Mr. Cooper Group Inc.

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, and Chris Marshall, Vice Chairman and CFO. As a quick reminder, this call is being recorded, and you can find the slides on our Investor Relations webpage at investors.mrcoopergroup.com. During 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. I'll now turn the call over to Jay.

Good morning, everyone. We're going to start this morning, as always, by reviewing the quarterly highlights. But first, I want to express my deep appreciation to all my team members at Mr. Cooper for your fantastic work in 2020. Despite the serious challenges of the pandemic, you never wavered in your commitment to our customers. Together, we helped thousands with forbearance plans. We helped thousands save money by refinancing them. And we were very diligent in managing the company through an incredibly volatile environment, which allowed Mr. Cooper to serve as a source of strength in the marketplace. And we produced outstanding results for all our stakeholders. From myself, the board, and the executive management team, thank you very, very much. Now let's turn to slide three and zero in on the highlights for the quarter. We reported $2 per share in GAAP EPS with pre-tax operating income of $329 million, which is equivalent to an ROTCE of 44%, and that's more than three times our target. Tangible book value grew at a very solid rate, ending the quarter at $26.27 per share. 2021 is shaping up to be another excellent year for growth in tangible book value. Originations turned in excellent results with pre-tax income of $435 million for the quarter. This is the third quarter in a row of income over $400 million, and I would add that first quarter is shaping up to be another exceptional quarter. These very consistent results speak to the benefits of our unique model in which most of our originations profitability relates to serving our existing customers. Funded volumes were up 57% sequentially to a new record level, thanks to a very strong ramp in correspondence. And last quarter, we told you to expect growth to pick up in the servicing portfolio, and it did. During the fourth quarter, we saw 7% growth to $626 billion. We're feeling positive about opportunities to win more bulk deals in 2021. For the full year, we're expecting the servicing portfolio to grow in the range of 5% to 10%. And as you know, capital allocation is a constant focus for us. And as you saw, we redeemed $100 million in senior notes during the quarter, which brings our debt-to-equity ratio back to the level it was prior to the WMAH merger in 2018. And during the fourth quarter, we also bought back 1.4 million shares of stock. Finally, we ended the quarter with nearly $700 million in cash, and we expect very strong cash flow from operations to continue throughout 2021. If you'll turn with me to slide four, I want to spend a few minutes and focus on return on equity. Prior to the WMIH merger, we were a controlled company with an operational mission. The merger transformed us into a fully independent public company with a mandate to create investor value. We initially set an ROTCE target of 12% plus, which is a reasonable level for an institution of our size. But as we've demonstrated over the last two years, in the right market conditions, our returns can be much higher. We all understand that market cycles are a huge driver of profitability in the mortgage industry, but I want you to know that Mr. Cooper's return on equity also reflects a multi-year focus on efficiency. As you can see, over the last five years, we've been driving steady improvements in unit cost in both servicing and originations. And this progress is really a good measure of our capabilities with technology. We've talked on past calls about Project Titan, HomeAdvisor, Project Flash, our digital forbearance self-service tools, and many other initiatives. And this is really where you see the results. Higher return on equity also reflects a cost focus at the corporate level, where we've taken a variety of actions to rationalize expenses, and this includes the refinancing and deleveraging I mentioned earlier. Those actions have cut our funding costs by 41% or $81 million per year. Going forward, you should expect us to continue driving efficiency gains in every part of the business year in and year out. In a normal environment with stable economic growth and interest rates moving within a reasonable band, we'd expect the company to generate returns on equity in a range of 12% to 20%. 