Mr. Cooper Group Inc.

Good morning, and welcome to Mr. Cooper Group's third 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, President, and CFO, and Jamie Gow, Deputy CFO. A couple of quick reminders. First, this call is being recorded. And second, 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.

Thanks, Kim. Good morning, everyone, and welcome to our call. Let's start on slide three with the highlights. I'm very pleased to report that during the third quarter, we earned net income of $299 million, which translates into $3.29 per share. These results included very strong pre-tax operating income of $263 million and a positive mark to market on our MSR portfolio. Return on tangible equity was 25.2%. which marks the 10th quarter in a row in which we've exceeded our 12% target. Thanks to strong income, tangible book value per share increased to $41.56 per share, which is up 73% from a year ago. And as you know, we repurchased a large block of stock. But even so, our capital ratios increased during the quarter, and our liquidity was excellent, with over $730 million and unrestricted cash at quarter end. I was very happy with our operational performance. Originations generated nearly $20 billion in funded volume and produced $273 million in pretax operating income, which was above the guidance range we provided last quarter. Servicing generated pretax operating income of $44 million, thanks to EBO revenues of $131 million right in line with our expectations. The portfolio grew 2% to $668 billion, which was slower than last quarter, but more than anything else, this was a timing issue as we have $32 billion in acquisitions scheduled to close after quarter end. We continue to project the portfolio growing by at least 10% this year. If you'll turn to slide four, let me share some recent news about the company. You've heard me say it before, but I truly believe in a simple philosophy. Happy team members lead to happy customers, which is great for business. For the third year in a row, Mr. Cooper has been certified as a great place to work. This certification is based on a third-party survey in which we continue to see a near 90% response rate and nearly 90% of our team members stating that Mr. Cooper is a great place for them to work. These statistics place us close to the top 100 companies worldwide. I'm also pleased that we were recognized by Google for our proprietary document reading technology, which is cloud-based and leverages machine learning, and which is significantly more accurate and versatile than traditional data extraction methods. Right now, we're using this technology to onboard and classify the millions of documents that we're picking up with our acquisitions. And we're studying other places to use it to drive efficiencies. We are also in discussions to license this technology to third-party mortgage companies. Now let's turn to slide five and talk about strategy. As you know, we've been on a path to rationalize and simplify the Mr. Cooper business model. And as you recall, in the second quarter, we sold our Title 365 business to Blend Labs for $500 million. Next, we announced the sale of our reverse portfolio. Then we sold two other business units in zone, valuations in August and field services in October. These were profitable and well-managed businesses, so in one regard, we were sorry to see them go, but we made these decisions in order to focus on the growth opportunities in our core mortgage business, which we believe are substantial. The sales also generated cash and book value gains that strengthened the balance sheet. Now let's talk about where we're taking this franchise as we build towards our overarching strategic goal of $1 trillion in UPB, which is a level of scale that we believe only a small number of firms will ever reach. In connection with this strategic target, our commitment to attractive returns and a super strong balance sheet are non-negotiable. We expect to generate returns on equity in most environments between 12% and 20%. And we will operate with a capital ratio measured as tangible net worth to assets of at least 15%. Additionally, Mr. Cooper will continue to be a very people-oriented place. Delighting customers and team members remain strategic imperatives. Let me share with you another strategic target. a refinance recapture rate of 60%. This target will require continuous improvements in customer delight and digitization, but consider how profitable we will be as a $1 trillion servicer with such a high level of customer retention. Now let's talk about the short term. Because we're at a transition point in the industry where excess capacity is driving very intense pricing pressure, in this environment, we're going to need to stay very nimble and keep our resources properly aligned with market opportunities. And as we look ahead to fourth quarter in 2022, efficiency is going to be a key thing for us. And now I'll turn it over to Chris.

