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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good day ladies and gentlemen and thank you for standing by. Welcome to Mr. Cooper’s first quarter earnings call. At this time, all participants are in a listen-only mode. If anyone needs assistance during the conference, just press star and zero for an operator. Later we will have a question and answer session, and to participate on that section of the call, press star and one. Thank you.
Now it’s my pleasure to turn the call to Mr. Ken Posner.
Good morning and welcome to Mr. Cooper Group’s first quarter earnings call. My name is Ken Posner, and I’ve SVP of Strategic Planning and Investor Relations. With me today is Jay Bray, Chairman and CEO, and Chris Marshall, Vice Chairman and CFO.
Let me start by reminding you of a few things. First, we’ll be referring to slides that can be accessed on our Investor Relations webpage at investors.mrcoopergroup.com. Second, this call is being recorded. Third, during the call we may refer to non-GAAP measures which are reconciled to GAAP results in the appendix to the slide deck. Finally, during the call we may make forward-looking statements. You should understand that these statements could be affected by risk factors that we have identified in our 10-K and other SEC filings. Further, we’re not undertaking any commitment to update these statements if conditions change.
I’ll now turn the call over to Jay.
Thanks Ken, and good morning everyone. We had a busy first quarter at Mr. Cooper with strong operational momentum to report in each of our segments. Before I dive into the quarterly numbers, though, I’d like to put the results into some context.
As you know, Mr. Cooper is a market leader among non-bank servicers with a 10-year track record of almost 40% annual growth in our servicing portfolio. We believe that growth reflects several sources of competitive advantage which our team has worked tirelessly to develop, including industry-leading home ownership preservation through our loss mitigation expertise, robust home finance solutions for our customers and best-in-class recapture capabilities, a low-cost platform, a strong compliance record, and our uniquely customer-centric culture.
As you know, 2019 is a year of integration and investment for us, designed to position this world-class platform for strong profitability and continued growth. Our focus this year is on integrating three recent acquisitions: Assurant, Pacific Union, and Seterus, and completing Project Titan, our servicing transformation initiative. We expect this integration and investment to strengthen our competitive position in the marketplace and to put us on a path to higher and more sustainable investor returns.
Now let’s turn to Slide 5 and we’ll hit some highlights for the quarter. The decline in interest rates in the quarter helped us produce very strong results in the origination segment where EBT increased by more than four times to $45 million, up from $11 million in the fourth quarter. This strong result was driven by strong growth in lot volumes and more favorable capital market conditions which led to recovery in gain on sale margins. Also benefiting first quarter results was the first two months’ contribution from the Pacific Union acquisition, which closed on February 1. We told you last quarter that the integration was moving forward very smoothly, and I’m pleased with our excellent retention of clients and team members and that volumes and margins are coming in consistent with the guidance we shared last fall when we announced the deal.
Our direct to consumer channel posted extremely strong results and we believe is the best-in-class recapture platform. As you may recall, last fall we rolled out a suite of digital tools for our customers aimed at helping them evaluate the benefits of refinancing across a wide range of different products. We also implemented a sophisticated call routing system that sends customers scored with a high propensity to refinance to a specially trained sales and service team. The early data suggests we’re getting an impressive lift in conversion rates and reduction in marketing costs which over time should be additive to our already strong margins in our direct to consumer channel. This initiative is actually a key part of Project Titan, whose benefits should become more visible as we enter 2020.
Meanwhile, the servicing segment continued to produce strong results. Thanks to the Pacific Union and Seterus acquisitions, we grew the portfolio to $632 billion, significantly surpassing the full year 2019 growth target we shared last fall. I am especially proud of our servicing team for seamlessly boarding 440,000 new customers in the space of 35 days. This is an operational feat that I don’t think the industry has ever seen before and well beyond the reach of our competitors. I’d like to recognize Mike Rawls, our Head of Servicing, his leadership team and the hundreds of Mr. Cooper teammates who were involved in the on-boarding and are now taking care of these new customers.
While additional acquisitions are not a priority for us in the near term, should the right opportunity present itself down the road, you should have very strong confidence in our ability to execute.
Turning to Xome, earnings were limited due to the impact of the Assurant acquisition, but this quarter should be the trough as the integration is moving forward according to plan. During the quarter, we consolidated facilities, we did some right-sizing, we completed a large data migration and systems conversion which set us up for cost savings later in the year. Additionally, I’m pleased to announce we hired Terry Shaffer [ph] as CFO for Xome. Terry is a veteran finance executive with a track record of managing important data and technology-intensive functions at major institutions like Fifth Third and Bank of America, and I’m confident he’ll make a huge contribution to Xome. Welcome, Terry.
