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Greetings and welcome to the Home Point Capital Fourth Quarter 2022 Financial Results Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Lesley Alli. Please go ahead.
Thank you, operator. Welcome to Home Point’s fourth quarter and fiscal year 2022 earnings call. Joining me this morning are Willie Newman, President and Chief Executive Officer; and Mark Elbaum, Chief Financial Officer. During our prepared remarks, we will be referring to a slide presentation, which is available in the Events section of the Home Point Investor Relations website.
Before we begin, I’d like to remind you, this call may include forward-looking statements, which do not guarantee future events or performance. Please refer to Home Point’s most recent SEC filings, including the company’s annual report on Form 10-K, filed for the year-end December 31, 2021, for factors which could cause actual results to differ materially from these statements. We maybe discussing certain non-GAAP measures on this call, which management believes are relevant in assessing the financial performance of the business. These non-GAAP measures are reconciled to the nearest GAAP figures in Home Point’s earnings release, which is available on the company’s website.
Now, I’d like to turn the call over to Willie Newman, President and Chief Executive Officer.
Thanks, Leslie, and good morning, everyone. During my prepared remarks, I'm going to discuss the mortgage environment, which presented as one of the most challenging years in history in 2022. I’ll also discuss the steps Home Point has taken to navigate this environment, as well as supporting our long-term sustainability, and our key areas of focus as we position ourselves for return to growth and profitability in 2023. After that, Mark will provide more details on our results for the fourth quarter and full year 2022, as well as some initial insight into the first quarter of 2023. We'll then open the call to take your questions. No doubt about it, 2022 was an incredibly challenging year for mortgage banking. The year was marked by multiple headwinds, including higher interest rates, low housing supply, and significant overcapacity, just to name a few. This ultimately resulted in extreme conditions for all market participants. These challenges have continued into 2023. With refinance transactions at all-time lows, seasonality has come back into our mortgage originations. As such, the first quarter of 2023 will likely be the low point in the current origination cycle. The good news is that the seasonality curve should slope upwards as we move into spring and summer. The MBA projects a 46% increase in origination volume in the second quarter of 2023 versus the first quarter, propelled by a seasonal increase in home purchase activity. At Home Point, we spent 2022 resetting the organization to both navigate through the current challenging environment, and as conditions improve, start to sustainably grow again. Our top priority has been to build and maintain a strong liquidity position. We have divested non-core businesses and sold non-core assets. We have maintained strong relationships with our leverage providers, and have ample access to additional liquidity. In addition to our focus on margin over volume, we've rebalanced our operating cashflow to best leverage the historically strong performance in our servicing portfolio.
In the second quarter of 2023, we expect to be operationally cashflow positive, which is a massive shift from our position in 2021 and 2022. This change in our cashflow dynamic is driven in large part by the historically strong performance in our servicing portfolio. This is driven by three factors, historically low prepayments, historically strong credit performance, and historically high levels of earnings on our servicing-related deposits. To give you an idea of the historical scope, prepayments are running at 3%, which is half of the historic floor level of 6%. Our servicing book is a critical input towards a path to profitability in 2023. We have also made extremely difficult decisions to reduce the size of our organization, including an additional reduction in force in early 2023. Our dramatically smaller cost profile is another other primary driver of our path back to profitability during 2023. Including all actions taken since the start of 2022, we have reduced our fixed expense base on an annualized basis by over $250 million. We have also expanded our efforts to reduce the overall size of our balance sheet, with the objective of having it be more reflective of our current size and operational scope. During the first half of 2023, we plan to largely complete these efforts, which will both enhance our liquidity through select asset sales and improve our operational performance. After all this hard work, we are finally prepared for sustainable growth as the seasonality curve ramps upward. All obtainable data indicates that the wholesale channel provides the greatest opportunity for origination's growth in 2023 and beyond. The systemic benefits created by the broker wholesale lender partnership are even more apparent in a challenging market, as we saw by the increased migration of retail loan originators in 2022. We are all wholesale all the time. So, what's the bottom line? We expect to be operationally cashflow positive starting in the second quarter of 2023, and we expect to be operationally profitable in the second half of 2023.
