Nationstar Mortgage Holdings' (NSM) CEO Jay Bray on Q1 2018 Results - Earnings Call Transcript

Nationstar Mortgage Holdings (NYSE:NSM) Q1 2018 Results Earnings Conference Call May 3, 2018 9:00 AM ET

Executives

Amar Patel - EVP and CFO

Jay Bray - Chairman and CEO

Analysts

Doug Harter - Credit Suisse

Bose George - KBW

Kevin Barker - Piper Jaffray

Operator

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the Nationstar Mortgage Holdings First Quarter 2018 Earnings Call. [Operator Instructions] And as a reminder, this conference is being recorded.

It is now my pleasure to turn the call to Mr. Amar Patel.

Amar Patel

Good morning everyone, and thank you for joining our first quarter 2018 earnings call. Before we get started, I would like to remind you that our quarterly press release and earnings supplement are available from the Shareholder Relations section of our website www.nationstarholdings.com.

In addition, we will make forward-looking statements during today's call that are subject to risk and uncertainties. Factors that may cause actual results to differ materially from expectations are detailed in our SEC filings; including the Form 8-K filed today containing our earnings release and quarterly supplement. Information about any non-GAAP financial measures referenced, including a reconciliation of those measures to GAAP measures can also be found in the earnings release and in the quarterly supplement available on the website.

I'd now like to turn the call over to Nationstar's Chairman and CEO, Jay Bray.

Jay Bray

Thanks Amar, and good morning everyone. Before discussing the quarter, I wanted to provide a brief overview of the company, as well as an update on our previously announced merger with WMIH. Nationstar is one-of-a-kind company with team members and a set of assets that are almost impossible to replicate. We have been the largest non-bank servicer for the past three years running and we are currently the third largest servicer in the United States.

We provide customer centric mortgage servicing solutions for over 3 million customers and earning fees on over 500 billion in loans. While servicing is the foundation of our business model, our origination segment replenishes our portfolio and allows us to gain new customers at attractive returns.

We ended the year as the 16th largest originator with 19 billion in funded volume over the last 12 months. [Technical Difficulty] services business which supports Nationstar and other third parties with a range of services including title, close, valuation and property preservation and inspection. Over the last year we have fulfilled over 414,000 services orders and sold over 11,000 properties. Our real estate platform has never been stronger and will enable us to thrive in the current environment.

Let's discuss the latest on the merger. As you know in February, we announced our agreement to merge with WMIH Corp and we are excited about the transaction. We firmly believe that this transaction creates value for all shareholders. The transaction provides near-term liquidity for those shareholders electing cash, while preserving long-term value for those electing stock.

Shareholders electing stock benefit from an increase in ownership of 14% and accretion to cash EPS of approximately 20% through the use of the net operating loss carry forward of WMIH. We will be a better positioned business with additional free cash flow created by the cash tax savings. We plan to utilize this increased cash flow for continued investments and deleveraging.

We've been working diligently on the change in control process including regulatory approvals. Today, we have received approval from over 80% of the 54 states and jurisdictions. Upon completion of the shareholder vote in mid-June in all regulatory approvals, we anticipate a third quarter close.

Now let’s look at the first quarter results. The company had a strong start to the year. We experienced improved revenue in servicing from reduced amortization, achieved profitability in our newly launched production channels, and expanded our third-party clients at Xome.

We reported GAAP net income of $160 million or $1.61 per diluted share and adjusted earnings of $44 million or $0.44 per diluted share. These results were driven largely by servicing which generated 5.5 basis points of adjusted profitability on a servicing portfolio of over $500 billion.

Originations earned $25 million adjusted pretax income and produced $5.1 billion in funded volume. Xome earned $14 million adjusted pretax income and sold over 2800 properties through the exchange business. We reentered the field services business at Xome and we look forward to developing this business over the course of 2018.

Now let’ move into the servicing. Servicing earned $69 million adjusted pretax income or 5.5 basis points in adjusted profitability. Our servicing portfolio ended with 500 billion and 3.2 million customers. We have built a self-sustaining platform that will benefit from rising interest rates.

As interest rates rise, prepayment speeds decline which increases the value of our portfolio and improves our financial results. In the first quarter, total revenue improved as a result of higher operational revenue and decreased amortization. The 13% amortization improvement stem from a reduction in prepayment speeds, net of recapture which declined 2 CPR from the prior quarter.

Over the first quarter expenses increased 5% driven by temporary increases in staffing costs to optimize advance recoveries. This allows us to shorten our collection timelines and reduce our financing costs while improving overall liquidity. We've demonstrated our platform and scale to take an additional - take on additional growth through more subservicing wins, organic replenishment and continued acquisitions.