While the operational progress of the company was very strong in the quarter, we did incur a non-cash mark to market loss of $293 million which resulted in an overall loss of $2.05 per share. This mark was consistent with the overall rate environment and in line with our expectations. To give you a sense of how we view the recurring earnings power of the company, excluding the mark and other non-recurring items, our operating income would have been $36 million, equivalent to an ROTCE of 8.7%. As you know, we have a deferred tax asset which we expect to shield earnings for many years to come, and therefore I’d point out that on a pre-tax basis operating income would have been $48 million and ROTCE would have been 11.5%.
To wrap up, there’s a lot going on at Mr. Cooper and I’m very pleased with our operational progress during the quarter. At the same time, the first quarter was also a reminder that our business is cyclical and that interest rates are difficult to predict; but regardless of the environment, we believe that the most important thing we can do to position the company for the future is to focus on our core platform by organically generating new customers through originations, lowering costs, delivering a great customer experience and improving profitability.
On that note, I’ll turn it over to Chris. Chris?
Thanks Jay, and good morning everyone. Let’s start with a high level review of profitability on Slide 6. As Jay mentioned, we reported a net loss of $2.05 per share, largely driven by a mark to market of $293 million. As you know, we have an exposure to declining interest rates which we partially manage through our recapture and origination capabilities, as well as the use of excess spread financings and growth in our sub-servicing book. While those offsets continue to grow, they don’t cover our entire exposure. So far in the second quarter, mortgage rates have reversed part of this decline, and if they remain at this level we’d expect to recover some of that mark at the end of Q2.
Now if you’ll turn to the table on the right, you’ll see we’re estimating operating profitability at 8.7% ROTCE, so let me explain how we get there. Under acquisition accounting rules, there’s a 12-month period to refine initial purchase price accounting interest. We made a couple of adjustments in the first quarter, which you will see impacted goodwill and tangible book value, as well as earnings. One adjustment was related to the Day 1 valuation for our reverse portfolio under the WMIH merger, which we mentioned in our 10-K is remaining under review. This adjustment resulted in a $9 million cumulative effect to earnings in the quarter. The other adjustment related to the acquisition of Assurant, which included an earn-out and an associated contingent liability, and based on current calculations we’ve reduced the amount of that liability by $11 million.
In addition to these tow accounting items, we’re backing out $20 million in merger and integration charges related to the Pacific Union and Seterus acquisitions, and then a third adjustment relates to our MSR amortization policy which is based on original costs, so when we back out the mark to market, we’re leaving in $25 million [indiscernible] the difference between carrying value and cost, which makes our operating results more indicative of the underlying profitability. The last adjustment adds back intangible amortization. Now if you look through these items, you’d see that on an operating basis, net income was $36 million and ROTCE was 8.7%, which is a starting place from which to project the path for higher returns over time.
Turning to Slide 7, this is another presentation of pre-tax operating income organized by segment. In summary, I’ll comment that the story for the first quarter should be very simple and clear: a very strong rebound in origination earnings and strong and steady results out of servicing. Xome results continued to be pressured by the Assurant transition but should improve from this level as we complete systems integrations and reduce certain redundancies. I’ll also mention that we’ve included additional information in the appendix to this deck to help you understand the economics of the business at the segment level.
Now let’s talk about the servicing portfolio on Slide 8, which ended the quarter at $632 billion, which is driven by the Pacific Union and Seterus acquisitions. As Jay mentioned, the servicing team did a fantastic job boarding 440,000 new customers in 35 days, and I want to add my congratulations to all of my teammates involved in that accomplishment. You’ll note that the sub-servicing ratio jumped to 48% from 41% last quarter, but that’s not reflecting any change in strategy; rather, the MSR we acquired from Seterus initially boarded as a sub-servicing contract. We’ll take on the MSR asset later in the second quarter and you’ll see that reflected in next quarter’s ratios.
We also saw growth in our existing sub-servicing relationships, but those volumes will change over time as our clients buy and sell loans, and we expect to see sub-servicing levels slightly lower next quarter as the result of some planned client sales.
Let me comment on the replenishment rate during the quarter. Total run-off for the owned MSR portfolio was $9.9 billion. During the first quarter, originations of $5.7 billion were equivalent to a replenishment rate of 58%, and if you included the full quarter of Pacific Union’s production, the replenishment rate would have been 68%, which is up significantly from 47% in the year ago quarter. As you know, a higher replenishment ratio allows us to sustain the portfolio at a more attractive cost and bulk MSR acquisitions, which obviously has positive implications for improvements in profitability and cash flow.
