Onity Group Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
August 3, 2023

There are 8 speakers on the call.

Operator

To the Ocwen Financial Corporation Second Quarter Earnings and Business Update Conference Call. At this time, all participants will be in a listen only mode. Later, we will conduct a question and answer session. I will now turn the call over to your host, Deepak Akzarelian, Senior Vice President, Corporate Communications. Mr.

Operator

Axaralian, you may begin.

Speaker 1

Good morning, and thank you for joining us for Ocwen's Q2 2023 earnings call. Please note that our earnings release and slide presentation are available on our website. Speaking on the call will be Ocwen's Chair and Chief Executive Officer, Glenn Zena and Chief Financial Officer, Sean O'Neill. As a reminder, the presentation or comments today may contain forward looking statements made pursuant to the Safe Harbor provisions of the federal securities laws. These forward looking statements may be identified by reference to a future period or by Use of forward looking terminology and address matters that are, to different degrees, uncertain.

Speaker 1

You should bear this uncertainty in mind and should not place undue reliance on such statements. Forward looking statements, which speak only as of the date they are made, involve assumptions, risks and uncertainties, including the risks and uncertainties described in our SEC filings. In the past, actual results have differed materially from those suggested by forward looking statements, and this may happen again. In addition, The presentation or comments contain references to non GAAP financial measures, such as adjusted pretax income among others. We believe these non GAAP financial measures provide a useful supplement to discussions and analysis of our financial condition because they are measures that management uses to assess Non GAAP financial measures should be viewed in addition to and not as an alternative for the company's reported GAAP A reconciliation of the non GAAP measures used in this presentation to their most directly comparable GAAP measures As well as management's view on why these measures may be useful to investors may be found in the press release and the appendix in the investor presentation.

Speaker 1

Now, I will turn the call over to Glenn Messina.

Speaker 2

Thank you, Diko. Good morning, everyone, and thanks for joining our call. Today, we'll review a few highlights for the Q2, take you through our actions to address the market environment and discuss why we believe Our balanced and diversified business can deliver long term value. Please turn to Slide 3. I'm pleased to report our 2nd quarter results, which reflect the strength of our balanced and diversified business and continued progress against our key initiatives.

Speaker 2

Adjusted pretax income of $23,000,000 for the 2nd quarter has materially improved versus the Q1, largely driven by reverse servicing. Profitability and originations and forward servicing improved slightly versus the Q1 as well. We reported net income of $15,000,000 $2.02 per share, which includes $6,000,000 of pretax loss relating to notable items. Notable items primarily include an unfavorable MSR fair value change due to interest rate assumptions, offset in part by a favorable adjustment to our legal and regulatory reserves for various matters, including the CFPB litigation. I am also pleased to report the CFPB did not appeal the District Court's May 2023 ruling in our favor.

Speaker 2

As a result, that ruling is now final and the case will remain closed. We look forward to normalizing our relationship with the CFPB. We're excited to put this legacy matter behind us, The last of the matters filed against the company in 2017. We believe this removes what may be a perceived uncertainty in the eyes of potential counterparties. Total servicing UPB was down slightly at the end of the second quarter versus the Q1, reflecting our continued discipline in purchasing MSRs, A sale by MAV of $5,000,000,000 of MSR UPB to optimize portfolio returns and consistent with expectations, We had nominal subservicing boardings in the Q2.

Speaker 2

With both short term and mortgage interest rates at the highest levels in 20 years, We're reducing our MSR interest rate risk exposure with higher hedge coverage and utilizing synthetic subservicing conversions And excess servicing spread financing. Our hedge coverage in the second quarter was roughly 92%. We added another new MSR investor and converted $7,000,000,000 of owned MSR to Synthetics subservicing. We've delivered over $100,000,000 in annualized cost reduction since 2Q last year and our expense management actions Throughout the company are on track. We nearly achieved our year end expense ratio target by the end of the second quarter.

Speaker 2

Total liquidity of $233,000,000 is consistent with 1st quarter levels despite the higher liquidity demands of our increased hedge coverage. We're very pleased with our results this quarter. The business is performing consistent with our expectations, and we believe we're on track to achieve our adjusted pretax income and return objectives for the remainder of the year. Now let's turn to Slide 4 to discuss the environment and our value creation plan. Market conditions in the 2nd quarter were generally consistent with expectations.

