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Nationstar Mortgage Holdings (NYSE:NSM)

Q2 2014 Earnings Call

August 06, 2014 9:00 am ET

Executives

Marshall G. Murphy - Executive Vice President of Corporate Development and Investor Relations

Robert D. Stiles - Chief Financial Officer and Executive Vice President

Jay Bray - Chief Executive Officer and Director

Analysts

Douglas Harter - Crédit Suisse AG, Research Division

Paul J. Miller - FBR Capital Markets & Co., Research Division

Bose T. George - Keefe, Bruyette, & Woods, Inc., Research Division

Cheryl M. Pate - Morgan Stanley, Research Division

Kevin Barker - Compass Point Research & Trading, LLC, Research Division

Bradley G. Ball - Evercore Partners Inc., Research Division

Michael R. Kaye - Citigroup Inc, Research Division

John Brandon Osmon - Hayman Capital Management, L.P.

Operator

Good day, ladies and gentlemen, and welcome to the Q2 2014 Nationstar Mortgage Holdings Inc. Conference Call. My name is Catherine, and I will be your operator for today. [Operator Instructions] As a reminder, this call is being recorded for replay purposes. I would like to turn the call over to Mr. Marshall Murphy, Executive Vice President, Investor Relations. Please proceed, sir.

Marshall G. Murphy

Good morning, everyone. Please note that this call and accompanying slide presentation are being webcast from the Investor Relations section of our corporate website, www.nationstarholdings.com. Please refer to that website for important information, including the second quarter 2014 earnings press release. A replay of this call will be available on the website within a few hours. Today's slide presentation is also currently available for download.

Financial results in today's press release are unaudited, and the matters we will be discussing today include forward-looking statements and as such, are subject to the risks and uncertainties that we will discuss in detail in our documents filed with the SEC, specifically the most recent report on Form 10-K, which identifies important risk factors that could cause actual results to differ materially from those contained in the forward-looking statements. The financial results in today's press release and the matters we will be discussing today include non-GAAP measures used by Nationstar. GAAP to non-GAAP reconciliation information is appended to our press release and investor presentation and is available on our website.

Presenting today is Jay Bray, our Chief Executive Officer; and Robert Stiles, our Chief Financial Officer. I would now like to turn the call over to Robert.

Robert D. Stiles

Thanks, Marshall, and thanks to everyone for joining us this morning.

Turning to our second quarter results. We delivered core EPS of $0.87 and GAAP EPS of $0.74. Our GAAP EPS was up 174% over the first quarter. These solid operational results were broad-based, with each segment sequentially delivering material increases in core pretax income. With the growth of our solutions segment, our desire to improve transparency and to demonstrate the inherent value in each of our businesses, we now present our financial results via 3 operational segments: servicing, Solutionstar and originations. Additionally, the corporate and other reporting unit includes corporate overhead not directly associated operation, our previous legacy segment and interest expense associated only with our unsecured senior notes.

On Slide 3, we provide additional information regarding change in segment. To be clear, the change in presentation has no impact on the previously communicated overall strategic initiative and financial goals of the company. We've also provided a reconciliation in the appendix of our investor presentation, showing the previous and current segmentation.

Turning to Slide 4. Let's talk about servicing. Our servicing operations continued to deliver strong core pretax income, which increased 9% sequentially. Core pretax income margin was roughly flat quarter-over-quarter at 28%. Operating profitability increased to 9 basis points, an increase from 8.2 bps on a comparable basis. The comparable operating profitability reflects the fact that although some of the growth associated with Solutionstar and move to its own segment, the servicing operations are very profitable with significant opportunities for both revenue and margin expansion. With the current segmentation and the removal of Solutionstar and corporate and other from the servicing segment, we now expect servicing's operating profitability to exit the year above 11 basis points. Simply stated, our servicing business is a large, profitable annuity-like portfolio with room to grow.

Next, we will talk about Solutionstar, which continues to deliver impressive quarter-over-quarter growth in both nominal pretax income and margin enhancement. This operating segment comprises our technology and data offerings, marketed under the HomeSearch and Real Estate Digital brands, as well as a settlement service offerings marketed under the Solutionstar brand. Jay will expand on our Solutionstar strategy on more depth, so just a couple of quick highlights here.

First, plenty of growth opportunities exist in terms of expanding service offerings, new customers and customer penetration for Solutionstar. And therefore, we expect the segment to continue to post solid quarter-over-quarter gains and continue to increase its mix of third-party business. Second, as previously noted, that we did adjust presentation Solutionstar's result for all periods to reflect the referral fees typically earned by servicers. This fee has been market practice for over a decade and compensates servicers for some of the carrying costs incurred with respect to defaulted loan. Considering the fee, Solutionstar remains on track to generate over $160 million in pretax income in 2014, which is consistent with the targets we established at the beginning of the year.

Origination segment delivered impressive results, including $69 million in core pretax income, a 73% improvement over the first quarter; and margins in excess of 40% as shown on Page 6. This reflects our focused execution, operational discipline and optimization of existing pipeline capacity by our originations team.

As noted in the earnings release, our funded volume and recapture rate decreased sequentially as a result of falsely originating higher-margin loans, declining HARP originations and officially managing capacity, while the operations begin the migration from multiple origination platforms to a single integrated platform and process.

