Ocwen Financial Corporation (NYSE:OCN) Q4 2023 Earnings Call Transcript
Ocwen Financial Corporation (NYSE:OCN) Q4 2023 Earnings Call Transcript February 27, 2024
Ocwen Financial Corporation misses on earnings expectations. Reported EPS is $-6 EPS, expectations were $1.09. Ocwen Financial Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Good morning, ladies and gentlemen, and welcome to the Ocwen Financial Corporation Fourth Quarter Earnings and Business Update Conference Call. [Operator Instructions] This call is being recorded on Tuesday, February 27, 2024. I would now like to turn the conference over to Dico Akseraylian, Senior Vice President, Corporate Communications. Please go ahead.
Dico Akseraylian: Good morning, and thank you for joining us for Ocwen's fourth quarter and full year 2023 earnings call. Please note that our earnings release and slide presentation are available on our website. Speaking on the call will be Ocwen's Chair and Chief Executive Officer, Glen Messina; and Chief Financial Officer, Sean O'Neil. As a reminder, the presentation and our comments today may contain forward-looking statements made pursuant to the safe harbor provisions of the Federal Securities Laws. These forward-looking statements may be identified by reference to a future period or by use of forward-looking terminology and address matters that are, to different degrees, uncertain. You should bear this uncertainty in mind and should not place undue reliance on such statements.
Forward-looking statements speak only as of the date they are made and involve assumptions, risks and uncertainties, including those described in our SEC filings. In the past, actual results have differed materially from those suggested by forward-looking statements, and this may happen again. In addition, the presentation and our comments contain references to non-GAAP financial measures, such as adjusted pretax income, among others. We believe these non-GAAP financial measures provide a useful supplement to discussions and analysis of our financial condition because they are measures that management uses to assess the financial performance of our operations and allocate resources. Non-GAAP financial measures should be viewed in addition to and not as an alternative for the company's reported GAAP results.
A reconciliation of non-GAAP measures used in this presentation to their most directly comparable GAAP measures and management's view on why these measures may be useful to investors may be found in the press release and the appendix to the investor presentation. Now I will turn the call over to Glen Messina.
Glen Messina: Thanks, Dico. Good morning, and thanks for joining our call. Today, we'll review a few highlights for the fourth quarter and the full year and take you through our actions to address the market environment and deliver long-term value for our shareholders. Please turn to Slide 3. Ocwen has undergone a significant transformation since 2019. Guided by our strategy, we've transformed the company into a well-balanced mortgage originator and servicer that creates positive outcomes for clients, homeowners, investors and communities. We've built up from our foundation in special residential and small-balance commercial loan servicing with the PHH and RMS acquisitions to include performing agency and reverse mortgage servicing.
Today, we're a top 10 nonbank servicer by UPB, with broad capabilities and multiple industry awards for delivering top-tier industry performance for customers and investors. We've added multichannel originations capabilities to replenish and grow our servicing portfolio and provide earnings balance through interest rate cycles. Our originations platform ranks as a top 10 correspondent lender and top five reverse lender by volume and endorsements, respectively, and we've substantially improved our portfolio recapture capabilities over the past four years. We believe our originations platform is positioned to grow volume and earnings should the forecast for lower interest rates in the second half of 2024 materialize. We've invested in technology to enable low costs, high performance and improve the customer experience.
We replatformed the entire business, invested in multiple digital interface channels, such as our AI-enabled chat bots and mobile app, and enabling technologies like robotic process automation. Our technology-enabled global operating platform is scalable, with a highly competitive cost structure, and we believe we will deliver further profitability improvement as we increase our total servicing UPB. Servicing is a capital-intensive business. So we focused on driving prudent capital-light growth to reduce capital demands. We have 113 subservicing clients and building from our successful MAV joint venture with Oaktree, we now have five capital partners which we believe will support our growth by converting new originations to subservicing and growing servicing UPB without traditional or additional MSR investment.