Speaker 2

We continue to see slow MSR runoff, higher float earnings and low delinquencies. During the 2nd quarter, MSR trading volumes in the bulk market remained elevated, and I think it's fair to say it was largely a buyer's market. While this represents a potential investment opportunity, at the same time, it can put downward pressure on MSR values, all other valuation factors being equal. Potential client interest in subservicing remains stronger than ever and our opportunity pipeline continues to grow. However, we continue to see clients extending RFP processes and decision making due to market factors and conflicting priorities.

Speaker 2

Opportunistic asset purchase transactions are beginning to appear as is interest from investors or seeking partners to source and service MSRs, whole loans and non performing loans. Moving to originations, we expect market conditions to continue to be reflective of interest rates being higher and for longer than expected at the beginning of 2023. This is impacting both forward and reverse origination volume opportunity. As a result, competition remains intense, but conditions are improving versus the Q1. Consistent with the Q1, we continue to observe market leaders Having an aggressive view of new MSR values relative to both market levels.

Speaker 2

We are seeing heightened M and A opportunities in both originations and servicing. However, seller price expectations may restrict opportunity. As we said before, the Board and management are committed to evaluating all options to maximize value Overall, we believe the environment continues to favor our core strength in servicing and remain focused on Leveraging our balanced and diversified business, prudent growth adapted for the environment, industry leading servicing cost structure, Top tier operational performance and unmatched breadth of capabilities and capital partner relationships to support our growth. We believe we have a strong foundation to create value for shareholders in the current environment. Let's turn to Slide 5 to discuss our balanced and diversified business.

Speaker 2

Over the past several quarters, while originations adjusted PTI has been depressed due to rising interest rates and declining industry volume levels, also took advantage of a unique special servicing opportunity that further contributed to servicing adjusted pretax income. We'll talk more about this in a moment. Based on projected seasonality and home purchase activity, we do expect to see seasonal changes in origination volume, portfolio prepayments and MSR runoff. Similarly, trends in property tax remittances and escalating insurance costs and their effect on escrow balances will also drive seasonal changes in MSR runoff. As in the past, changes in interest rates and bulk market trading prices of MSRs do impact the value of our MSRs and can drive quarterly volatility on our GAAP net income.

Speaker 2

Market conditions and forward originations are beginning to improve. We remain laser focused on yields versus volume and increasing our mix of higher margin channels and products. Total originations volume is up 6% versus the 1st quarter And margins in Forward are up as well. After our decisive cost actions, originations returned to profitability in May June and was roughly breakeven for the quarter. We continue to closely manage reverse originations where industry volume levels remain depressed And we have been impacted by spread volatility in the Q2.

Speaker 2

Despite current market conditions, our origination business serves well its purpose replenish our MSR portfolio, our focus on diversification is evident when looking at our portfolio composition. Our operating performance and proven capabilities have supported material growth in forward and reverse subservicing. We believe our emphasis on growing subservicing and GSE owned MSRs also helps mitigate our exposure to liquidity demands due to advancing requirements in the event of a recession. Let's turn to Slide 6 to discuss our growth focus in the current environment. In this environment, we're focused on growing our higher margin origination channels and products, capital light subservicing and leveraging our unique special servicing skills to capitalize on high return investment opportunities.

Speaker 2

As I just mentioned, our originations team delivered 6% growth in total originations volume quarter over quarter and correspondent was up 8% versus the Q1. Our mix of higher margin channels and products increased by 11 percentage points versus the Q1 and 22 percentage points over Q2 of last year. As mentioned earlier, opportunistic asset purchase transactions are emerging. We did execute on one such opportunity in the Q2, which was enabled by our superior performance in special servicing. We purchased a $133,000,000 portfolio of reverse whole loans and REO previously repurchased from Hekman Securities.

Speaker 2

We combined these assets with roughly $167,000,000 of our own existing buyouts and successfully financed the pool in the new non recourse, Non mark to market securitization. This securitization allowed us to diversify our sources of funding and reduce our potential exposure to mark to market volatility. The combined transactions generated approximately $15,000,000 in adjusted pretax income, That's favorable for liquidity and provide a stable financing source for future transactions. This is a terrific example of how our superior operating capabilities and diversified business allows us to capitalize on unique opportunities that are emerging in this environment. We continue to evaluate other similar opportunities.

