Q4 2023 Mr Cooper Group Inc Earnings Call
Jay: In 2024, you should expect further positive operating leverage in servicing and across the company. Second, we believe there's enormous opportunity for ROTC accretion in our asset light strategies, including subservicing and our MSR fund, since they don't take up any of our liquidity. Third, we're reengineering our DTC platform to drive higher volumes and wider margins in all environments.
Jay: And finally, the strength of our balance sheet and risk management give us confidence we can hit these higher returns, even in the face of market volatility or less favorable macro conditions. In summary, let me share our vision for where the company is going over the next few years. We envision Mr. Cooper as playing a leadership role in the mortgage industry with a platform that's scalable and offers best-in-class efficiency. For our customers, we'll offer an experience that is frictionless and personalized, and as a result, we'll retain our customers for life. For our stakeholders, Mr. Cooper will work tirelessly to retain their trust. And for our investors, we're optimistic that the company's stock price will, over time, receive a premium multiple, reflecting the outlook for return on equity, our track record, and the quality of our balance sheet. Obviously, we do not control the valuation.
Jay: That's up to you. But we will work diligently to compound tangible book value at a double-digit pace, which for us is an exciting process. Now, I'll turn the call over to Chris to take you through more details on our operational performance. Thanks, Jay.
Chris: And on that point, it's nice to see our stock finally trading over tangible books. I couldn't help but remember when I first got here in 2019, our stock dropped at one point to as low as half tangible, but before the market understood the resilience of our balanced business model. But I don't think this one time's tangible book is the end of our story, not by a long shot, certainly not for a company with such a successful track record and now such an impressive leadership position. By the way, this will be my last call as a speaker. Next quarter, you'll hear from Mike Weinbach, Mr. Cooper's new president, who brings exceptional leadership experience at some of the most respected financial institutions in the country. Welcome, Mike.
Chris: I can't imagine anyone better qualified than you to lead Mr. Cooper forward on our path to further growth and higher return. So with that being said, I'll start this morning on slide seven and discuss servicing portfolio growth, which was very strong this quarter as we ended the year at $992 billion, up 14% year over year. As Jay mentioned, you should look for the portfolio to exceed $1.1 trillion by the end of the first quarter. As you recall, we announced the trillion-dollar target in July of 2021 when the portfolio was only 650 billion. It's taken an enormous amount of energy, discipline, and effort on the part of our entire workforce, and it's really very gratifying to be reaching the target so much faster than most people believe is possible. And now we're already exceeding it. So I really need to share my heartfelt thanks to every single member of the Mr. Cooper team for your amazing work. I couldn't be more proud of all of you.
Chris: Now looking ahead, growth conditions remain extraordinarily attractive. We're seeing a very significant pipeline of deals coming to market with rich margins. Consider this.
Chris: We recently raised a billion dollars in high-yield debt at a cost of seven and an eighth, and we're seeing bulk deals come to market with yields of plus or minus 13% for conventional loans and even higher returns for GENI loans. That's a spread of roughly six percentage points, whereas three years ago, we were funding a plus or minus six and investing in around nine. But that's not even the whole story because the pools today are highly seasoned with note rates well out of the money and a very significant equity cushion. On a risk-adjusted basis, spreads today are second only to what we saw in the aftermath of the global financial crisis, and you can see this in option-adjusted spreads for bulk MSR deals, which have more than doubled in the last three years. What's driving these returns is the huge supply-demand imbalance, which reflects the large volumes of MSRs retained by originators during the refinance boom, as well as the ongoing retreat of banks from the mortgage sector.
Chris: Mr. Cooper is extremely well positioned to exploit this opportunity because of our ever-widening cost advantage, which means that we enjoy materially higher cash flow yields than our competitors. Also, we have an information advantage consisting of a decade's worth of data on collateral performance on the part of literally thousands of sellers. This information allows us to generate alpha by outperforming market returns.
Chris: Subservicing is also a great opportunity for us. As you know, we're currently underwriting a $90 billion portfolio for a very important new client, and we're optimistic about additional wins in 2024. We're in the process of raising capital for our first MSR fund, which will also be a source of subservicing volumes. Currently, we are in discussions with several institutional investors, as well as pension plans, sovereign wealth funds, asset managers, and family offices. We've also received reverse inquiries from some very large and sophisticated investors interested in separately managed accounts. Investors are focused on the secular opportunity resulting from the pullback of banks, which is a recurring theme in the private credit sector.