While boarding activity is seasonally light in the first quarter, we have transfer schedule in the second half of the year that will help achieve growth in the portfolio by at least 5% or above 533 billion. As discussed last quarter, we continue to believe there is a long runway of opportunity to provide a differentiated customer experience with more efficient processes. Our project management office is already started identifying these initiatives. These projects are not all quick fixes and they will take time and investment to achieve. We will provide a more detailed update on these as we execute them.

A low prepayment environment and identified cost savings for 2018 will drive continued improvement in our results and allow us to achieve our stated target of six basis points of adjusted profitability.

Now let’s move into originations. Originations performed in line with our expectations in a challenging market environment. The segment delivered 25 million in adjusted pretax income on funded volume of $5.1 billion. The 30 year mortgage rate increased over 40 basis points during the quarter and the banks reported a 21% decline in origination volume quarter-over-quarter. This decline came in a bit worse than the 16% decrease in consensus forecast from MBA Fannie and Freddie and for us our volume was flat from the prior quarter. So a great result.

Correspondent volume increased 10% versus the prior quarter which accounted for the total revenue decline of 10% quarter-over-quarter. We continue to diversify our offerings. This past year we made investments to expand our purchase a new customer acquisition channels. These channels have already achieved profitability and we are thrilled that they are positioned to contribute to our overall results and growth efforts.

After interest rates moved significantly in the first quarter, we acted quickly and recalibrated the business to the current market environment. In March, we achieved $12 million adjusted pretax income for the month. We maintained our full year target of $140 million pretax income for 2018.

We will be able to drive further new customer growth through our latest customer tool which we call Home Intelligence. This was a new product launch and next I’d like to provide some detail around this exciting tool.

We are in a great position to help both new and existing customers improve their financial well-being by offering personalized debt consolidation solutions in a very simple and effective manner. Today, the U.S. consumer debt load is an all-time high. Many of our customers face financial stress as debt balances from credit card, auto or student loans continue to rise. However, the mortgage market remains extremely healthy. Home equity is at a record high and default rates are at record lows. Our own portfolio has over 400 billion in home equity or an average of 100,000 per customer.

As you can see on the slide, we were able to help Scott one of our customers achieve over $500 in monthly cash savings by utilizing the available [equity at Xome] [ph], refinancing his current mortgage and finding a significantly lower rate on homeowners insurance. This data-driven solution is called Home Intelligence and it's a tool to leverage what we know about our customers and matching them with the right product mix from our suite of solutions.

There are over 60 million outstanding mortgages in the United States and approximately 19 million of these consumers have a profile similar to Scott's. Substantial home equity, and high interest rate consumer debt where we could save them over $500 a month. This presents a significant opportunity to improve the financial situation of our customers, as well as significantly expand our customer base.

Home Intelligence will positively impact the financial situation for various homeowners and provide a powerful new customer acquisition channel for volume growth even in the current interest rate environment.

Now let’s move to Xome. This quarter Xome achieved $14 million in adjusted pretax income. While the origination market is down and delinquencies remain near all-time lows, Xome achieved 17% quarter-over-quarter earnings expansion primarily from third-party growth. Third-party volume accounted for 36% of total inflows and I think it's important to recognize third-party customers are replacing Nationstar volume.

This is an impressive achievement and I am extremely proud of the team. The exchange business sold over 2800 properties in the quarter, a 6% increase over the prior quarter. Despite a decline in foreclosure inventory, FHA's increasing volume and the growing adoption of auction by the GSEs and FHA suggest that Xome can continue to increase its market position as a large nationwide real estate service and technology provider.

Additionally, customers are consolidating their vendor footprint to high performers with national scale and expanding business with vendors who offer comprehensive solutions across the mortgage lifecycle. Xome is building on strong new business acquisition momentum. We executed six new third-party customer wins in the first quarter and we had a very active and attractive sales pipeline.

Xome did execute one strategic transaction during the quarter. In 2014 the company acquired real estate digital, a data provider and aggregator powering online real estate for Xome and many third parties. The first quarter adjustment of 8 million was related towards a strategic decision to sell RED’s non-core brokerage web hosting business.

Xome will retain the data side of RED. Xome has a proven track record of incubating, launching and expanding services. We recently began taking orders for our field service business which fulfills property preservation and inspection orders.

Last year Nationstar spent $185 million on field service orders with third parties and we plan to capture a significant portion of this revenue opportunity as the business ramps. We are targeting a $20 million earnings run rate in field services by the end of 2018.

In closing, this morning's first quarter results reflect our team's commitment to operational excellence and we are reaffirming our 2018 targets. As we look to 2018 and beyond, we do so from a position of financial and operational stream. We've achieved scale and efficiency, and we believe there is a compelling opportunity for a significant cost savings across the platform in the next two years while improving the customer experience.