Speaker 2

However, the timing and the profitability of any such transaction cannot be estimated at this time. Regarding subservicing, Demand remains stronger than ever and our total opportunity pipeline continues to grow. In the last 24 months, we've added $118,000,000,000 in new loan on boardings. As expected, subservicing additions were roughly $3,000,000,000 in the quarter as we're seeing clients extend RFP processes and decision making due to market factors and conflicting priorities. With the delays we're seeing, we're now expecting roughly $15,000,000,000 to $25,000,000,000 in new subservicing additions through the Q1 2024, down from roughly $30,000,000,000 through the end of Q4.

Speaker 2

With those additions, we expect our mix of subservicing to increase Approximately 60% over the next three quarters and total servicing UPB of roughly $305,000,000,000 to $315,000,000,000 Please turn to Slide 7 for an update on our expense management actions. We remain committed to achieving and maintaining an industry leading servicing cost structure, while at the same time improving customer experience and maintaining an appropriate risk and compliance framework. In the Q2, servicing operating expenses as a percent of UPB declined by 1.8 basis points or roughly 15% versus Q2 last year with comparable UPB levels. We've made solid progress towards achieving our year end servicing operating expense efficiency objective. The year over year improvement in its operating expense ratio with servicing UPB roughly flat demonstrates we're getting true unit cost productivity Through execution of our technology roadmap, process reengineering and improving utilization of our global platform.

Speaker 2

While we're driving improved efficiency, we're also improving the borrower and subservicing client experience with net promoter scores up 11 and 12 percentage points respectively over last year. With the improvements in our cost structure, we believe scaling up our subservicing portfolio With capital light subservicing can add between 2.5 to 3 basis points in pretax income per $1,000,000,000 of UPB added. We would expect the profit contribution from government, reverse, commercial and special servicing additions to have more favorable pretax income contribution. Please turn to Slide 8 for an update on our operating performance. We continue to maintain industry leading operational performance, improve service delivery to customers, clients and investors and sustain a prudent risk and compliance framework.

Speaker 2

Our breadth of capabilities is unmatched in the industry. We service forward, reverse and small balance commercial loan portfolios covering GSE, Ginnie Mae, Federal Home Loan Bank and Private Label Products. We've been recognized by Fannie Mae, Freddie Mac and HUD for delivering industry leading operating performance for investors. Over the last several years, while we have been driving productivity improvements, we've continued to invest in the client and bar facing technology And robotic process automation to improve customer experience. The execution of our technology roadmap has enabled reduced cycle time, Enhanced access to information and 20 fourseven assistance through multiple digital interface channels.

Speaker 2

For example, Our artificial intelligence powered borrower chatbot has hosted 600,000 sessions with an 80% success rate, giving customers improved responsiveness and minimizing calls to our call center. Our mobile app and loss mitigation bots Are also aimed at increasing responsiveness to borrowers to improve their experience. We believe our investments in technology Will allow us to further improve productivity without adversely impacting bar experience as we scale up our platform. We continue to demonstrate proven leadership in special servicing in both forward and reverse. Last quarter, We spoke about the significant performance improvements in customer experience we delivered for 1 of our key subservicing clients, Our ability to secure 60 plus delinquencies and our superior HUD claims assignment performance.

Speaker 2

As you can see, On the right, we also demonstrate strong performance in maximizing REO sales price versus appraised value, while selling within the time frames allowed by HUD, which maximizes our claim recovery. These performance elements were key drivers that enabled the financial outcome of our opportunistic reverse hold loan purchase in the 2nd quarter. Now please turn to Slide 9. We continue to focus on expanding our capital partner relationships to support our growth objectives on a capital light basis. Over the past 2 years, we have grown servicing UPB supported by Capital Partners to $79,000,000,000 using a variety of subservicing, synthetic subservicing, which includes MAV and ESS transaction structures.

Speaker 2

In the last 12 months, we have grown our UPB funded with capital partners by over 75%, and we now have active relationships with 4 capital partners. With multiple investors, we have the capacity to fund MSRs purchased through our originations channels and bulk transactions, which meet investor requirements, further enhancing our ability to generate capital light growth as we manage our exposure to MSR valuation changes due to interest rates. Looking ahead, we're focused on developing additional investor relationships to support our growth objectives across multiple asset types. We're evaluating a diverse range of potential structures with several potential investors to satisfy their unique needs and further diversify our structural alternatives. We believe the development of investor relationships will further help us achieve our servicing scale objectives.

