Mr. Cooper shores up liquidity ahead of pending capital rule changes

Mr. Cooper reported that it amassed near-record levels of liquidity in the second quarter as it braces for potential changes to bank capital rules that could affect its financing.

The company had roughly $1.8 billion in unused lines of corporate credit secured by mortgage servicing rights and $500 million in unrestricted cash for a total of $2.3 billion in the period. That compared to around $1.2 billion in total the previous quarter and $1.9 billion a year earlier.

"It's not just the half billion of cash on our balance sheet, but we've got $1.8 billion in additional available MSR financing that is truly readily available to us. It's committed financing, and we have pledged mortgage servicing rights against it, so we could draw that down at any point in time," Chief Financial Officer Kurt Johnson told this publication in an interview.

While acknowledging the risk to a change to bank standards expected Thursday pose to the availability of financing it and nonbank mortgage companies get from depositories, Johnson said the company is somewhat insulated from the regulatory capital risk.

Mr. Cooper's financing providers tend to be larger money-center or Wall Street banks rather than the smaller regional institutions that are more likely to be impacted by new capital standards, considering they were those most affected by the recent banking crisis, he said.

Johnson also said during the call that the company's executives will be careful in the future of the extent to which they finance their operations as they remain mindful of regulatory capital considerations.

"The primary driver of incremental returns in the future will likely be profitability rather than leverage," he said. "We're mindful of regulatory expectations, including Ginnie [Mae]'s risk-based capital rules [for nonbanks]."

Even if the new rules affect the company's financing in some way, it will likely have plenty of time to reposition its business to address them, Johnson said in the interview.

"We'll see what the proposed regulations are tomorrow, but based on what we've been hearing as rumbling in the marketplace, I think the timeline for rolling those out is probably going to be fairly long," he said.

Analysts view the current financing as sufficient to support the company's business goals, including chairman and CEO Jay Bray's long-running goal to become a $1 trillion servicer.

"We … see enough liquidity to support additional bulk MSR purchases, as banks, in all likelihood, will be net sellers of servicing over the foreseeable future," Eric Hagen and Jake Katikis, analysts at BTIG, said in a report on Mr. Cooper's earnings.

The unpaid principal balance of the company's portfolio, including sub- and special servicing, rose to $882 billion in the second quarter; representing a 3% increase from the previous quarter and 10% compared to a year ago. With pending additions included, its total size is $957 billion. 

"We're over $950 billion which is nearly on top of our $1 trillion target," Chairman and CEO Jay Bray told analysts during the company's earnings call on Wednesday.

That number includes the planned addition of Home Point Capital's conventional mortgage servicing rights valued at roughly $1.1 billion, which comprise the majority of a portfolio of MSRs with an unpaid principal balance of around $83 billion, Johnson said in the interview. The $83 billion is not completely additive due to some runoff of existing business, he said.

While the planned acquisition of HPC has been held up by an incomplete tender offer that's gone through multiple extensions, the current short-term expiration of July 31 and the 98.3% of shareholders on board reflects the expectation that the acquisition has the critical mass needed to move forward.

"You should see us as pretty close to the $1 trillion by year-end," Johnson said, noting that the Home Point Capital transaction is expected to close in the third quarter.

While the HPC deal is still pending, Mr. Cooper did close another one during the quarter, its acquisition of Rushmore Servicing. The Rushmore transaction added a significant special-servicing portfolio to Mr. Cooper's holdings. The remainder of related licensed entities Mr. Cooper is slated to acquire in conjunction with it, including sister company and registered investment advisor Roosevelt Management, should follow, Johnson said.

Over half (52%) of the overall portfolio consists of $459 billion in servicing rights. Subservicing accounts for $380 billion or 43%. Special servicing from the Rushmore acquisition, which has been added to the company's existing operation in that business segment, makes up the remaining 5%. Mr. Cooper also is planning to start its own MSR fund, executives said during the earnings call. 

"By year-end you'll probably see us be 60-65% MSR owned," said Johnson. "That's what the returns look like now. There also are a couple subservicing clients that we have that now have their own platforms."

Economies of scale play a role in the financial management of servicing operations, and the company fared well on that count as well, with earnings from that business segment driving its profit considerably higher than the previous quarter and nearly matching year-ago numbers.

Efficiencies contributing to record pretax operating-income in servicing also came in part from upgrades to interactive voice response technology that helps the company better leverage machine learning applied to customer data that anticipates needs and reduces calls.

"We started that process four years ago in terms of the upgrade to the IVR and I think it's really now starting to bear fruit," Johnson said.

Average servicing calls per loan fell to annualized 1.5 year-to-date as of the second quarter, down from 1.7 in 2022 and approaching a target of 1.25 that Mr. Cooper has.

Pretax operating income from servicing rose to a $182 million in the second quarter from $157 million in the first and $30 million a year ago, despite some legal and regulatory expenditures this year linked to questions about whether it followed pandemic-era rules correctly, in line with a broader compliance concern in the industry. Mr. Cooper also was involved in a Consumer Financial Protection Bureau settlement involving a vendor that company worked with that misprocessed payments, but its involvement was secondary to the service provider's.

Overall, Mr. Cooper earned $142 million in net income during the second quarter, up from $37 million in the previous fiscal period  and nearly matching $151 million a year earlier.

Originations generated $38 million in pretax operating income compared to $23 million the previous quarter and $63 million a year earlier. Volume in this business line totaled $3.8 billion for the fiscal period, compared to $2.7 billion the previous quarter and $7.8 billion a year ago.

While production volumes were higher on a consecutive-quarter basis, analysts at Keefe, Bruyette and Woods said, "Mortgage origination locks of $3.8 billion were slightly below our $4 billion estimate."

During the quarter, the correspondent channel became the main driver of volume, with $2.2 billion of that amount derived from it and the remaining $1.6 billion coming from direct-to-consumer. 

The split in the previous quarter was $1.3 billion in correspondent volume and $1.4 billion worth of DTC channel originations. A year ago, $3.3 billion of mortgage production came from the correspondent channel and $4.5 billion came from direct-to-consumer originations.

Correspondent margins rationalized during the period with the departure of a large player from the market, Johnson said.

The company still plans to build more volume in the direct channel, which it's working to apply various automated efficiencies to, including upgrades of customer relationship-management databases and self-serve tools for borrowers who prefer them, which also could help with recapture rates attractive to its subservicing clients.

Meanwhile, Xome, a foreclosure auction and traditional home listing service that the company has considered selling in the past, broke even after a 24% rise in sales on a consecutive-quarter basis. Johnson said the company wouldn't rule out an offer for the business, which runs independently from its servicing operation, but also is comfortable holding it given its stable performance and potential counter-cyclical benefit if the U.S. were to move into a recessionary environment.

Post-pandemic loss mitigation options introduced recently by the Federal Housing Administration extend the timelines for foreclosure, which imposes some limitations on the market Xome serves. But they help improve the odds distressed borrowers will be able to resume payments and stay in their home, a circumstance that also helps servicing assets retain value.

Other strategic moves the company made during the quarter included $57 billion in stock buybacks, for which it will pay a 1% excise tax under new rules that went into place this year. The company's board also increased its authorization in this area to $200 million.

"You should take this as a signal of our very strong confidence in Mr. Cooper's business model, and specifically the outlook for continued growth and strong returns, which we do not see reflected in the stock price," Bray said.

Mr. Cooper's stock was trading higher at around $58 per share Wednesday afternoon, compared to around $54 at the close of trading on Tuesday.