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Walter Investment Management Corp (NYSE:WAC)

Q2 2014 Results Conference Call

August 11, 2014 – 10:00 AM E.T.

Executives

Whitney Finch – VP of IR

Mark O'Brien – Chairman and CEO

Gary Tillett – EVP and CFO

Denmar Dixon – CIO, EVP, and Vice Chairman

Analysts

Bose George – Keefe, Bruyette & Woods

Cheryl Pate – Morgan Stanley

Douglas Harter – Credit Suisse

Henry Coffey – Sterne, Agee & Leach, Inc.

Brad Ball – Evercore Partners

Mike Grondahl – Piper Jaffray & Co.

Operator

Welcome and thank you all for standing by. At this time all participants will be in listen-only mode. During the presentation we will conduct a question-and-answer session. [Operator Instructions] I will now turn the call over to Ms. Whitney Finch. Ma'am, you may begin.

Whitney Finch,

Thank you. Good morning and thank you for joining us for Walter Investment Management Corp.'s earnings conference call for the quarter ended June 30, 2014. This call is being webcast live on the Internet, archived on our website for at least 30 days. This morning management will discuss earnings for the quarter ended June 30, 2014, as well as our current business outlook.

Let me remind you that comments on the call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act. These statements are based on the Company's current expectations and involve risks and uncertainties that could cause actual results to differ materially from those in the statements. Please refer to our SEC filings for a full discussion of the risk factors that may affect any forward-looking statements. Except for any obligation to disclose material information under federal securities laws, we undertake no obligation to release publicly any revisions to forward-looking statements to reflect events or circumstances after this conference call.

We will discuss non-GAAP financial measures [indiscernible] call. These non-GAAP measures are fully reconciled in the tables attached to the earnings press release we issued earlier today and the presentation accompanying this call. We believe that these measures provide investors useful information about our business trends. However, our non-GAAP measures do not replace and are not superior to GAAP measures.

Participating in today's call are Walter Investments' Chairman and CEO, Mark O'Brien; CFO Gary Tillett; Vice Chairman and Chief Investment Officer Denmar Dixon; and CAO Kim Perez. Once we have completed our prepared remarks we will open the call to questions from our dial-in participants. At this time, I will turn the call over to Mark.

Mark O'Brien

Thank you, Whitney, and good morning, everyone. Walter Investment has a rich 56-year history of providing high-touch specialty servicing to credit-sensitive assets. From the very inception of our Company we have recognized that the single most important way to derive value from our assets was to provide the highest level of relationship-based services to our customer. Throughout the years our practices and protocols have evolved but we have maintained our focus on helping customers stay in their home.

Since our acquisition of Green Tree 3 years ago, we have completed nearly 123,000 modifications, and since the startup of our originations business in February 2013 we have originated more than 92,000 HARP loans, assisting customers during some of their most challenging times. We believe this type of specialty servicing brings significant benefit and alignment amongst the key constituents in our industry – consumers, servicers, stakeholders, and regulators.

As our business continues to evolve into a best-in-class organization, which has embraced a culture of compliance and performance, we see substantial upside to ensuring that those items at the top of the regulators' agenda are firmly embedded in business practices, servicing protocols, processes and procedures, as ultimately these items will support the long-term sustainability of our business. By following best practices, industry and reputational risks are lowered; operations are more efficient; and the result our customers experience with the servicers should improve. Ensuring accuracy of information drives improvement not only for the customer in their interactions with us but also reduces industry risks, improves operational efficiency and lowers reputational risk for the servicer and improves portfolio performance for the investor.

A focus on counterparty risk will strengthen the industry by providing stability amongst constituents. As Walter Investment further incorporates these concepts more deeply into our day-to-day operations we are confident that a robustly developed best-in-class organization will emerge, driving shareholder value and sustainability of our business model.

Before I turn the call over to Gary and Denmar I want to take a moment to thank Keith Anderson, our Executive Vice President and Chief Operating Officer, for his many years of distinguished service and significant contributions to Walter Investment. We are very appreciative of Keith's thoughtful guidance and counsel as we have defined and executed our strategic initiatives following our acquisition of Green Tree. We will miss him as he enjoys his well-deserved retirement.