Now with the portfolio at $632 billion, we’ve exceeded the growth targets we laid out for you last fall, and this may be the high water mark for UPB for the remainder of 2019 as our focus from here will be optimizing profitability. In 2020 and beyond, as we’ve mentioned previously, we’re planning for a sustained mid-single digit growth rate.
Now let’s turn to the servicing margin, which we’ve historically discussed excluding the full mark and Titan expenses, and on that basis it was 7.5 basis points in the quarter and 6.8 basis points with Titan expenses left in. We’re very pleased with this margin, which is in line with the guidance we shared with you last fall; however, I’d call out for you a $20 million benefit we earned during the quarter from the collapse of the securitization trust. We expect to see the servicing margin benefiting from various large transactions from time to time, largely related to recoveries and claim settlements, but as a general rule we plan for more modest levels than what you in the first quarter. Additionally, while CPRs were low in the first quarter, we expect them to increase from here, and therefore you should expect higher amortization going forward. As a result, we’re anticipating the servicing margin over the remainder of the year, excluding marks and Titan spending, to average out somewhere around 6 basis points.
Delinquencies were slightly higher in the quarter, but that was entirely due to the boarding of the Pacific Union and Seterus portfolios, which had higher delinquency rates. Excluding these acquisitions, our delinquencies would have continued to decline slightly. As the third largest servicer with nearly 4 million customers, we have very good insight into the health of the consumer, and for now our data points to delinquencies remaining stable at their current low levels.
Now let’s switch gears and talk about originations on Slide 10. As you know, the origination segment plays a key role in our business model because we originate new MSRs at a lower cost than buying MSRs in bulk transactions at market prices. Strong, efficient origination capabilities improve the company’s free cash flow and profitability, and is a key part of our strategy to improve returns. This quarter was a case in point with a four-fold increase in origination EBT to $45 million, and you’re seeing the benefit of two months’ worth of Pacific Union, which is delivering at or above the volume and margin targets we shared with you last fall when we announced the acquisition. As Jay mentioned, the integration is going extremely well.
Excluding Pacific Union, our volumes were down slightly, reflecting the lagging impact of last fall’s rate shock as well as normal seasonality. The origination margin rebounded to 70 basis points in the quarter, reflecting strong increase in lock volume and more favorable capital markets conditions, which led to improved gain on sale margins. So far in the second quarter, volumes and margins continue to look good.
Turning to Xome on Slide 11, you can see that results continue to reflect the impact of the AMS integration, but as Jay mentioned, there’s a lot of good operational momentum, which includes facilities consolidation, right-sizing, systems conversions, and additions to the leadership team. I’d also call out a $2 million cost in the quarter associated with a strategic planning review that won’t recur. As a result and with systems conversion remaining on current schedules, we’re feeling very good about Assurant reaching breakeven by year-end, if not a little before then.
Excluding the impact from AMS, Xome’s pre-tax income was roughly flat, reflecting seasonality and very low delinquencies. While Xome’s income is small right now, the unit has strong potential over time to contribute to the company’s overall profitability and cash flow and to do so in a way that acts as a natural hedge against higher delinquency environments without requiring the same levels of capital as servicing or originations. In this regard, Xome was an integral part of our plan to drive higher investor returns, but to make that happen, we’re well aware that we have a lot of disciplined execution remaining.
If you’ll turn to Slide 12, I’ll wrap up my comments by addressing leverage and cash flow. From a high level perspective, adjusted EBITDA as its defined in our debt covenants is a rough proxy for operating cash flow, as it reverses out several non-cash items such as fair value marks, amortization and depreciation, and nets out the cash cost of originating new MSRs. As you can see in the first chart, adjusted EBITDA increased strongly in the first quarter thanks to the improved origination profitability, and this led to a reduction in the debt to EBITDA ratio. On a long term basis, we believe the debt to EBITDA ratio of five times or less, which is where the company operated historically, is a level that will improve profitability and financial flexibility and leave us with some dry powder to take advantage of market dislocations, should they occur.
We expect the debt to EBITDA ratio to decline further over time as EBITDA grows, and you may be seeing us reducing debt when the board and the management team feel market conditions are favorable, but you may also see us building up cash and liquidity for a period of time which would offer us the optionality to weigh de-leveraging against other uses of cash.
With that, I’ll turn it back to Ken to wrap things up.