Turning to Slide 7. We ended the quarter with $624 million in cash and a strengthened balance sheet. Our first priority in utilizing cash was for future acquisitions that meet our investment criteria. I'm pleased to report that in the third quarter, we already have commitments for over $20 billion in servicing acquisition. The other principal use of this cash has been de-leveraging the company by paying off some of our higher coupon debt, as we did last month. By eliminating our 10 7/8 [ph] coupon debt, our interest expense will decline by over $30 million per year, which has a positive impact on the profitability of our business and increase our credit profile. Our pro forma net leverage ratio of 2.1x, pro forma interest coverage rate of 5.6x and intangible network asset ratio of 9% also demonstrates our strong capital position.

Finally, it has been our expectations since the beginning of the year that our earnings would grow throughout the course of the year, with sequential progress each quarter. We remain ahead of our 2014 budget and accordingly are affirming our 2014 GAAP EPS guidance of $4 to $5 per share.

I will now turn the call over to Jay to provide a strategic update and business outlook.

Jay Bray

Thank you, Robert. Although we've improved the reporting and financial transparency of our operations, we have not changed our focus on execution with respect to the 4 key initiatives that we've laid out at the end of last year. Those areas shown on slide 8 include strong cash generation, increased servicing profitability, investment and growth and Solutionstar and continued improvement in our origination operation. We have made significant progress in each of these areas. And while there is much to be proud of, there's much more we can accomplish. Fundamentally if we continue to execute on these initiatives, we will position Nationstar to take advantage of these huge opportunities that exist today within the residential real estate market.

As shown on Slide 9, the U.S. housing market is enormous, yet highly fragmented, making the home buying process frustrating for consumers. The process issues are numerous and varied, but we firmly believe the solution rests with timely delivery of high-quality data, services and financing options to be a leading technology platform that seamlessly engage all market participants from homebuyers to home sellers and agents that serve them. We are one of the few players with the unique combination of assets to really drive change and improve the home buying experience. Our objective is simple: To enhance the overall home purchase experience for all market participants, with Nationstar playing a critical role as the lender, servicer and services provider of choice. The integration of our recent acquisition of Real Estate Digital is a significant step forward in the development of this end-to-end real estate experience. Although there's much more to come, the integration of RED is already enhancing the existing HomeSearch.com platform as the combined suite of technology solutions serves as the plumbing necessary to complete residential real estate transactions.

Moving to Slide 10. We are proud of the fact that Nationstar has helped more than 430,000 customers over the last 4 years by providing real solutions to homeowners, while at the same time helping investors earn better returns. In the second quarter alone, we helped 29,000 customers, including 23,000 workout solutions and nearly 6,000 HARP loans. We are executing on our goal to provide solutions to our customers to keep them in their homes, while saving the money and making their mortgage more affordable. I'm pleased to report that Nationstar's processes HAMP modifications 52% faster than the average for the top 10 servicers. In addition, we remain focused on reducing complaints, which is good for customers and fundamentally good for business. In an effort to continuously improve customer service, we're investigating the root causes of complaints, evaluating all of our processes and improving our complaint escalation and resolution procedures. At a minimum, our ability to reduce complaints will increase brand loyalty, reduce our costs and create a better customer experience. We remain steadfast in our commitment to be the preferred servicer for the agencies, and I'm proud to report that we are improving our performance in scorecards, which translates into improved rankings with Fannie Mae, Freddie Mac and Ginnie Mae. This validates that we are making the right investments in people, technology and processes.

Turning to Slide 11 for a recap of our servicing segment. We remain extremely bullish about our servicing capabilities in both near- and long-term market opportunities. Today, our servicing business is becoming more like an annuity, poised for growth that generates long-term recurring revenues and predictable cash flows. We expect cash flows to extend in duration as the economy improves and interest rates rise. In addition, numerous growth opportunities including continued execution of our profitability initiatives, portfolio acquisitions, servicing of nonperforming loans and the execution of our real estate exchange strategy. Specifically, with respect to acquisitions, financial institutions continue to signal their desire to shed servicing assets, and we plan to be an active participant, with a keen focus on opportunities that meet our investment return requirements. The active pipeline of servicing opportunities currently exceeds $300 billion, although we anticipate the average portfolio size of transfers to be less than $25 billion. As previously mentioned, since the end of the second quarter, we have commitments to acquire over $20 million in servicing portfolios as of today and continue to actively evaluate additional portfolios. We expect market activity to accelerate over the second half of the year and continue to feel very positive about our ability to move forward on acquisitions by working proactively with our numerous regulators.

At the end of day, we believe our demonstrated record of significantly improving the performance of the portfolio we've acquired is good for the homeowners and investors and achieves the desired outcome by regulators. In addition, we're also investing more resources to nonperforming loan servicing space. Although this expertise has existed within Nationstar for years, we think our market opportunities warrant us enhancing our capabilities. We believe the NPL market opportunity is large and growing upwards with upwards of $30 billion of NPL sales over the next 18 months.