With that, I'd like to turn the call over to Mark.
Thanks Willie, and good morning, everyone. We've included in the presentation and earnings release, our standard period-over-period financial results. I'm going to focus my discussion on the steps we've taken to best position our company for a return to growth in 2023. We'll be happy to answer any questions you have regarding the financial results following our prepared remarks. Looking back at our financial results for the fourth quarter and year ended December 31, 2022, we effectively delivered on three primary objectives, maintaining a strong liquidity and leverage position, executing on expense reduction and efficiency initiatives, and improving our cashflow and earnings profile. As Willie mentioned, liquidity was our top priority in 2022. In the fourth quarter, we completed divestitures of non-strategic assets in Longbridge and the HPMAC asset management vehicle. We also sold approximately $6 billion of our Ginnie Mae MSR book. These actions resulted in a year ending available liquidity of $663 million, up from $569 million in Q3, a strong foundation to support our company for long-term growth. Moving forward, we will continue to opportunistically sell Ginnie Mae servicing rights, and strategically right-size our warehouse lines of credit to minimize associated costs and more efficiently operate in an increased interest rate environment.
On the expense side, in the fourth quarter of 2022, we further reduce quarterly expenses by 31% quarter-over-quarter, excluding the $13.4 million restructuring, and $10.8 million of goodwill impairment charges in the third quarter. Comparing Q4 of 2022 to Q4 of 2021, we reduced our expenses by 58.5%. As previously reported, we took cost-cutting measures that resulted in approximately 970 people exiting during the fourth quarter of 2022, reducing our year-end headcount countdown to approximately 830. Additional actions in the first quarter of 2023, further reduced headcount, which, taken together, will result in an annualized cost savings of approximately $80 million. In the first half of 2023, work continues on the expense side, as we review contracts and facilities for additional cost reductions to support the current size of the organization.
Speaking to our improved cashflow and earnings profile, our servicing segment earnings trended positively in the fourth quarter of 2022, generating an adjusted contribution margin of $33.3 million in the period. Our weighted average coupon on the servicing portfolio is 3.35% and 60-plus day delinquencies remain less than 1%, resulting in record low prepayment levels, which we continue to see thus far in Q1. As Willie mentioned earlier, we strategically prioritized margins over volume. Consequently, we produced total fourth quarter origination volume of $1.7 billion, and $27.7 billion in total volume for the full year. Gain on sale margins attributable to the channels before giving effect to the impact of capital markets and other activity, increased to 86 basis points in the fourth quarter of 2022, compared to 51 basis points in the previous quarter, and 58 basis points in the fourth quarter of 2021. The other loss on sale declined to $8.7 million from $17.4 million in Q3, as a result of more stable capital market spreads, lower charges to our inventory held for sale outside of agency execution, and declining provision for repurchase reserves. Reserves are based on historical production levels, and the margin is based on current production levels, so we do expect them to begin to align this year. Reiterating Willie's comments on our forward action plan and financial outlook, we view the proactive steps that our organization took in 2022 as necessary building blocks for a stronger performance in 2023. We were able to hit the mark on objectives related to cost reduction, liquidity enhancement, and cashflow improvement, and anticipate a return to strategic production growth in 2023, even in the midst of continued market pressures.
That concludes our prepared remarks for this morning. We are now ready to turn the call back to the operator to take your questions. Operator.
Thank you. [Operator Instructions] Our first question comes from Doug Harter with Credit Suisse. Please go ahead.
Thanks. Willie, on your comment that you would expect, I guess, what was it, cashflow, is it cashflow breakeven, cashflow positive in the second quarter? Can you just talk about what type of volumes you would expect in that environment and kind of how you would trade off kind of volumes versus cashflow in that scenario?
