Mr Cooper Group Inc (COOP) 2022 Q2 法說會逐字稿

Good day, and thank you for standing by. Welcome to Mr. Cooper Group Q2 2022 Earnings Conference Call. (Operator Instructions) Please be advised that today's conference is being recorded.

I would now like to hand the conference over to your speaker today, Kenneth Posner. You may begin.

Good morning, and welcome to Mr. Cooper Group's second quarter earnings call. My name is Ken Posner and I'm SVP of Strategic Planning and Investor Relations. With me today are Jay Bray, Chairman and CEO; Chris Marshall, Vice Chairman and President; and Jaime Gow, Executive Vice President and CFO. As a quick reminder, this call is being recorded. Also, you can find the slides on our Investor Relations webpage at investors.mrcoopergroup.com.

During the call, we may refer to non-GAAP measures, which are reconciled to GAAP results in the appendix to the slide deck. Also, we may make forward-looking statements, which you should understand could be affected by risk factors that we've identified in our 10-K and other SEC filings. We are 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, and welcome to our call. I'll start with the quarter's highlights, and then I'll spend a minute on how we're positioned to deal with the current cycle and possibly a recessionary environment, which obviously is the concern on everyone's mind right now. And after me, Chris and Jaime will take you through operations and the balance sheet as we always do, and then we'll take your questions.

So let's start on Slide 3. And in summary, I'll say the quarter was consistent with our expectations and the guidance we shared in May, and then our results demonstrated the consistency and predictability of our business model. We generated $151 million in net income, thanks largely to a positive mark on our MSR portfolio. Strong net income drove tangible book value per share to $54.51 which is up 46% year-over-year, and that's certainly performance we're quite pleased with.

Strong net income also drove our capital ratio above 30%, which puts us in a phenomenal position. The servicing segment earned $30 million in pretax income, up from $7 million last quarter, driven by the rise in interest rates as we guided you to expect. Based largely on the forward curve as well as continuous incremental operating efficiencies, we're now projecting servicing pretax income at or above $125 million in the fourth quarter. The steep ramp in servicing income is a huge benefit in this transitional environment given the obvious pressure on originations. This is exactly the reason we operate with a balanced business model, and it is a major differentiator for Mr. Cooper.

In terms of growth, the servicing portfolio exceeded $800 billion, and it's exciting to be making progress towards our $1 trillion target. But you'll notice the growth was a little slower this quarter, and that's because we used more cash for stock repurchase. In fact, we bought back $100 million in shares this quarter, almost 3x the level of the first quarter, which shows you how we're constantly thinking about capital allocation and where we can get the best possible returns. You will probably see us continue growing at a modest pace for the next few quarters as we watch to see if more stress develops in the mortgage market.

Now turning to originations. Pretax income was $63 million, which was slightly ahead of guidance. Last quarter, we made the difficult and necessary decision to reduce capacity, and we tried to do that in a manner that was figure and transparent. Having taken those steps, we're now appropriately aligned with the current level of demand and are continuing to produce new loans with solid margins. I'd like to compliment the originations team for implementing the necessary changes quickly and without sacrificing focus on our customers. As a result, we hit the strategic target we set last year of 60% refi recapture and then we passed it in July to 68%.

Finally, I'll mention some results that don't show up on our income statement, but are just as important as those that do. This quarter, we were proud to be certified as a Great Place to Work for the fourth consecutive year and with world-class team member engagement I might add. In addition, just last month, Fortune Magazine named us as one of the best places to work in Texas. And finally, and actually, just yesterday, Forbes Magazine named us as one of the best employers for women. I'm extremely proud of this recognition because it demonstrates the core element of our business philosophy, which is that we can best serve customers by providing a purposeful, inclusive environment for our team members. So let me pause here to say thank you to every single team member at Mr. Cooper for your contribution to the company's results.