Coupled with the benefits of a rising rate environment and enhanced free cash flow from the merger [Technical Difficulty] we will continue to build value for our shareholders over the long-term. 2018 is a defining year for our company and I would like to personally thank all of you for your partnership.

And now, I’d like to turn it over to the operator for Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question is from the line of Doug Harter from Credit Suisse. Your line is open.

Doug Harter

Jay, I was hoping you could put a little color behind the move from the profitability of servicing in the first quarter to the over six basis points for the year. How much of that is cost saves and how much of that's further amortization declines?

Amar Patel

I think the way to think about it's probably about 50-50, honestly. If you look the amortization that's - actually it’s probably three components. One is, the overall revenue as we sit today we actually are ahead of schedule we think from the overall pipeline and growing the portfolio, the 5% that we previously outlined. So I think revenue is call it third of it, I think a third of it is amortization and a third of it is expense cuts.

So, and I mean the amortization obviously the quarter was - came in a little better than expected from an amortization standpoint. The second quarter I think is in line with kind of how we thought about the quarter and then the expense saves, as we’ve talked about we have a number of initiatives underway so we feel good about that as well.

Doug Harter

And just on the boardings, are most of the boardings going kind of be backend loaded such that kind of the growth really happens in the third and fourth quarter or should we see some additional boardings in the second quarter?

Jay Bray

You’ll see more in the second then you saw in the first. Yes, you'll see the majority - I mean as we sit today you’ll probably see somewhere between 16 million and 20 million total additions in the second quarter probably close to 50 in the third and ramp down about 25 in the fourth.

So you'll see more in the second, third will be the biggest and then fourth will come in around that 25 billion as we sit today.

Operator

And our next question is from Bose George with KBW. Your line is open.

Bose George

Actually first just on the field services revenue at Xome, was there any of that in the first quarter and then can you just reiterate – sorry, that music wasn’t from me. Can you reiterate what you said about the annual revenue and EBITDA from the field services revenue once it’s fully ramped? And also I assume that’s fairly seasonal, so can you just sort of give us the breakout like how it falls on a quarterly basis roughly?

Amar Patel

First question first quarter no, there was zero revenue or EBITDA. I think when we exit the year we would expect that business to be at 20 billion EBITDA kind of run rate. And it's about 18% margin business call it Bose. And so…

Jay Bray

It’s about 110 million to 120 million in revenue.

Amar Patel

Yes, so 110 million to 120 million in revenue and I mean I think you’re right you will see some seasonality obviously slowing down in the first and the fourth and strongest in the second and third is that how we’re thinking about it.

Bose George

And then on the servicing sort of the pipeline for larger tractions, can you just talk about what you’re seeing out there on that front?

Jay Bray

I mean in the first quarter we acquired a couple of books in the smaller range call it 3 billion to 5 billion range. We're having a lot of success on the subservicing side partnering with previous partners and some new partners as well which of most of that will board in the third quarter.

And then the fourth we've got a couple of books, we think that we’ll be borne in as well. So it's a - as I said I’m pretty optimistic that we’ll continue to exceed kind of our year-end goal that we laid out. And I would say the overall supply is - I mean if you think about what's going on in the market it’s pretty consistent with what we thought would happen.

You’re seeing more supply coming to market from a variety of different players. I think it's the first step in what would ultimately may lead to industry consolidation. But you’re seeing originators selling some servicing now which we expected to happen. And so I think we’re pretty bullish about the pipeline and what's to come.

Bose George

And actually just one more in terms of the strategy on the consumer loan home equity loan product. How far along do you think you are - when do you think we could start seeing some traction with that business and are there other companies out there that are doing it successfully at the moment?

Jay Bray

Well I think, I mean interesting thing right and you’re probably seeing this in the overall marketplaces. The refinance segment of the market has moved towards debt consolidation or cash out. So you move from rate term to really debt consolidation. And even today it's probably close to 67% of our refi business.

So it's starting to happen and I think with the new app that we’re rolling out we’ll do that on a pilot kind of beta basis call it May/June-ish and then roll it out in a more meaningful way in the third quarter.

And we’re pretty bullish about it I think it's - in our mind there is a lot of people that talk about that consolidation. There's a lot of people that attack in different ways, but there's really not one place you can go to kind of truly understand the value of your home and Xome gives us all the assets we need to make that a very rich user experience. And then also be able to kind of take a look at the liability side of your balance sheet and help you figure out the best solution. And I think Home Intelligence is going to do that for not only our customers but new customers. And it may in our case not be a refinance, a debt consolidation refinance.