Sure, Doug. So, yes, I mean, as Mark talked about, we are kind of fixing into a certain margin level. It approximates what we had in the fourth quarter. We're trying to get a little bit more out of it based on what's happening in the market, and we're going to let volume kind of toggle. So, I think volumes in the first quarter will be lower than they were in the fourth quarter, and we would expect an increase from there. But I don't think, Mark, at this point, we have specific numbers on that.
We're not giving, yes, that level of forward guidance. But the point, Doug, would be that the earnings off of the servicing portfolio, are going to be pretty high and outweigh at that lower production level. While we think second quarter production will be higher than first quarter production, it's still going to be relatively low. And consequently, it burns a lot less cash. Couple that with the expense reduction moves that we make that will be fully baked in by the time we get to the second quarter, that's going to lead to cashflow positivity.
Got it. And just on the near-term margin environment, it seems like the competitive environment, a little bit of pullback from some of the competitive pressures. Are you seeing that in one - so far in the first quarter?
We are - we have more recently. So, I think the quarter started off pretty tight and it's kind of loosened up a little bit. So, because we're fixing more in margin, we're going to see a little bit more inflows. And so, our flows have increased certainly in March over what we saw in January and February.
Okay. Thank you.
Our next question comes from Mihir Bhatia with Bank of America. Please go ahead.
Hi. Good morning, and thank you for taking my question. I wanted to start with the 64 basis points headwind in the gain on sale, just trying to bridge the gap between reported and the channel gain on sale margin. You mentioned it briefly, but can you provide a little bit more color on what exactly is happening there? Why has it been so challenging in 2022, and how long does the timing impact you talked about take to rectify, if you will?
Yes, sure. So, we continue to have what I think we described in the past as a denominator problem. And what I mean by that is, the reserves and the provisions that we need to take for repurchase activity is based on a circa 12-month lag. So, if you look at our volumes 12 months ago, we were originating maybe $20 million or - well, I forget exactly how much, but a lot more than we're originating today, substantially more. And so, those are the reserves we're taking. And because of the way GAAP works, I look at margins based on current period production, which for this particular quarter was about $1.4 billion of total fallout adjusted locks. So, if you look into the details, you'll see that in the third quarter, we took provisions in other activity of about $17 million. This quarter, that number was down to about $8.7 million. But because I'm dividing it by such a small denominator, it puts a lot of pressure on that topline number. So, that's what's going on. The reality of it is that I expect that to normalize over time. If you're looking at a 12-month lag, it should start to normalize itself out by the second part of 2023, just as - because that tail starts to more closely replicate our current level of production. And in fact, that could even reverse itself as I start to see production grow as we come through seasonality into a more normalized market.
Right. And that's what gives us a greater degree of comfort that we’ll be operationally profitable in the second half, is that we expect those things to converge to the more normalized level, I guess the new normal as it relates to volume.
Got it. And then just going back to I think like Doug’s question just about how you get to be operationally cashflow positive in 2Q and then I guess profitable in 2H ’23, are the cost - on the cost side, do you feel like you have now taken all the actions? I think there's a little bit more of right sizing of lines it sounded like, but beyond that, like from a headcount or other cost savings perspective, are the actions now already been taken and now it's just a point of like you just wait as volumes come back a little bit, that's what gets you there? Or is it like you still have to do more stuff on the cost side?
Yes. At this point in the cycle, I don't think we're ever done with the cost side. So, we'll continue to be very focused on looking at everything that we're spending money on, how we're staffed to structure the organization, et cetera. What I would say is, like the very significant actions we've taken, it it's going to be smaller scope likely than what we've done previously. But we're still - we're going to be on it consistently. And we're - I would say though that we're not wholly dependent on that focus in order to get to operational profitability, but it certainly supports getting there, and maybe gives us a little bit of cushion in case there's variances in the market that are unforeseen at this point.
Got it. Thank you for taking my questions.
Our next question comes from Rick Shane with JPMorgan. Please go ahead.
Thanks, everybody, for taking my question or questions. First thing, obviously, one of the big factors in the fourth quarter was the significant decline in the comp expense. I'm curious, as we look towards ‘23, is that the run rate or is there a variable function there that as volumes pick up, we should anticipate?