Now let's turn to Slide 4 and talk about our track record, especially in the context of concerns about a possible recession. You know that today, Mr. Cooper is the largest nonbank servicer. But for those of you who weren't following us during the last financial crisis, I'd point out this was a time when our portfolio growth really started to take off. All of our stakeholders, our investors, the agencies, the regulators recognized us as the platform to help homeowners. With their support and approval, we took on very large distressed portfolios from some of the leading banks. We consistently demonstrated that we had the operational skills to work with our customers who are struggling with financial hardships and help them whenever possible to stay in their homes. We saved millions of borrowers from going into foreclosure, and we saved investors and agencies hundreds of millions of losses. Consistently during this period, we cured delinquent loans at a much faster pace than the rest of the industry, which is again the best possible outcome for both borrowers and investors. And of course, it allowed us to significantly expand our business.

It was also during this time that we began building our Xome Auction Exchange with the goal of improving and streamlining the foreclosure process. In my view, there's not another mortgage company with as much experience as Mr. Cooper. In a severe recession, I'd expect to see a shakeout among servicers who don't have our capabilities, and I believe that would lead to new growth opportunities for us just like you saw after the last crisis.

Clearly, I'm very proud of our track record. But now let's turn to Slide 5 and talk about how we're positioned today and how we expect to deal with the obvious issues that may emerge in the future. To start with, in addition to our unmatched level of experience, today, we have the industry's most efficient servicing platform due to the large investments we've made to develop and expand our best-in-class technology. The investments we've made in automation and digital tools means that whatever the next cycle looks like, we'll be able to manage through it much faster and with significantly less cost than we did in the past. For example, following the enactment of the Cares Act, you saw us roll out digital self-service tools within days. These tools enable borrowers to initiate and manage a forbearance plan with ease. Then using our automated modification system, we helped almost 0.5 million borrowers exit forbearance and return their loans to current status. At the same time, we improved our overall efficiency and widened our cost advantage over peers, as Chris will show you in a moment.

Now let's talk about subservicing, which I'd remind you represents 51% of our portfolio. In a recessionary environment, we expect our subservicing margins to remain stable or even increase slightly because our contracts include incentive fees based on delinquency status, and our costs are very efficient. Also, we've launched a new specialty default servicer called RightPath, which we recently acquired. The timing of this move wasn't accidental. If we go into a recession, special servicing expertise and capacity will be another big differentiator for servicers. As you know, we have a process underway to monetize our Xome Auction Exchange, which is a high-margin digital franchise that sells foreclosed properties. We'd expect the recessionary environment to drive higher volumes and earnings for the exchange and potentially result in a higher valuation.

And finally, as Jaime will take you through, our capital and liquidity is rock solid. A strong balance sheet makes us the partner of choice and positions us to exploit dislocations in the market should they occur.

And with that, I'll turn the call over to Chris.

Okay. Thanks, Jay, and good morning, everyone. So let's turn to Slide 6, and I'll start with the servicing portfolio, where total UPB ended the quarter at $804 billion, which represents the mortgages of 3.9 million customers. As you can see, the portfolio is up 23% year-over-year. But as Jay mentioned, we intentionally slowed the pace of growth in the second quarter in order to allocate more cash to stock repurchase, which resulted in fewer bulk acquisitions this quarter. Now in terms of our $1 trillion UPB target, frankly, we're running well ahead of plan. So we're a little more inclined at this point to be more patient, more opportunistic, especially given the uncertainties surrounding the economy. But we remain very active in the market. And right now, we're focused on a small number of bulk deals, which we believe would provide the opportunity for very attractive returns.

Jay also mentioned RightPath, our recently acquired default servicing arm, which included $20 billion in subservicing UPB. And I'm going to talk more about RightPath in just a minute. But first, I'd like to draw your attention to a transaction in which we sold $15 billion in owned UPB to an investor with whom we have a close relationship and with whom we entered into now a broad subservicing and recapture agreement. Now that transaction pushed our mix of owned to subservice back down to about 49% and provided us with additional liquidity to pursue other opportunities. Now I'm pointing this out because it's a great example of the flexibility we have with our business model, which is to pivot to a more asset-light strategy when that makes sense, which allows us to keep growing our customer base and our operational scale without employing as much cash.