Speaker 2

In addition, our investor driven approach to MSR purchases introduces an added level of price discipline for the originations business. I want to thank our business partners at Oaktree and our new MSR investor partners for the trust and confidence they've placed in our team to help them achieve their growth and profitability objectives. Now, I'll turn it over to Sean to discuss our results for the Q2 and outlook for 2023. Thank you, Glenn.

Speaker 3

Please turn to slide 10 for our financial highlights. I'm very pleased with the performance in the 2nd quarter, especially the material improvement in adjusted pretax income from last quarter. Our results represent the hard work and resilience of our dedicated employees. Going to the blue column, in the Q2, we recognized GAAP Net income of $15,000,000 due primarily to strong adjusted pretax net income of $23,000,000 Add to that a net notable and income tax result of a negative $6,000,000 to result in earnings per share of $2.02 Book value per share of $57 Finishing off the table to the left, I would note liquidity was stable quarter over quarter at about 230,000,000 and expected to be well within excess of the new FHFA Ginnie Mae liquidity requirements starting this September. With respect to liquidity, in addition to our reverse securitization transaction we conducted this quarter, other drivers have been our strong track record in obtaining, Extending, renewing and rebalancing various asset backed financing facilities throughout the quarter to support our growth and reduce our cost of debt.

Speaker 3

On the right side of the page, first, I'll note that quarter over Quarter, our GAAP net income improved by about $56,000,000 This was driven by a $15,000,000 gain From the opportunistic whole loan and REO purchase in the reverse space, which was then subsequently securitized in the same quarter. This securitization was our 1st private label securitization, as Glenn mentioned, and was quite successful in terms of generating liquidity and migrating our assets To a more stable and safe financing structure, which includes being a non mark to market and non recourse. In addition, we saw about $7,000,000 from improved operations across our businesses, dollars 28,000,000 due to significant legal and regulatory settlements During the quarter and an improvement in the MSR valuation quarter over quarter of $6,000,000 With the positive GAAP net income result, you can see that our effective Tax rate is only about 5% due to our existing portfolio of tax net operating loss carry forwards. The tax impact we did record was due to our Asia Pacific operations. Adjusted pretax income Showed a strong improvement quarter over quarter of $17,000,000 with the same business driver shown in GAAP net income, but it excludes as always The MSR valuation adjustments and other notables.

Speaker 3

Finally, at the bottom of the page, I would mention we expect our 3rd quarter Adjusted pre tax income to be closer to our Q1 levels. This is due to seasonally higher runoff in the 3rd quarter, Slightly lower pretax income due to the migration of $15,000,000,000 AUM to a sub service status And lack of another opportunistic reverse transaction in the Q3. I'd like to recap the notable items for the quarter that connect Adjusted pretax income to GAAP net income. We provide adjusted pretax income as a supplemental measure for greater investor transparency, and it is a metric we use in managing the business. 2nd quarter notables, which are detailed in the appendix, are comprised primarily of 2 items, A $33,000,000 decline in MSR valuation adjustments net of hedge.

Speaker 3

This is due primarily to changes in the valuation model assumptions Made by our 3rd party valuation agent in response to market indications, and this includes 2 significant MSR transactions we recently initiated. The other driver is a $27,000,000 gain in notables. This is a positive $28,000,000 impact due to legal and regulatory settlements and minor offsets across severance and facility consolidation. In terms of adjusting guidance for 2023, the only change we are making at this point Is reduction in our subservicing segment forecast for a slightly lower growth ranging of 15,000,000,000 to 20 5,000,000,000 UPB in gross adds for the next three quarters. This will have no significant impact to our outlook on servicing income as We adjust our variable costs to mirror lower volumes.

Speaker 3

For a more detailed view of the quarter over quarter changes and adjusted pre tax income, please turn to Page 11. This page breaks out our typical income bridge with a view of all segments and then servicing and origination separately. The servicing graph on the upper right shows the impact of the whole loan purchase plus an additional $1,000,000 profit improvement from forward servicing. More detail will follow on Page 13. The origination graph on the lower right has a slight improvement to a $1,000,000 loss.

Speaker 3

Not captured here is the much stronger May June results and origination that we anticipate will continue to improve in the near term. On Page 12, I will describe our hedging approach and the impact of our capital light strategy on interest rate risk. The graph on the left shows the difference between what appears on our balance sheet for MSR assets, about $2,700,000,000 of fair market value, versus the amount of our net exposure that we actually hedge, which is about $1,700,000,000 of fair market value. The difference is primarily the transactions that don't achieve true sale, like the Mav or Rhythm assets for which we do not assume any interest rate risk. Thus, the hedge for interest rate impact is focused on the smaller amount on the right of that graph.

