Ocwen Financial Corporation (NYSE:OCN) Q3 2023 Earnings Call Transcript

Ocwen Financial Corporation (NYSE:OCN) Q3 2023 Earnings Call Transcript November 7, 2023

Operator: Good morning, ladies and gentlemen, and welcome to the Ocwen Financial Corporation Third Quarter Earnings and Business Update Conference Call. [Operator Instructions] This call is being recorded on Tuesday, November 7, 2023. I would now like to turn the conference over to Mr. Dico Akseraylian, Senior Vice President, Corporate Communications.

Dico Akseraylian : Good morning, and thank you for joining us for Ocwen's third quarter 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 at different degrees uncertain. You should bear this uncertainty in mind and should not place undue reliance on such statements.

Forward-looking statements, which speak only as of the date they are made, involve assumptions, risks and uncertainties, including the risks and uncertainties 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 reference to non-GAAP financial measures, such as adjusted pre-tax 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 the non-GAAP measures used in this presentation to their most directly comparable GAAP measures as well as management's view on why these measures may be useful to investors may be found in the press release and the appendix of 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 third quarter and take you through our actions to address the market environment and deliver long-term value for our shareholders. Now please turn to Slide 3. I'm excited to report our third quarter results, which reflect continued progress against our key initiatives and the benefits of our balanced and diversified business. Adjusted pre-tax income for the third quarter of $10 million was primarily driven by our servicing segment. Both originations and servicing were profitable in the quarter. Adjusted pre-tax income for the quarter has improved materially versus the same quarter last year and slightly better than the second quarter, excluding the reverse whole loan transaction gain realized during that quarter.

Our third quarter results achieved a 9% annualized adjusted pre-tax return on equity. Net income of $8 million or $1.10 per share is above consensus, but lower than the second quarter, again, largely driven by the reverse whole loan transaction gain reported in 2Q. Notable items for the quarter were roughly zero, largely resulting from our increased hedge coverage ratio and our market-based MSR valuation and benchmarking process. In the third quarter, total servicing UPB was up 2% versus the second quarter and up 5% versus the prior year, driven by growth in subservicing UPB. Subservicing UPB with MSR capital partners and mortgage banking clients increased 6% versus the second quarter and 10% versus prior year. We're pleased to report that we and Oaktree have mutually agreed to extend the commitment period for MAV through May of 2025.

In addition, we and Rithm have mutually agreed to extend our subservicing agreement through December of 2024. We greatly appreciate our relationships with Oaktree and Rithm and the confidence they've placed in us. We take their trust seriously and are committed to helping them achieve their objectives. We continue to focus on enterprise-wide cost management. Third quarter annualized operating expenses, excluding expense notables are materially lower than our second quarter '22 baseline and lower than the second quarter 2023. During the third quarter, we opportunistically repurchased $14 million of our PHH notes at attractive prices and are prioritizing continued corporate debt reduction as excess liquidity is available. Total liquidity of $194 million is down versus prior year end due to the allocation of capital to reduce our corporate debt and the higher liquidity demands of our increased hedge coverage.

We're very pleased with our results this quarter. The business is performing in line with our adjusted pre-tax return on equity guidance, we're executing well against our key initiatives and we believe we're on track to achieve our return objectives for the remainder of 2023 and 2024. Please turn to Slide 4. The execution of our strategy and key business initiatives have helped us to reposition the business to operate profitably in the current industry environment. While the originations environment remains challenging, it's a favorable environment for servicing, and we expect the current industry dynamics to persist for the foreseeable future. We've continuously improved adjusted pre-tax income over the past 5 quarters. The business is delivering financial performance in line with our ROE guidance without relying on a material income contribution from our originations segment.

Looking forward to the balance of 2023 and 2024, our financial objectives start with sustaining the financial and operating performance improvements we've achieved to date. This will require a continued focus on cost improvement, disciplined MSR investing and maintaining a prudent risk and compliance management approach, which we have demonstrated are core competencies for us. Next, we're focused on increasing return on equity and we have 3 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. We're laser-focused on converting our subservicing opportunity pipeline and working with our MSR capital partners to fund new originations and win both purchase opportunities.