2021 looks like another exceptional year with returns likely to be well above this range. Now let's move to slide five and talk about growth. As I mentioned this quarter, we posted strong portfolio growth of 7%. And as you know, over the last two years, we told you that we were taking a pause on growth in order to focus on integration, deleveraging, and efficiency. But we said pause, and we didn't say stop. And the growth pause is now over. I want to remind you that prior to the pause, Mr. Cooper had a very impressive growth record with a 12-year CAGR in our servicing portfolio of 39%. This growth propelled us to the number one spot among non-bank servicers and number three overall. And this growth record is solid proof of our technology and operational capabilities. From here, we're planning to grow the portfolio at a rate of 5 to 10% per year, although the actual rate could be faster or slower depending on a number of factors. We've made the technology investments to drive new customer growth in the correspondent channel, and to retain our customers in the direct-to-consumer channel. We have an unmatched track record of acquiring large portfolios. In terms of subservicing, we are the partner of choice for MSR investors. And we have the operational capacity to double our portfolio to more than $1 trillion. So we think we're really well positioned. But having said that, we've never chased market share, and we're not about to start now. We will grow more quickly when financial returns in the market are attractive and more slowly or not at all if they are below our hurdles. Furthermore, we will grow in a disciplined and responsible manner, which means strict attention to capital and liquidity and an unwavering focus on the customer experience. I'm going to wrap up my comments on slide six with some thoughts on the outlook for 2021 and longer term. For 2021, we see very strong housing fundamentals plus current low interest rates as underpinning another year of outstanding financial performance. We expect to generate very strong RLTCE well above consensus expectations. We're very pleased with our momentum and originations, and given the huge number of customers who could save money by refinancing, we expect to benefit from elevated margins throughout 2021. which will normalize as we roll into 2022. However, we expect our results in 2022 and thereafter will benefit from ongoing technology investments, many of which, like Project Flash, are focused on further digitization and which will help us continue to drive down unit costs. While we've been very focused on refinances recently, I want to remind you that we have a proven playbook for purchase markets too, which you saw us deliver on in 2018 when our volumes were 65% purchase money. The servicing margin will benefit from EBOs in 2021. And as we move into 2022, the margin should benefit from slower prepayment speeds and reduced amortization. If interest rates drift upwards, we stand to mark up our MSRs, which could drive sizable gains in tangible book value. We believe this positioning is a major differentiator. as most of our peers are heavily overweighted to originations, whereas our business model is much more balanced. Our cash and liquidity are strong, and we're projecting robust cash flow throughout 2021. As you know, we've undertaken a strategic process to monetize our zone subsidiary. That process is ongoing, and a successful conclusion could generate significant additional cash. Also, I'd remind you when projecting our cash flow, don't overlook the value of the net operating losses we took on with the WMIH merger, which will shield us from paying federal taxes for many years to come. Finally, acting as the stewards of your capital will continue to be thoughtful and disciplined about how we allocate our capital and cash. August 1st of this year marks the third anniversary of the WMIH merger. at which point tax limitations will be reduced significantly, giving us considerably more flexibility to buy back stock starting in five months' time. And if that's the best use of capital for investors, that's where we'll turn. And with that, I'll turn the call over to Chris.