We are pleased that he will remain with the Company for the next 90 days as we search for a candidate and transition to someone to fill his very big shoes. And he is staying on as a consultant for the next year. We have very capable managers running our business and I anticipate a smooth transaction and do not expect any disruption to operations of the business during this period.

And with that, I would like to ask Gary and Denmar to cover offer natural and operational highlights and our outlook for the business. Gary?

Gary Tillett

Thanks, Mark. Absent one significant charge and a fair value mark, Walter Investment delivered strong financial results for the quarter. Our originations business delivered increased profits. Servicing delivered results generally consistent with expectations and their investment management business realized a significant performance fee earlier than expected.

Our reverse business continues to be challenged. However, we believe changes made in our strategy will have positive impact in the future. Before I go any further, I want to note a change in nomenclature for one of our metrics and to point out a couple of unique items for the quarter. First, our non-GAAP measure formerly known as core earnings is now adjusted pretax earnings or APTE, and core earnings after-tax has become adjusted earnings after-tax. Management believes the revised name is preferable and more consistent with regulatory guidelines. The calculation of this measure has not changed.

The charge I mentioned earlier relates to the impairment of goodwill at our reverse mortgage segment of $82 million, and we also had a reduction in value of our mortgage servicing rights of $43.4 million related to changes in inputs and assumptions. For the quarter we had a GAAP net loss of $13 million or $0.34 per diluted share, which includes a $27 million after-tax or $0.70 per diluted share reduction to the fair value of servicing rights related to changes in valuation inputs and the $82 million goodwill impairment charge I mentioned earlier.

Net income adjusted to reflect these items was $45 million or $1.19 per diluted share. Adjusted earnings after-tax of $70 million or $1.86 per diluted share increased 21% as compared to the first quarter. Adjusted pretax earnings also increased to 21% over the prior quarter and adjusted EBITDA of $199 million increased 19% as compared to the first quarter. Significant drivers to the earnings increase include strong originations earnings from $145 million of gains on sales of loans due to higher locked volumes, higher expenses of $44 million associated with newly boarded portfolios in our servicing segment and $34 million of performance fees earned by our investment management business.

For the second quarter of 2014 our funds generated in period were $137 million before our investment in originated and retained MSRs of $46 million. We ended the quarter with GAAP cash and cash equivalents of approximately $303 million.

Now, let's spend some time in some of our key operating segments. Our servicing, ARM and insurance businesses contributed $86 million of adjusted EBITDA, a 35% decline as compared to the results for the first quarter of 2014, reflecting the impact of increased servicing costs associated with the 289,000 accounts boarded by the servicing segment this quarter, and delivered a combined adjusted EBITDA margin of 15 basis points. In addition, we were able to complete nearly 14,000 modifications, helping our customers stay in their homes, and also directed customers to our HARP refinance program, originating more than 16,000 HARP loans, driving a portfolio disappearance rate of 13.8% for the quarter.

During the quarter our ARM business acquired a $3.3 billion UPB portfolio of consumer loans at an attractive return. In addition to the acquisition, the Company entered into an agreement to acquire on a flow basis future portfolios of charged-off loans. In July we completed our first flow acquisition under this arrangement.

As expected, the results of our insurance business were impacted by the loss commissions on lender-placed product in our GSE portfolio, which went into effect June 1. The originations a segment generated adjusted pretax earnings of $71 million during the quarter, funding $4.4 billion of loans, including over 16,000 HARP loans providing affordable refinance options to homeowners.

Recapture rates for the quarter declined to 39%, reflecting a higher percentage of payoffs resulting from purchase transactions and lower recapture rates on our more mature portfolios. These were offset by higher than expected recapture rates on the newly acquired portfolios.

In our consumer lending channel we earned a direct margin of 344 basis points for the quarter. Margins showed improvement as compared with those of the first quarter, as a result of higher than expected pull through on locked volumes and favorable execution gains. Margins are anticipated to return to the range of Q1 next quarter. We continue to monitor margins and volumes in our correspondent channel as we manage that channel for profitability. And while down for the quarter as a whole, June margins returned to expected ranges.

Volumes for our consumer lending and correspondent lending channels are expected to remain strong through the third quarter with current trends supporting this view. During the quarter we capitalized OMSRs of $46 million, broken down as $34 million of base MSR capitalized at a multiple of 3.87 and (technical difficulty) excess MSR capitalized at a 3.7 multiple.