Second, as our excess liquidity permits, we expect to continue to delever the business through opportunistic debt repurchases to further improve ROE as well as decrease enterprise risk and earnings volatility. Third, we believe we can further enhance ROE by improving the profitability of our legacy owned MSRs. Roughly $18 billion or 14% of our owned MSR UPB is comprised of pre-crisis subprime and Ginnie Mae loans originated prior to 2015. This portfolio segment has a total delinquency of over 15% and is not delivering returns consistent with our target levels. Lastly, we are continuously scanning the market to identify and capitalize on market cycle asset opportunities that match our unique skill sets. This includes positioning for distressed asset transactions as well as special and commercial subservicing transaction and disruption resulting from consolidation in other areas where we have expertise.

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 on our financial objectives to further deliver value for our shareholders. Please turn to Slide 5. 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 from a position of strength. Our servicing business is delivering strong earnings and cash flow performance driven by slow MSR run-off, higher float earnings and continuous cost improvement. Despite current market conditions, our originations business serves well its purpose to replenish our owned MSR portfolio as well as drive growth in subservicing.

Our diverse capabilities in commercial and reverse subservicing, and within those niches, strong default management and loss mitigation capability is giving rise to unique earnings opportunities to invest in distressed assets. In the second quarter, our purchase and securitization of reverse whole loans was enabled by our special servicing skills and reverse mortgages. This same expertise is also driving cash flow performance in these assets well above projected levels. We've also been able to carefully grow performing and delinquent small balance commercial loan subservicing over the past 2 years. We're optimistic about the potential growth in this higher margin subservicing niche. We are seeing increased opportunities in these areas and remain focused on acting on high-return transactions where we can add value to investors, clients and consumers.

Lastly, we believe our diversified servicing portfolio with the growing mix of subservicing helps mitigate business risk in the event of a recession. Over 85% of our servicing portfolio is subservicing and GSE owned MSRs with a materially lower exposure to advances in the event of a recession as compared to PLS and Ginnie Mae owned servicing. Now please turn to Slide 6. We remain focused on driving organic growth in our higher margin origination channels and products as well as growing subservicing. In the third quarter, our mix of originations volume from higher margin channels and products increased 21 percentage points versus prior year. We increased volume from our higher margin channels and products by 50% on a sequential quarter basis.

However, mix was down 2 percentage points due to an overall increase in total originations volume. Our enterprise sales team delivered strong growth versus the second quarter in both owned MSRs and subservicing. However, total servicing additions were down roughly 10% versus the prior year due to the contraction in total industry originations volume. Subservicing additions and subservicing retained MSR sales to capital partners of $15 billion for the third quarter was up 50% versus the second quarter and more than double prior year levels. Our subservicing growth with mortgage banking clients and our MSR capital partners has allowed us to significantly grow our subservicing business more than offsetting run-off in the Rithm subservicing portfolio.

Our subservicing portfolio excluding Rithm is up 9% on a sequential quarter basis and up 20% versus the third quarter of last year. We've boarded $111 billion in subservicing additions in the last 24 months, including over $8 billion in subservicing additions in the third quarter. While interest remains strong, we continued to see potential subservicing clients extend RFP processes and decision making or selling MSRs due to the difficult originations market. Our MSR capital partner relationships can be helpful in these situations. We can bid on MSRs with a capital partner, giving us the ability to retain the business or win incremental subservicing if our capital partner wins the MSR bid. This is an optionality that several of our more traditional subservicing competitors do not have.

Considering the client environment, we're targeting roughly $15 billion to $25 billion in new subservicing additions through the second quarter of 2024. Based on expected subservicing additions, we expect our mix of subservicing to increase to approximately 60% over the next 2 quarters with total servicing UPB in the range of $305 billion to $315 billion. Please turn to Slide 7. Our servicing platform continues to deliver industry top-tier operational performance, while maintaining a highly competitive cost structure. Our breadth of capabilities is unmatched in the industry. And we have been recognized by Fannie Mae, Freddie Mac and HUD for delivering industry-leading operating performance for investors. We have also been named 2023 Affiliate Company of the Year by the National Association of Mortgage Brokers for our expertise in reverse mortgages.