Let's turn to Slide 12, where we provide an update on Solutionstar. Solutionstar continues to grow revenues, earnings and third-party customers. In addition, outstanding growth prospects remain in front of us. To capitalize on these opportunities, we have dedicated business development teams, focusing in increasing allocations from our existing customers, identifying new clients and launching new products and services. In addition, we've reorganized Solutionstar into 2 divisions. The real estate exchange division comprises the HomeSearch and Real Estate Digital offerings and serves as the core of our residential real estate technology and data solutions platform. Our real estate services division comprises of Solutionstar-branded residential settlement services, which principally includes title, close, escrow, collateral valuation and asset management services. We believe each of these divisions have the ability to grow significantly for the foreseeable future. The key financial driver for this segment today is property sales. In the second quarter, we sold nearly 5,700 properties, leveraging HomeSearch and our real estate panel. And we expect to pace themselves to continue to increase over the course of the year, resulting in over 20,000 properties in 2014. We continue to see exceptional execution rates of property sold through HomeSearch. Compared to traditional retail sales, the sales price to reserve ratios are on average 8% higher and inventory is sold 45 days faster on the HomeSearch platform, our strong execution results and higher realized values for homeowners and investors.

In addition, we're diversifying HomeSearch's earnings base through expansion of services and customers. We launched several test campaigns third-parties in the second quarter and believe that our execution rates and customer-friendly portal will position us for third-party business wins.

More importantly, we have said aggressively -- set aggressive quarterly goals with respect to our desire to transform the real estate marketplace. For the third quarter, our principal focus is the launch of HomeSearch.com 2.0, which we expect will occur in the second half of 2014. Although there will be dramatic improvements in the look and functionality of the site, there's much more under the covers. We have reengineered HomeSearch to be a data-rich search environment that provides homebuyers an enhanced alternative to the search options available today. We believe this to be a key step to driving market acceptance of the site beyond the default space. We will utilize this new portal to launch additional features for homebuyers, home sellers and agents over time. As I'm sure you can tell, we remain ecstatic about the possibilities within this vertical and are extremely focused on execution every step of the way.

Let's turn to Slide 13 to discuss the progress in our origination business. Our overarching strategy for our origination segment remains unchanged: to generate attractive, long-term servicing assets at a profit that will sustain and grow our servicing portfolio. We funded $4.4 billion in originations in the second quarter, including $2.9 billion in our consumer direct channel. As Robert mentioned, we are transitioning to a single integrated platform and process. This important initiative, which we expect to be complete by year end, has already resulted in an improved turn times and operational performance. We continue to make progress on our non-agency strategy. The underwriting criteria is in place, and we are currently partnering with investors to launch a product that could provide refinance solutions to the portion of our servicing portfolio that currently does not qualify for a government loan.

We plan to leverage our heritage as a non-agency originator and servicer to provide the appropriate risk adjustment financial solutions to this developing market on a measured basis. With the improving macroeconomic landscape, purchase origination opportunities will increase, and we plan to be active participants. Our KB Home JV, Home Community mortgage, Greenlight and potential new partnerships are all areas that can provide growth and purchase money originations.

In conclusion, we remain critically focused on the initiatives we set out at the beginning of the year. We are excited as ever about the growth prospects for this company because of the assets and operations we own today and the strategic plan we have set out in front of us. The market opportunities are tremendous, and we intend to continue to execute on our initiatives that will allow us to seize the opportunity and create additional value for our shareholders.

And with that, I would like to open the call up for question-and-answer session.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Douglas Harter from Crédit Suisse.

Douglas Harter - Crédit Suisse AG, Research Division

Maybe you could give us -- tell us a little more detail about the $20 billion of servicing acquisition and just what state of -- what still needs to happen before those loans can close?

Jay Bray

Well, we won the deals. So that's the good thing. And in some cases, actual agreements. In some cases, we have letters of intent. It's a competitive market, so I'm not really going to discuss counterparties, but I would say it's probably 75% kind of GSE product and 25% POS product, but we're -- I would say in the very final stages of a good chunk of that and in the Letter of Intent kind of agreement stage with others.

Douglas Harter - Crédit Suisse AG, Research Division

I guess, just on that, I mean, what needs to happen from a regulatory approval on those? And just give us an update on any conversations you've had around that.

Jay Bray

Well, we've been very proactive in working with the regulators as part of this process. So I mean, we are, I would say, in the final stages with them as well. Our approach now, frankly, is to be proactive. And as soon as we are awarded an opportunity, then we let the regulators know. And in some cases, even as we're bidding on opportunities, we work with them for approval. So we feel like we're in good shape.

Douglas Harter - Crédit Suisse AG, Research Division

Got it. And so you wouldn't expect any regulatory issues to prevent the closing of those?

Jay Bray

No.

Douglas Harter - Crédit Suisse AG, Research Division

And then, just shifting to originations. It looks like the recapture rate fell significantly in the quarter, I guess. What was behind that?

Robert D. Stiles

Sure. There's a couple of things behind it. As we mentioned in the script: One is HARP is down; two, we are in the process of migrating from multiple platforms to one platform. So we just wanted to be careful as we did that migration that we didn't -- that we manage the capacity appropriately through that process. And in doing so, we were selective on the products or the originator loans and gave us the highest margins for the lowest risk basically. So as -- I wouldn't say plan, but it was managed through the quarter, was really the primary factor driving that write-down.