Thanks Chris. I’m going to ask our operator to start the Q&A session at this time.
[Operator instructions]
Our first question is from Bose George with KBW. Your line is open.
Hey guys, good morning. Can you remind us how much Project Titan expense is left for the remainder of the year, and also I can’t remember, have you mentioned what the integration expenses remaining are as well?
Yes, good morning, George. Titan spending is going to remain at about its current level, which was about $10 million in the quarter, through Q4. It may ramp down a little bit, but you should expect it to stay at these current levels.
Then I think the question was integration expense--Assurant, and I think--well, I’ll go through each of them. Assurant integration expense is about $8 million in the quarter, and that will drop off gradually as we get through the next two quarters and finish systems integration. I won’t try to give you exact guidance on that, but it will decline as each of the systems gets completed. Then with regard to the Seterus and Pacific Union acquisitions, I’m not sure I have the exact number, but I would guess that the remaining integration costs are about half of what they were this quarter. As you probably know, Seterus, we did that in two pieces. We initially boarded the loans as sub-servicing. We’ll actually close on the MSR purchase, so there will be some slight costs there, and then we still have a hold-over of certain personnel from Pacific Union that will continue into next quarter, so about half the level.
Okay, great. Thanks. In terms of the longer term profitability of Xome, is there a way to think about the timeline to get to even where you were before the Assurant acquisition, sort of the trajectory to get back there?
Well, if you think of Assurant--we’ve talked a lot about Assurant getting to breakeven, and we expect that to happen by the end of the year. As we’ve said, we feel actually better than we did last quarter about getting there maybe even sooner. If you were to remove the Assurant overhang, Xome’s profitability would still be a little bit lower than it was prior to the acquisition just because of the low delinquencies and headwinds. I’m not sure I want to give you exact guidance on a number, but you should see their profitability change significantly once we complete systems integration. I would think of it as largely flat with where we were before the integration, before adjusting for delinquency and volume changes.
I think there’s some momentum there, Bose. If you look at new clients, you look at--I think to Chris’ point, we’re a little ahead now on the integration itself, and we also are getting some tailwinds from rate environment, certainly helping a couple of the businesses, so I think the latter half of the year you’ll definitely see improvement.
Okay, thanks. Then just one on the--you know, the operating ROTCE that you guys broke out, obviously that makes sense. The way you show your servicing profitability, is there a plan to make that consistent as well since now one includes the $25 million and one excludes it?
I’m not sure we’re going to change that. The whole idea on isolating the fair value to cost is to try to show the underlying profitability of the platform based on where we buy things. That’s how we’ve presented it historically, so I don’t think we’re going to change that; but we’re hopefully providing enough information that you can make any adjustments on your own.
Absolutely. Great, thanks.
Thank you. Our next question comes from Mark Hammond with Bank of America High Yield. Your line is open.
Thanks, good morning Jay, Chris and Ken. I had two questions. The first, if you could walk through that Slide 25 that you included or introduced this quarter, and just walk me through what it means?
Slide 25? We’ve had a lot of questions about cash flow and specifically what amount of cash flow is required to maintain the portfolio at a steady state. We’ve gotten that from a number of people, so there’s actually two slides here - 25 and 26, and these are purely illustrative charts to try to give you an idea using this quarter and normalizing for non-recurring or non-cash charges to show you--again, using EBITDA. Slide 25 is a walk-through to give you an idea of what discretionary cash flow is, and then the following page gives you an idea on how much discretionary cash would be required to maintain the portfolio at its current level and current mix.
Effectively, Mark, if you look at what--we’re trying to present what additional cash we would need to maintain at a steady state. You can look at that on UPB or an economic basis. I think on an economic basis on 26, you’re effectively--if you look at the right-hand side of the page, we think we’re at 96% replenishment rate with the new MSRs we’re creating because you don’t really have a co-invest associated with that, so from an economic standpoint, that’s really what we’re trying to present on that page. The two--you have to kind of link the two pages together.
Yes, I do really like the introduction of them from the credit side. Then dovetailing with that and the potential cash flow generation of the company, what’s the time frame of getting to that target leverage that you put out, that five times?
There isn’t any specific time. I think we are just trying to remind people. That’s how we’ve always operated. There shouldn’t be any assumption that we have changed our target leverage ratio, and over the long term that’s where you should assume we will be. But hopefully what we’ve shown here is that we are generating cash flow at a healthy rate and I think our messaging was clear that we will communicate any specific plans to de-lever when and if we--you know, the board feels it’s appropriate to start paying down the debt. In the meantime, you should expect to see us allowing cash balances to build and beyond that, we wouldn’t comment on any specific schedule to pay down the debt.