To enhance returns, we continue to focus on asset management transactions that leverage our core competency in special servicing. These transactions, including cleanup calls, claims processing and asset recovery, delivered $15 million in pretax income in the second quarter of 2023, and we expect more transactions in 2024. We've meaningfully improved business performance, capabilities and the potential for growth and value creation. We believe the continued execution of our strategy of balance and diversification, capital-light growth, low costs, top-tier operating performance and dynamic asset management will deliver long-term value for shareholders. Now please turn to Slide 4. Despite the challenging environment for originations, we continued to improve adjusted pretax income in the fourth quarter and throughout 2023.
We reported fourth quarter adjusted pretax income of $11 million, an improvement on both a sequential quarter and year-over-year basis. Adjusted pretax income for the year of $49 million is up $118 million over last year. Adjusted ROE is in our target range for both the fourth quarter and full year. We reported a $47 million loss in the fourth quarter and a $64 million net loss for the full year. The net loss for both the quarter and full year was largely driven by MSR fair value changes, net of hedging. Our fourth quarter unfavorable MSR fair value change was driven by an 82-basis point reduction in key interest rates, offset by hedge coverage of 69%, which was aligned with our average target for the quarter. In December, we increased our hedge coverage ratio target to 100% to protect book value should rates fall in 2024, as anticipated.
The full year unfavorable MSR fair value change reflects the impact of high hedge costs due to the inverted yield curve and rate volatility and a 5-basis points reduction in our own portfolio value versus prior year-end to align with both market value levels. In servicing, we continued to grow average servicing UPB in the fourth quarter and have entered 2024 with subservicing boarding commitments roughly 1.5x our total additions in 2023. Also in 2023, we made great progress on enterprise-wide continuous cost improvement. Full year operating costs were down 19% versus last year, excluding expense notables, further improving our cost competitiveness as we enter 2024. Year-end liquidity of $242 million is up versus both the third quarter and the prior year, due in part to support our higher hedge coverage ratio and higher seasonal disbursements in the first quarter.
We intend to continue to opportunistically repurchase corporate debt in 2024 as excess liquidity permits. As we look ahead, third-party estimates project industry volume remaining low in the first quarter of 2024 before moving into the spring and summer homebuying season. Declining interest rates for the second half of the year are expected to help drive $2 trillion of total industry originations for the full year. I'm excited about how we're positioned entering 2024. We believe our balanced business model positions us well if interest rates remain steady or decline as projected. Now please turn to Slide 5. The execution of our strategy has helped us to continuously improve adjusted pretax income over the past six quarters and delivered financial performance in line with our adjusted return on equity guidance.
For 2024, our financial objectives start with sustaining the performance improvements we've achieved to date. This will require a continued focus on cost improvement, disciplined MSR investing with optimized hedge coverage and maintaining a prudent risk and compliance management approach. Next, we're focused on improving return on equity and capital ratios and have three levers to do this. First, by growing our subservicing portfolio, while we hold our owned MSR UPB in the $115 billion to $135 billion range. Second, as our excess liquidity permits, we expect to continue to delever the business through opportunistic debt repurchases, which we believe will also help reduce enterprise risk and earnings volatility. Third, by improving the profitability of our legacy owned MSRs. Roughly 11% of this $18 billion portfolio is over 60 days delinquent, and it carries $458 million in advances, which is dilutive to earnings and returns.
Lastly, we're focused on capitalizing on market cycle opportunities. We believe our originations platform is positioned to take advantage of a lower interest rate environment. Roughly 17% of our owned portfolio would be refinance-eligible if the 30-year fixed-rate mortgage drops to 5.5%. We continue to execute accretive special servicing and subservicing transactions. We've executed four transactions in the past five quarters and continue to scan the market for opportunities. As always, we remain flexible and committed to considering all options in this dynamic market to maximize value for shareholders. We're pleased with the performance improvements we've driven and are committed to executing our financial objectives to further deliver value to shareholders.