Jay Bray

Yes, I mean -- [indiscernible] I'm not concerned by it at all. I think what we've done is a fantastic job this year. And frankly, rightsizing the origination operation. We're moving Greenlight, Nationstar to one common platform. And so the focus has been -- was optimize our capacity. And in doing so, we continue to do a number of HARP loans and help consumers that really need help. And I think, in the coming quarters, there clearly will be an increase in recapture and continuing -- and we're still seeing very strong application in locks [ph] and so I'm pretty bullish about it.

Operator

The next question is from the line of Paul Miller from FBR Capital Markets.

Paul J. Miller - FBR Capital Markets & Co., Research Division

Yes, yes. On the origination front, your originations were relatively flat, but your -- but the revenues coming off the originations were up pretty significantly. Is there any way you can break up for us what was cash, what was noncash? Like in other words what were you booking the MSR at?

Robert D. Stiles

We don't break out that information, Paul, but let me set it like this. We haven't changed our procedures in any way being that we originate loan. We keep the servicing right at -- I'm sorry, originate the loan, we mark the MSR to the market conditions at that time. We keep the servicing right and sell the rest of the loans off. There is some noise going through there from impact of hedges that we've seen some positive moving onto hedging positions in all as well, so that's causing part of that gain, but there's been nothing changed. That's really market conditions that are driving that.

Jay Bray

Yes, I think, Paul, tied to that, it's been a good market from origination standpoint as rates. Mortgage rates, at least, remained relatively calm. So we see some strong execution across the board in secondary with respect to specified pools, et cetera. As far as the servicing market and our consumer direct business, I mean, it really -- even from a basis point standpoint didn't change materially quarter-over-quarter. So it's a cash composition. I think it's pretty consistent with the first quarter. So we're killing it and doing a great job, I think, in Originations. And it's a good environment. Again, when you look at kind of overall gain on sale, kind of market -- a calm mortgage market is a good thing for us.

Paul J. Miller - FBR Capital Markets & Co., Research Division

And you just mentioned hedging gains. I mean, is it -- I mean, some of the hedging gains, was that the main driver of the big increase? Or was it -- how material was it? Like 10%, 20%?

Robert D. Stiles

It's not the main driver, Paul. It's really what Jay was saying as far as the market is stable, and we're killing it in the pool and things of that nature. Hedging gains was a small component of it.

Paul J. Miller - FBR Capital Markets & Co., Research Division

Small component, okay. And then, when you -- on the onetime expenses, the $25 million, is that is all associated with the advances going over NRZ? And that sounds kind of high. Can you just add some color behind that?

Robert D. Stiles

Sure. Yes, it's predominantly as expenses over NRZ and there's really 2 components to it. So one is, the pull-forward of the liabilities that were inherent in the MSR. Initially, we had to pull those forward and actually recognize those expenses. And then, the second piece is deferred financing cost write-off associated with to sell the advances as well. All this is noncash. So -- but it is all related to the NRZ. So the primary reason people might be missing is the deferred financing piece was a sizable component of that one time as well.

Jay Bray

I mean, the way to think about it, Paul, I think we talked about is in the first quarter. We did the first phase of advancing in the first quarter. We've been doing that -- we did the second phase and close to being done with the advance sale in the second quarter. And in any fees we paid associated with existing financings as we paid our bankers, our attorneys, our accountants, et cetera, those fees are set up and then amortized over some life of the original financing agreement. Well now that we sold those, we write that off. So that's the lion's share of what those costs are. Clearly onetime, clearly noncash. And frankly, we're pretty close to the finish line on the advanced sell as well, so you will not see that going forward.

Paul J. Miller - FBR Capital Markets & Co., Research Division

So if for the third quarter numbers, we will not see any type of onetime charges associated with the advance sales?

Jay Bray

I think we have a small piece that's left to be sold, but it will be tiny.

Paul J. Miller - FBR Capital Markets & Co., Research Division

Okay. And then, the NPLs trade you guys just mentioned about starting to get into. Is that -- are you going to be in partnership with NRZ on this type of trades? Like will NRZ buy and then you service them? Or is that just independent of NRZ?

Jay Bray

No. It will be a combination. We're actually pretty excited about the opportunity there. We are partnering with NRZ, and we have partnered with NRZ. And so I think that'll be kind of an ongoing partnership that was going to grow over time. They are actively looking at opportunities, and we're working with them but we also think -- we have probably 8 third-party clients today in that business, in our what we call our special servicing business. And we think there's a tremendous opportunity on the third-party side as well. And so we're working with a number of counterparties.

Paul J. Miller - FBR Capital Markets & Co., Research Division

So will they own the asset and you will service the asset? Is that the relationship? Or will you actually own some NPLs on your portfolio also?

Jay Bray

No. I think that, that'll be -- the primary relationship will be they'll own the asset, we'll do the servicing. And there may be opportunities for us to invest in certain pools in a small way, but the strategic focus, we'll be the servicer and they'll be another asset owner. And as we think about that, I mean, I think not only is it good for kind of the core servicing business. It's frankly very attractive for Solutionstar as well. So you'll get to see -- and could even be the origination business for re-performers, et cetera. So by controlling those assets, we think there's going to be a lot of opportunity.

Operator

The next question comes from the line of Bose George from KBW.

Bose T. George - Keefe, Bruyette, & Woods, Inc., Research Division

Actually, just wanted to touch on the reaffirmation of your guidance. If the first -- what was the GAAP number that you guys have done for the first half of the year so far?

