COOPER-GROUP Earningcall Transcript Of Q2 of 2024


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Jay Bray -- Chairman and Chief Executive Officer

Thanks,  Ken,  and  good  morning,  everyone,  and  welcome  to  our  call.  As  you  saw  from  our  press

release  this  morning,  we've  got  a  lot  to  cover,  including  super  strong  second  quarter  results  and

some  exciting  news,  the  acquisition  of  Flagstar's  mortgage  operations.  We'll  take  you  through  the

materials as we always do, making sure to leave plenty of time for your questions. But before we get

into the acquisition, let's start on Slide 3 with a quick review of the quarter, which was quite strong.

For  the  second  quarter,  pre-tax  operating  income  came  in  at  $219  million,  which  is  up  46%  year

over year. Operating ROTCE was 15.3%, up nearly 400 basis points from a year ago. At the end of

last year, we said we expected ROTCE in a range of 14% to 18% in 2025. We're pleased to be in

that range already, and we're feeling positive about our momentum heading into next year.

I'm super excited with the 17% year-over-year increase in TBV, which reached $68.67 at the end of

the  quarter.  This  was  a  function  of  earnings  plus  stock  repurchase,  which  has  reduced  the  share

count by 4% over the last year and by a cumulative 35% since inception. The board approved an

additional  $200  million  for  stock  repurchase.  I  would  add  that  despite  stock  repurchase  and  asset

growth,  we've  maintained  a  rock-solid  balance  sheet  with  our  capital  ratio  still  above  our  stated

target range and ample liquidity.

Turning  to  operations.  The  servicing  team  produced  fantastic  results,  with  $288  million  in  pre-tax

income, up a massive 58% from a year ago. These results reflect strong growth, with the portfolio

ending the quarter at $1.2 trillion, together with exceptional efficiency gains. In fact, you couldn't ask

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for a better demonstration of operating leverage.

Now,  shifting  to  originations  where  the  environment  remains  challenging.  Pretax  operating  income

was $38 million, which was at the high end of our guidance, thanks to strong execution in both our

DTC  and  correspondent  channels.  Now,  let's  turn  to  Slide  4  and  take  you  through  the  transaction

with  Flagstar.  We  announced  we're  acquiring  Flagstar's  mortgage  operation  from  $1.4  billion  in

cash.

This is a simple transaction structure in that it's an acquisition of assets, not a business combination.

The  assets  include  Flagstar's  MSRs  and  advances,  which  totals  $1.2  billion;  its  subservicing

business, with total UPB of $270 billion, as well as a third-party lending platform. Additionally, we will

subservice  $9  billion  in  Flagstar  loans  remaining  on  their  balance  sheet.  The  total  UPB  is

approximately $356 billion.

The acquisition will be funded with cash on hand and MSR line draws. Flagstar servicing operations

will be integrated onto our platform in a quick, efficient and thoughtful manner. On this note, I'd like

to  say  welcome  to  Flagstar's  team  members  who  will  be  joining  the  Mr.  Cooper  family,  and  also

thank  you  for  all  the  hard  work  you've  put  into  growing  your  business  and  taking  care  of  your

customers.

Flagstar's  customer-focused  culture  really  lines  up  well  with  our  core  values,  and  we  are  excited

about  the  opportunities.  Now,  if  you'll  pull  up  for  a  moment  and  think  about  what  this  transaction

means, first, it's a collaborative win-win for us and Flagstar, which showcases Mr. Cooper's ability to

provide a full-service solution. In this case, we helped Flagstar solve for their balance sheet goals by

selling their MSR asset at a fair price to a credible partner in a single, quick, low-risk transaction.

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We also helped Flagstar simplify its operations by taking on their existing subservicing business, as

well  as  providing  servicing  for  some  of  their  own  loans.  From  an  economic  perspective,  this

transaction provides us with excellent returns on capital, thanks to the fee income from subservicing,

which comes on top of the market yields on the MSR, and we get a major step up in scale and the

opportunity to realize additional operating leverage. If you'll turn with me to Page 5, I'd like to put this

transaction in the context of Mr. Cooper's strategic journey.

If you recall, we started talking about the dislocation in the MSR marketplace nearly 18 months ago.