You probably recall, Mark, prior to the merger we significantly reduced the debt to EBITDA ratio using free cash flow and repurchased over $600 million of debt, so I think we’ve got a track record of doing it. To Chris’ point, the timing is kind of to be determined.
Thanks. The last one is on that five times, is that net or gross of cash?
That would be gross of cash.
Okay, perfect. Thank you.
Thank you. Our next question comes from Kevin Barker with Piper Jaffray. Your line is open.
Good morning. First off, I’d like to say all the new disclosures that you put out there are extremely helpful. I think it’s a great step forward and I appreciate you putting them out there. Just to follow up on some of the leverage comments, do you have a goal for a debt to equity or debt to equity excluding the DTA? I understand you have a debt to EBITDA numbers and those are what the focus is from some of the rating agencies, but the tangible common equity ratio and the debt to equity ratio are important metrics for the GSEs and FHFA, so do you have any color there?
I’m not sure we’d offer any specific goals, Kevin. I have to apologize - I didn’t hear--I as having trouble hearing your exact question. I think what you’re asking is do we have additional metrics that are of interest to the GSEs?
Do you have a goal for a debt to equity , or debt to equity excluding the DTA?
No, we don’t have--we haven’t communicated and we don’t have any specific metric that we’re managing to for debt to equity excluding the DTA.
I think, Kevin, we run--obviously we’re well in excess of any GSEs or FHA [indiscernible] requirements. That’s very, very important to us, and Ken can lead the charge here, we’ve run sensitivity and stress case scenarios around that as well, so we feel very confident that we’ll be more than adequate for our partners there. But to Chris’ point, I don’t know that we set a specific target that we can talk about today.
Okay. I asked the question because the GSEs require a 6% tangible common equity ratio, and that’s in reference to that comment. In regards to the cash flow slide on Page 25, to follow up on some of those questions, what was the discretionary cash flow in 2018 compared to the $51 million that was disclosed in the first quarter of ’19?
I’m not sure I have that number in front of me, Kevin, but we’d be happy to walk through that with you after the call. That’d be easy enough to calculate.
Okay. Going back to your guidance on the 6 basis point average pre-tax operating margin in the servicing segment, is that in relation--is that apples to apples to the 7.5 basis points you disclosed in the first quarter or the 6.8 basis points?
No, it would be apples to apples to the 7.5 basis points. I think if you went back to last quarter, we said we thought overall servicing profitability would be somewhere about 6.5 basis points for the year, and so we are really just reinforcing that guidance. We knew we had the trust collapse in the first quarter - that benefit was about twice the level, it was $20 million of benefit. We generally average about $10 million a quarter from one-off items that tend to occur just about every quarter, so if we looked out for the next six or eight quarters, we’d have some transactions expected, so that’s one element.
The other element is CPRs were low in the quarter. We would expect them to rise a little bit next quarter, so that number 6 may be slightly different quarter to quarter, but I think that’s a good number for you to expect us to average over the balance of the year.
Yes, because the amortization expense was very, very low this quarter.
Right.
Do you have an expectation for amortization expense in the second quarter versus the--I believe it was $23 million this quarter?
We track CPRs and payoffs and every metric possible, so we do have numbers but they change as we go, so I’d rather not give you any guidance now because it may be materially different. But we do expect CPRs to rise maybe 200 basis points.
Okay, that’s fair. Then gain on sale improved significantly in the origination segment as interest rates declined through the quarter, and we saw the primary-secondary spread expand. Do you have an update on where gain on sale margins are running through April versus what you recorded in the first quarter?
Again, we track those daily. I’m not sure I have that, but we can talk to you about that offline. But more importantly, I would just say we feel very good about originations in the second quarter overall, not just gain on sale margins, volumes. Just about every metric looks very, very good. If you don’t mind, we’ll address that question after the call. I don’t have that data in front of me.
Kevin, if you look at originations in the first quarter, our funded volume was up I think overall 5%, the market was down 17% - now obviously, some of that is due to Pacific Union, and then our rate locks were up over 22%. We’re seeing, to Chris’ point, a lot of momentum in originations still, so feel good about that at the moment.
Do you expect the gain on sale margins in the first quarter to be sustained through the rest of the year?
Yes, I don’t think we’d want to make that forecast. That would be terrific if they are, but we wouldn’t be the ones to forecast that.