The reverse mortgage segment generated an adjusted pretax loss of $4 million for the quarter. We generated blended cash margins of 376 basis points in the period on $359 million of securitizations, representing the spread between proceeds from the securitization and our basis in the loans. Blended cash margins were higher compared to the first quarter as result of better pricing on origination volumes in the higher-margin retail channel. This segment recorded $9 million in servicing revenue and fees for the quarter, servicing a total of 104,000 loans with a UPB of approximately $17 billion.

The reverse mortgage sector in our business has experienced significant changes over the previous 12 months. New regulations, including those relating to product and process changes, have significantly impacted the near-term profitability of the business. These changes, including the shift of cash flows towards later years, have decreased the current value of the reverse mortgage business, and as a result we recorded the $82 million charge to impaired goodwill in the quarter. We remain optimistic that the reverse mortgage sector will benefit from increased consumer demand in the future. This growth of demand, coupled with our revised strategy to aggressively grow the high-margin retail originations channel, will drive profitability for the business in the long-term.

I want to point out that, even the non-deductibility of goodwill, our expected tax rate for GAAP purposes is now estimated to be 119% for the full year 2014. Absent any significant variance in the operating results, that rate is expected to be used for the last 2 quarters [indiscernible] producing GAAP net losses. This item will not impact our cash taxes for the year.

Our servicing profitability requires a review of the combined results of our servicing ARM and insurance businesses to be truly comparable to our peers. For the second quarter our combined adjusted EBITDA margin for servicing-related operations was approximately 15 basis points of adjusted average UPB service. As we have discussed previously, we anticipated margins to return to expected levels from the higher margins seen in the first quarter. Factors driving the change during the quarter included increased costs for compensating interest due to the increase in HARP activity, higher cost associated with the addition of the EverBank platform and employees, and a significant increase in our provision for losses on advances, given continued assessment of age balances. Additionally, the first-quarter margin included the benefit of $13 million related to the settlement of amounts associated with a servicing contract.

Year to date, the combined adjusted EBITDA margin was 18 basis points, in line with management's expectations and at the high-end of our expected margin for the year. As we have said in the past, it is important to view the business on annual basis, given that results can vary between periods.

Now, I would like to spend a few minutes covering our balance sheet. While sizable at $18 billion, it is important to note that 66% or approximately $11.4 billion of the liabilities are nonrecourse to the general assets of the Company. Approximately $11.5 billion in assets are collateralizing these liabilities. These net physicians will be recognized over time and exclude $99 million of deferred non-cash income in the reverse mortgage business, which will be recognized over the life of this portfolio, residual interest in the legacy Walter portfolios of $271 million, which are carried at amortized cost. During the quarter this portfolio generated adjusted EBITDA of $10 million, mandatory cleanup call obligations in certain of the non-residual trust, which are expected to take place between 2017 and 2019 and are carried at a negative fair value of $44 million and $13 million of equity in certain servicer advanced trust.

I would now like to turn it over to Denmar, who will cover sector dynamics and our outlook for 2014.

Denmar Dixon

Thanks, Gary. We believe that Walter Investments' significant strategic capabilities position us quite well for continued growth. Our businesses, each of which has a fundamental focus on the residential mortgage market, provide us with significant optionality and a strong array of core competencies to deploy against market opportunities. This positioning will allow us to capitalize on the current trends of the mortgage market as the banks and others look to concentrate on core clients and core competencies and outsource or sell non-core client-related assets such as credit-sensitive servicing.

We believe we will continue to drive growth in our core servicing business as we deploy multiple strategies to grow the portfolio. We believe that there continues to be a significant multiyear market opportunity resident in the $3 trillion to $4 trillion of existing credit-sensitive assets. Our dialogue with clients remains robust and we are seeing more deal flow in the markets. In addition, our originations business is providing a cost-effective source of replenishment for high-quality assets and we are actively pursuing flow agreements to augment our growth strategy.

And as this sector continues to mature, we see a significant opportunity for future growth as private capital returns to the mortgage market and investors focus on driving strong portfolio performance through value-added servicing to maximize return.