Specifically, in our fourth quarter 2022 call, we highlighted a cyclewide opportunity to acquire MSRs

and suggested pools would trade at extremely attractive yields. If you go back and look at our slides

or  read  the  transcript,  you'll  see  we  pointed  to  financial  pressure  on  originators  and  regulatory

capital considerations for banks as the drivers of this dislocation, and we even shared with you our

proprietary forecast for the bulk MSR market. We anticipated the dislocation, we moved swiftly and

decisively  to  capitalize  on  the  opportunity,  and  now  you  see  the  results,  with  our  portfolio  up  79%

from year-end 2022 to $1.6 trillion in mortgages and 6.6 million customers.

What this shows you is that we are the fundamental best buyers of MSRs, and as a subservicer, we

are the best operating partner, period. We have robust operational capacity. We carefully manage

our capital liquidity, and we have years of experience in the bulk market, including proprietary data

amassed  over  a  decade's  worth  of  acquisitions,  which  allows  us  to  underwrite  assets  quickly  and

accurately. We have relationships with sellers who trust us to close on time and take care of their

customers, and we have special tools like Pyro, which is our proprietary patented AI system, which

we  use  for  document  extraction  and  classification,  and  this  gives  us  a  major  advantage  in  due

diligence, negotiations and onboarding.

As we think about the industry strategically, it's clear that the servicing sector has entered a phase

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of  rapid  consolidation.  While  financial  pressure  and  regulatory  capital  rules  are  recent  catalysts,

what's  ultimately  driving  consolidation  is  the  power  of  technology  to  create  massive  scale

economies,  which  is  the  same  trend  you  see  in  many  other  sectors  of  the  financial,  fintech,

payments  and  processing  industries,  where  the  leaders  control  very  significant  market  share.  Our

strategy  at  Mr.  Cooper  is  to  position  ourselves  for  a  highly  concentrated  in-state  and  mortgage

servicing.

We have a strong position today, but we are not pausing to celebrate. Instead, we're going to stay

focused on building out the industry's most efficient and scalable platform. We will work even harder

to  provide  an  amazing  experience  for  our  customers  and  our  clients,  and  we  are  committed  to

playing  a  constructive  leadership  role  in  the  industry,  earning  the  continued  support  of  all  our

stakeholders.  And  with  that,  I'll  turn  the  call  over  to  our  president,  Mike  Weinbach,  to  take  you

through our operational results in more detail.

Mike Weinbach -- Analyst

Thanks, Jay, and good morning, everyone. Let's spend another minute on Slide 5, and I'll give you a

little more color on the second quarter, just so you're clear on where we stand today prior to layering

on the Flagstar portfolio. We ended the quarter at $1.2 trillion in mortgages with close to $100 billion

in additions during the quarter, reflecting both MSR deals and subservicing growth. With respect to

subservicing, I did want to make a point about client selection since we deliberately partnered with

the leaders among banks, investment companies and originators.

As they've grown, we've grown, and this played out nicely in the quarter. Also, I'll share that we're

quite  pleased  with  our  Rushmore  team's  performance  in  growing  our  special  servicing  business,

which is solidly profitable, has a roster of important blue-chip clients and represents a very important

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capability  for  the  point  where  the  cycle  eventually  turns.  In  total,  once  the  Flagstar  deal  closes,

subservicing  will  account  for  52%  of  the  total  portfolio,  and  owned  MSRs  will  be  48%,  which  is

closely  in  line  with  the  50-50  mix  that  we  believe  optimizes  our  profitability  and  balance  sheet.

Looking ahead, we're totally focused on providing Flagstar's customers with a smooth and seamless

onboarding experience, as well as welcoming our new team members on to the Cooper platform.

Our plan is to complete this process by early 2025. During this period, we aren't constrained from

considering  other  growth  opportunities,  however,  these  would  be  a  distant  second  priority  to

delivering  on  our  commitments  in  this  transaction.  Turning  to  Slide  6.  Let's  dig  into  servicing

earnings.

We reported pre-tax income of $288 million, up 58% year over year, reflecting the benefits of growth

in operating leverage, while CPR speeds came in slightly below expectations. Now, the key theme

for us is operating leverage, and it's worth spending a moment on this topic, given that Flagstar will

add considerably more scale to our operations. For a better perspective, let's look at the numbers

over the last 12 months. Servicing revenues were up $162 million year over year or 37%, which is

very much in line with the growth of the portfolio.