Across numerous servicing metrics, we delivered superior performance versus other servicers. 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 assignment claims performance and our ability to maximize REO sales price versus appraised value, while selling properties within the timeframe allowed by HUD. Here again, you can see we also consistently achieved lower delinquency levels compared to the industry average, as reported by Inside Mortgage Finance. In addition, since the fourth quarter of 2020, more of our borrowers have exited forbearance either as current, paid in full or 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 even when measured against competitors over twice our size. Based on the results of the MBA's annual Servicing Operations Study for 2022, our fully loaded forward residential servicing cost in basis points of UPB are 27% lower than our large bank peers and on par with our large independent mortgage banking peers. The large independent mortgage banking peer group includes 3 of the industry's largest servicers and 2 of the industry's largest pure-play subservicers. This group has an average forward residential servicing UPB more than twice our size. Moreover, our servicing cost and basis points of UPB are inflated relative to large servicer peers due to our relative high concentration of PLS servicing.

If we compare cost per loan for performing and non-performing loans versus this group, we're materially lower in every comparison. Our cost competitiveness does not rely upon sheer size and scale. It comes from continuous process improvement, strategic investments in technology and our global operating capability. With roughly 30% of our cost structure, servicing cost structure, fixed or semi variable, we believe we can further improve efficiency as we grow our 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. Please turn to Slide 8. While we're delivering improved efficiency, we're also delivering improved borrower and client experience. Our Net Promoter Scores were up 6 percentage points over last year and subservicing client Net Promoter Scores are up 18 percentage points.

Over the last several years, we've continued to invest in client and bar facing technology and automation to improve the customer experience by reducing cycle time, enhancing access to information, enabling 24/7 assistance and reducing process variation. We're using multiple digital interface channels such as our chatbots and mobile app and additional enabling technologies like robotic process automation. Our AI-powered chatbot has hosted 800,000 sessions with an 80% success rate. Our mobile app has over 100,000 log-ins per month. And we have 26 bots supporting 156 processes with 8 new bots under development. These technologies work together to improve access, speed, accuracy and responsiveness, while enabling further productivity as we scale up our platform.

A woman signing a mortgage loan in a modern banking hall.

To support our subservicing clients, we have a robust and holistic infrastructure with 40 individuals dedicated to addressing client needs. This team has an average tenure in the industry of 20 years in response to over 4,000 client inquiries per year, most of which are addressed in less than 24 hours. We've invested in technology to build our LoanSpan Discovery platform to provide transparency to clients about their portfolio and our operational performance as well as enable self-service data mining for clients. We're committed to investing in people, process and technology to deliver a superior experience to both borrowers and clients. Please turn to Slide 9. We continue to focus on expanding our capital partner relationships to support our growth objectives on a capital-light basis.

The most successful of these relationships is our joint venture with MAV, which has purchased $78 billion of MSR UPB since its inception. As I previously mentioned, we and Oaktree have mutually agreed to extend the investment period for MAV to May of 2025 and we have capacity to support $20 billion to $25 billion in additional servicing acquisitions. Over the past 2 years, we've grown total servicing UPB supported by capital partners to $89 billion using a variety of transaction structures. Over the last 12 months, we have leveraged active relationships with 4 capital partners to nearly double our UPB funding. All our capital partners have long-term conviction about owning MSRs. Nearly all of them currently have individually more capacity for investment than MAV.

With multiple investors, we can fund MSR purchases through either our originations channels or the bulk market dependent on partner requirements. Our investor-driven approach to MSR purchases enhances our ability to generate capital-light growth and helps manage our exposure to MSR valuation changes due to interest rates as well as introduces an added level of price discipline for the originations business. Looking ahead, we're focused on developing additional investor relationships and evaluating a diverse range of potential structures to support our growth and scale objectives across multiple asset types. I want to thank Oaktree and our other MSR investor partners for the trust and confidence they have placed in our team to help them achieve their growth and profitability objectives.