Robert D. Stiles

[indiscernible] $12 [ph] Well, year-to-date, we're just sitting over $1, Bose. But just a couple of things taken to consideration: One, talking a lot about onetime cost in the first half of the year. There was a quite a bit in the first quarter, quite a bit in the second quarter. We don't expect that similar noise in the second half of the year. In fact, expect very little, as Jay just mentioned. So that's a big uplift. Servicing profitably continues to perform. And as we've said, we expect that to actually over 11 bps, just looking at servicing itself. So that's a big uptick. The market right now remains strong for origination. They are ahead of budget significantly year-to-date. We expect that to continue through third quarter. Solutionstar has a long runway in front of them as well. And then, the other pieces, we're being smarter about our corporate financing cost. So we're getting tougher about reducing basic corporate cost and getting smarter about our use there. We paid off that $285 million. So that reduces called on the $15 million [ph] remaining year-to-date and well being smarter about our use of our advance positions and our other liquidity positions, reduce interest expense. We've reduced banking fees. We reduced our warehouse lines. So it's pretty broad-based initiatives we have going on to really continue the growth in the second half of the year and get us to at least the low end of the guidance range. We think is very doable.

Bose T. George - Keefe, Bruyette, & Woods, Inc., Research Division

Okay. That makes sense. But just on the math, given what you've done so far, the low end of the guidance implies something like about $1.50 a quarter, right? Is that, right?

Robert D. Stiles

That's fair.

Bose T. George - Keefe, Bruyette, & Woods, Inc., Research Division

Okay. And then, actually just switching to refinance program that you mentioned, that you're exploring with private partners, is that -- can you just discuss that? Is that the start of our private alternative to HARP? Or how does that program work?

Jay Bray

You're talking about the non-QM activities?

Bose T. George - Keefe, Bruyette, & Woods, Inc., Research Division

Yes, yes, yes.

Jay Bray

Yes, it's -- yes, it would be a product that is not offered today by any of the government programs. So potentially, lower FICO but lower LTV product, or higher LTV product and then with a high FICO, et cetera. Just kind of different products that are outside of the existing guidelines but still from an overall risk profile, we feel comfortable with. And again, we're not going to be taking into principal risk there. We would be originating on the behalf of someone and servicing on behalf of someone. So that's the way we're thinking about it.

And I would say, Bose, and our view is, we going to go at that at a measured pace. That market is still not very mature, and you're seeing more activity, but still not a lot of activity. But we are talking to several investors about what's possible there and how to put guidelines together, et cetera. I mean, if you look at the landscape today, there's a ton of customers that are not being served, and we think we'd be a great solution provider to them. But that's how we're thinking about it.

Operator

The next question comes from the line of Cheryl Pate from Morgan Stanley.

Cheryl M. Pate - Morgan Stanley, Research Division

First, I guess, just a couple of questions on the origination segment. Do you have any sort of updated target in terms of volumes for the year?

Robert D. Stiles

I think at this time, Cheryl, we're sticking to the original guidance we've provided, which is $16 billion to $18 billion.

Cheryl M. Pate - Morgan Stanley, Research Division

Okay. And then, just in terms of the pretax margin, I know we've spoken to you before about 125 basis points and obviously, running ahead of that, pretty nicely year-to-date. Any thoughts to sort of the puts and takes from here? Are you maintaining the 125? Could it be better than that?

Jay Bray

It really depends on market conditions. As Jay mentioned before though, we're seeing right now, a nice, stable origination market and that's allowing us to execute on our own portfolio and the direct-to-consumer market. As long as those market conditions exist, I would think we would exceed the 125, but it's really going to be dependent upon the future market conditions.

Jay Bray

Yes, we're continuing to see a strong July and August, but I think Robert said it well, but it's -- we've done a lot of good things there and really got our cost to a point where we think we can achieve those margins long term.

Cheryl M. Pate - Morgan Stanley, Research Division

And just in terms of the consumer gain-on-sale margin, was there a material difference between HARP versus non-HARP? I know we've spoken before about the fairly significant portion of the portfolio that could benefit from refinancing. Have the economics changed significantly in the HARP channel that may make that less attractive going forward?

Robert D. Stiles

Not really. I mean, I think people are -- there's a demand for newly originated quality product is really the question, as well as the answer. And I don't think it matters whether it's HARP, non-HARP or -- as long as you originate good quality product, there's a solid demand and a solid pricing for it there today.

Jay Bray

Maybe just look at our overall supplies down right in the market. So we are seeing good appetite for really, both products, to Robert's point, and strong gains in both HARP and non-HARP. And there hasn't really been a material change in either one.

Cheryl M. Pate - Morgan Stanley, Research Division

Okay. And then just on the Solutionstar business. Can you just explain a little bit more, the adjustment that you're making for the referral fees? And then, how does that translate into pretax margin expectations on sort of the $160 million pretax income target?

Robert D. Stiles

Sure. So the referral fee, for well over a decade, servicers have collected a fee that just basically was meant to defer some of their advanced costs and other cost like the foregoing of servicing fees, things of that nature. So it is a standard market item, it does vary depending on whether you're doing a short sale or various other things. So there's no set fee, they're all market rates. As far as the margins, I mean, the reality is Solutionstar is a high-margin business, so we would expect to see it continue to produce results in the 40% margin range. Some of that's going to be dependent upon mix. The real estate exchange business is a higher-margin business than the real estate services. But even the real estate services businesses today can operate at a low 20% margin business in and of themselves. Overall mix will put them over 40%.