Yes. So, here's how I would think of it, Rick. If you look at where we landed in the fourth quarter, take that number, and I had mentioned on the call that actions we took in the fourth quarter and additional actions we took in the first quarter, will result in a salary and benefit reduction of circa $80 million on an annualized basis. So, figure that's roughly $20 million a quarter. That should get fully baked by the time we get into the second quarter. And then, I would add maybe a 20 basis-point variable load to production. So, whatever your volume production is, it'll be 20 basis points on that. And that is probably a decent way for you to forecast your salary and benefits line.
Got it. So, and Mark, just to - so when we think about it, total expenses in the fourth quarter were $63 million. That annualizes to $250 million. You're saying there's $80 million of cost cuts from there, then add the 20 basis points of variable volume activity. Is that the runway?
Let's be careful with that. So, if we're at 63, and I'm just going to go quarterly, because that's how I think of it. If we're at 63, you can deduct 20 from that, okay? And that takes us to, let's call it 43. Already in that 63, a circa 20 basis points of variable cost on the $1.7 billion that we funded, okay? So, now take your model and assume plus or minus 1.7 and attach 20 basis points to that variance.
Got it. Okay. Very helpful. Thank you for walking me through that. The other question I have is, obviously as part of this, you have, in terms of both cost reduction and focus on margin, you have conceded substantial market share, probably cut your market share in half on a quarter-over-quarter basis, and could be down 80% on a year-over-year basis. Do you think that with the revised cost structure, you will be in a position to start regaining market share? Will that come to you naturally because of what's going on in the market? Or will you need to reinvest in the business in order to recapture some of that share going forward?
Yes. Hey, Rick, it’s Willie. So, we have been reinvesting in the business. We've been very focused on specific activities that will help us regain some of the market share that you referenced. We've also been able to preserve the significant majority of our coverage from a sales standpoint. And so, really that combination we think will result in - we'll get the natural growth from the seasonality curve, but additionally, we'll start to take market share from that the market - some of the market share back that we've conceded.
Got it. Okay. Hey, guys, I just want to acknowledge, I know that there's been a lot of hard work and a lot of hard decisions to get where you are, and it's going to be interesting to see how it plays out over the next year. Thank you, guys.
Our next question comes from Kevin Barker with Piper Sandler. Please go ahead.
Great, thank you. Just to follow up on the losses, were there other provisions you put up for reps and warrants due to higher interest rates? Can you give us - can you outline the level of reserves you have in place today? And then also, have you taken a significant amount of losses throughout 2022 just because of higher rates impacting reps and warrants?
Yes. So, Kevin, we’re - the answer is yes. We started 2022, we were able to trade our scratch and dent inventory in the circa 90 context, is where we started 2022. By the time we got to where we are now, that market’s trading around the mid-70s, low 70s. So, that's a source of a lot of the losses that we've taken, is just having to mark, not only the scratch and dent inventory down, but also the reserves for potential future repurchases. We had to increase the severity on that. So, that was the cause of a lot of the losses. Now, the good news, if you will, is that we're starting to see that market certainly bottom up, if not recover. And we're starting to see numbers that are closer to the mid-70s to high 70s. So, we feel at least that that's trending better. I think that's a combination of credit risk spreads tightening, and there's a fair amount of demand for the paper. Our scratch and debt inventory tends to be performing. It tends to have dock defects. So, if you think about a performing loan that you can buy at less than $0.80 on the dollar, that's a pretty nice yielding asset. And so, that's what we're seeing with our scratch and dent inventory. But that's a source of a lot of the losses that we've taken. The additional provisions that we took in the fourth quarter were quite a bit less than they had been in previous quarters, in part because, number one, we're starting to see that stabilization that I mentioned. And number two, we’re getting caught up in terms of the audits and the repurchase requests as well. The agencies are working their way through that. So, that's why I have reason to believe that as we move through 2023, we're going to start to see that relationship normalize relative to current production.