We continue to see a heightened level of regulatory oversight in the sector. While it has impacted near-term activity, over time we believe it will prove to be beneficial to the sector as clarity regarding best practices, processes, and standards will allow for more efficiency and certainty in operations. As Mark noted in his comments, there exists a significant alignment between the constituencies and the sector. As has been stated publicly by key regulators, a healthy and liquid market for MSR transfers is important for the whole market as a whole. Significant barriers to entry exist in the sector and we believe participants such as Walter who are driving a business model with a focus on compliance and consumer experience, have scale, can demonstrate a strong track record of success and solid capital and liquidity will be best positioned to succeed.

Now, let me turn to a discussion on the trends and outlook for our key businesses for the remainder of the year. We expect our servicing arm and insurance businesses to deliver a combined adjusted EBITDA margin of 14 to 18 basis points. Our value-added model continues to drive solid performance in our portfolios. As previously noted, we are seeing a pickup in market activity. We believe this trend will continue and strengthen as we move through the end of the year. We anticipate the increased level of regulatory oversight to continue for some time but, as we've discussed, believe that we are making progress and clarity will be a net benefit for the sector.

In our originations segment we delivered strong results in the second quarter as production in the consumer lending and corresponded lending channels increased 37% and 76%, respectively, as compared to the first quarter, generating high-quality, cost-efficient MSR for our servicing business. We currently have in excess of 340,000 in-the-money HARP-eligible accounts in the portfolio. We see continued strength in our retention business as the interest rate environment is accommodative, margins remain stable, and our new portfolios are mined for HARP. We have seen a renewed focus on the HARP product instigated by Mel Watt and FHFA, who have embarked on a multi-city program to drive awareness for those eligible borrowers who have not yet taken advantage of the product opportunity. We will remain focused on reducing fixed expense in the business and are continuing our cautious buildout of our retail channel and managing our correspondent business and volumes to maximize return.

In the reverse mortgage business we have revised our strategy and operating model to fit the new market environment. We are investing in the business to grow our retail footprint and to bring efficiencies to our servicing operations. There continues to be margin pressure in the wholesale channel, which we believe will abate over time as the market sorts out post the product changes and retail margins remain attractive. In the near-term we have more work to do to achieve our desired results and expect continued softness in the business.

We believe there will continue to be industry consolidation as a result of the increased compliance and regulatory costs and changes in loan sale economics. As an industry player with size and scale and a leading franchise, we believe we will be well positioned to capitalize on these changing sector dynamics. We will be opportunistic in growing this business in both the servicing and origination segments in the future.

We also realized the significant contribution from our investment management business in the quarter, recording $34 million of performance fees associated with the liquidation of certain assets in the managed portfolio. We are excited about the growth opportunities resident in this business and we look to build on our past success and add to our assets under management. We believe Walter is uniquely positioned to source, price, and execute on credit-sensitive assets.

Finally, we continue to review numerous opportunities and strategies to lever our core competencies across our businesses and will remain opportunistic on this front.

Now, let me turn to our outlook for the remainder of the year. Based on our performance for the first half of 2014 and outlook for our key segments for the remainder of the year including continued softness in our reverse mortgage segment, the Company anticipates results for the year are likely to be in the low to mid point of the previously provided outlook for 2014. This includes an adjusted EBITDA range of $650 million to $725 million and an adjusted earnings per share after-tax range of $5.25 to $6.25 per share. These ranges include estimates for certain business development and growth opportunities and assume a reasonably consistent economic environment. The 2014 adjusted earnings range does not include any estimate for future fair value adjustments.

I will now turn it back over to Mark to close.

Mark O'Brien

Thank you, Denmar. What are investment is focused on executing against it's a strategic objectives and honing its heritage as the high-touch specialty servicer to drive the long-term sustainability of our business model. Our ongoing focus on compliance, best practices, and the consumer experience remain a key focus of each of our businesses and will serve us and all of our stakeholders well as we continue to capitalize on the significant sector opportunities.

This concludes our prepared remarks and we will now open the call for questions.

Questions-and-Answer Session

Operator

[Operator Instructions]. Our first question comes from the line of Bose George from from KBW Sir, your line is open.