Speaker 3

Furthermore, that $1,700,000,000 includes assets like the excess servicing spread or ESS transactions. Here we only hedge a fraction of the total net exposure of the $259,000,000 to match the economics that we retain. In addition, we also have the PLS MSR book or non agency MSR book, Which is primarily hedged only on a float component given that they have very low interest rate sensitivity. Our hedge coverage ratio for Quarter was in the low 90% range. A very high hedge coverage ratio will diminish the impacts on the P and L of either interest rate increases or decreases.

Speaker 3

On the right, this graph shows the rapid growth of our excess servicing spread structures over the last few quarters. More detail on ESS can also be found in our Q, which we release at the end of business day to day. Since we retain title to these ESS MSRs, They remain on our balance sheet, cannot be sold or have the servicing transferred, unlike a standard subservicing contract. In addition to the ESS and MAV structure, we have other synthetic servicing transactions Where we sell the MSR title and the bulk of the economics to a third party in return for liquidity and retain servicing rights. Often we have very high termination fees in the 1st few years to discourage the contract from being moved early in the life of the MSSR.

Speaker 3

In conclusion, we have leveraged synthetic servicing, including MAV and ESS transactions, which translates to less capital on the hedge and less risk in a declining interest rate scenario. Now we'll go into more detail on the segment information on Page 13. We'll start with servicing where we show adjusted pre tax income in the upper left chart. In addition to the previously mentioned reverse transaction, Servicing saw improved flow income due to both higher balances, which are seasonal and higher rates and of course lower expenses. Subservicing volumes saw gross adds of about $3,000,000,000 offset by runoff in both forward and reverse.

Speaker 3

The reverse runoff was primarily due to higher assignment volume, which helps the MSR owner maximize returns by delivering the loan back to Ginnie Mae faster, but lowers the balance serviced. As a recap, the annual cost reduction year over year ended the second quarter was $45,000,000 for the Servicing segment. Please turn to Page 14 for an overview of our origination segment, both forward and reverse. The origination forward business is starting to normalize With correspondent lending and flow, that's CL on the upper left chart, experiencing much better margins and slightly higher volumes the Q1, mainly due to continued focus on high margin products such as Best Effort and Ginnie Mae loans. You can see here the margin improvement in the upper right graph, product growth in the lower left, client growth in the lower right.

Speaker 3

This returned the correspondent channel back to a positive adjusted pre tax income this quarter. We believe we are on a good trajectory for the rest The year and we will continue to price this product for an appropriate yield linked to our corporate cost of capital. Consumer Direct Continues to have improved volumes, albeit off a small first quarter base as well as better margins and is tracking towards profitability. This channel has shifted to a purchase cash out focus versus refinancing. Reverse had stronger origination volume, but experienced Spread widening in the quarter, similar to the Q3 of last year.

Speaker 3

This was mostly driven by the regional bank crisis and inflationary pressures. We continue to ensure that the origination segment is sized appropriately for the prevailing market volumes in 2023. Please turn to Page 15 for a view on our stock price. Using the same starting point, which is year end 2020 that we have used in prior years, Our stock continues to outperform not just the Russell 2000, but also a basket of our peers, which we list in our proxy and also show in the end notes. We believe this performance is due to the strength of our balanced business, industry leading cost structure, top tier operational performance and prudent capital light growth as well as our agility and broad expertise to execute on accretive opportunities such as the reverse whole loan and REO transaction and other opportunities going forward.

Speaker 3

While we are pleased with our performance versus our peers, At the end of July 2023, our stock was trading at about 60% of current book. This is an improvement over most of the 2023 trading range, But we think this discount is still not representative of the value we are creating nor the strength of our current balance sheet. Before I turn the mic back to Glenn, I want to point out to investors a few additional data points in our appendix. We continue to provide data on fully diluted shares in equity on Page 27. Our MSR valuation assumptions on Page 28 show many valuation parameters across the 3 major investor types.

Speaker 3

With respect to our balance sheet, we provide a more granular view on Page 20, which delineates assets that require matching Asset and liability gross ups under GAAP treatment. These are primarily due to an inability to achieve accounting true sale. These balance sheet impacts fall into 3 categories: the mavrhythm assets that I referred to earlier reverse Hekkem assets and Ginnie Mae MSRs that are eligible for an early buyout. As a reminder, the excess servicing spread asset Sit within the all other MSR category on the far right of this page. Back to you, Glenn.