Thanks, Jay. And good morning, everyone. I'm going to start on page six with a high-level summary of our results. And to recap, net income was $299 million. for $3.29 per share, with very strong pre-tax operating income of $263 million, which was equivalent to an ROTCD of 25%. Originations generated $273 million in operating EBT, however I point out that the FHFA's decision to remove the adverse market fee added about $20 million to our revenue. Our servicing business produced results right in line with our expectations. with lower EBO revenues of $131 million. And in terms of ZOM, it's still premature to look for revenues from the auction exchange. However, we're starting to see a pickup in inventory as clients resume allocating foreclosures to our platform, which is a very good sign for 2022. You'll notice that we're no longer presenting ZOM as a separate segment and now including its contribution in the corporate segment. We made this change to simplify our financial since the only business left in zone is now the auction exchange. We had a total of a million dollars in other adjustments, which included a $7 million gain related to the sale evaluations offset by $4 million in trailing transaction costs related to the title three 65 sale and $2 million in severance. As a reminder, you'll see a gap tax provision of $100 million in our income statement. But as you know from our sizable DTA, we're not currently paying federal taxes. For this reason, I'd point you to our pre-tax operating income of $263 million as a good proxy for cash flow, which we define using the steady state discretionary metric, which was $280 million this quarter. Finally, I wanted to point out that average diluted shares declined in the quarter to 82 million due to the stock repurchase. But bear in mind, this number reflects the timing of the transaction. You should use an average deleted share count of 78 million as a starting point for the fourth quarter. Now let's turn to slide seven to talk about tangible book value, which we regard as an important measure of our progress in creating shareholder value. I hope you'll agree that we've had excellent growth in TBB this year. At quarter end, TBB per share was $41.56, which was up 73% year-over-year. The chart on the right provides you with a walk from second quarter to third, and as you can see, growth was driven primarily by strong net income. In addition, stock repurchase added a net $0.72 a share. This was a sizable transaction, which we took advantage of due to the favorable price, but we did so in the context of our commitment to a strong balance sheet. And as I'll comment on in a minute, despite the repurchase, our capital ratios actually increased during the quarter. Looking ahead, as we make progress towards our strategic goals, we expect to generate significant growth in TBB per share. To start with, returns on equity in the range of 12 to 20 percent will grow retained earnings. And to the extent that interest rates rise faster than expected, we stand to benefit from positive MSR marks. Of course, as we've previously shared with you, we'll also evaluate monetization options for the auction exchange, which we think is certainly the most valuable of all the zone business units. And finally, as a reminder, if the Biden administration succeeds in raising the corporate tax rate to 26.5%, that would increase our TBV by another $3 per share. So let's turn to slide eight to discuss the valuation of our MSR. During the quarter, swap rates increased by nine basis points, while mortgage rates rose a quarter end after dipping earlier in the quarter. Based on market participant assumptions, we decreased the lifetime CPR assumption for our own portfolio from 13.6 to 12.9%, which resulted in a positive $153 million mark. That brought the value of our MSR up by six basis points, to 121 basis points of UPB. And by the way, this mark is a good reminder of the power of a balanced business model. If rates continue rising, of course that will put additional pressure on originations for the entire industry. But we'd expect to benefit from additional markups to the MSR as well as stronger servicing margins. That's not to say that our earnings would be the same in every scenario, but growth in TBV per share should be more consistent for us than for many of our peers. The chart on the right gives you a sense of the opportunity in our customer base for rate and term refinances. The number of customers who could save $100 to $200 a month by refinancing was roughly stable quarter over quarter. Further, we estimate another 800,000 additional customers could benefit from a cash-out refinance. Under Fannie, Freddie, and Ginny guidelines, these customers have over $150 billion in equity available for cash out refinancing. So the bottom line is we have plenty of customers out there we can help. Now let's turn to slide nine and talk about our origination segment, which produced strong results with pre-tax operating income up 28% sequentially to $273 million. As I mentioned, This included $20 million in one-time revenues from the adverse market fee removal. So I'd call this a very strong quarter with normalized income of $253 million. Funded volume was $19.9 billion, and our locks grew by 9% sequentially to $20.1 billion. Excluding the adverse fee benefit, the margin compressed by eight basis points to $127. You'll notice from the chart in the lower right that we're still above the historic range of 94 basis points, which we earned over the five years prior to the pandemic. Slide 10 gives you a dashboard view of our key metrics for the origination segment. A corresponding channel, as we discussed previously, provides us with our primary exposure to the purchase market. As you can see from the chart in the upper left, our purchase share increased to 58% this quarter, outpacing MBA projections for the industry of 45%. In terms of DTC, we're doing extremely well with cashouts, which, as you can see in the chart in the lower left, increased from 30% to 40% of funded volumes. Now let's talk about gain-on-sale revenues. As we guided you to expect last quarter, DTC revenue margins compressed during the quarter, but at a relatively slow rate, while correspondent margins stabilized. However, with the recent uptick in mortgage rates, we're experiencing another burst of extreme pricing pressure, which is impacting both correspondent and DTC. As Jay mentioned, we're at a point of transition, and we're projecting further margin pressure in the fourth quarter as we move closer to the historic average. Turning to the final chart in the lower right, you'll notice that the refinance recapture dropped from 42% to 40%. Honestly, as competition intensified, we were a little bit slow to react, and this may weigh on the recapture rate for the fourth quarter as well. The 60% refinance recapture target that Jay shared is a very important strategic goal. Our first priority is driving down costs, both through automation and where necessary, by rationalizing capacity so that we can meet the current level of pricing in the market. We recently took steps to right-size our infrastructure, and I guide you to expect some charges next quarter in the range of $5 