Bose George – Keefe, Bruyette & Woods

Okay, first, can you talk about the legal and regulatory expenses? What is driving that? And does that normalize next quarter or is it just going to take a little longer to run off?

Gary Tillett

Yes, we are incurring legal and regulatory expenses in conjunction with matters, as you've seen disclosed. And obviously, those expenses are being provided in accordance with GAAP. The ones that we called back in our adjustments relate to the [indiscernible] in the course of business. And those – they may continue in the future. But today we have provided what we think is appropriate under GAAP through the quarter.

Bose George – Keefe, Bruyette & Woods

Okay. And in terms of the timeline for it to run off, is it a little hard to tell at the moment?

Gary Tillett

It would be difficult to tell for the matters that are disclosed in the footnotes. When we resolve those matters is when they would run off. I think just normal servicing and, as we've said in the past, changes to our policies, procedures – all those things are built-in and they stay in the cost of servicing. And those obviously continue but they are mitigated by other things as the portfolios mature, et cetera.

Bose George – Keefe, Bruyette & Woods

Okay, thanks. And just switching to the origination side, actually what was the HARP percentage? I didn't know if you gave that in your comments or not – this quarter versus last quarter.

Denmar Dixon

I think our retention channel – I don't have a number right in front of me, Bose, but I think it was about 50% of the volume in the quarter.

Bose George – Keefe, Bruyette & Woods

Okay. And are the gain on sale margins there much different from the rest of the retail channel now? Is it much of a premium?

Denmar Dixon

Yes. I think the HARP related business absolutely has the strongest margin and really drives our overall margins, given the mix between it and correspondent. And I think just for a little color, I think from the first quarter we saw slightly better margins. Some of the HARP buy-ups have returned, I think 20-25 basis points or so. So good, stable, robust margins and a little bit of tailwinds in the quarter.

Bose George – Keefe, Bruyette & Woods

Okay, great, thanks.

Operator

Our next question comes from the line of Ms. Cheryl Pate from Morgan Stanley. Ma’am, your line is open.

Cheryl Pate – Morgan Stanley

Hi, good morning. Just a couple questions – first, on the commentary in terms of low to mid point of the guidance range, can you just help us think about the second half in a bit further detail? It looks like the front half ran at 336. Is it really just a lower outlook in the reverse business? Or what other drivers would take you to the low end versus the mid-point from here?

Denmar Dixon

So I think, Cheryl, your first observation is correct. So we've had a pretty good first half of the year. Right? We are not calling for much in the way of improvement in reverse segment through the rest of the year. And then keep in mind seasonally the fourth quarter is not a strong quarter for originations in most environments, if you will. So there's a little bit of that that will come into your numbers. So I think it was really just our normal conservative view that we've done so well, so far in the year. When we look at the businesses and extend the numbers forward, we felt comfortable guiding you to the mid to lower end of the range, keeping in mind that we've got a couple things in the first half that were helpful – first-quarter servicing, asset management this quarter, et cetera.

Cheryl Pate – Morgan Stanley

Okay. And then just on the servicing, in particular, the realization of expected cash flows were almost double first-quarter levels but the disappearance rate on the portfolio was fairly similar. Is there anything specific to point out there?

Denmar Dixon

I think the only thing more specific, Cheryl, is the portfolios we boarded late in the quarter were on for a full quarter this time. So that's a majority of the increase from the first to the second. And that amortization or realization of expected cash flows does kind of move over time, as the portfolios mature, as well.

Cheryl Pate – Morgan Stanley

So the second-quarter level is probably more indicative of the run rate going forward, given everything that's been boarded now?

Denmar Dixon

Yes, that's correct. I will say it was driven somewhat also by the boarding of those portfolios and the efforts on the HARP to capture it.

Cheryl Pate – Morgan Stanley

Okay. And then just one last one, if I might. In terms of the gain-on-sale margin, any color to how that's been trending since quarter end?

Denmar Dixon

Yes. Since quarter and we have been relatively in the same range, at least where we were. HARP is still strong. Our correspondence actually, as I think Gary noted in his comments, was a little better in June as we got the volume up, and that has continued.

Cheryl Pate – Morgan Stanley

Great. Thanks very much.