Hey, thanks, Jay. And good morning, everyone. I'm going to take you through the details of the quarter. And as always, I'll start on page seven with a high-level summary of our results. We were very pleased with net income of $191 million, or $2 a share, which included $85 million in breakage costs for the senior note refinancing we completed, as well as $10 million in other adjustments, as well as a $6 million mark-to-market charge. On an operating basis, pre-tax operated income was $329 million, and as Jay mentioned, fully taxed operating ROTCE was 44%, which represents the seventh consecutive quarter during which we've exceeded our 12% target. As I said, adjustments totaled $10 million. There was a $5 million total of severance across the servicing zone and corporate segments related to corporate actions which if you recall, are efficiency initiatives we've been working on over the past two years to lower expenses and standardize our operations. Also, we shut down a small unit in Zone whose contribution wasn't material, which resulted in another $5 million charge. In terms of other notable items, I'd point out that servicing benefited from $81 million in early buyout revenues which I'm going to talk more about in just a minute. We're very happy with these results, which translated into excellent growth in tangible book value, which increased 10 percent quarter over quarter to $26.27 a share. Jay mentioned the potential for strong TBV growth in 2021. And depending on what happens in the macro and policy environment, there's potential for additional upside that could be quite meaningful. So, let's turn to slide eight and discuss other catalysts for book value. The chart on the left shows the benefit that rising interest rates would have on our MSR asset. For example, if interest rates went up by 100 basis points, we'd expect to mark up the MSR by $418 million, which would equate to an increase of $3.54 a share in tangible book value. Now, bear in mind, these estimates are based on models, which factor in many different variables. As you know, we carry the MSR in our books at fair value, which reflects market participant expectations, not our own proprietary views. Also, these estimates assume a parallel rise in rates relative to what's already discounted to market expectations. For the purpose of valuing the MSR, the most important rate is the fixed mortgage rate. as this drives prepayment speeds. And of course LIBOR and the swap curve also matters. They drive expectations for income on custodial deposits. Now turning to the slide on the right, I'm sorry, the chart on the right, let's talk about the DTA. The Biden administration has proposed raising the corporate tax rate to 28%. If this goes through, it will result in a markup to our DTA by almost $400 million, which would add $4.28 in tangible book value, which would be an increase of 16%. In that scenario, our cash flow will be unaffected by higher corporate tax rates since the NOLs will shield us from paying federal taxes for many years to come. I'd add that due to the tax planning strategies we've put in place, the composition of the DTA is changing. we've converted roughly one-third of the DTA from NOLs associated with the WMMIH merger, which have expiration dates, to ordinary NOLs, which never expire. And that conversion will continue over the next two years or so. Now let's turn to slide nine and discuss the MSR, which was flat quarter over quarter at 100 basis points of UPB. The mark was relatively small at $6 million and reflected lower mortgage rates in the quarter, leading to an increase in the lifetime CPR assumption, partially offset by higher swap rates, which, as I just mentioned, drive expectations for custodial deposit income. Each quarter, we provide you with an estimate of how many of our customers could save at least $200 a month by refinancing, which would be roughly 35% of the average monthly payment. With rates having drifted down during the quarter, you won't be surprised to see approximately 800,000 customers could benefit from refinancing. We also have another 511,000 customers who could lower their payments by $100 a month, which would still provide very meaningful savings. Additionally, we have hundreds of thousands of customers with substantial equity in their homes who could benefit from cash out refinances, which is not counted in these numbers. Our DTC channel has a lot of experience doing cash out refinances, which you saw from our performance in 2018. And this capability will help us sustain volumes once the opportunity with rate and term refinances has returned to normal levels. Now, on that note, let's turn to slide 10 and talk about the origination segment, which continued to produce excellent results with pre-tax income of $435 million in the quarter, which is the third consecutive quarter over $400 million. Funded volumes increased 57 percent quarter over quarter to a new record level. Last quarter, we guided you to expect a ramp in correspondent, which is a cost-effective channel for new customer acquisition. Over the last couple of years, we've been investing in technology, rationalizing the cost structure, and growing our network of clients. Fourth quarter saw record correspondent funded volumes of $13.6 billion, which was more than double the prior quarter. We also had record fundings in DCC. We're constantly improving our technology, and in 2020, those investments allowed us to smoothly and significantly expand capacity. Those actions also