Yes, I think we answered the …
And the balance was about $26 million in reserves, and that's reserves against potential future repurchases that are not yet on our balance sheet.
Yes. The other thing that's happening, Kevin, is that the rate gap is narrowing because rates are obviously floating kind of high, but the repurchases, because of the lag Mark mentioned, we're kind of - not only are we getting the lag is kind of catching up to our lower level of production, it's also catching up to the higher rates for that lower level of production. So, you kind of have two or three positive trends in a - to kind of start to narrow what's been happening.
And then can you remind us how far back the agencies could look back for any loans that may have defects?
They could look back as long as three years, Kevin.
Okay. But typically, they have like an upfront review where - or some review in the beginning, right, to try to?
I mean, they typically review upfront and they try to do as much as they can. Post that, if the loan's performing and it's in a pool, it's not really in their interest to try to find loans to have us buy back. If the loan goes into default, that might be a different issue and they could certainly look at it at that point and buy it back. But most of the review happens with earlier fresher production, if you will, although they are behind. And so, we do have this one year lag, roughly.
Yes, which again, with our servicing performance, that's why we feel good about where we're at from a reserve standpoint.
Great. And so, that provision was, by my math, $8.7 million in the fourth quarter on $1.7 billion of production, which would imply what, roughly 51 basis points of headwind in the fourth quarter on the margin?
It does, yes. Except that if we were to do it on a vintage basis, that 8.7 would be applied to a much larger denominator, but that's just not the way the math works. And the way the math works is the way you described it.
Okay. And so, what was the average amount of basis points hit on gain on sale that you recorded in 2021 when rates were, I would say, less volatile or not persistently increasing like we saw? So, what I'm trying to get at is like, what is a normalized gain on sale that you would be producing right now, given the movement in provision?
Yes, I understand your question. So, on every loan that we originate, we have to put aside something for potential rep and warrant losses. In 2021, that number was circa two to three basis points. Now, that number looks more like between six and seven basis points on every new loan that we put up.
Yes. And I'd say normalized level is somewhere in between those two numbers.
I would agree. I would agree. The reason it's so much higher now is because I'm providing at around a low 70s number for severity that's probably not going to persist because we're going to have rates, and your current note rates and investor required rates for scratch and dents are going to converge.
Right.
Okay. So, in a benign interest rate environment, we should see absolute margins?
I would say in the 4-ish context. Yes.
Okay. All right. Thank you for taking my questions.
Our next question comes from Steven DeLaney with JMP Securities. Please go ahead.
Thanks. good morning, Willie, and Mark, congrats on all the progress you've made on expenses and the operational overall. Look, I was going to - Kevin did a good job on the gain on sale. I was going to kind of hit the same thing, so I'll move on to something else. You've targeted your Ginnie Maes as the MSR product that you're primarily trying to reduce. Is that due to just higher general operating costs to service, or does credit come into that as a big factor in why you're sticking with the GSEs, but moving away a bit from Ginnie?
Yes. Hey, Steve, it's Willie. So, it's actually both. I'd say in my experience, especially if you're not servicing the Ginnie Mae product yourself, and this is not to say anything bad about our servicing provider, it's just that we're one step removed from the action, and there tends to be hidden costs associated with Ginnie servicing, with the advances for non-performing, whether it's some of the dings that you take when you actually sell the servicing that you may not recognize as easily when you're holding the servicing. And so, all of that, and the fact that, as you know, we've sold a significant part of our Ginnie Mae previously, just led us to the point where to create liquidity and to make our servicing more predictive from a return and performance standpoint, it just made sense for us to sell the Ginnie.
Got it. That makes sense. Now, you saw your total UPB drop about $5 billion in the fourth quarter. Obviously, the pace of shrinkage and servicing has really slowed. Where do you see - is it - have you reached sort of a stabilization point, and just looking out over the balance of 2023 for year-end, would you expect your MSR UPB to be smaller than the $89 million or flat, or what’s kind of your outlook for the size of the servicing book?