Operator

Our next question comes from the line of Mr. Douglas Harter from Credit Suisse. Sir, your line is open

Douglas Harter – Credit Suisse

Thanks. Denmar, I was hoping you could give a little update on the environment for transfers, the willingness of regulators to allow you to do other transfers and where you might be in terms of getting more transfers announced or boarded.

Denmar Dixon

Sure. I think, as we said in the comments, we are actually seeing the number of transactions in the market. And it's early, but they are starting to pick up. I think we've had good conversations with both sellers, our clients, and regulators about where we stand today. And our expectations are we will execute some transactions in the back half of the year and look to grow the portfolio.

Douglas Harter – Credit Suisse

Great. And then I noticed in the 10-Q there was new disclosure around the HUD investigation. If you could just give us a little more color on that.

Denmar Dixon

Yes. As you can expect, we can't comment in any detail further than what we put in the Q. I think my qualitative commentary would be the regulatory environment right now is the new normal. We are reacting to it positively. We are engaging with the regulators. We look forward to fact-based dialogue with them, and we would look to cooperate and move forward on any of the different issues that are noted, as quickly as we can, to bring them to a reasonable conclusion. But obviously, we can't predict what that may be at this point in time.

Douglas Harter – Credit Suisse

Is there any other detail you can give us as to what that investigation relates to?

Denmar Dixon

Not really. And I think you've noted when we purchased RMS and got in, we took a reserve for certain costs there related to curtailment, et cetera. And we noted that, and this appears to be a follow-on to that process.

Douglas Harter – Credit Suisse

Great. Thank you.

Operator

Your next question comes from the line of Mr. Henry Coffey from Sterne Agee. Sir, your line is open.

Henry Coffey – Sterne, Agee & Leach, Inc.

Yes, good morning, everyone. Congratulations on a good quarter. To put all this into context, what number of loans did you originate in this quarter? And we are trying to figure out how much HARP life is really there.

Denmar Dixon

I don't have the number of loans right in front of me, Henry. We can certainly get that for you. There's a little more detail back in the supplemental. If you want to go through that. So I think we would be happy to step you through it after the call in more detail if we can't grab it here in the next 30 seconds or so.

Henry Coffey – Sterne, Agee & Leach, Inc.

But what is your expectation in terms of in the mortgage business, for the shelf life of your HARP opportunity? And how do you see yourself replacing that over time?

Denmar Dixon

Okay, I would address that this way. I think that, again, still having 340,000 in-the-money HARP-eligible borrowers gives us a pretty robust inventory. The current rate environment is pretty accommodative toward our continued efforts to recapture those clients. And we are looking at portfolios as we speak today that have HARP content in them. And as you know, the program runs through 2015. So I think the view is that the HARP base and retention, if you will, provides us a great base to transition our business through the rest of 2014 and 2015 to a more steady-state where we look to develop our retail channel. And that's boots on the ground in consumer direct and correspondent along with what will always be a pretty decent sized retention off of our $2 million plus base of units.

So the way we think about originations is it is core to our business. We like the replenishment it provides with good quality control and good pricing. And we are going to use the base provided by the HARP retention, if you will, to fund and move forward the transition through the rest of 2014 and 2015.

Mark O'Brien

One of the things that you need to know is that we launched this business in the winter of 2013. We have – as you know, we have been a – maybe even the largest on a ratable basis – Fannie Mae HARP producer. But during that time we have worked with FHA, VA, and USDA to add additional products that will enhance our opportunity to deliver against the retail channel. Over the course of the last 90 days we secured all the authorities we need to expand our FHA, VA, and USDA product, which we think will add to our competitive posture.

Henry Coffey – Sterne, Agee & Leach, Inc.

Thank you. And in terms of the balance sheet, can you give us a preview in terms of what WCO will look like for you? And at this point in the cycle, should we expect to see debt balances start to decline? Corporate debt obviously.

Denmar Dixon

Yes. So I think the preview was the $75 million excess trade that we did. I know you are familiar with the accounting there. That will be, for GAAP purposes, recorded as nonrecourse debt on the balance sheet and mark to market over time. So I think for the next couple of trades we do in conjunction with WCO, we would expect that the excess structure would be the structure we would utilize, although we are working very hard, as you know, to get WCO licensed. And we are contributing Marix, our second servicer, licensed servicer, if you will, to WCO, such that it can actually own MSR outright, at which time the bulk of the cash in any acquisition would come from WCO.