Chris: And they find the return profile of MSRs extremely attractive, given the potential for fully hedged double-digit returns, which are uncorrelated to systemic risk factors, and investors clearly understand the strengths we bring to this strategy as the market's leading platform with significant scale-driven operational and informational advantages. Now let's turn to slide 8 and talk about pre-tax servicing income, which totaled $229 million in the quarter, which was just slightly ahead of our revised guidance, as Jay mentioned. There could potentially be some headwinds in 2024.
Chris: So we got you to model servicing income climbing steadily, but at a pace below our portfolio growth. Specifically, based on the Ford curve, we're planning for slightly lower interest rates, which of course will benefit our origination segment, but could drive CPRs and amortization to higher levels and put some pressure on net interest income. Having said that, we're at a point where many of our strategic initiatives are paying off, and as a result, we're extremely confident in our ability to deliver additional operating leverage in 2024. One of the key initiatives we've commented on recently is our no-touch environment.
Chris: The goal of which is to drive lower call volumes and not by cutting back on customer service but by providing more information to our customers and easy-to-access digital tools. Through the fourth quarter, you can see that calls per loan continue to fall. During 2023, we spent a lot of time focused on calls related to payments, and by reworking our processes, we were able to eliminate as much as 90% of calls in that category. But this is only the tip of the iceberg. We're now using generative AI to predict the intent of customer calls, so we can route those calls to the right team members and prompt our team members with the right information to answer questions on the fly, and then to summarize call logs and transcripts so we can identify opportunities to further refine our process.
Chris: Jay mentioned our Pyro Mortgage-Centric AI platform, which we rolled out three years ago. Pyro gives us a decisive advantage in terms of onboarding portfolios because the system identifies missing documents, signatures, and stamps, and it does this with extremely high levels of accuracy without humans in the loop. Last year alone, we scanned, extracted, and classified millions of documents comprising 676 million pages of data.
Chris: This contributes to our advantage in the bulk servicing market, where prior servicing documentation is critical in understanding the profile of the loans being boarded. Now let's turn to slide 9 and talk about originations, where we generated $10 million in EBT, which was above the high end of our updated guidance range as our DTC team was very nimble in taking advantage of the late-quarter rally in mortgage rates, and we also enjoyed a wider gain on sale margins from improved capital markets execution. Bear in mind, these numbers were impacted by the cyber event in November, excluding that impact. We estimate EBT would have been double this level.
Chris: For similar reasons, refi recaptures dip slightly during the quarter, but it's now back up over 80%. Clearly, this remains a difficult environment for origination, but I'd highlight the tremendous progress we've made expanding the scope of DTC. During the refi boom, DTC focused on rate and term refinances, but as rates began to rise, they did a fantastic job pivoting to cash out refinances.
Chris: Since then, we've rolled out second liens and are now making great progress with Purchase Recapture, which together make up more than a third of our total volume. Our DTC platform is extremely profitable, and Maximizing DTC's Contribution is a strategic priority for us. In fact, it's one of the key initiatives that will help us lift the company's overall return. We will continue to invest in the platform to drive lower costs, faster turn times, and a more personalized customer experience. These investments include Project Flash, which is our approach to digitizing and automating workflow, which helped drive down unit costs by 22% in 2023.
Chris: Looking ahead, we guide you to expect $20 to $30 million in operating EBT in the first quarter. Bear in mind this guidance is based on current market conditions, and both volumes and margins could change if interest rates surprise in either direction. Okay, if we can move to slide 10, I'd like to finish with an update on Zones. Our team made a lot of progress during the year, enhancing our platform, winning market share, and performing admirably in very difficult conditions. Sales were up 75% year-over-year in the fourth quarter, and inventories continued to grow. But the foreclosure market remains dormant, thanks to home price gains and generous government programs.
Chris: And as a result, Zone continues to operate at roughly break-even. But we'll update you further on conditions as the year progresses. And with that, I'll turn the call over to Kurt. Thanks, Chris. Good morning, everyone.