Jay Bray

And I think, really, as I mentioned in early on in the call, we are mostly excited in Solutionstar when you look at what's possible there, right? With HomeSearch and our ability to bring search capability to that site and to bring more functionality to that site, I think it's going to drive a tremendous amount of traffic, and frankly, can transform Solutionstar into a household name for all things real estate. So with the acquisition of Real Estate Digital, I can say we're ahead of plan as far as what we're planning to do with kind of HomeSearch next generation, and we feel great about that. And from the ancillary businesses, we've hired a title executive, we've hired a valuation executive, to really focus and grow this business as well. So I think there's a tremendous runway on what's possible in all those ancillary businesses. I mean, we're just really scratching the surface there.

Operator

The next question is from the line of Kevin Barker from Compass Point.

Kevin Barker - Compass Point Research & Trading, LLC, Research Division

Could you give a little bit more color on the type of servicing that you acquired this quarter? And a little bit more detail on the type of Servicing you're acquiring in the third quarter? Is that higher delinquency rates on the GSE portfolio? Or is it lower delinquency rates, lower advantages?

Jay Bray

It's a combination. I mean, in the second quarter, I would say the most delinquent portfolio we acquired was probably in the 12% to 15% rate. And so it wasn't materially delinquent, but again, one of the pools was more credit-sensitive. Even though it was current, it needed a special servicing touch. In the third quarter, I think that theme is going to continue. I mean, we're seeing, I would say probably 30% of it is going to be in a newly originated cleaner and then 70% is going to be the more seasoned, slightly delinquent, credit-sensitive type portfolios. So I don't know, Kevin, that it's frankly changing that much. I think we're still seeing a good blend of that and a good combination of kind of legacy and newly originated. And we still think, as we said, I mean, there's more portfolios that are being brought to market, and we feel good about those as well.

Kevin Barker - Compass Point Research & Trading, LLC, Research Division

Okay. Are you looking to increase your flow programs and possibly on newly originated MSRs? Or are you looking to do more bulk acquisitions like you're doing right now?

Robert D. Stiles

Yes.

Jay Bray

I think there's opportunity in both. I mean, on the flow side, we're at a run rate now of probably close to, call it, $24 billion, $25 billion annually, and we're adding new participants every month. And then, I think on the bulk side, there's still a very, very sizable pipeline that we think we're going to get our fair share of. So I don't think we'd really change that. I mean, I really believe that you're still going to see a blend of both. I will say that the size of the bulk transfers is definitely going to be smaller, unless we do something strategic with the financial institution or another party. So it's probably going to be in that $25 billion or less range, which is perfectly fine. But I think that's kind of what you're going to see in the future. But we're focused on both, and there's still plenty of opportunity in both.

Kevin Barker - Compass Point Research & Trading, LLC, Research Division

Okay. And then, given that you've acquired these portfolios in the most recent quarters and you repaid the debt, could you give us an estimate of how much excess capital you think you have today and you could utilize for further investments?

Robert D. Stiles

I think the simple way to think about it, Kevin, is the acquisitions that we're doing today will utilize the cash on hand to pay for those acquisitions, for our piece of them, at least. So that will be the primary use of cash as we talked about. We've also indicated our desire to continue to de-leverage over time, so we will continue to look at ways we can do that with our current debt stack and our current structure and are already in conversations with people. I think the third piece, though, to think about is in today's market, to get as the regulators are looking at some of these trades, their capital structure is becoming more and more important. So you'll see -- we believe you'll see servicers, including ourselves hold a little bit more cash than you might have been used to in the past. And that's really just to strengthen up the balance sheet and add some shock value, for lack of a better term. But we're really comfortable with the cash we're generating and think that we can continue to do these acquisitions with cash and continue to de-lever the company.

Jay Bray

I mean, clearly, with the cash on hand, we can acquire and setting aside kind of what we think we need to run the business and address Robert's other comments, in excess of $100 billion. So we got plenty of dry powder from an overall acquisition standpoint, given where we're at today.

Kevin Barker - Compass Point Research & Trading, LLC, Research Division

So correct me if I'm wrong, let's just say you acquire $100 billion worth of servicing at roughly 60 basis points, 70 basis points, roughly $600 million, and you have to hold more capital for the potential for new capital standards to be out, and you have -- given where your debt to equity ratio stands today, it would seem that there's little room to really bring that down. Do you feel that way? Or do you feel like there's still a lot of room there in order to make acquisitions off of your -- the way your balance sheet's positioned today?

Jay Bray

Well, the way you would think about the $600 million first, right, is we would more than likely do a co-invest, right? So you're really talking 1/3 or less of kind of what the Nationstar contribution would be. And so no, I don't think we feel that way. I think we feel like we've got liquidity for that or investable capital for that and then, plenty of -- if you look at kind of where we're trending now and where we're projecting the end of the year, we're continuing to improve overall cash and capital position in a pretty material way.

Robert D. Stiles

I agree completely with Jay. I mean, you take into the co-invest, we're comfortable, you take into the timing of when these transact, when we'll need to put the cash out for these transactions. We're still very comfortable with our cash position and ability to grow it.