helped us drive the refinance recapture rate by four percentage points to 35 percent. Similar to last quarter, we're showing you how the recapture rate varies for different parts of the portfolio. For DTC customers, meaning people have already gone through a refinance transaction with us, our recapture rate is 66%. You should take that as a very good indication that our customers appreciate the service we provide and the money we help them save. The refinance recapture rate is also strong in the correspondence channel, which will make up a growing proportion of the portfolio now that we're ramping up volumes. There's also opportunity for us to do more with the bulk portfolios we've acquired, although these portfolios do contain some older loans with low balances, which is part of the reason that recapture rates there tended to be lower. Now, turning to the outlook, just like Q4 origination volumes, in January and so far in February, volumes continue to be extremely strong. and we're projecting funded volumes to remain strong through the end of the quarter. Turning to slide 11, let's shift gears for a minute and talk about margins. The total pre-tax margin compressed only slightly by nine basis points down to 186 basis points, but that slight compression was due entirely to mix shift, as lower margin correspondent volumes ramped up to 55 percent of total funded volumes from only 41 percent in the prior quarter. As a reminder, when we talk about origination margins, these are all net of costs. Now, let's talk about revenues for a minute. The chart on the right shows you the trend in revenue margins, by which we mean gain-on-sale revenues plus associated fee income divided by net LOX. As you can see, corresponding gain-on-sale margin declined quarter over quarter. which was the result of more aggressive pricing to grow the channel. We previously limited volume to focus on pockets in the market where we could maximize revenues. Now we're bringing our pricing more in line with market, although we have backed out of and will continue to avoid certain niches where we're seeing signs of irrational competition. While the corresponding gain on sale margins are down, we significantly lowered costs during the year, which helped us sustain overall profitability in the channel. In the DTC channel, gain on sale margins have been very strong over the last three quarters, reflecting favorable secondary market conditions. Because these are existing customers who value their relationship with us, our marketing costs are essentially zero, and we don't face the same level of competitive frenzy as you might see in the retail and wholesale markets. And based on what we've seen so far in January and February, we expect our total originations margin to remain strong in the first quarter. Now, let's turn to slide 12 and review the servicing portfolio. Total UPB was up 7 percent, ending the quarter at $626 billion. The growth benefited from subservicing in particular And as you may recall, last quarter we commented on a new relationship with a large investment firm, which is off to an excellent start. In addition to originations, we added $11 billion to the portfolio through bulk and flow deals, where we have very strong relationships in the market. Despite CPRs at 33 percent, our net MSR position, which excludes excess spread, grew by 9 percent sequentially. which is equivalent to a net replenishment rate of 130%. This means that if you net out the runoff attributable to excess spread investors, our originations were more than sufficient to sustain and grow the portfolio. Going forward, you should expect the portfolio to be up slightly in the first quarter. But as Jay mentioned earlier, by the time we get to the end of the year, we'd expect to see solid growth of 5% to 10%. Strong correspondent volumes and higher DTC recapture rates bode well for steady growth with upside potential from both subservicing and bulk. And we're encouraged by recent pickup and activity in the bulk market. We've been watching a number of sellers holding on to product over the last few quarters in hopes of better pricing. But recently, we've seen them starting to come to market and expect that to continue. Now, let's talk for a moment about forbearance. Since the CARES Act was first signed, we've helped approximately 364,000 homeowners go on forbearance, and we've helped 186,000 of them resolve and exit forbearance. The forbearance requests have continued to trend down. In January, we had 9,000 new requests compared to an average of 13,000 a month in the fourth quarter. Currently, about 5.5% of customers are still on forbearance which is down from our peak of 7.2%. Now, let's turn our attention to the servicing margin on slide 13. Excluding the full mark, the servicing margin was a negative 1.4 basis points. Now, as you'd expect, fast CPRs and low interest rates continued away on the servicing margin, with amortization up to 8.6 basis points in the quarter. which equals 3.3 basis points that were lost in margin over last year's already elevated rates. However, just to state the obvious, we get the benefit of low interest rates in the origination segment, and what matters to us is the company's overall profitability, which in this environment continues to be well above our target range. As you think ahead to 2022, Remember, that will naturally benefit in the servicing margin from a slower CPR and reduced amortization. Last quarter, we told you to expect at least $250 million in revenues