Now please turn to Slide 6. Our balanced and diversified business offers several benefits in the current market cycle. We are, first and foremost, a servicer, and our servicing business enables us to navigate current market conditions, delivering strong earnings and cash flow performance. While originations today is not a material earnings contributor, as you can see, in 2021, when interest rates were lower, originations delivered more substantial earnings. Our diverse capabilities in both origination and servicing create opportunities and give us multiple avenues to generate earnings growth and returns. We have a top 10 or better market position in both originations and servicing, multiple volume acquisition channels, diverse capabilities spanning small-balance commercial and reverse servicing and strong default management and loss mitigation capability.
In addition to growing our agency forward servicing UPB, we've executed multiple transactions enabled by our special servicing skills and are growing performing and delinquent small-balance commercial loan servicing. We're excited about the potential growth in these higher-margin areas. Lastly, we believe our diversified servicing portfolio with a growing mix of subservicing helps mitigate business risk. We've substantially improved our portfolio mix over the past several years, decreased client concentration risk and reduced liquidity demands, with over 85% of our servicing portfolio in subservicing and GSE-owned MSRs, where we have materially lower exposure to advances. Now please turn to Slide 7. We remain focused on capital-light growth and have built a strong foundation with a diverse investor base to support our growth objectives.
Total servicing additions were down 31% in 2023, in line with the 32% reduction in overall industry origination volume. We increased the mix of subservicing additions by 15% and doubled the volume of MSR UPB sold to capital partners, consistent with our goal of driving capital-light growth. In 2023, we grew our average servicing UPB, supported by capital partners, by over 70% and established two new MSR capital partner relationships and closed the year with five capital partners in total. We're targeting to add two more by mid-2024. The most successful of these relationships is our joint venture with Oaktree and MAV, with an investment position for an investment period that runs through May of 2025 and capacity to support $20 billion to $25 billion in additional servicing acquisitions.
Nearly all our capital partners have individually equal to or more investment capacity than MAV. I want to thank Oaktree and our other MSR capital partners for the trust and confidence they have placed in our team to help them achieve their growth and profitability objectives. Our subservicing growth with mortgage banking clients and MSR capital partners has allowed us to more than offset runoff in the Rithm subservicing portfolio. Our average servicing UPB, excluding Rithm, is up 13% in 2022 -- versus 2022 and up 3x over the last two years. We've boarded over $100 billion in subservicing additions in the last 24 months and have client commitments to board $29 billion in servicing UPB in the first half of 2024. We're targeting $69 billion in subservicing additions from all sources in 2024.
Our investor-driven approach to MSR purchases results in capital-efficient growth, helps manage our exposure to MSR valuation changes due to interest rates and introduces an added level of price discipline for the originations business. Now please turn to Slide 8. In 2023, we remain dedicated to disciplined MSR investing. Our enterprise sales team delivered solid performance in 2023. Our origination volume was down roughly 27%, versus down 32% for total industry originations volumes. Consistent with our strategy to drive capital-light growth, you can see the significant increase in MSR originations funded with capital partners. It was a highly competitive market in 2023, and that's unchanged so far in 2024. Market leaders in correspondent and co-issue channels continue to have what we believe is an aggressive view of MSR values.
Notwithstanding, we remain disciplined in originating MSRs that meet or exceed our yield objectives, which resulted in an 18 percentage point increase in mix in total additions from higher-margin channels and products versus 2022. We remain committed to managing our owned MSR portfolio in a range of $135 billion to $115 billion, as we have done in the last three years. This helps us manage interest rate risk and supports our objective of opportunistically repurchasing debt as excess liquidity permits. We're also using excess servicing spread transactions to further mitigate interest rate risk as well as reduce exposure to high hedge costs and performance variation when interest rates and the financial markets are volatile. We continue to grow our subservicing UPB with the success of our enterprise sales team and intend to accelerate growth with our MSR capital partners in 2024.