Okay, I’ll get back in the queue. Thank you for taking my questions.
Thank you. Our next question is from Doug Harter with Credit Suisse. Your line is open.
Thanks. Last quarter, you guys talked about starting to look at the possibility of hedging the MSR portfolio. Can you just give us any updated thoughts on where you are on that decision?
Nothing really has changed. We are taking a fresh look at the pros and cons of hedging, but you shouldn’t expect any change in our strategy, which has been to manage rate exposure through originations and expanding use of excess spread, and the growth in sub-servicing. You should expect us to constantly look at hedging, and we are--largely because I’ve just recently joined the company, I’m probably taking a more comprehensive look, but I don’t want anyone to read into it that there is a change afoot. So we’ll do that over time, this is something that we are planning to wrap up in the back half of the year, but don’t expect any change unless we--I guess if we are going to change, we’ll clearly communicate that to you.
Great. It looks like you guys added a little over $30 billion to the servicing balance beyond Pacific Union, Seterus in the quarter. Can you just give some additional detail as to what that looked like?
It was a mix. We bought about $14 billion in MSRs and picked up about $16 billion in UPB from existing sub-servicing customers, and I think we commented on the fact that we expect that some of that sub-servicing may drop a little bit in future quarters, but slightly. It was a mix of customers, there’s not any specific number, but just shows that there are good flows coming in across the board and there were a few opportunities for us to buy some pools that we thought were at good values.
Thank you, Chris.
Thank you. Our next question is from Giuliano Bologna with BTIG. Your line is open.
Hi, thanks for taking my questions. Starting off, [indiscernible] thinking about the cash question, the cash comments you made earlier in the call, should we think about any kind of upper bound in terms of the amount of cash that you’d want to hold on your balance sheet or leave undeployed?
No, I wouldn’t guide you to any number at this point. I think you should think of cash flow as something that is just part of the overall capital allocation decisions that the company makes, and I guess what we’re trying to make clear is we will probably see cash balances grow, but at the same time we will revisit that question along with the broader capital allocation discussion with our board each quarter. If something does change that’s material, we’ll let you know, but there’s not an exact number that we’re guiding you to expect.
I think you should think of it as not necessarily not deployed, because typically what we will do with excess cash is pay down operating debt throughout the quarter, so we’ll use that cash, if you will, to pay down advance lines, pay down origination lines, etc. so there will be some benefit from that, from a deployment standpoint.
That makes sense. Kind of extending on that point, in terms of deleveraging, you can obviously pull down on some of the operating debt on a quarterly basis, or intra-quarter How should we think about deleveraging as a whole? Would you rather take out maturities as they become due or buy back some debt in the market?
I’d rather not give you a specific plan there, because we will--we’re going to be opportunistic. It would all depend on what market conditions are. Obviously we do know what our maturity schedules are and we have to plan for those accordingly, but we want to not just retain but create additional optionality so that we can react to things that might happen in the market.
Historically if you look again back to the debt pay down prior to the merger, it was a combination. We paid down some maturities as well as opportunistically bought debt in the market.
That makes sense. Going back to the originations business, in terms of thinking about the cadence of volumes there, obviously the core business came down a little bit, but how should we think about the mix going forward in terms of the original core business versus the PacU contribution?
First of all, we said PacU has been performing as expected. I would just normalize that for three months and assume that what happened in the first quarter is a good proxy for what the mix should be going forward.
That makes sense. Thank you for answering my questions, I appreciate it.
Thank you. Our next question is from Henry Coffey with Wedbush Securities. Your line is open.
Good morning everyone, and again I’d like to add my thanks for the additional disclosure and the new template. A couple of questions, just to make sure we have those numbers right. I know some of this was covered, so. You have $20 million in merger related costs - that does not include Titan, or it does include Titan?
It does not.
Okay, and then--
That, Henry, was related to the Pacific Union, Seterus predominantly.
Okay, but--then the--yes, so that’s a fairly solid benchmark there, and the fair value amortization mark, that’s the--the technical term is change in fair value from realization of cash flows. Is that correct, that’s what that is, or is that something else?
Which number are you referring to, Henry?
The fair value amortization of $25 million.
That’s the difference between fair value and cost of the MSRs that paid down in the quarter.
Okay. It’s not confusing to me because I’ve see it this way forever, but your credit quality is getting better, your CPRs are going down, but because of the change in interest rates, you got hit with a pretty hefty mark. What should we expect going forward, given the fact that the fundamental performance of the MSRs seems to be very favorable?