Kevin Barker - Compass Point Research & Trading, LLC, Research Division

Do you have a specific debt-to-equity ratio you're targeting by the year end?

Robert D. Stiles

No. I don't think we have a specific debt to equity ratio. As you know, there are covenants in our arrangement, there are operating metrics that we meet with respect to the Fannies and Freddies in all of the world, and we're going to continue to improve those metrics and provide just -- the business naturally will do that but there's -- we're already way beyond or above our current covenants and metrics and we're just going to continue to improve on that but there's no real specific year-end target at this time.

Operator

The next question is from the line of Brad Ball from Evercore.

Bradley G. Ball - Evercore Partners Inc., Research Division

Yes, following up on the reaffirmed $4 to $5 of GAAP guidance. What are some of the assumptions underlying your view of the second half? Are you assuming additional acquisitions beyond $20 billion that you've already mentioned? And how much would that be?

Robert D. Stiles

I mean, we are assuming some minor additional acquisitions, but the reality Doug, [ph] is it will have minimal impact into the second half by the time things board. So at this point, acquisitions really are becoming more of a 2015 event than it is a 2014. So it's really we still think that there is opportunity within our current portfolio to continue to invest and improve our servicing profitability. We think there's tremendous opportunity still within Solutionstar, both with existing clients, with new clients, that we're in the process of testing and boarding. We sold our first third-party client asset on HomeSearch in the third quarter. And the originations market continues to remain strong among the other things that we talked about of reducing corporate cost. So yes, there is some acquisition amount in there, but we have been boarding some in very late September and some in late December, which would effectively have no impact in 2014, or minimal impact, I should say.

Bradley G. Ball - Evercore Partners Inc., Research Division

So the $20 billion, just to be clear, some of that's going to be boarding late September, some late December. So that amount, as you're saying, won't have a big impact this year, it'll have a larger impact next year?

Robert D. Stiles

Just to be clear, the $20 billion, we would expect to board between now and, call it, mid-October, is our current expectation. Some will board sooner because, as Jay mentioned before, we're further along in the process. And some will take 30 to 45 days. What I'm saying is that -- and if you look at our numbers, we do have expectations. And as we talked about, we expect acquisitions to continue to pick up over the second half of the year. So if we go into letter of intent, say, this month or September for another deal, then that will start boarding later October, early November type deal. But for budget purposes, we just put some at the end of September and some at the end of December. But what's in the pipeline today, we expect to board between now and, call it, mid-October.

Jay Bray

And then, anything else we acquire is really going to be a minimal impact in '14, like Robert was saying.

Bradley G. Ball - Evercore Partners Inc., Research Division

Right. Got it. And is there any MSR fair value mark assumption in that for $4 to $5 GAAP guidance?

Robert D. Stiles

There is not.

Bradley G. Ball - Evercore Partners Inc., Research Division

Okay. And then, I think you said earlier that your originations target is $16 billion to $18 billion, that's retail for the year. Do you have any correspondent expectations? You didn't do a lot in correspondent this quarter.

Jay Bray

I mean, I think we're acquiring, call it, $400 million-ish a month in correspondent. And as we've stated previously, we view that as a channel that can be attractive. But we're going to be pretty disciplined in how we acquire that Servicing. So there will be some but I don't know that it's going to be in excess of that $400 million to $500 million kind of run rate a month.

Bradley G. Ball - Evercore Partners Inc., Research Division

Okay. So the $16 billion to $18 billion of retail at a pretax margin of 125 basis points, that's what you're essentially baking into the $4 to $5 guidance?

Robert D. Stiles

That's right. That's a component of it, yes.

Jay Bray

That hasn't really changed. [indiscernible] No, go ahead.

Bradley G. Ball - Evercore Partners Inc., Research Division

I was going to say your prior guidance shifting in Solutionstar was for $400 million of revenue. You're now talking $160 million of pretax earnings. So are you still thinking that $400 million revenue number is doable and the margin are going to hold in a sort of 40% to 45% range?

Robert D. Stiles

We think the revenue will come down because that referral fee we talked about before is booked directly into servicing. There's no gross up. So there's not a large revenue in service and Solutionstar and then an expense out. It's booked in the divisions or in the segments. So the revenue will come down with the margins but will remain north of 40%.

Jay Bray

But in total, we're absolutely -- like if you include the Servicing and the Solutionstar piece, as we did previously, then you're absolutely going to hit the $400 million and you're absolutely -- your margins are going to stay the same. Robert's point is in the new segments that we've provided there will be -- some of that revenue will be in the servicing segment.

Bradley G. Ball - Evercore Partners Inc., Research Division

Okay, great. And then, separately, can you comment more broadly, Jay, on what you're seeing on the regulatory front? Is there any incremental increase in cost related to regulatory compliance? Where do we stand with respect to the New York DFS inquiry? Do you expect regulatory cost to rise in the second half related to the FHFA's call for capital adequacy guidelines? Any commentary you can give there will be helpful.