to $10 million related to corporate actions. For the fourth quarter, we're projecting originations segment EBT of $150 to $175 million based on fundings of $16 to $20 billion. Now let's shift to the servicing segment, and we'll start on slide 11 and talk about portfolio growth. This quarter, the servicing portfolio increased 2% to $668 billion. As Jay commented, this was a slower pace than last quarter, but that was mostly a function of timing. As we've been expecting for several months now, the bulk market is starting to present us with more sizable opportunities. During the quarter, we closed on $22 billion in acquisitions, which was up 31% from the second quarter level. But our pipeline is even stronger, with $32 billion in UPBs scheduled to close after quarter end. As we've been forecasting, pricing pressure is putting pressure on originators' cash flow, which is causing them to sell MSRs more in line with normal practice. Subservicing volumes were down slightly in the quarter. Some of our clients enjoyed strong growth in the prior quarter, but you should also understand that for some of our clients, their portfolios are in runoff mode, which is what you saw this quarter. CPR has improved slightly, but at 22%, they're still running at almost double the pace we'd expect in a normal environment. Given the current interest rate levels, we're expecting CPRs to remain elevated in the fourth quarter as well. Based on the forward curve, were planning for an environment in 2022 with CPR still in the high teens, which would imply limited servicing margins but improving prospects for portfolio growth. Now, let's turn to slide 12 and talk more about margins. Pre-tax operating income for the servicing segment was $44 million, thanks to strong EBO revenues of $131 million. Amortization remained elevated, at 204 million in the quarter due to the high CPR speeds I just mentioned. Now let me comment on amortization. What we're showing you here is total amortization, which you can estimate by multiplying the runoff rate in the quarter by the carrying value of the MSR. Historically, we've talked about amortization and servicing margins on a cost basis. Starting today, and in the spirit of keeping things simple, we're going to drop the cost basis And just talk total amortization. So using total amortization, we characterize the servicing margin in the third quarter as 2.7 basis points. Now looking ahead into the fourth quarter, EBO revenues should continue to decline to roughly $60 million. And even with a slight reduction in CPRs, amortization will remain a headwind And as a result, we're currently projecting our servicing segment EBT to be approximately $10 million in the fourth quarter. Now let me comment on the longer term. As we make progress towards our trillion dollar goal, we'd expect the servicing margin net of total amortization to eventually rise to about five basis points. Now that level of profitability will require higher interest rates, of course, which would help us with amortization and custodial deposit income. Additionally, to reach that level, we'll need to fully leverage the technology investments we've already made. For example, you've seen how our investments in automating claims processing helped us roll out digital forbearance tools. And as an aside, forbearance activity is now dropping to much lower levels, so we should have an opportunity to reallocate headcount to other functions. As another example, I'd share that we're in the final phases of deploying a next-generation phone system that incorporates AI and omni-channel capabilities. This system is going to allow us to provide more efficient and more consistent service for our customers while still lowering our operating costs. Now, if you turn to slide 13, I'll give you an update on the auction exchange, which is the last remaining business that's owned. While still too early to look for revenues, we're starting to build inventory again as clients look to the resumption of foreclosure sales next year. As of quarter end, Zome had nearly 15,000 units in inventory, which is up 700 units quarter over quarter. Now, I don't want you to think we're sitting by idly waiting for orders. We've been working on a series of projects designed to take the exchange to the next level of performance. These include simple, sensible steps like migrating the infrastructure to the cloud and completing a comprehensive redesign of our website. These investments will be fully implemented by the second quarter, which will position Zone to gain additional market share at the same time that the foreclosure market is ramping back up. Now, just to anticipate the question, we're still projecting approximately $50 million in EBT next year, which will be back-end loaded. but we expect EBT to rise to potentially as high as $150 million in 2023. All right, I'll briefly touch on liquidity on slide 14. As you can see, advances entered the quarter at $923 million, up 5% quarter over quarter. Now, bear in mind, we typically see a seasonal uptick in fourth quarter due to tax payments, but that's not really an issue given $1.2 billion in committed unused capacity. Working capital was relatively neutral this quarter, with the largest cash use being the haircut on accelerated buyouts, which will recover as soon as these loans are re-delivered. You'll notice we increased our borrowings on our MSR lines slightly to $305 million. This reflects the fact that we expanded capacity on these lines, and it's our practice to draw the minimum amount necessary to avoid fees. You may see us use these lines to manage working capital fluctuations, including MSR acquisitions. But if we see significant growth opportunities in the marketplace, our preferred strategy would be to fund them with new issuance of senior notes. Finally, as a reminder, we still have a six-year liquidity runway with no maturities until 2027. Now I'm going to wrap up my comments on slide 15 by talking about capital and leverage. You've heard both Jay and I pound home the importance of a strong balance sheet as a pillar of our strategic thinking. And as you know, we're managing to a ratio of tangible network to total assets as a key high level target. This quarter, we're pleased to report the ratio increased from 13.8 to 14.5%. As you can see, the impact of our stock repurchase was more than absorbed by strong profits, the markup in the MSR, and the overall lower level of assets. We expect the sale of our reverse portfolio to close in December, which will drive this ratio up to 17.5%. Furthermore, if you took out EBOs, which are government-guaranteed assets which are consolidated on the balance sheet for accounting reasons, but which are in the process of rapidly running off as we buy out and re-deliver loans, then you'd see a ratio above 20%. We've come a long way from the WMIH merger in 2018. As we make progress towards our strategic goals, we expect at the same time to keep strengthening our balance sheet. We're very pleased to see S&P recognize our progress with an upgrade in the quarter to B+. And I'd comment that we see ourselves on the path to eventually earning a solid double B rating. So with that, I'll turn the call back over to Ken for Q&A.