Are you asking specifically about a mark, or are you--
Yes, what should we expect in terms of a--I think in terms of fundamental performance, it should be getting better, but in terms of fair value marks, is there anything that would result in a negative mark of this size again, or do you think that you pretty much adjusted to the current interest rate environment?
Well, the vast majority of the mark is rate related, so there’s no expectation for any other type of negative mark. If rates were to fall significantly, yes, we would see additional mark. Where we are so far this quarter, it looks like rates have come back. They’re maybe about a third of the way back from the decline we saw last quarter, and so if we were to end the quarter today, I’d say that’s a rough proxy for what we might see in terms of a reversal and a positive mark. But more importantly, I think you made the point earlier, what we’re seeing here is very healthy growth in our UPB even over and above the deals we announced. - we had $30 billion of growth in UPB and a nice mix of purchased and sub-servicing growth. Profitability - while we are saying profitability may normalize at a slightly lower level, we feel very good about profitability of the servicing platform and we think you should too. Originations, that was an incredibly strong quarter, but we feel very good about the second quarter and we feel although Xome is feeling the pressure of the Assurant integration, we feel pretty good about Xome coming back.
So overall, we think the company, while we don’t like having a big negative mark any more than anyone else, we think if you look past that, the company is positioned for very strong profitability in the future.
Just two more quick questions. Gain on sale margin improved from 0.5 to 0.7, or 20 basis points. Could you add a couple of--you know, another digit to that, because 0.5 is a pretty wide number, 0.7 is an equally potentially wide number in something that’s measured in basis points. It looks like it was a 20 basis point improvement, but I was wondering if we could put another digit into that.
I tell you what - we will track down a number and we’ll get to you right after the call.
Great. Then finally, a more complex question. In terms of your equity capital and your tangible book value, the DTA as a defining element, I’ve looked at it, I’ve come up with my own assumptions, but I’m an outsider looking in. Is there any risk that you might have to revalue that asset in lieu of your current outlook, or have you looked at all those factors and walked away and said, this is just a rock-hard asset, we don’t need to worry about someone changing it, we’re not--there’s no anxiety around this one?
I have no anxiety around this one. I would remind you, we’ve got a $300 million valuation allowance against our DTA. If anything, I think we have upside to recapture that.
All right, thank you very much.
Thank you. Our next question is from Sam McGovern with Credit Suisse. Your line is open.
Hey guys. In your prepared remarks, you commented that you may de-lever, you may take advantage of opportunities in the market. In the latter scenario, how should we think about how high you might take leverage and for how long, and how focused are you on maintaining your corporate credit ratings?
I think our corporate credit rating is important and I wouldn’t guide you to expect that we’re adding leverage. I think our message was clear that we intend to pay down our debt in a responsible way, but as opposed to giving a specific schedule, all we’re saying is our cash flow is healthy, we expect our profitability to grow and in turn our cash flow to continue to grow. If anything, what we’re saying is we just may allow our cash balances to build so that we have some optionality, as opposed to just calling debt early and paying it down. That’s just a clarification.
I 100% agree with that. I think you will not see additional corporate leverage, corporate debt leverage. We have no plans at all, and to Chris’ point, through operating earnings, cash flows, we will map out a plan to de-lever over time.
Perfect, thank you very much. I’ll pass the line.
Thank you. Ladies and gentlemen, as a reminder, to ask a question, just press star and one.
Our next question is from Dan Carroll with Inherent Group. Your line is open.
Hey guys, a couple quick questions. First similar to Henry’s question, on the deferred tax asset, it looks like it actually went up a little bit in the quarter. Is that partially because of a release of any valuation allowance, or was it something else? Within that, how much was that of gross NOL actually used on offsetting cash taxes?
Two, if you guys can just talk a little bit more - I know you have a chart in your deck about customer sat, but also the other non-financial measures you guys track, including employee engagement and regulatory compliance, just how you’re doing on those especially given everything that’s going on with the integrations. Thanks.
Let me start with regard to the DTA. That grew because we had both a GAAP and a taxable loss, so we didn’t use the DTA to avoid any cash taxes. I’d just go back and reiterate that the profitability of the company going forward looks very strong. That’s what we use to project the value of the DTA, so I’m not sure if I maybe was confusing on my earlier question, but that’s why the DTA grew, not related to any valuation release.
How would you have a taxable loss in the quarter if all the loss is from a write-down?
There are timing differences, right, in the MSR mark for tax purposes, and that’s really what drove the increase in the DTA. We can walk you through that offline in detail, but that’s really what drove it.