Kurt: I'll start on page 11, which provides you with a summary of the financial results. I'll start by taking you through the adjustments, which consisted of $27 million in costs related to the cyber incident, as we previously disclosed, $8 million in deal costs associated with the Roosevelt and Homepoint transactions, $2 million in severance, and a $2 million share in losses of FASIA.
Kurt: During the quarter, we marked down the MSRs by $217 million due to lower interest rates and higher expected CPR, leading to a quarter-end valuation of 155 basis points of UPB, or a 5.2 multiple of the base servicing fee strip. Now, this was offset by a $176 million hedge gain, which equates to 81% coverage. That's well within policy tolerance as we continue to target a hedge ratio of 75%. Subsequent to quarter end, we issued a billion dollars in senior notes with a coupon of seven and eight, priced at seven and a quarter percent yield to maturity. As a result, you should model in an incremental $12 million in corporate interest expense in the first quarter and $18 million in each quarter thereafter. This expense will be offset by lower MSR line interest expense in the servicing segment.
Kurt: Finally, I'd like to add some additional color on the ROTC outlook. As Jay mentioned, we expect ROTC to rise over the next two years into the mid to upper teens in 2025. Now, this forecast assumes slightly lower rates in line with the current yield curve and modest economic growth. Based on the consensus estimate for Mr. Cooper, tangible books should exceed $70 per share a year in 2024.
Kurt: On this basis, it would be reasonable to look for $10 or more per share in operating EPS in 2025. I would echo Jay's comments. If we deliver on higher returns and demonstrate the continued sustainability of our business model, it's not hard to imagine that our stock might trade at a higher multiple of earnings on book, implying significant potential upsides. Now, obviously, we've got a lot of work to do to produce these results, and of course, we don't control the valuation. We do look forward to continuing our growth story as the market leader in services. Now, if you'll turn to slide 12, let's give you an update on asset quality. I'll be brief because concerns about recession have diminished in the last few months. But even so, we want you to know that we're positioning the company to weather a future turn in the cycle, whenever that may occur. In this regard, it was nice to see delinquencies fall another notch to 1.3%. That's the lowest level in Mr. Cooper's history as a public company.
Kurt: Turning to slide 13, let's review liquidity. We use the billion-dollar proceeds from the high-yield offering to pay down MSR lines, and as a result, on a pro forma basis, our liquidity totaled $3.4 billion at year-end, consisting of cash and immediately available capacity on our MSR line. New bonds aren't due until 2032, which leaves us with a very strong liquidity runway for the next eight years. Finally, I'll comment briefly on advances, which declined 2% year over year despite growth in the portfolio. Now, that's consistent with the favorable delinquency trends I just mentioned.
Kurt: To summarize, our balance sheet has never been in better shape. If you'll turn to slide 14, I'd like to wrap up by putting our high yield offering in some historical context. As Jay mentioned, when the WMIH merger closed in 2018, our first priority was deleveraging, and the reason for that was our core philosophy that balance sheet strength is non-negotiable for market leadership. I think it's fair to say that our approach to balance sheet management has been favorably received by the marketplace, as you can see our spreads have compressed by almost half over the last three years. During the fourth quarter, Fitch initiated coverage on us with a WB rate, and subsequent to quarter end, Moody's upgraded our corporate credit rating to BA3.
Kurt: At quarter-end, our capital ratio is measured by tangible net worth to assets at 29.3%. However, this was down slightly quarter over quarter on continued asset growth, still well above our target range of 20 to 25%. With that, I'd like to thank you for listening to our presentation, and now I'll turn the call back to Ken for Q&A at www.kevinbarker.com. Victor, we're ready to take questions, please. Thank you. And at this time, we'll conduct the question and answer session. As a reminder, to ask a question, you need to press star one on your telephone and wait for a name to be announced. To address your question, please press star 1 1 again.
Juliano Bologna: One moment while we compile the Q&A roster. One moment for our first question. Next, our first question comes from Juliano Bologna from Compass Point. Your line is open.