Now I'll turn it over to Sean to discuss our results for the third quarter.

Sean O’Neil : Thank you, Glen. Please turn to Slide 10 for our financial highlights. I'm very pleased with the performance in the third quarter from both the financial and operational perspective. Servicing and originations are profitable. And after removing the positive impact of the opportunistic reverse whole loan transaction gain in the second quarter, we showed continued improvement in both GAAP net income and adjusted pre-tax income. Our results continue to reflect the hard work and resilience of our dedicated employees, the strength of our operations as well as our balanced business model. Going to the blue column, in the third quarter of 2023, we recognized GAAP net income of $8 million. GAAP net income at several significant drivers last quarter that did not occur this quarter, primarily a $15 million gain in the whole loan transaction and a $28 million positive impact from legal and regulatory settlements.

After adjusting for those, we're pleased with the $8 million of GAAP net income, which reflects an improvement of over $3 million from our originations and servicing businesses quarter-over-quarter as well as $1 million gain from the repurchase and retirement of $14 million of corporate debt. The adjusted pre-tax income of $10 million closely aligns the GAAP, indicating no material notables this quarter as well as reflecting the lower volatility in our P&L due to a higher hedge coverage ratio. As Glen pointed out, liquidity is down slightly this quarter due to the debt repurchase, the hedging instruments and the higher cash used in originations to support the higher volume. Our liquidity remains well in excess of the new FHFA and Ginnie Mae liquidity requirements.

With the positive GAAP net income result, you can see that our effective tax rate for the quarter is only about 11% due to our existing portfolio of tax net operating loss carryforwards. We do expect to continue to deliver 9%-plus adjusted pre-tax income ROE going forward with some seasonal impacts throughout 2024 and we will provide more robust guidance assumptions for 2024 on our year end earnings call. For a more detailed view of the quarter-over-quarter changes in adjusted pre-tax income, please turn to Page 11. The all segment view on the upper left clearly shows the positive and growing trend in adjusted pre-tax income when the positive $15 million impact for the whole loan transaction is removed for consecutive quarter comparison. This indicates our balanced business model is delivering net income growth, and the blue bar at the bottom shows the growth in adjusted PTI ROE as well.

The total segment view on the upper right shows the impact of the improving profitability of both origin, servicing offset with some corporate impacts, and I will cover the segments in more detail in a few pages. Page 12 highlights the debt repurchase we initiated in the third quarter. The transaction actually bridged the quarter in early October, so we are showing the total impact for both quarters as well as the Q3 impact alone. In my comments, I'm going to be referring to the total impact that bridges Q3 and Q4. We used excess liquidity to repurchase $15 million of corporate debt held at the PHH entity. This debt now stands at $360 million, down from $400 million 18 months ago. Our payment obligations have been reduced as well as our ongoing interest expense.

We bought the debt into discount and thus recorded a gain of $1.3 million on retirement of the debt. This is in line with the guidance we have provided, which is to delever the balance sheet to bring our debt-to-equity metric in line with our publicly-traded competitors. On Page 13, I will describe our hedging approach and the impact of our capital-light strategy on interest rate risk. The graphs on the left shows the difference between what appears on our balance sheet for MSR assets. We show here both in UPB and fair value for the third quarter. The fair value of $2.86 billion in the third quarter represents the GAAP balance sheet, but due to transactions that didn't achieve accounting through sale, which is $1.1 billion of the fair value, and the excess servicing spread transactions, which is an additional $255 million of fair value, that leaves us with about $1.5 billion of fair value of MSR assets.

