adjustments included $8 million in deal costs associated with the Roosevelt acquisition and a $39 million loss from equity investments largely tied to retained interest in Title 365, which as you may recall we sold to Blend Labs in 2021 for $450 million in cash and a $50 million retained interest in the title company.

With this adjustment that retained interest is now marked down to $3 million on our balance sheet. Second, I comment that with the acquisition of Roosevelt, you should expect corporate expenses to be roughly $2 million higher per quarter, which reflects the cost of our asset management strategy and the team which will be overseeing the MSR fund. That expense will be more than offset by increased revenue once the fund is raised and starts acquiring MSRs. Third we marked up the MSR annual balance sheet by $254 million, reflecting higher interest rates and lower CPRs, leading to a quarter end valuation of 161 basis points of UPB or 5.3 multiple of the base servicing fee strip. This markup was offset by hedge losses of $192 million, which equates to coverage of 76%, completely consistent with our target ratio which remains at 75%.

Finally, I'd like to update you on our deferred tax asset, which declined by $158 million this quarter and now totals $499 million. The significant decline reflects deferred tax liabilities assumed as part of the Home Point transaction as well as strong operating results. When we merged with WMIH in 2018, the DTA totaled $1 billion dollars and the fact that we've been able to significantly reduce this asset speaks to our thoughtful approach to tax planning, but particularly the company's strong profitability. We estimate the remaining balance will continue to limit our federal cash tax liabilities for at least the next three years, continuing to maximize the cash generated by the company. Now let's turn to Slide 12. I'd like to comment further on our balanced business model because it's a term that many of our peers use despite reporting much less stable results than us.

This slide provides you with our view on the relatively narrow range of returns on equity that we would have generated using three key results as a baseline, even if mortgage rates have been 100 basis points higher or lower than what actually occurred. Starting in the center of the table, we anchored the analysis on actual third quarter results where mortgage rates averaged 7.2% and our CPR speeds were 5.6%. The left hand side shows a hypothetical scenario with mortgage rates 100 basis points lower and CPRs 90 basis points higher. In this scenario, servicing suffers from higher amortization expense. However, this pressure is mostly offset by originations resulting in overall ROTC of 13.2%, slightly lower than what we actually reported in the quarter, but still quite healthy and within our target range.

Conversely, if rates had risen 100 basis points, we estimate CPRs would have only been down 30 bps, leading to stronger servicing income and additional compression in originations profits resulting in overall ROTCE of 13.0%. This simple high level example shows how originations and servicing naturally offset each other, leading to relatively stable results for companies that have the right balance between the two. Now if you'll turn to Slide 13, let's talk about another aspect of our balanced business model, namely the company's resilience to adverse credit environments. We've carefully constructed our MSR portfolio. You can see this quality in our 60-day delinquencies which continued to decline during the third quarter on an overall basis and in each loan category with our MSR portfolio showing the lowest delinquency levels in our history as a public company.

I would also point you to weighted average FICO scores, which have been rising nearly every quarter for the past three years and to our loan to value ratio, which remained 54% in the third quarter. This speaks to the very substantial equity of our customers. Not only is our portfolio quite solid, we're also well positioned for more adverse environments by virtue of Rushmore, our special servicing operation, which as Chris said is already generating nearly $20 million per quarter in EBT. Now in a stressed environment, Rushmore would play a very important role, working with troubled borrowers to help them stay in their homes. Needless to say, this would also be a huge service to our clients and there could be substantial upside in Rushmore's volumes, not to mention a larger contribution from Xome.

Now let's turn to Slide 14 and review liquidity. As you know, balance sheet strength is a cornerstone of our strategy, which incorporates capital and liquidity planning, asset quality, compliance and enterprise risk management. So let's dive into equity where we had a record level of $2.7 billion at quarter end comprised of $553 million in cash with the remainder in MSR line capacity, which is fully collateralized and immediately available. The Home Point acquisition brought a $700 million of additional capacity secured by Home Point's MSR of which we drew down $385 million to fund the acquisition. Since last quarter, we have renegotiated our existing MSR lines, pushing out substantially all maturities to 2025. Finally, I'll comment briefly on advances, which declined 8% year-over-year despite growth in the portfolio.

Now that's consistent with the excellent delinquency trends I just mentioned and strong performance from our servicing group. I'll wrap up my comments on Slide 15 with a few thoughts on our strong capital position. Our capital ratio increased to 31% as measured by tangible net worth asset, thanks to strong operating results and the accretion from the Home Point transaction. We have commented previously that we intended to deploy some of this capital into asset growth. To provide you with more clarity around the goal posts, we're disclosing a new target capital ratio of 20% to 25%. We think that range is appropriate because our balance sheet position changes somewhat with interest rates. So right now our assets are more heavily weighted to MSRs whereas if rates were to rally, we would expect a higher balance of loans held for sale.

Looking ahead into 2024, we feel that the company is in great shape to grow the portfolio and at the same time drive and sustain higher levels of return on equity. We intend to pursue growth through asset light strategies also which emphasize subservicing as well as prudent balance sheet growth consistent with our capital and liquidity targets. We are also monitoring spreads on high yield debt issuance. We've started receiving inquiries about potential issuance of high yield bonds and we're definitely considering the option, but only if spreads fairly reflect our strong credit profile. In recent conversations with rating agencies and high yield investors, we're getting significant recognition for the company's progress since we became fully independent in 2018.

These discussions center around strong capital liquidity, excellent asset quality, rising profitability, our 75% hedge ratio and of course, our long-term track record of growth, which not only validates the competitive advantage of our business model, but leaves us today as the markets #1 servicer. With that, I'd like to thank you for listening to our call and I'll turn the call back over to Ken for Q&A.

Ken Posner: Thanks, Kurt. And Towanda, if you could start the Q&A session please?

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