associated with early buyouts of Ginnie Mae loans in 2021. During the fourth quarter, we had EBO revenues of $81 million, which reflects buyouts of $1.3 billion redeliveries of $600 million, and a margin in excess of 6%. You'll see this under other ancillary revenues in the detailed servicing P&L we provide in the appendix. As you may recall, under Ginnie Mae's streamlined modification program, we're able to refinance qualifying customers impacted by the pandemic into a new loan with a market rate and then buy out and redeliver that loan. This is an excellent program for customers as it helps them get back on their feet and provides a break in their mortgage payment. And it's straightforward for us to administer since it doesn't require extensive documentation or a lengthy trial period. For Ginnie Mae customers who don't qualify for streamlined mods, we can still buy out delinquent loans, modify the terms, and then re-deliver them after a trial period. Based on our latest projections for 2021, total EBO revenue is looking likely to be meaningful higher than our previous $250 million estimate. Now, with forbearance policies having recently been extended, the timing will continue to evolve, and we'd expect to see larger buyout volumes in the second half of the year. Also, I'd note that for planning purposes, we think 4% is a more realistic margin Looking at the first quarter, we'd expect the servicing margin to end up being right around break-even. Now, turning to slide 14, you can see that Zone produced another solid quarter with pre-tax operating income of $18 million in line with the prior quarter, thanks to continued strong performance in our title unit. With Ginnie Mae foreclosure moratoriums now in place through the end of June, the REO exchange continues to sit idle with no contribution during the quarter and none expected until the second half of the year. While moratoriums are a sensible policy to protect borrowers, at some point there will be a backlog of REOs in the system that need to be processed and cleared. And at that time, the exchange will ramp back up again and we would expect it to earn very strong profits once it's back in operation. Last quarter, we talked about the question of whether ZOM is getting appropriate recognition in our stock price, given the fact that many investors focus on tangible book value, and the book value associated with ZOM is immaterial. We told you we were open to a variety of strategies to monetize the value of ZOM, including raising a minority stake, issuing debt, or considering a disposition of parts of ZOM or the entire subsidiary. Whatever would position this very profitable and well-run unit to get full market, full credit from the market. At this time, I can report to you that our strategic process is underway, and we'll let you know more about what decisions we come to once that process is complete. Now, if you'll turn to slide 15, we'll focus on the balance sheet and talk a little bit about liquidity. We generated strong cash flow in the quarter with an estimated $370 million in steady state discretionary cash flow. This allowed us to redeem $100 million in senior notes, absorb the breakage costs associated with the refinancing, buyback, $34 million in shares and invest $100 million into flow and bulk MSRs on top of what we originated, while ending the quarter with robust cash of nearly $700 million. As we guided you to expect, advances increased to approximately a billion dollars this quarter through the typical seasonal trends related to tax payments, although they're actually down by 4.9% year over year, which is a much more positive trend than what we were planning for when the pandemic first hit. From a liquidity perspective, however, we will continue to plan for adverse environments to ensure that Mr. Cooper always serves as a source of stability and strength. Today, our liquidity is extremely robust. We have almost 1.4 billion in unused capacity for servicing advances on multi-year committed lines. We have significant excess capacity on our originations and MSR lines as well. So from a liquidity standpoint, the company has never been in better shape. Now let's finish up with some comments on capital and leverage on slide 16. Operating with strong capital is a clear expectation for any financial institution that plays an important role in the U.S. mortgage market. At the beginning of 2020, we disclosed an internal leverage target defined as the ratio of tangible network to assets of 15% or higher. Now, that ratio is under temporary pressure from Ginnie Mae Loans eligible for buyout, which under accounting rules, we consolidate on our balance sheet as soon as the underlying loans go 90 days delinquent, whether we buy them out or not. During the quarter, consolidated EBOs increased by 1.2 billion. Excluding EBOs, our capital ratio has increased to 13.2 percent from 11.6 percent a year ago. So, based on the current outlook, we expect to reach the 15 percent target during the second half of 2021. Meanwhile, to give you another perspective, on how far we've come in building capital and deleveraging, you can see on the right that our debt-to-equity ratio is now down to 105, which is well below where we were prior to the WMIH merger in 2018. Additionally, we've significantly extended maturities to the point that we now have a liquidity runway with no senior notes maturing for six years. which is obviously a great position to be in. So with that, I'll turn the call back to Ken for Q&A.