I think the right way to say it is we are at the beginning of the transition period. Where purchases in the past were 100 cents on the dollar Walter purchases, on a go forward basis we are likely to partner with WCO. And they would provide, napkin math, 40% to 50% of the capital. And then when we get to where they are owning the MSR outright, then they would provide the bulk of the capital.

Gary Tillett

And, Henry, with regards to our balance sheet, obviously we look at our capital structure. We have some efficient leverage on the balance sheet today. But as we have capital and we look to deploy that capital, we look for the right opportunity to do that. So we consider those, but that decision is made as we go through and manage the business.

Denmar Dixon

I think one other point I'd make, Henry – it's a little off-topic, but I'm going to be a politician and use the opportunity to say what I want to say. Our asset management business – we are very excited about our ability to grow that business over time. That's a high-value revenue stream. WCO is a core channel where we would look to grow assets under management. We may look at others. As we said in the comments, we are very well positioned. So I think it was very positive and the timing was good that we had the performance fees kick in this quarter, which is a pretty good tribute to the quality and success we've had in that business and should make people comfortable that we can drive that business forward over time and grow that revenue stream, which is important to our future.

Mark O'Brien

Henry, one last point – you asked about the balance sheet and WCO's effect on it. I think the way to think about that and the way we think about it is it gives us significant optionality as we look at how our balance sheet will develop over time. And I think at the end of the day that's probably the most important aspect of our relationship with WCO.

Henry Coffey – Sterne, Agee & Leach, Inc.

Denmar, back to your point, with WCO I'm assuming then it can participate in a broader range of asset classes?

Denmar Dixon

Absolutely. So WCO – as you know, there's a bit of payer trade with what we are doing with Walter. But it is chartered and set up to do a very broad spread of assets – re-performing loans, non-performers, MH. And we fully intend to look at those not only in partnership with Walter on the purchase side but utilizing Green Tree's capabilities as a high-touch servicer to add value to assets like that. So I would fully expect that we would look to add assets to WCO that would be WCO-oriented but really derive value from Green Tree servicing away from Walter's balance sheet.

Henry Coffey – Sterne, Agee & Leach, Inc.

Great, thank you.

Operator

Our next question comes from the line of Mr. Brad Ball from Evercore. Sir, your line is open.

Brad Ball – Evercore Partners

Denmar, you commented on the $3 trillion to $4 trillion longer-term market opportunity. I wonder if you could comment on the nearer term. Last quarter you talked about the pipeline of $300 billion. You didn't update any commentary around that. Can you give us any color about the pipeline?

Denmar Dixon

Yes. So I think we just made a decision that quantitatively the pipeline hasn't moved around much. Qualitatively, it's as robust as it has been. We feel good about where the pipeline is and we feel, I think, very positive about how the market – as we said, we are starting to see some transactions accelerate in the market. And we think we will see flow pick up again from what has been a little bit of a lull. So I think, going forward, our thought is we will give you some qualitative color around the pipeline.

But given some of the difficulty in sizing certain transactions and all, it became less important, I think, to give a gross number. But, look, we are very excited about the market opportunity, the $3 trillion or $4 trillion of credit-sensitive assets. We have said we think $1 trillion or so trades over the next several years. We think we are very well positioned to get more than our fair market share of that. And we are excited about what we will be able to do. And that's existing opportunity.

We still think, legging into the future, that we will see opportunity from a return of the private label market or capital into the market. They will take, as is usually the case, we will probably come down, open the credit box some. And that's all servicing and assets that really fit our value-added model.

Brad Ball

Okay. Would you say that you feel more or less likely that deals will happen over the next couple of quarters versus this time last quarter? In other words, are you not giving specific $300 billion pipeline guidance because you don't think deals are going to happen as soon as you previously did?

Denmar Dixon

No, absolutely not. I think I feel more confident this quarter than last quarter that we will get deals done through the end of the year.

Brad Ball – Evercore Partners

Great. And then shifting to the commentary you made on the call and in the release about increased regulatory burdens, can you give us any framing of how much additional cost you are expecting? And just to clarify, in your guidance, low to midpoint of the range, are you including any additional legal and regulatory or litigation and regulatory costs like you did this quarter? So the $13.2 million, which I think you responded earlier is unusual and one-time – but do you expect that to be recurring in the second half? And is that in your guidance?