Speaker 2

Thanks, Sean. I'd ask you to please turn to Slide 16 for a few wrap up comments before we go to Q and A. I'm proud of how our team is executing And the strong results we've delivered in the Q2. We've made solid progress towards achieving our financial objectives. I'd like to thank and recognize our global business team for their hard work and commitment to our success.

Speaker 2

As we continue to execute our business strategy, we believe Perform across multiple cycles. We're executing a focused growth strategy, leveraging our superior operating capabilities to grow subservicing across multiple investor and product types. Our subservicing opportunity pipeline is robust, and we are positioned to deliver value to clients, investors and consumers in any economic environment. We remain steadfast in our pursuit of industry servicing cost leadership by driving continuous cost and process improvement, and we'll continue to optimize expenses further during 2023. We remain equally determined to maintain our industry leading operational performance.

Speaker 2

We have delivered measurable performance improvements for our clients, borrowers and investors and provide an unmatched breadth of capabilities. Through our investment in technology and global operating capability, we've built an efficient and mature platform with capacity for growth that delivers industry leading performance and improved financial outcomes for clients. We continue to expand our capital partner relationships. We are prudently managing capital and liquidity for economic and interest rate volatility as well as the market risks and opportunities. Lastly, we're excited to put the legacy CFPB matter behind us, the last of the matters filed against the company in 2017.

Speaker 2

We believe this removes, but maybe a perceived uncertainty in the eyes of potential counterparties. Overall, We're excited about the potential for our business and do not believe our recent share price is reflective of our financial position, growth opportunities or strength of our business. With that, Jen, let's open up the call for questions.

Operator

Thank And our first question comes from Eric Hagen with BTIG.

Speaker 4

Hey, good morning. Hope you guys are well. A couple of questions here. I mean, at this point, do you think you'd support a stronger ROE If mortgage rates are higher or lower than where they are today, like how much upside do you feel like there is in MSRs if rates go higher? How are you thinking about the impacts of hedging and what you could potentially recapture and maybe just the overall growth rate for the market if rates were to come down?

Speaker 4

Then as a follow-up to that, I mean, when you sort of guide to get into $300,000,000,000 plus of servicing into early next year like you do on, I think, Slide 6. I mean, do you have an estimate for how much incremental capital you're using to get there or even how much you might even free up With the portfolio that says?

Speaker 2

Sure. Good morning, Eric. Look, Yes. I think in the industry, if you look overall, it's fair to say that originations in a stable environment or certainly in a downward rate environment generates substantially higher return on equity than servicing does. I think that's just the dynamics of our industry.

Speaker 2

So look, I think with An embedded base of very low coupon MSRs, I think further upside value appreciation in MSRs as interest rates rise It's going to be limited and not consistent with historical MSR value increases we've seen. The S curve effect of prepayment speed, so to speak. So from a return on equity And this is, I'll call it, an adjusted pretax ROE. I think the adjusted pretax ROEs would be, probably better With rates trending down because it creates refi opportunity, which again creates originations uses less capital. So the refi margins typically expand in a downward rate environment.

Speaker 2

As I think about the growth in our portfolio, Eric, look, our strategy is capital light growth. So as we're growing our portfolio forward, we don't expect to deploy incremental capital to do that With the exception of the opportunistic transactions like we executed in the Q2 for special servicing opportunities, those always require a little bit of capital, but have Very high returns as we demonstrated in the Q2. So the growth that we're expecting in the portfolio is really going to come from Yes, growth in our subservicing book, both with new third party subservicing relationships and growth in our capital partner book.

Speaker 4

Okay. Okay, that's a helpful direction. On Slide 10, you show the same liquidity quarter over quarter. Even though the book value went up normally, maybe wouldn't you have more liquidity if your capital position is improving? And would you say that there's a threshold for liquidity Is it even strengthened enough where you might look to repurchase some stock?

Speaker 3

Hey, Eric, it's Sean. Good morning.

Speaker 4

Good morning.

Speaker 3

So what we do is we sometimes delever assets As needed, because we don't want to have excess cash since it's a pretty low returning asset. With respect To having excess liquidity in our options, that pretty much remains the same as recent quarters where we would consider Debt repurchase and stock buyback, currently we're probably leaning more into a debt repurchase mode given our high degree of leverage on the company. And then having cash for either opportunistic asset purchases or for M and A transactions is also the other variable that we're

Speaker 4

Okay. Thank you guys very much.