It's going to be in that neighborhood, I think. So far, prepaids are extraordinarily slow, but so too is the amount - the level to which we're replenishing it, but I would expect us to be able to replenish a little bit faster than our speeds as we move through the cycle and get out of the seasonality period. But not substantial. I think 90-ish. We are going to continue to sell Ginnie, by the way. So, that's going to be a negative on that number. And we have a Ginnie sale teed up for closing on the second quarter. So, that's coming as well. But you can think of it being in that high 80s, 90 area.
Thanks, Mark. That's helpful. And one final quick thing, Willie. I realize this is premature. But in your - in this market, if you can do long range planning, I guess that's anything past next week, but like the board, when the decision was made to eliminate the smaller $0.04 dividend, are there any like benchmarks, and I'm thinking 2004, let's say, or whatever that point is, of accomplishment, of stability and where - conversations with the board, what timeframe should we think and investors think is realistic to have any expectation of the possible reinstatement of a cash dividend? Thanks. That's it for me.
Yes, no, thanks Steve. So, I think kind of first things first, for us, which is, let's stabilize the cashflow, get cashflow positive, and let's get the earnings positive. And then after we do that for a period of time, we'll consider other alternatives. I think right now, because we are creating liquidity, our primary focus is on, one, making sure the business is supported, which at this low level, there would've to be very significant shocks before we would suffer from a business standpoint. And then secondly is to pay down some of the debt that we have.
Got it. I can understand the debt. Thank you both for your comments.
[Operator instructions]. Our next question comes from Doug Harter with Credit Suisse. Please go ahead.
Thanks. Following up on that last comment about paying down debt, as you kind of return to operating cashflow positive, kind of how do you think about using your liquidity in order to pay down debt? Just kind of what are your thoughts around using that return to cashflow positivity?
Yes. So, Doug, as I mentioned, really our primary focus right now is in paying down our debt, especially our MSR line is based on short term rates and with the curve being where it is, that's gotten a lot more expensive than it was previously. So, really because we're in that position where we're generating cash, and we also have additional asset sales, as Mark mentioned. So, we're going to be able to make a meaningful reduction in that line over the next couple of quarters. So, that will be our area of focus.
And then I guess just how do you think about the MSR lines versus the unsecured debt, which obviously trades at a meaningful discount and being able to create some equity value by paying it down at a discount?
Yes, we certainly will consider that as well. Again, we want to first get to that operationally cashflow-positive point. So, we don't want to be too premature in committing the cash that we're generating into something that is based on that longer-term tenor on the debt. So, but it's certainly something that we've looked at and we will consider.
Got it. And then lastly for me, just kind of given the smaller size of the business, just how do you think about long-term kind of staying kind of staying independent versus possibly considering strategic alternatives and selling the business?
Well, I think, you have to be kind of cognizant of what's happening in the market, and we are a smaller footprint. We also have lots of liquidity that we're in the process of generating and have access to. So, we’re looking out and seeing what might make sense. And being a public company, we’re kind of open to having dialogue in either direction, but it is an environment where we do believe things will consolidate, and we kind of have our eyes open about that.
Okay. Thank you.
There are no further questions at this time. I would like to turn the floor back over to Willie Newman for closing comments. Please go ahead.
Yes, thanks. So, first of all, I really appreciate the questions and your interest in Home Point. With having the smaller footprint, sometimes we wonder how much interest we’ll have, but we do appreciate the questions and the intelligence of the questions. I do want to recognize Mark before we sign off, because everybody knows Mark's leaving the organization in a couple of weeks. And Mark came into our organization at a time when the business and the company were growing very rapidly, and at the same time we were doing this little thing called an IPO. And so, he had to learn kind of about who we were and what we were doing, at the same time he had to really be one of the leaders in taking us public. So, and he did both those things extremely well. And then he was faced with the challenging market that we've experienced over the last 18 months, and he's helped us navigate through in a way where now, again, we're looking at growth and opportunity. So, Mark, want to thank you, wish you the best in all your future endeavors, and you'll always be a friend of Home Point. So, and thanks, everybody, again for your interest.
This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.