This represents the amount of our net MSR exposure that we actually hedge. This illustrates our capital-light strategy where we intend to maintain a consistently sized book in the range of $115 billion to $135 billion UPB of owned MSR to reduce our interest rate risk. As we've discussed, our MSR valuation is based upon input from 2 independent valuation experts that use market observed trading levels as well as comparisons to public filings, PwC and KPMG surveys and our own model output. Our mark-to-market approach is different than a mark-to-model approach. The right graph shows the last 3 quarters of our hedge coverage ratio and the consistently higher hedge coverage ratio mitigates the earnings volatility from both rising and falling interest rates.

The last 2 quarters coming in at 73% and 92% of hedge coverage ratio are above the target of 60% that we set in the second quarter of this year. Now we will cover a more detailed segment information on Page 14 where we start with the servicing segment. This is both data on forward and reverse. The upper left chart of adjusted pre-tax income shows an improvement in reverse servicing from $3 million to $4 million quarter-over-quarter due to lower operating expenses from process improvements. Forward servicing PTI, which excludes asset sales and mark-to-market, was down slightly quarter-over-quarter due to higher run-off in the third quarter as well as lower revenues from the migration of some assets to subservicing. Float income continues to improve as balances grew and the forward subservicing volume grew across quarters by $9 billion or 7% and 10% year-over-year.

Please turn to Page 15 for an overview of our origination segment also both forward and reverse. The origination business improved adjusted pre-tax income by $3 million quarter-over-quarter, but lagged versus prior year when correspondent margins were significantly higher. Correspondent lending and co-issue saw significantly higher volumes this quarter than the prior quarter. They're up 63% for a quarterly total of $7.2 billion of UPB. We continue to price this product for an appropriate yield linked to our corporate cost of capital. Consumer direct or the retail channel continues to increase volumes and experienced margin declines to stay slightly below breakeven. This channel has shifted from a rate term refinancing, trade purchase cash-out focus.

It will be the key driver of future profitability when mortgage rates do decline. Reverse had flat origination volumes and the HMBS spreads continue to be wider than recent historical averages, which suppresses gain on sale. We continue to ensure that the origination segment is sized appropriately for the prevailing market volumes, which can be seen by our better cost to originate both year-over-year and quarter-over-quarter. This data in the lower right corner is even more impressive when you consider the year-over-year volume is essentially flat. Please turn to Page 16 for a view on our stock price. Using the same starting point of year end 2020, our stock is now performing in line with the Russell 2000 Index, but slightly underperforming a group of our peers.

The discount to book also gave back some recent progress, likely due to the strong increase in the 10-year treasury yield, which can have a negative impact on an origination-centric company. However, the bulk of our profits have come from the servicing business for the last 6 quarters. The discount to book in the lower graph is measured as the share price following our earnings release versus at quarter end book value. We continue to assert that our positive growth trends in profitability, big growth in our servicing book, the ability to run originations at a profit during a difficult market period and our willingness to reduce our senior secured debt, all support a stronger stock price than we currently receive. Back to you, Glen.

Glen Messina : Thanks, Sean. Please turn to Slide 17 for a few wrap-up comments before we go to Q&A. I'm proud of how our team is executing. In the third quarter, we delivered results and achieved our annualized adjusted pre-tax ROE target. Our balance and diversified business creates opportunities, mitigate risks and supports our ability to perform across multiple business cycles. We're executing a focused, prudent growth strategy, leveraging our superior operating capabilities to grow subservicing across multiple investor and product types. Through our investment in technology and global operating capability, we've built an efficient and mature platform with capacity for growth that delivers industry-leading performance and measurable improvements for clients, bars and investors.

We remain steadfast in our pursuit of industry servicing cost leadership by driving continuous cost and process improvement. Our investment in people, process improvements and technology are driving improved borrower and client satisfaction and remain committed to delivering a superior experience to borrowers and clients. We continue to expand our capital partner relationships to enable subservicing growth and capitalize on unique investment opportunities. With the support of these relationships, 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-related risks. Overall, we're excited about the potential for our business and do not believe our recent share price is reflective of our strong financial position, growth opportunities and the strength of our business.

As we continue to execute our business strategy, we believe we are well positioned to navigate the market environment ahead and deliver long-term value for our shareholders. And with that, Laura, let's open up the call for questions.

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