Mr. Cooper Group Inc. (NASDAQ:COOP) Q4 2023 Earnings Call Transcript

Mr. Cooper Group Inc. (NASDAQ:COOP) Q4 2023 Earnings Call Transcript February 9, 2024

Mr. Cooper Group Inc. 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 day, and thank you for standing by. Welcome to the Mr. Cooper Group’s Fourth Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to hand the conference over to our first speaker today. Please go ahead.

Ken Posner: Good morning, and welcome to Mr. Cooper Group’s fourth 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; Mike Weinbach, President; and Kurt Johnson, Executive Vice President and CFO. As a reminder, this call is being recorded. You can find the slides on our Investor Relations webpage at investors.mrcoopergroup.com. During the 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. And with that, I’ll now turn the call over to Jay.

Jay Bray: Thanks Ken, and good morning, everyone, and welcome to our call. Typically, we start by reviewing the quarterly highlights, but I assume you saw our pre-release. So instead, I’ll make some brief comments on full year results, talking about our $1 trillion target, and then share some thoughts on where we’re going from here. Turning to Slide 3, let’s talk about 2023. For the full year, ROTCE was 12.5%, which was back within our target range. Pretax operating earnings totaled $660 million, thanks largely to servicing, while originations made a smaller contribution, given where we are in the cycle. Tangible book value end of the year at $63.67, up 2%. The servicing portfolio grew 14% to $992 billion at year-end, which we believe establishes us as the industry’s number one servicer.

As we commented last quarter, we expect to achieve our $1 trillion target during the first quarter once pending transactions have completed boarding. Contributing to portfolio growth during the year, we acquired Home Point and its $83 billion portfolio in a transaction, which was accretive to tangible book value and which was essentially self funded through the assumption of $500 million in senior notes. Additionally, the acquisitions of Rushmore Servicing and Roosevelt Management added another $32 billion and brought us best-in-class special servicing capabilities in the infrastructure to launch our first MSR fund. A key theme for 2023 was operating leverage. We grew the portfolio at a double-digit pace during the year, while at the same time cutting costs company-wide by 8%.

These results showcase our highly efficient digital platform, the benefits of incremental scale, and our agile management of originations capacity. Finally, stock repurchase totaled $276 million for the year at an average price of $49.53. And given the current stock price, we’re obviously quite pleased. With that, let’s skip ahead to Slide 5 and spend a moment on our $1 trillion target, because this milestone represents the culmination of a multi-year journey. One that’s taken us from very humble beginnings to our current position as industry leader. We’re extremely proud of our track record. Very few companies can boast of 30% growth compounded over 15 years. We did this by relentlessly focusing on our platform, investing in the right technology and building a people first culture.

If you go back to the WMIH merger in 2018, which is when we became a fully independent public company, our first priority was deleveraging, which we accomplished by refinancing our senior notes and extending our liquidity runway. At the same time, we were rolling out Project Titan, which was a series of technology investments designed to ready our platform for the next leg of growth. These investments paid huge dividends during the pandemic, when we helped over 500,000 customers enter and exit forbearance plans, while at the same time driving lower unit cost in servicing. In fact, since 2018, we’ve cut servicing costs by 30%, leaving us now 38% below industry peers based on the most recent Mortgage Bankers Association benchmark study. Our investments also paid big dividends when we sold our cloud native servicing technology to Sagent, which allowed us to focus our IT resources on the customer experience and the latest developments in generative AI.

We told you we would monetize zone, and while we still have work to do with the auction exchange, we generated $528 million in gains in 2021 by selling title valuation and field services with extremely opportune timing. We’ve distinguished ourselves with industry-leading customer retention, which is currently near 80%, or almost 4 times the industry average. And as you recall, during the refi boom of 2020, we generated in excess of $1 billion in profits from originations. The WMIH merger brought us $1 billion in deferred tax assets. At the time, there was skepticism about their value. Today, we have realized 63% of that balance in the form of incremental cash flow, which has helped us exceed expectations in terms of both growth and stock repurchase.

So where are we going from here? We’re now seeing some of the best growth opportunities in the company’s history, and we will continue to grow our servicing portfolio as we have for the past 15 years. But our strategic focus is now squarely on return on equity, which shouldn’t surprise you since we’ve been commenting on ROTCE on every quarterly call. If you’ll turn to Slide 6, let me share some updated guidance with you. From 2019 to 2021, the entire mortgage industry enjoyed outsized returns. Thanks to the massive refinance wave that generated what will probably turn out to be once in a lifetime margins. During 2022, we passed through an inflection point as the market struggled with the sharpest mortgage rate increases in recent memory, which impacted originations immediately, while it took servicing a few quarters to ramp up.