Gary Tillett

Yes. This is Gary. As we think about the regulatory compliance matters that we are dealing with as a matter of course, as the sector goes through, as we said before, being a high-touch servicer and all the changes that have happened in the last couple of years, including the standards that came in in January, and everything we have to do, we are continuously monitoring our processes, adding to those. And those costs are all being incurred and built into the numbers that we deliver, including as we think about the rest of the year in our guidance.

The matter that we called out in the 10-Q this time relates to things that we think are not the normal-course type items, some of the more significant matters as we work through the things that we disclosed in the balance sheet. So those are 2 different things.

So as continual developments happen, we may incur more costs. But the guidance would include what we think we are presently set to incur for the normal regulatory and compliance changes we're making.

Brad Ball – Evercore Partners

Okay, that's helpful. Thank you.

Operator

Our next question comes from the line of Mr. Mike Grondahl from Piper Jaffray. Sir, your line is open.

Mike Grondahl – Piper Jaffray & Co.

Thanks for taking my questions. The first one – the investment management area had that approximate $36 million gain. Most of it was performance fees as you liquidated a fund. Do you have other funds that are outstanding? And do we think about you guys going back into this business now?

Denmar Dixon

Yes. So, Mike, I think we do advise on some smaller funds. I think of those as more run rate fee than a performance catch-up fee like we had from the liquidation of most or certain of the assets in this recent fund. But WCO is the primary opportunity, if you will. We get a very fair market-based base fee for managing WCO. And we have a performance fee built into its operations also. So, as we increase our assets under management, principally through our advisory – our management position for WCO, we have an ability to build not only the base stream but to add performance fees.

So I think it's important that when you think about where we are focusing time and effort, the investment management business is, as I said, a high-value stream. We are really well positioned to source assets, price assets, execute transactions, high-touch management of those assets. And then we are coupled with, we think, the best high-touch specialty servicer in the business. That should allow us to attract money to manage and add to assets under management and drive not only base fees but performance fees over time if we are successful.

Mike Grondahl – Piper Jaffray & Co.

Okay. And then in your prepared remarks in the release you had talked about compliance and regulatory fees being higher. But those would be offset by efficiency gains, I think in the servicing business. Where are those gains coming from?

Gary Tillett

So what we said is we continue to incur ongoing legal and compliance costs as we modify our servicing procedures and change this development. I think we've said that those would be somewhat mitigated as we gain efficiency. And I think is portfolios mature and we work through and improve the performance of those portfolios, you just don't have as high a cost. You don't have as much labor costs, people cost, et cetera. You gain efficiencies over time.

Secondly, we are continuously increasing the technological impact we have with the servicing business. And that gives us efficiencies over time as well. So those 2 things continue to improve our processes. But I would say maturities of the portfolios is a big factor.

Mark O'Brien

Mike, one of the things that may differentiate us from some of our competitors is that we have continued to invest in compliance matters. But we are not starting from ground zero. Obviously, as new compliance requirements arise, we have some costs associated with implementing those. But we are not starting from a basis of zero. And that was largely driven by the fact that we are primarily a Fannie. Our book of businesses is, what, 85% or so Fannie Mae. So, we have had a lot of required protocols that we have had to comply with, over the last 2 or 3 years. So we continue to invest in this. So, our marginal investments are likely not as heavy as some others.

Mike Grondahl – Piper Jaffray & Co.

Okay. And then just lastly, for clarification, your adjusted EPS guidance of $5.25 to $6.25 – that incorporates the $1.86 for 2Q? Is that correct?

Gary Tillett

That's correct.

Mike Grondahl – Piper Jaffray & Co.

Okay. Thanks, guys.

Operator

Speakers, at this time we have no further questions. On to you.

Mark O'Brien

Seeing that there are no further questions, then we will truncate the call. And we thank everybody for their support. Thank you all. Good day.

Operator

Participants, the call has concluded. You may now disconnect. Thank you.

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Source: Walter Investment's (WAC) CEO Mark O'Brien on Q2 2014 Results - Earnings Call Transcript

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