Speaker 3

Thank you. Thanks, Eric.

Operator

And our next question will come from Matt Howlett with B. Riley Securities.

Speaker 5

Good morning, everyone. This is Mike Schafer on for Matt. So I was wondering if you could give some commentary on the overall reverse space in the context of Interest rate volatility that we're seeing and kind of how you'd expect that outlook to adapt as the Fed roadmap develops?

Speaker 2

Hey, Mike. Thanks for your question. Look, in the reverse space, look, it's no surprise reverse originations, The reverse originations market opportunity has declined substantially, probably more than 50% with the rise in interest rates. HECO Mortgages are a variable rate. Short end of the curve is very high.

Speaker 2

So again, the amount of even though there's been home price appreciation, Because interest rates have gone up quite a bit, the amount of equity that people could tap in their house with the reverse mortgage Is limited by the level of interest rates. So we have seen originations volume come down. That said, I think it's fair to say that We are if you look at the lead tables on Hekim issuance, we're still either number 3 or number 4 in the lead tables and year over year our share is going up. What we've seen during the course of 2023 has been a fair amount of volatility in what's called the discount margin or Spread essentially that reverse mortgage backed securities get priced off of or HECM securities get priced off of. So that spread volatility has Impacted our originations business and frankly has impacted the valuation of our MSR portfolio.

Speaker 2

As market conditions continue to normalize, We'd expect to see those spreads stabilize and approach longer term averages. And I would say over right now, Hekman spreads are probably Good 20, 30 basis points at a minimum above the long term average, maybe even more. In the servicing space, The servicing side of the business continues to perform very well for us. The platform we acquire from RMS, reverse mortgage servicing, the BAM waterfall had previously owned, performing well. We've Driven a lot of cost productivity and as we discussed, the special servicing side of that business performs extremely well It's given us the opportunity to take advantage of opportunistic assets purchases and generate decent returns for the company.

Speaker 2

So I think the reverse space is still one we like. I still think the demographics of the U. S. Population Support long term stable consistent growth in reverse mortgage originations, but it's been a choppy market and that's been The industry and I think it's us and others. But again, we think there's long term opportunity in both the origination and the servicing side.

Speaker 5

Sure. Thank you. So as far as the opportunistic side of the reverse segment, I see on the deck that you're not expecting any whole loan purchases in Q3, but I was curious if you could quantify You might think that would look like for the next year.

Speaker 2

So it's because these are opportunistic asset purchases, It's really hard to quantify. And I think I said on the call that, look, we it's right now trying while we are working on a couple of things, both on the forward and reverse side, It's really hard to dimension it. There could be small opportunities, could be large opportunities. So unfortunately, right now, I just can't I really can't dimension it, other than to say that, we are seeing an increased number of opportunities pop up in the market. But here, obviously, you've got to buy the assets right, you've got to price them right, but I'm convinced that the assets come to market And we can acquire them at a fair price that makes sense for us.

Speaker 2

We certainly have the servicing skills to address it and generate Nice returns.

Speaker 5

All right. Sounds good. I appreciate it. Thank you.

Speaker 2

Thank you,

Operator

And our next question will come from Derek Sommers with Jefferies.

Speaker 6

Hey, good morning, everyone. Just given the increased capital requirements for mortgage activities at banks and kind of the correspondent volume trend at Wells Fargo, I was wondering if You all could provide kind of an update on how things are shaking out among the correspondent sellers. Has Has that market share been reallocated? Is the wallet share still shifting or are things stabilized? Thanks.

Speaker 2

Good morning, Derek. Thanks for your question. So we are seeing look, we saw the correspondent market Conditions improve in the Q2. We still I think I said on the call, we still believe there are certain market leaders who have Yahoo's view of MSR values is not necessarily reflective of what we're seeing in the bulk market. That aside, our volume went up And our margins went up as well too.

Speaker 2

So I think the market is beginning to improve. I'd say the capacity that existed That shifted from Wells Fargo was kind of balanced around. I think there's always an opportunity for performance, Relationship, an opportunity to expand our customer base. As Sean talked about, our Correspondent customer base continued to grow in the second quarter and the team is continuing to look to add new sellers for the balance of the year. So I still think there's an to grow in the correspondent space for the balance of the year.