Chris: Let me just start off by saying, great quarter, and Chris, you'll be missed not being on the conference calls going forward. I remember way back when you first started, and I think in the single digits, and we were both trying to get the message out there back then. So congrats on that. If I shift a little bit, you obviously did a large bond deal, you have a lot of capital and liquidity, and you have a lot of MSRs announced for the first quarter or in the pipeline. How should we think about your ability to onboard or the pace of onboarding new MSRs over the next few quarters? Can you do $50 billion a quarter, or can you do $100 billion a quarter? I'm just curious about what the structural limitations are from a platform perspective because the opportunity is obviously great out there. Giuliano, first of all, thank you very much.
Chris: I remember our very first road show and appreciate you showing us a little love early on. So, thank you Look, there's obviously some physical limitations. But it's kind of theoretical. I mean, we're onboarding somewhere around 400,000 loans as we speak. So our ability to ingest large pools is pretty significant. We have talked to you about some of our tools in the past, the technology we've developed, probably the most noteworthy is Project Pyro, which, or the tool Pyro, which allows us to ingest four or five times the amount of data and reconcile invoices really in real time. So we made a lot of advances there. I wouldn't think of the technology or the process as being any kind of limitation.
Chris: If you look back even ten years ago when we bought the B of A portfolio, it was $200 billion, and we blew it up in nine months. And to Chris's point, the level of sophistication of today, the level of investment we've made, obviously, we're much more capable today. So I think we can handle pretty much any size and without any issues. That's great. And to Chris's point, fortunately, I have my projections out there, but fortunately, you guys came in above and beyond consistently. So that made me look along the way.
Chris: The next question that I wanted to ask was related to the Originations platform. You're obviously bringing on a lot of new MSRs that should substantially increase your recapture opportunity. I'm curious how you think about the evolution of getting new MSRs on board versus the delay to potentially being able to pivot recapture onto the Mr. Cooper Origination platform. Well, remember, we're buying pools of all different types. A lot of the pools we're buying are well out of the money, but some of them are.
Chris: I mean, everything's priced differently, but in our time lapse between us boarding a proposal and evaluating it for its recapture potential, that may be a couple of days. I mean, we rescore our entire portfolio every night, so polls are loaded on a Monday. It may take till Wednesday, but it's very, very quick.
Chris: That's very helpful. Thank you very much, and we'll jump back into Q. Thank you, Juliana.
dial-in pin, and press pound when finished.
Kevin James Barker: Thank you. One moment for our next question. Our next question will come from the line of Kevin Barker from Piper Sandler. Your line is open.
Kurt: Thanks for taking my question. I echo Giuliano's comments; you will be missed. You know, I just wanted to follow up on, you know, the guidance, the ROE. Could you lay out the different scenarios?
Kurt: coming to the lower end, versus the higher end, what type of macros, or what type of shifts in the market may cause you. Lower end or the, Hey, Kevin, it's Kurt. So I think realistically, the way that we've modeled everything going forward is based on the forward yield curve today. And that doesn't show a whole lot of change in the 10-year or, in fact, in mortgage rates over the next couple of years. Um, you know. Realistically, what we've also said is we've got a, you know, an equity to asset ratio range of 20 to 25 percent, and we are and We're trending closer to 30 percent at this point in time.
Kurt: I think, you know, we took on a billion dollars of debt. I think that gives us a lot of ability, as we're seeing MSRs with really attractive returns, to invest in those MSRs and to boost earnings, and I think that's what you'll see going forward. Obviously, if we get into an environment where there's, you know, good refinance and recapture ability, we can go up to the top end of the range, but I think we're comfortable with a forward yield curve within that range, as we've reported. Thank you for taking the time to join us. Thank you. Thank you, Kevin.
Kevin James Barker: Thank you. One moment for our next question. And our next question comes from the line of: Boze George from KBW. Your line is open. Hey everyone, good morning.
Boze George: I have one follow-up on the guidance on the ROTCE. So you guys noted, you know, next year you expect to reach the high end of the range. For full year 2024, do you think you'll be above the low end of the range, so 14% plus for full year 2025? Hey, both.
Kurt: Look, I don't think we are giving specific guidance, nor have we historically, right? I think. But I think, again, if we're able to execute on our plan, if we're able to acquire servicing at continued attractive yields, you know, we've indicated where we're comfortable. And, to your point, I think guiding 2025, we've said, you know, mid to high teens, and I think we're comfortable with that as well. Okay, great. Thanks.