During 2023, we crossed back into our target range of 12% to 20%. And today, as we look out over the next few years, we would expect to drive these returns to a higher level. Specifically, we’re forecasting ROTCE to steadily increase, reaching the mid to upper teens by the end of 2025, which is a level that we believe we can sustain thereafter. Now, bear in mind, as is always the case, we face some headwinds. The market expects somewhat lower rates in 2024, which could create some margin pressure for servicing in terms of higher amortization expense and lower levels of interest income, although these would likely be offset by a pickup in originations. But the story for Mr. Cooper isn’t about interest rates. The real story is the strategic initiatives we’re working on that will lift ROTCE to a sustained higher level.

Let me highlight four broad categories. First, we’re making terrific progress with servicing cost, for example, by driving lower call volumes with better digital solutions for our customers. Plus, we think there’s enormous potential from rolling out the latest generation of AI. I’d remind you that Mr. Cooper is already a leader in AI with our mortgage centric Pyro technology, which we developed in partnership with Google in 2021, in which today, we’re using internally and marketing to third parties. In 2024, you should expect further positive operating leverage and servicing, and across the company. Second, we believe there’s enormous opportunity for ROTCE 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 re-engineering our DTC platform to drive higher volumes and wider margins in all environments. And finally, the strength of our balance sheet and risk management gives 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, will 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 valuation. 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 prospect. And now, I’ll turn the call over to Chris to take you through more details on our operational performance.

Chris Marshall: Thanks, Jay. And on that point, it’s nice to see our stock finally trading over tangible book. I couldn’t help but remember when I first got here in 2019 and our stock dropped at one point to as low as half tangible book before the market understood the resilience of our balanced business model. But I don’t think one times 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 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. I can’t imagine anyone better qualified than you to lead Mr. Cooper forward on our path to further growth and higher returns. So with that being said, I’ll start this morning on Slide 7 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 $1 trillion 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 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. 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. We recently raised a $1 billion in high yield debt at a cost of 7/8, and we’re seeing bulk deals coming to market with yields of plus or minus 13% for conventional, and even higher returns for Ginnie loans. That’s a spread of roughly 6 percentage points, whereas three years ago, we were funding a plus or minus 6 and investing at around 9. But that’s not even the whole story, because the pools today are highly seasoned, with no rates well out of the money, and very significant equity cushions.

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 from 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 the banks from the mortgage sector. 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. Subservicing is also a great opportunity for us. As you know, we’re currently boarding 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’re 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, 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 pretax 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, so we’d guide you to model servicing income climbing steadily but at a pace below our portfolio growth. Specifically, based on the forward 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, 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 fourth quarter, you can see that calls per loan continued 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 to 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 processes. 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.

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 Slide 9 and talk about originations, where we generated $10 million 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 wider gain on sale margins for 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. For similar reasons, refi recaptures dipped slightly during the quarter, but it’s now back up over 80%.

Clearly this remains a difficult environment for originations, 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 period. As rates began to rise they did a fantastic job pivoting to cash out refinances. 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 volumes. 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 returns. We’re continuing 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 help drive down unit costs by 22% in 2023. Looking ahead, we guide you to expect $20 million 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 Xome. 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.

And as a result Xome continues to operate at roughly breakeven, but we’ll update you further on conditions as the year progresses. And with that, I’ll turn the call over to Kurt.

Kurt Johnson: Thanks Chris. Good morning everyone. I’ll start on Page 11 which provides you a summary of the financials. 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 Home Point transactions, $2 million in severance and a $2 million share in losses at Sagent. During the quarter, we marked down the MSRs by $217 million due to lower interest rates and higher expected CPRs 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 $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 $1 billion in senior notes with a coupon of 7/8 priced at 7.25% 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 each quarter thereafter. This expense will be offset by lower MSR line interest expense in the servicing segment. Finally, I’d like to add some additional color on the ROTCE outlook. As Jay mentioned, we expect ROTCE to rise over the next two years into the mid- to upper-teen levels in 2025. Now, this forecast assumes slightly lower rates in line with the current yield curve and modest economic growth. Based on consensus estimate from Mr. Cooper tangible books should exceed $70 per share a year in 2024.