Speaker 2

In correspondent, we're getting very attractive, We call it cash on cash yields, which includes the quote origination margin. So we're essentially Buying the MSR at a price lower than its fair value. So we're we feel good about our position in Correspondent. I think our team there is executing really well. I think the returns we're seeing are attractive, and we're approaching the market with a very disciplined and thoughtful approach, Making sure we price consistent with our cost of capital and where our MSR investors are looking to, the returns they're looking to get.

Speaker 2

So I think with the new bank capital standards, it's going to create more opportunity for Those who aren't affected by those capital standards, our focus on growing our portfolio on a capitalized basis with MSR Investor Partners, we've got 4 now. We're looking to expand that. And I think the more capital partners we have in the portfolio within reason It gives us multiple investors with different buy box appetite, so to speak, which will allow us Take advantage of the growth opportunity should volume shift into the correspondent sector and the bulk markets as a result of Thanks for apps exiting or not being as aggressive in the MSR space as they have been historically. So it takes an exciting time for us and others in this industry.

Speaker 6

Got it. Thank you. It's helpful commentary. And then just one more. Just on the guidance, it seems Consistent quarter to quarter and previously the 9% pretax ROE was contingent upon The origination segment normalizing.

Speaker 6

With this quarter's improvement in gain on sale margin, do you view the Normalization, as primarily missing volume or further increases in margins or what's the missing piece For that segment to normalize?

Speaker 2

Yes. I mean, for us, I think it'd be a little bit more volume. I think it's fairly widely known. Look, home sales transactions are just not robust, Right. For all the reasons that people talk about, people have golden handcuffs with low mortgage rates and all that kinds of good stuff, right?

Speaker 2

So we'd love to see a little bit more volume activity in the marketplace. I think that would be good and healthy for the industry and certainly good and healthy for the homebuyer, homebuilder segment as well too. So I think it is a volume issue at this stage of the game. Again, I think conditions are improving. We did see volume go up in the second quarter.

Speaker 2

And Yes. Right now, I'd say the early read on the Q3 from what we saw in the press is home sales were up for June, Which in fewer home purchase applications are up in June, so that would bode well for July August, The summer buying season, but it's just not as robust, I think, as people as we'd like to see it.

Operator

Got

Speaker 6

it. Thank you. That's all for me.

Speaker 2

Great. Thanks, Derek.

Operator

Your next question today will come from Howard Amster with Ramit Securities.

Speaker 7

Hi, Glenn. Just wondered why the Employee costs went up like $28,000,000 for the quarter and also from the previous year.

Speaker 2

Tom? And Howard, good morning, by the way. Thank you for your question. It's great to hear from you.

Speaker 3

Good morning, Howard. So Our staffing was flat quarter over quarter. We did pay higher incentive comp In some of the businesses like correspondent and CD, given the much higher volumes we experienced in some of those channels. So that was the primary driver of that as well as merit raises came through, Which during a period of high inflation, that's one of the things we have to do to make sure we're taking care of our employees to Grant married. So comp and Veni went up staffing state level.

Speaker 7

I see. Was any of that Due to severance or I mean $28,000,000 on a $56,000,000 base seem really high, just maybe Way above like merit increases.

Speaker 2

I'm looking at the 3 months ended Page 21 of our appendix. 3 months ended June 22 comp and VIN was $84,000,000 3 months ended June 30, 2023 was $58,000,000 So I'm seeing a reduction and it looks like it's relatively flat to the Q1 as well. Sean, am I reading it right?

Speaker 7

Maybe I misunderstood.

Speaker 3

Yes. Howard, you may be looking at the June 30 it starts June 30, 2022 And then it jumps end of Q1 to end of Q2 and Q1 to Q2 on Page 21 is flat at 58.

Speaker 7

Got you. Okay. I must have read it wrong. Thank you very much. Thank you.

Speaker 2

No worries, sir. All good. Yes.

Speaker 7

Okay, good.

Operator

And this concludes our question and answer session. I'd like to turn the call back to Glenn Messina for any additional or closing remarks.

Speaker 2

Thank you, Jen. Look, I'd like to thank our shareholders and key business partners for their unyielding support of our business. I'd also like to thank and recognize our Board of Directors and Global Business team for their continued hard work and commitment to our success. I'm excited about the results we delivered for the quarter and look forward to updating you on our progress at our next earnings call. Thank you.

Operator

And this concludes

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Earnings Conference Call
Onity Group Q2 2023
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