Jay Bray

Yes. I mean, I think as we've said previously, the regulatory landscape is a way of life for us, right? I mean, we are always, and have always been regulated. We've always worked with the regulators. We think we have a common goal, right? Ultimately, we want no complaints and happy customers, they want no complaints and happy customers, and we think we're doing a darn good job in achieving that. We have active dialogue with everyone. And has the cost increased? Yes. Will they continue to increase? Probably. But again, that was kind of factored into how we thought about the world at the beginning of the year and how we'll continue to think about the world. But I mean, look, our approach and our goal is that we really do believe fundamentally, that we're all pulling for the same thing here, right? We ultimately want to have a great mortgage process that delivers value to the customer. And when we work with the regulators, that's the overriding goal. So I think we have a good relationship. We'll continue to work on those relationships and we've made a lot of progress and continuing to work with them on a variety of fronts. But from a cost standpoint, I think -- and I will tell you this, every business review that I go into, I feel like there's just a tremendous amount of opportunity for us to continue to get more efficient and be better. And so, highly confident that we're going to continue to be more efficient in our servicing operation and that we can handle a regulatory cost and improve the customer experience. I just firmly believe that. So long answer to your question, but that's kind of the current state of affairs.

Bradley G. Ball - Evercore Partners Inc., Research Division

Any commentary regarding the New York DFS specifically?

Jay Bray

We work with them. And we have ongoing -- they sent a request to us in March, we responded to that request, and we continue to have active dialogue with them. But again, our view is we want to be proactive in working with them and finding solutions for homeowners. And that's our approach day in and day out.

Operator

The next question is from the line of Michael Kaye from Citigroup.

Michael R. Kaye - Citigroup Inc, Research Division

I'm just wondering if you had any updated thoughts on the potential spinout of Solutionstar? I just didn't know if the additional breakdown to a new segment was a precursor for that?

Robert D. Stiles

I don't know that I would call it a precursor, but we do continue to evaluate the timing of that. We definitely have taken that into consideration as we did the new segmentation. This is how we believe it would be shown as a separate company, but there's no update today on timing other than to say, we continue to evaluate, we continue to look at the opportunity there. I do think it's important to note, we've set out a very -- in growth, some strategic initiative here. I mean, it's a large, strategic opportunity in front of it. And so having it as part of Nationstar, at least, for the very short term and allowing it to get its feet in this new market, rebuild the portal, get new third-party customers on there, work with agents, integrate RED, is very helpful in the short term, but it's not going to be in that distant of a future where I think we will have more and more talks about separation and timing.

Jay Bray

Yes, I think the segment is a great first move and I think it provides a lot of transparency for investors, and I think it was the right thing to do. And I do think we believe we are truly in the top of the first on what's possible at Solutionstar. It's just amazing to me, the opportunity that's out there. And again, by acquiring RED, we think we have the data, the technology to be the premier provider, and we firmly believe that. So I think it will be, in and of itself, is going to be an incredible earnings machine and customer machine in the near future. But I agree with Robert, we want to continue to grow it, mature it, build out this next generation site, but we're constantly looking at what's the right strategy for RED.

Michael R. Kaye - Citigroup Inc, Research Division

Great. One of your key competitors had said their compliance with the national mortgage settlement will eventually give them a competitive advantage on acquisitions. Just wondering if you agree with that assessment and do you think you're going to eventually have to comply with the national mortgage settlement?

Jay Bray

Well, as part of one of acquisitions that we've made last year, a very large acquisition, we agreed to comply with those standards. And so we have an internal program that is compliant, if you will, with those standards. And it includes audit process, some external assistance as well. So in addition to that, as you guys know, I mean, we've got a lot of oversight from the GSEs, from Ginny, FHFA, et cetera, which incorporate some of those components as well. So I think we're -- I don't agree with that statement. I think we're in great shape with respect to that, and I think we would be able to certainly acquire assets and demonstrate our ability to adhere to all of those standards without question.

Operator

The next question is from the line of Brandon Osmon from Hayman Capital.

John Brandon Osmon - Hayman Capital Management, L.P.

Yes. I was just curious, kind of focusing back on Solutionstar again and the 2 very different segments, the exchange and services. How should we think about top line growth in both of those segments? And will exchange eventually kind of overtake services? Or should we just kind of think about right now, modeling those out kind of with the same type of growth rate?

Robert D. Stiles

I think that's fair. I mean, they both have significant growth opportunities still. I mean we'll take real estate services first. We continue to launch new products in the title space and the valuation space. As Jay mentioned, we have hired new title leads and valuation leads, so we still think that there's a lot of growth there. Having said that, if you think about the overall strategy around HomeSearch and the real estate exchange space is really the technology and data space. So yes, that's a big piece of the strategy and eventually, that will overtake real estate services. It is a high-margin business as technology and data businesses are. And I don't think it'll be in that distant of the future wherein real estate exchange takes over real estate -- real estate services.

Operator

I would now like to turn the call over to Mr. Jay Bray, CEO of Nationstar. Please go ahead.

Jay Bray

Thanks, everyone, for joining us. To be respectful of other earnings calls that are coming out, we'll close this out. And we appreciate everyone's participation, and we'll certainly be available for continued dialogue today and throughout the week. Thanks, guys. I appreciate it.

Operator

Thank you for joining today's conference. This concludes the presentation. You may now disconnect, and have a very good day.

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Source: Nationstar Mortgage Holdings' (NSM) CEO Jay Bray on Q2 2014 Results - Earnings Call Transcript
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