Kurt: And then actually one on the MSR hedge, you guys were right at 80% this quarter. Any thoughts about increasing that, or do you just feel like the remainder is kind of covered by your macro hedge and sort of keep it at that level? Yeah, I think that we're planning on keeping it at that level. I think, you know, we probably have probably outperformed in both directions over the last quarter when, you know, when the portfolio was going up, we had a little bit less than 75% coverage, which was great, which meant that we didn't lose as much on the hedge. And when the mark was going down, we did better.
Kurt: So we gained a little bit more on the hedge. So I think our hedge effectiveness over the last couple quarters has been really good, but we're still targeting that 75%. And I think, you know, as we continue to acquire a new current coupon portfolio, we've got a little bit of loans that are going to be in the money if we see a rate rally. And we think that can really give us sort of the upside potential against the remaining 25%. Yeah, okay, great, thanks.
Boze George: Thank you. One moment for our next question, and our next question will come from Terry Ma from Barclays, Illinois. Hi, thanks. Good morning.
Terry MA: I just had a follow-up on the ROE range of 14 to 18%. If I look at slide 8 on the 2024 outlook, is it possible to maybe dimensionalize some of those drivers, portfolio growth, operating leverage, and DTC, how much they contribute toward that ROE rate? Terry, we wouldn't break it down in those pieces.
Chris: I think we're giving you guidance that we expect a certain amount of operating leverage. We've been generating it for the last three years consistently, so if you're asking for a specific percentage for each, no. I'd say, on balance, we're very comfortable at the range, and I think we should just leave it at that point.
Chris: I would say on originations it won't take much in terms of rates to move to see originations produce more meaningful levels. Obviously, in the quarter, we had that rate rally right at the end of the quarter, and our team turned on a dime and started producing a much higher volume of fundings. And that was really, maybe 10 or 15 days of activity.
Chris: So if rates do start to move down, as many people expect them to this year, I would expect Originations to play a bigger role. Got it. That's helpful. So, if I look at the fourth-quarter ROE of 11 percent... Is it possible to, I guess, quantify what the RO, or have the adjusted ROE for the disruption, like what it would have been?
Chris: Yeah, if not for the disruption of the fourth quarter, we would have doubled that, that operating income, originations are perspective, it would have been about 12 12% ROTC for the 4th quarter. Servicing business was back up, but just to remind everyone, our servicing business, although the event was disruptive, our servicing business was back up and running in four days. So there was an interruption, but it was not very significant.
Chris: Right. Although we did have to call 7 to 8 million because we waived late fees for the month. And again, doing the right thing for the customer is something we're always going to do. And it did have a slight impact.
Chris: So if you add kind of Chris's doubling of originations plus the servicing waiving of late fees, I think you'll get kind of that you come back into that same 12 and a half number. Got it. Okay, that's helpful. Thank you. One moment for our next question, and Mr. Cooperman. Thank you.
Chris: Once again, one moment for our next question. Our next question will come from Doug Harder from UBS. Your line is open.
Chris: Thanks. Can you talk about the outlook for regulation for yourself in light of Treasurer Secretary Yellen's comments yesterday? I think if you're talking about regulation in terms of size growth, I think you really have to look at our portfolio in two pieces. While the overall portfolio has grown considerably, and we expect it to grow by another 25 percent this year. Only half of it is owned by MSR. The other half is subserviced for a number of clients. So I don't think if there are any limitations on concentration, I think it would be focused more on people on owned MSRs.
Chris: So I think we have quite a bit of room for us to grow before that becomes a concern to anybody. And if you look in total, I mean, we're still in kind of a single-digit market share. And so I think there's plenty of room to grow from there. And if you look at other sectors, you know, in financial services, payments, processing, other processing businesses, you certainly see consolidation to a few players. And so, you know, I think that makes sense for the servicing business as well. I mean, it's a scalable business. You know, you have to be able to invest in the technology, et cetera.
Chris: And so we don't have any concerns about, you know, continuing to grow the platform. And, you know, the key for us is sustainability, right? We've invested heavily in technology and compliance and risk. And so, you know, those are real, you know, key strengths of the company.
Chris: And, you know, we'll continue to focus on those. We feel good about future growth prospects. Any risks?