So, we’ll have other products that personal loan, second liens, homeowner insurance, I think what our goal is to put more money into our customer's pockets and I think this will do that. So you should expect more updates from us, call it on third quarter call is the way to think about it.

Operator

And our next question is from the line of Kevin Barker with Piper Jaffray. Your line is open.

Kevin Barker

Help us understand some of the mix shift between nonagency, agency and subservicing. Obviously agency, non-agency servicing tends to have or the capacity to have better margins in some of the other servicing. And then we’re obviously seeing a big mix shift towards a larger subservicing portfolio and a capital light model. Could you help us understand like the different profitability that you expect on a pretax basis between non-agency, agency and then subservicing as well.

Jay Bray

Amar you want to take the first piece of that and I can - I mean I think the way I think about it Kevin is, I mean you know this but our portfolio has changed dramatically right from a delinquency profile standpoint. So now we are, call it 97% less than 60 days delinquent and that in of itself, I mean if you look at the agency piece of that business it’s highly profitable right. I mean the margin on that is very strong.

And so I think the profitability between the private label and frankly the Fannie, Freddie and Ginnie has evolved and is pretty consistent now because you got such a clean book in your Fannie, Freddie and in Ginnie businesses.

And on the subservicing, I think - look we've always said we're going to be thoughtful in how we think about subservicing. And we’ve got arguably the best client in history of the world with USAA and we've added some other clients along the way and its performing as we expected.

It’s performing in that two to three basis point range and the margins are well above 20%. And so I think it's actually a great business that obviously requires no capital. So, I think the model is working kind of as we designed. I don’t know if Amar has to add anything to.

Amar Patel

Only thing I would add to that is on - so Jay talked about subservicing and profitability being the two to three basis points. MSR profitability can be certainly higher but requires capital investment. And the MSR profitability depend on how much leverage you put on to it can vary.

If you out no leverage on to it, it could be 10 to 12 basis points. And I think that is consistent like Jay said across the various investor types, agency, nonagency what the differentiator is the price. Because the dynamics could be different and the price for agency is higher than nonagency and that's what brings it to a common profitability.

Kevin Barker

You mentioned 10 to 12 basis points potential profitability, are you realizing that level of profitability within the agency and non-agency portfolios today?

Amar Patel

Well as I mentioned that is without any financing applied to it till invest anything like that. Obviously we've used a number of different capital structures for our own profitability. And so our overall is less because we applied core invest to that. So you take our MSR profitability which is north of 8 to 9 basis points along with our subservicing profitability that winds us to the 6 basis points, or 5.5 to 6 basis points profitability.

Kevin Barker

And so if that's running in the 8 or 9, and subservicing around 2 or 3 and continue to have this mix shift towards more subservicing in the capital like model which obviously is higher ROE given in this regard very little. Could you help us understand if the six basis points is sustainable going into 2019/2020 as you make this mix shift?

Jay Bray

Well we made the big shift really last year as our portfolio ended up being approximately 60% MSR and 40% subservicing. And given the boarding activity that we have outlined for this year, we expect that not really change that much. So with our current mix shift of additions that we're putting on with MSR and subservicing, we certainly believe that’s sustainable.

Amar Patel

And I think if you look at the profile of the portfolio today, there is still more cost to take out clearly and we have talked about that. And then just the overall performance and I think you’re going to continue to see default cost come down.

We have invested heavily there. We continue to invest heavily in the claims area et cetera to recover our money faster and I think there is opportunity for the default cost to continue to decline.

So I think between kind of maintaining our mix where we are at today, I think with the cost initiatives that we have and frankly I think with default cost continuing to come down both from an efficiency standpoint and from a performance standpoint, I think we feel good about the coming years and the overall profitability that we outlined.

Kevin Barker

And then in regards to the corporate segment we saw a pretty big drop in expenses, and you are guiding to further expenses. Can you just detail what is the main drivers of that, and whether the current rate will sustain itself or decline as we move through 2018.

Amar Patel

We targeted a $30 million reduction year-over-year and we’re off to a great start in Q1 given the fact that we've got a $9 million reduction for the quarter. We think the overall corporate expense will pick up there over the course of the year, but we feel comfortable in achieving the $30 million target.

Now that reduction has caused by few things. We have been buying back debt along the way last year and this year, and we will reduce our overall corporate debt expense that’s about half there, and the other half is overall the efficiencies we are gaining in the corporate segments for consolidating some of the functions that we had previously and that was the large pick-up that we saw in Q1.

Operator

Thank you. And ladies and gentleman this concludes our Q&A session and program for today. Thank you for participating. You may all disconnect. Have a wonderful day.