Sure, okay. [Indiscernible].
On the employee--look, I think our engagement levels have never been higher. We are actually in the month of May rolling out our next employee engagement survey, which is kind of the great places to work survey methodology, and ultimately our goal is to be a top 50 great places to work, and I think we’re on the path to do that. If you look at the priorities that our employees have communicated to us through the surveys from last year, we have addressed the top five items that they wanted to focus on, they’ll tell you, when I have breakfast with Jay, when we have town halls and we have employee engagement and interaction, it’s quite good, and we’re seeing that in turnover metrics, we’re seeing that again in engagement metrics, and I would expect the survey will be great, and I expect it will kind of lead us to the next items that we want to focus on.
On the customer side, same story - I mean, we’re seeing complaints are at an all-time low, we have a customer health index that we’ve worked a lot on, where we measure engagement from a digital standpoint, just overall engagement, those metrics are good. I think the first quarter, when you board that many customers, you’re obviously going to experience some longer call times, hold times, etc., and we expected that and we communicated that, frankly, to our customers. When you look at the underlying metrics, I think it’s very healthy and moving in the right direction.
Great, thanks guys.
Thank you. Our next question is from Kevin Barker with Piper Jaffray. Your line is open.
Just wanted to check up on Assurant. Was there a write-down of the acquisition and did that impact some of the profitability this quarter, and where did that come through?
It did, Kevin. It was--as part of the Assurant acquisition, there was an earn-out associated with that deal, and associated with that earn-out there was a contingent liability recorded. So just looking [indiscernible] the fair value of that, and based on our assumptions this quarter, we released $11 million of that contingent liability.
Okay.
If you back that out of Xome, there were also about $11 million of non-operating items in the quarter, so they sort of balance, but yes, that write-down directly impacted Xome.
Okay.
Kevin, back to your question on capital earlier, we can walk you through the math, and I think we’re today at 16% on the ratio that GSEs are looking for. I think we’ve got a lot of cushion there, but offline I can walk you through how that’s calculated.
Okay, that’s helpful. Then a follow-up on the Pacific Union acquisition, I believe they put out an 8-K earlier in the quarter where it appears they lost $32 million in 2018, which I believe includes $9 million of mark over the MSR - correct me if I’m wrong there. Could you just lay out the path to profitability at Pacific Union and what you’re doing in order to get Pacific Union to be profitable in 2019 versus what they reported in 2018?
Kevin, it’s Ken, I’ll take that question. You’re correct on Pacific Union’s 2018 result, but bear in mind a couple of things were going on there. First, they were in the process of downsizing and taking some charges, given the weak market conditions in 2018, and they got through that and restored profitability. Then additionally, their results include a mark to their MSR to conform to our pricing models, so that’s all done. So as we commented in that 8-K, they made a positive contribution to the origination segment EBD in the first quarter, so not to say there couldn’t be some more cost savings going forward, but they are now making a positive contribution.
You’re saying--
Yes, and as you would naturally expect, Kevin, there’s a lot of expense that’s been taken out from a corporate perspective, so that’s certainly a piece of it as well, as Ken alluded to.
So you’re saying they were profitable near the end of the year on a quarterly basis, and then the loss on the yearly basis was related to earlier in the year, and then you have additional operating expenses that you’re able to take out, is that right?
That’s right.
That’s correct.
Okay, all right. That’s all I had at this point, thanks.
Thank you. We have a follow-up from the line of Giuliano Bologna with BTIG. Your line is open.
Thank you for taking my follow-up. Just one quick question on the reverse book. How should we think about the run-off of that book and the capital associated with that book, and how fast that could be released as the reverse book runs down over time?
Well, let me see if I can give you a succinct answer. With reverse, part of the run-off you’re seeing goes back to the fourth quarter when we said we had a very high level of assignment activity, and as a result of that we had a significant benefit in the fourth quarter. I think year over year, we’re running off at about 30%, and I think that is probably a good number to assume going forward at that same level.
In terms of capital being released, I’m not sure I have a breakout that I could refer to. I’d be happy to follow up with you and talk in detail about it, but in terms of the run-off of the book, that’s what you should assume.
Thank you, I appreciate it. That was all for me. Thank you.
Thank you. This concludes our Q&A session for today. I would like to turn the call back to Kenneth Posner for his final remarks.
Thanks very much, Carmen. We look forward to following up with everybody and reporting in second quarter.
With that, ladies and gentlemen, we thank you for participating in today’s conference. This concludes the program and you may all disconnect. Have a wonderful day.