Chris: Obviously, you're well above your own sort of target capital ratios, but if, if they were to apply more Capital Rules to you kind of how to use capital or liquidity rules, you know, how do you think you would fare, you know, if it went to kind of more of a bank like capitals? Well, the targets, the equity targets that we put out range from 20 to 25, are so much so far ahead of what is required of banks that I don't think that's any type of concern for us. I can't even imagine it becoming anything of a conversation again. We're talking about a range of 20 to 25. We're at 29 today. I'm not sure what the average bank is, but maybe it's half that level, I appreciate that.
Chris: Thank you. One moment for our next question, and our next question will come from Michael K. Sorry about that. Michael K. from Wells Fargo.
Chris: Hi, you know, you've grown your servicing portfolio very fast, and the outlook for the acquisition seems very favorable. But bringing on so much business, how do you think ahead and avoid a melting ice cube effect for the servicing portfolio when the acquisition opportunity eventually slows down? Even now, with the very low runoff of the portfolio, your originations are nowhere near able to offset that. Well, in actuality, they are.
Chris: With an 80% recapture rate, the concept of a melting ice cube doesn't really apply to us. We're growing the portfolio, and CPRs are very, very low at the same time.
Chris: And we're growing it both through acquisitions and through subservicing growth. So I think if you look at the mortgage industry as a whole, historically, that melting ice cube description did apply. But when you have recapture as high as we do, as well as the correspondent channel and the co-issue channel, replenishment has not been a problem for us at all. And I can't imagine even if acquisitions were to slow down to half the levels they've been, and if you look back to 2019, through 2020, that was the situation. And we were still growing at a very, very strong clip. Yeah, Michael, to be specific, if you look at our co-issue correspondent DTC business, we can maintain the portfolio and grow it slightly. So, you know, we have a sustainable model without any bulk acquisitions, but, I mean, look at our track record over the last, you know, 25 years from a bulk acquisition standpoint, and I think it speaks for itself.
Chris: There's always going to be portfolios in the market, and as you've seen us do in the last few years, I mean, we will get our fair share of those. So, you know, I think from a growth standpoint, we feel very good about our existing channels of origination and the co-issue channel, and the bulk opportunities are going to be there. And so I think we feel really good about it.
Derek Summers: Okay, thank you very much. Thank you. Once again, as a reminder, that's star number one for questions. One moment for any questions, and I'm not. I'm not showing any further questions in the queue. I'd like to turn the call back over. Actually, I have a question from Derek Summers from Jeffries. Hi, good morning.
Chris: On the $1.1 trillion guide for servicing book at the end of 1Q, what should we anticipate for the mix between forward MSR and subservicing? And then if you could talk about kind of your pipeline expectations for subservicing moving forward, that'd be great. It's a great question.
Chris: I think in the first quarter, it's about one-third subservicing. No, no, no. It's about two-thirds of servicing, one-third owned.
Chris: A lot of these deals were deals we closed in the fourth quarter, and they're just boarding now. Over the course of the year, we'd like to see a little bit more subsidizing because, traditionally, as we've told you, we like to have a 5050 mix. And we're a little bit higher; I think we ended the year more like 6040 or roughly. So we'd like to board some large subservicing companies, but it's a little too early to tell, and that'll play out depending on what market opportunities present themselves.
Chris: Got it. Thank you. And then on your comments about Everett Nation's EBT being double if it weren't for the cybersecurity incident, is the assumption on that double that the incremental volume would have come mainly from the DTC channel? Yeah, yeah, exactly. And you know, just the timing of the event. It happened really as there was that mini rate rally, so we did lose some key days in the quarter.
Chris: Okay, got it. And then if we were to see any pickup in, you know, in originations volume looking forward, with those, you know, assumptions to hold that, you know, the mix would shift towards the DTC channel as well. Yeah, of course. I mean, Correspondent and Co-Issue are pretty steady producers. DTC, obviously, is going to flex up and down depending on rates. We don't expect rates to go much higher, but as they do come down, that should immediately generate more activity in DTC.
Chris: Got it. Thank you for answering my question. Thank you. And I'm not showing any further questions in the queue. I'd like to turn the call back over to Jay for any closing remarks. Thank you everybody for joining us, and we look forward to further conversations. Thank you. Thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Everyone, have a great day; the phone rings www.kevinbarker.com