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 and book implying significant potential upside. Now, obviously we’ve got a lot of work to do to produce these results, and of course we don’t control the valuation, but we do look forward to continuing our growth story as the market leader in servicing. 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 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 Mr. Cooper’s history as a public company. Turning to Slide 13, let’s review liquidity. We used the $1 billion 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 lines. 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 delinquencies trends I just mentioned. To summarize, our balance sheet has never been in stronger 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, where 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 BB rating, and subsequent quarter end Moody’s upgraded our corporate credit rating to Ba3. At quarter end, our capital ratio is measured by tangible net worth to assets with 29.3%.

While this was down slightly quarter-over-quarter on a continued asset growth, it’s 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.

Ken Posner: Richard, we’re ready to take questions please.

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question will come from line of Giuliano Bologna from Compass Point. Your line is open.

Giuliano Bologna: Let me just start off by saying great quarter, and Chris, you’ll be missed, not be on the conference calls going forward. I remember way back when you first started and I think the share price is 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 of new MSRs over the next few quarters? Can you do $50 billion a quarter? Or is it can you do $100 billion a quarter. I’m just curious about kind of what the structural limitations are from a platform perspective, because the opportunity is obviously large out there?

Chris Marshall: Giuliano, first of all thank you very much. I remember our very first roadshow and appreciate you showing us a little love early on. So thank you. Look, there’s obviously some physical limitation, 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 4 or 5 times the amount of data and reconcile invoices really in real time. So we’ve made a lot of advances there. I wouldn’t think of the technology or the process as being any kind of limitation.

Jay Bray: And if you look back in even a decade ago, when we bought the BofA portfolio it was $200 billion, and we boarded it in nine months. And to Chris’s point, the level of sophistication today, 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, is the way I think about it.

Giuliano Bologna: That’s great. And, to Chris’ point, fortunately, I had my projections out there. But fortunately, you guys came in above and beyond consistently. So, that made me look at along the way. The next question that I want to ask was related to the originations platform. You’re obviously bringing on a lot of new MSRs that should substantially increase or recap for opportunity. I’m curious how you think about kind of the evolution of getting new MSRs onboard versus the delay of potentially being able to pivot recapture onto the Mr. Cooper origination platform.

Chris Marshall: Well, remember, we’re buying pools of all different types. A lot of the pools we’re buying are well out of the money. Some of them are. I mean, everything’s priced differently. But in our – the time lapse between us boarding a proposal and evaluating it for a recapture potential, that may be a couple of days. I mean, we rescore our entire portfolio every night. So pools are loaded on a Monday, it may take till Wednesday, but it’s very, very quick.

Giuliano Bologna: That’s very helpful. Thank you very much, and I will jump back in the queue.

Chris Marshall: Thank you, Giuliano.

Operator: 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.

Kevin Barker: Great. Thanks for taking my question. I echo Giuliano’s comments, Chris. You will be missed on these calls. I just wanted to follow up on the guidance for the ROE 14% to 18%. Could you lay out the different scenarios where you think you would come in the lower end versus the higher end? What type of macro scenarios should we consider? Or what type of shifts in the market may cause you to go at the lower end or the upper end of that viewpoint? Thanks.

Kurt Johnson: 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, the mortgage rates over the next couple of years. I think, realistically what we’ve also said is we’ve got an equity-to-asset ratio range of 20% to 25%, and we are – and have been consistently above that amount. We’re trending closer to 30% at this point in time. I think we did $1 billion 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 the earnings. I think that’s what you’ll see going forward. Obviously, if we get into an environment where there’s good refinance recapture ability we can go up to the top end of the range. But I think we’re comfortable in a forward yield curve within that range as we reported.

Kevin Barker: Great. Thanks for taking my questions.

Chris Marshall: Thank you, Kevin.

Operator: Thank you. One moment for our next question. And our next question comes from line of Bose George from KBW. Your line is open.

Bose George: Hey, everyone. Good morning. Actually one follow-up on the guidance of the ROTCE, so you guys noted, 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 the full year 2024?

Kurt Johnson: Hey, Bose, 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 it on our plan, if we’re able to acquire servicing at continued attractive yields, we’ve indicated where we’re comfortable. And to your point, I think guiding to 2025, we’ve said mid to high-teens, and I think we’re comfortable with that as well.