In  contrast,  expenses  were  only  up  $24  million  year  over  year  or  16%.  37%  revenue  growth  with

16%  expense  growth  resulted  in  58%  growth  in  EBT,  which  we  hope  you'll  agree  is  a  pretty

compelling demonstration of operating leverage. Now, let me clarify something. Operating leverage

results in part from growth because we do have a certain level of fixed costs.

but  that's  not  the  major  driver.  Rather,  what  you're  seeing  is  a  result  of  process  improvement  in

technology investments, which has been an unremitting focus for years and years, really going all

the way back to the company's formation. Let's talk about our digital first strategy, which is designed

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to  improve  the  customer  experience  by  anticipating  their  needs  and  proactively  providing  the

information they're looking for so they don't have to pick up the phone and call us. As you can see

from the chart on the lower left, our call volumes have been slowly and steadily drifting lower.

In fact, the ratio of cost per loan has fallen by 50% over the last three years. Let me give you a few

examples of what we're doing here. First, we're having lots of success with chat technology, which

for many of our customers is their preferred means of engaging it with us. A second focus area has

been our IVR, which we're constantly fine-tuning to get customers where they need to go as quickly

as possible.

And  third,  we've  had  very  encouraging  results  from  new  self-serve  tools.  For  example,  we  have  a

subset of customers who frequently make more than the required payments each month, which in

the  past  led  to  lots  of  phone  calls  about  how  they  wanted  those  extra  funds  applied.  We  recently

rolled out a very simple online tool, which allows them to tell us their preference with a few clicks,

and  we're  seeing  significant  customer  adoption.  Thanks 

to 

this  and  other 

initiatives,

payments-related calls are down 57% year over year.

At the same time, let me stress that when our customers do need to talk with someone, we're here

for them. Based on recent benchmark data, we're comfortably outperforming the industry in terms of

standard  call  center  metrics  like  average  speed  to  answer  and  abandonment  rate.  Before  moving

on,  let's  talk  for  a  second  about  the  macro  environment.  I'd  be  remiss  if  I  didn't  point  out  that

amortization increased by $47 million sequentially, reflecting both portfolio growth and seasonality.

For the third quarter, we guide you to expect servicing income to be roughly flat in the $280 million

to $300 million range as CPRs will likely hit their seasonal highs for the year. Looking further ahead,

as we all know, CPRs are at record low levels today with likely nowhere to go but up. This means

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that  we  expect  amortization  expense  will  be  a  headwind  in  2025.  Also,  we're  expecting  Fed  rate

cuts, possibly starting in September, to put pressure on our interest income.

These  are  macro  forces,  which  are  obviously  outside  of  our  control,  and  we  just  want  you  to  be

conscious  of  them  as  you  work  on  your  models  for  2025.  What  is  under  our  control  is  portfolio

growth,  the  customer  experience  and  operating  leverage,  and  those  are  the  areas  where  we're

working  to  drive  continued  strong  results.  Now,  let's  turn  to  Slide  7  and  discuss  originations.  Our

team generated a pre-tax income of $38 million, coming in at the high end of our guidance.

Refi recapture was back up at 73% this quarter as we adjusted some of our pricing and marketing

strategies. Purchase loans accounted for 28% of total volumes, and second liens remained strong at

14%,  demonstrating  the  versatility  of  our  platform,  where  we've  evolved  the  product  set  to  keep

pace with changing customer needs. Turning to correspondent. Volumes picked up to $2.1 billion as

we focused on deepening our relationships with key sellers.

Now, that we've passed the halfway point of the year, I think it's safe to say that 2024 will go down

as one of the most challenging originations markets in recent history. However, as we look ahead to

2025, as mentioned, we'd expect CPRs to start rising, which given the size of our portfolio, should

translate  into  more  meaningful  recapture  volumes.  We've  been  putting  a  lot  of  work  on  our  DTC

platform  to  get  ready  for  a  bigger  market.  This  includes  continued  investments  in  workflow

automation, the customer experience and scalability.

The benefits of this work will show up in 2025, and we'll give you more color on the outlook as we

get closer to year-end. For now, as we look to third quarter, we guide you to expect originations EBT

in the range of $35 million to $45 million. And as always, this guidance assumes the current level of

mortgage rates. If you'll turn to Slide 8, I'd like to make one more comment on originations related to

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the 2025 outlook by walking you through the coupon stack in our MSR portfolio.

Over the last two years, we found some of the best OAS yields on deep out-of-the-money collateral,

and  you've  heard  us  comment  on  the  high-quality  stable  cash  flow  those  pools  will  provide  us  for

years to come. But that's not all we've been buying. As you can see, today, 18% of the portfolio has

coupons of 6% or higher. This is a big change from where we were in 2022 when only 3% of the

portfolio was in that bucket.