Now please turn to Slide 9. We have been relentlessly focused on building one of the best performing servicing platforms in the industry while maintaining a highly competitive cost structure. Our platform delivers superior performance versus other servicers across numerous servicing performance metrics, and our capabilities have been recognized by Fannie Mae, Freddie Mac and HUD, with top-tier industry performance awards for several years. In previous quarters, we spoke about the improvement in customer experience we've delivered for clients, our ability to cure 60-plus day delinquencies, our superior HUD claims assignment performance and our ability to maximize REO sales price versus appraised value, while selling within the timeframe allowed by HUD.
Here again, you can see we also consistently achieve lower delinquency levels compared to the industry average, as reported by Inside Mortgage Finance. In addition, since the fourth quarter of 2020, more and more borrowers have exited forbearance either as current or paid in full with an active loss mitigation plan than the industry average as reported by the MBA. Our focus on continuous cost improvement has positioned us with a highly competitive cost structure. Based on the results of the MBA's Annual Servicing Operations Study for 2022, our fully loaded forward residential servicing costs in basis points of UPB are 27% lower than our large bank peers and are favorable to our large independent mortgage banking peer group that has an average forward residential servicing UPB more than twice our size.
Moreover, our servicing costs in basis points of UPB are inflated compared to large servicer peers due to our relative high concentration of PLS servicing. If we compare cost per loan for performing and nonperforming loans versus this group, we're materially lower in every comparison. Our cost competitiveness comes from continuous process improvement, strategic investments in technology and our global operating capability. With roughly 35% of our servicing cost structure fixed or semi-variable, we believe we can further improve our efficiency as we grow total servicing UPB. I believe this, along with the other metrics I discussed, demonstrate that we are one of the strongest operators in the industry. Now I'll turn it over to Sean to discuss our results for the fourth quarter.
Sean O'Neil: Thank you, Glen. Please turn to Slide 10 for our financial highlights. I'm going to cover both fourth quarter and full year 2023 results. Overall, I'm proud of our positive progress and results for both the quarter and the year and excited about our financial outlook for 2024. For the quarter, the headline is both our servicing and origination businesses continued their profitable trend and collectively demonstrated yet another quarter of improving positive adjusted pretax income. Let's start with the fourth quarter first, the gray column in the middle of the page. The decline in GAAP net income, negative $47 million versus prior quarter's positive $8 million, was driven by interest rate impacts on our MSR, net of hedge, due to about an 80-basis point decline in rates.
The adjusted pretax income is up from Q3 to $11 million for the quarter, driven by servicing, with a small contribution from originations. This resulted in an adjusted pretax ROE in line with our prior guidance of 9.4%. Fourth quarter was also up year-over-year, by $7 million, due to both higher revenue and lower costs. For the full year 2023, please go to the far right to the blue column, where we recognized GAAP net income loss of $64 million, primarily driven by MSR fair value changes and hedging performance. Our full year adjusted pretax income of $49 million illustrates the strength of our year, bringing our adjusted ROE back to low double digits, at 10.1%. Finishing off the table to the left, I'd note liquidity ended the fourth quarter higher than normal, due to cash inflows from the MSR hedges and seasonally lower origination volumes.
Our portfolio of tax net operating loss carryforwards continued to have a positive effect, as the NOL saved us over $3 million in cash by mitigating our 2023 tax expense. Our expectation of an adjusted pretax income ROE of 12-plus percent in 2024 builds on the 10-plus percent we delivered in '23. There will be more guidance for 2024 in a few pages. For a more detailed view of the interest rate impacts on the MSR valuation, please turn to Page 11. The chart on the left shows the movement in our owned MSR portfolio from year-end '22 to year-end '23. As a reminder, we obtain our MSR marks from independent valuation experts and benchmark the experts' mark against other outside marks, external surveys and our own market observations. Over the year, the fair value declined by 5 basis points; 136 down to 131 basis points.
This reflected market pricing. In addition to market pricing, the calibration of the book was impacted by the increasing note rate of the portfolio, which grew by 50 basis points as we added new origination at higher current rates and also sold MSRs with relatively lower note rates to MSR capital partners. Typically, higher-note-rate MSRs are more susceptible to prepayment risk as rates decline, and, all else being equal, this can lower the value of a higher-note-rate MSR compared to a lower-note-rate MSR. The right chart shows the impact of interest rate on our owned MSR book for all four quarters in 2023, along with the hedge offset and the net result. As you can see, Q1 and Q4 were both quarters where interest rates declined, driving down MSR values, as they're more likely to prepay.
Interest rates are shown by the solid line, showing the 10-year swap. Thus, Q1 and Q4 resulted in declines in the MSR value, that's the gray bar, offsetting improvements in the hedge, which is the light blue, and a resulting net loss or gain. The magnitude of the hedge offset is driven by our hedge coverage ratio, which is shown here as both a target and an actual result in the table below the graph. Even a 100% hedge coverage ratio that is perfectly efficient, meaning no basis difference between the asset and the hedge, will still have other offsets, such as negative carry or option volatility of pricing. Most firms refer to this collectively as hedge costs. So the end result for the year is the combination of asset movement, hedge offset and hedge costs.
As you can see, we have been increasing our hedge coverage ratio throughout the year and most recently have adopted a hedge coverage ratio of 100% as of December 2023. We expect this to reduce the volatility of our MSR value in both up- and down-rate markets, but it comes at a higher cost overall than a lower HCR hedge approach. Page 12 gives some perspective on our desire to deploy excess liquidity to continue to deleverage the company. Starting with the top graph, this shows liquidity growing year-over-year. And from the third quarter, some of this liquidity is reserved for the higher hedge coverage ratio than prior quarters as well as higher seasonal disbursements in the first quarter. We executed a repurchase plan to retire debt in Q4 and early Q1.
But since we had to set the debt price in advance of execution, the improvement in our debt price kept our planned bid outside the range where sellers were active, and no debt was retired. We are currently approved to retire up to $40 million of debt by our board and intend to execute another plan shortly and expect to remain committed to using excess liquidity to retire debt. The lower graph shows our current debt-to-equity ratio and where we intend to target a lower ratio by the end of the year through a combination of better earnings and debt retirement. We believe this will facilitate any future transactions to refinance our remaining corporate debt, with an objective to execute on that refi sometime in the next five quarters. We also plan to opportunistically pursue subservicing retained MSR sale opportunities where appropriate, as this will reduce MSR hedging and valuation exposure as well as provide immediate liquidity.
Finally, we have begun plans to launch a separate legal entity to hold our Ginnie Mae forward assets to meet the new Ginnie Mae risk-based capital ratio requirements and have had preliminary discussions with Ginnie Mae to vet this approach. Please turn to Page 13 for an overview of our Servicing segment, both forward and reverse. Servicing continued to improve its contribution to net income for both year-over-year and trailing quarters. You can see this in the upper-left graph that shows adjusted pretax income improvement. This was driven by higher revenues and lower operating expenses in the forward servicing space. The reverse space remained strongly profitable, but declined slightly quarter-over-quarter due to declining reverse portfolio balances.
Continuing a capital-light approach, we grew subservicing volumes by 6% year-over-year measured in UPB due to transactions with existing and new capital partners as well as winning new clients. Already in 2024, we have signed contracts with counterparties to board over $29 billion of UPB in the first six months of the year. This amount is 1.5x the entire full year 2023 subservicing volume adds. So we're off to a good start. The other driver was continued cost improvements with technology, continued migration away from paper and other process improvements. Please turn to Page 14 for a snapshot of profit and liquidity drivers enabled by special and reverse servicing skill sets. We lowered advances on our legacy asset book year-over-year by 14% as we reduced the UPB of these assets by 10%.