The MSR we're acquiring from Flagstar has a similar distribution of coupons. On a pro forma basis,

we'll have $132 billion of mortgages with coupons above 6%, which again points to the opportunity

to scale up originations in 2025. With that, I'd like to turn the call over to Kurt to take you through the

company's financials.

Kurt Johnson -- Executive Vice President, Chief Financial Officer

Thanks, Mike, and good morning, everyone. I'll start on Slide 9 with some comments on adjustments

in  the  MSR.  Adjustments  totaled  $8  million  this  quarter  and  included  a  $4  million  purchase  price

adjustment related to final tax calculations on the Home Point acquisition and $4 million representing

our share of losses at Sagent. Turning to the MSR, we marked up the asset to reflect higher rates

and lower expected lifetime CPRs, resulting in a quarter end valuation of 153 basis points of UPB

and a multiple of 5.3 times the base servicing fee.

Offsetting  the  markup,  we  incurred  hedge  losses  of  $103  million,  equating  to  72%  realized

coverage. Our target hedge ratio remains at 75%. The mark line also includes the $27 million gain

from  selling  the  excess  servicing  strip  on  our  Fannie  Mae  and  Freddie  Mac  MSRs.  As  you  may

recall,  in  recent  quarters,  we  retained  a  larger  servicing  strip  from  securitized  pools  above  the  25

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basis point contractual minimum to optimize capital market execution.

With  this  transaction,  we've  monetized  that  trade,  and  in  addition  to  the  gain,  the  sale  generated

$222 million in cash. Bear in mind, by selling the excess strip, we do lose that recurring revenue in

the servicing segment, which is part of the reason we're guiding to relatively stable servicing EBT in

third  quarter  of  $280  million  to  $300  million.  Slide  10  gives  you  an  update  on  asset  quality,  which

remains a real strong point for Mr. Cooper.

In the interest of time, I won't comment beyond pointing out that our MSR delinquencies declined to

1%, which is a new record low. This is a function of thoughtful portfolio construction, which you can

see  in  the  rising  FICO  scores  and  declining  LTV  ratios  for  our  customers,  as  well  as  our  ongoing

loss mitigation efforts, evident in a 34% year-over-year increase in loan modifications and workouts,

which  is  a  very  important  part  of  our  mission  to  keep  the  dream  of  homeownership  alive.  The

Flagstar  MSR  has  a  similar  high-quality  credit  profile  and  will  not  materially  affect  these  results.

Now, turning to Slide 11.

I'll  comment  that  our  balance  sheet  was  in  strong  shape  at  quarter  end.  Before  considering  the

Flagstar  acquisition,  liquidity  remained  near  record  levels  at  $3.2  billion,  and  our  capital  ratio  as

measured by tangible net worth of assets was still well above our target range of 28.4%, reflecting a

strong pace of internal capital generation and discretionary cash flow. With the transaction, we will

add $1.1 billion in MSRs and $85 million in advances. On a pro forma basis, our capital ratio would

have  been  approximately  26%  at  quarter  end,  still  somewhat  above  the  upper  end  of  our  target

range.

We expect to pay for the acquisition by drawing down on our MSR lines, which will utilize some of

our excess liquidity, although we will still be comfortably in compliance with our internal guidelines.

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Also,  we  continue  to  see  favorable  conditions  in  the  high-yield  market  and  are  evaluating  the

prospects  for  new  issuance  as  we'd  like  to  continue  increasing  the  mix  of  unsecured  debt  in  our

capital stack to keep upward pressure on our ratings. To wrap up, I'll reiterate Mike's comment about

macro  headwinds,  namely  rising  amortization  and  lower  deposit  yields  and  the  offset,  which  is

potentially  higher  origination  earnings.  Having  said  that,  the  Flagstar  deal  clearly  provides  us  with

additional momentum on top of our very strong execution.

Thanks to the transaction, I would guide you with respect to the outlook for ROTCE in 2025 that we

now  feel  comfortable  at  the  midpoint  of  our  14%  to  18%  range.  With  that,  I'd  like  to  thank  you  for

joining us on today's call and for your interest in Mr. Cooper. I'd now like to turn the call back over to

Ken for Q&A.

Kenneth A. Posner -- Senior Vice President, Strategic Planning and Investor Relations

Thanks, Kurt. Siobhan, if you could now start the Q&A process, please.

Questions & Answers:



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