This improvement results in lower borrowing costs on servicing advances, which helps our net income and allows us to divert liquidity to other areas. Whether it is our owned book that we are servicing or a client's book, our goal is to improve returns via better performance of the assets. Each special servicing portfolio is unique, and we have a broad range of skills and expertise to manage different legacy pools. On the reverse side, our existing reverse servicing insight and valuation expertise helped us to execute a transaction in the second quarter of '23 that generated significant excess liquidity and pretax income, and we're expecting to leverage this expertise for more transactions in 2024. Please turn to Page 15 for an overview of the Originations segment, both forward and reverse.
In originations, we continue to maintain profitability despite seasonally slower fourth quarter volume. The main driver was again our correspondent and co-issue channels, which overcame small losses in the reverse and consumer direct channels. While volumes were lower quarter-over-quarter in all three channels, the right graphs demonstrate robust margin management and focus on MSR cash yields to maintain margins in correspondent and reverse and only suffered a slight deterioration in the CD channel. Although we remain a top 10 correspondent lender and a top five reverse lender, we are committed to profitable growth versus rankings. Page 16 gives a view on our stock price, which is now performing in line with the Russell 2000 but slightly underperforming a group of our peers.
The discount to book just prior to this earnings release was around 55%. And as a reminder, while we may trade in line with some originators, we are primarily a servicer, and the bulk of our profits and book value improvement have come from the servicing business for the last seven quarters. The discount to book in the lower graph is measured as the share price following our earnings release versus our quarter-end book value, with the exception of the fourth quarter bar on the right. We continue to believe our positive growth trends in adjusted pretax income, the growth in our servicing book, our ability to run originations at a profit during a difficult market period as well as our ability and willingness to reduce our senior secured debt all support a stronger share price than we currently have.
There is a roadmap on Page 17 that gives guidance to profitability targets in 2024. I won't go through the details, other than reaffirm our target of 12-plus percent adjusted ROE for the full year. Before I turn the mic back to Glen, I wanted to point out to investors a few additional data points in our appendix. We continue to provide data on fully diluted shares in equity. We have a page on MSR valuation assumptions that is incredibly transparent and can be used versus pure data and surveys, where we show many valuation parameters. With respect to our balance sheet, we provide a more granular view, titled condensed balance sheet breakdown, which delineates assets that require matching asset and liability gross-ups under GAAP treatment. I invite you to look at these and other pages in the appendix to help you with your analysis.
Back to you, Glen.
Glen Messina: Thanks, Sean. Please turn to Slide 18 for a few wrap-up comments before we go to Q&A. I'm excited about how we're entering 2024 and believe we are well positioned, to navigate the market environment ahead and deliver long-term value for our shareholders. Our balanced and diversified business creates opportunities, mitigates risks and supports our ability to perform across multiple business cycles. We're executing a focused prudent capital-light growth strategy, leveraging our superior operating capabilities, to grow subservicing across multiple investor and product types. We've expanded our client base, grown our originations volume mix from higher-margin channels and products, and continue to improve recap performance, and believe our originations platform is positioned to take advantage of declining interest rates.
We have a strong pipeline of subservicing boarding commitments, and we've expanded our MSR capital partner relationships, to accelerate subservicing growth. Our servicing platform delivers top-tier operational performance levels, resulting in measurable improvements for clients, borrowers and investors. Through our investment in technology, global operating capability and process improvement, we've built a scalable servicing platform with the best practice cost structure and capacity for growth that delivers improved borrower, and client satisfaction. Lastly, we are prudently managing capital and liquidity for economic, and interest rate volatility and deleveraging our balance sheet as excess liquidity permits to further improve financial performance and mitigate capital structure risks.
Overall, we're excited about the potential for our business and do not believe our recent share price is reflective of our financial position, growth opportunities or the strength of our business. And with that, Joelle, let's open up the call for questions.
Operator: Thank you. [Operator Instructions] Your first question comes from Bose George with KBW. Please go ahead.
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