Now let's turn to Slide 7. Let's talk about servicing income, which is starting to ramp very quickly. During the quarter, servicing generated $30 million in pretax income, which was right in line with our expectations and which was up from $7 million in the prior quarter as we're just starting to see the benefits of higher interest rates. In the third quarter, you should expect servicing income to at least double from the second quarter. And in the fourth quarter, we expect that it's going to double again, reaching somewhere around $125 million or more, which should set us up for a very robust earnings and cash flow as we head into 2023. And this projection doesn't really require much imagination since it's, for the most part, simply a function of lower CPRs, the forward curve and the benefits of process optimization, and lower amortization of loan should equate to roughly $175 million per year in higher operating earnings on an annual basis.

So to sum this up, this slide shows you the importance of our balanced business model, which provides us with solid earnings and cash flow during periods when the originations market is under pressure as it obviously is now. Now just to state the obvious, this is a huge competitive differentiator for Mr. Cooper since as you know, most of our peers are more concentrated in originations.

Now let's shift our focus from interest rates to operational expense, which is something we can control and which lies right at the heart of our strategic thinking. If you'll turn to Slide 8, I think you'll see that there's a very good story here. The upper left chart gives you some historical perspective. Looking at operational expenses in basis points of the portfolio, you can see we've driven a 39% reduction since 2018, which, as you recall, was when we completed the merger with WMIH. Now for some extra perspective, you can compare our cost to serve using the NBA pure survey, which is the chart on the lower left. And as you can see, we've widened our cost advantage from 15% below the peer average to 30%. And it wouldn't surprise you since we've just recently completed our transaction with Sagent, that the main driver of lower costs has been our cloud-native servicing technology, which is state-of-the-art and best-in-class. And the chart in the lower right shows you the significant increase in loans per FTE we're able to handle, given the functionality and scalability of those systems.

Now turning to the upper right, let's zero in on the last 5 quarters. Now there's been obviously some quarter-to-quarter variability with some favorable accruals in the first quarter and an increase in expenses in the second quarter, which, by the way, reflected the additional headcount we added as part of the RightPath acquisition. But in total, what you're seeing is 12% growth year-over-year in expenses versus 23% growth in UPB, which I think you all agree is a pretty good example of positive operating leverage. Now I don't want to guide you to expect the same pace every quarter, but we have set a long-term strategic target for operating expenses that is significantly lower than where we are today.

So let's talk about how we're going to get there. As part of our strategic planning process, we've identified a series of work streams to drive further significant operational efficiencies. These include rolling out more digital self-serve functionality, improving our online content, driving much higher IVR containment and digital engagement and streamlining our processes for key areas like payments and escrow. Also, we're improving our Six Sigma discipline with the goal of further reducing errors and rework. And as an aside, I'd stress that none of this is coming at the expense of the customer experience. To the contrary, most of these initiatives will drive both efficiency gains and produce a more personalized, friction-free experience for our customers. And over time, you should see not only lower expenses, but an upward trend in customer satisfaction metrics as well.

So to sum up this slide, cost leadership is a central element of our strategy. And as we make more progress with costs, we're going to drive higher returns, we're going to deepen our competitive moat and we're going to cement our position as the dominant residential mortgage servicer in the United States.

Now Slide 9 gives you some more information on RightPath Servicing, which I think, as you all know, is a specialty servicer with a focus on high touch or severely delinquent loans and a very impressive 25-year track record. We acquired this business in the second quarter, together with an excellent leadership team and existing subservicing relationships with several large sophisticated investors. Now notwithstanding our own very deep experience, we are very impressed with the tools and capabilities of this platform, including some very interesting work they've done with machine learning techniques to optimize customer engagement, drive very high modification conversion and cure rates and reduced recidivism while improving customer satisfaction. We're currently integrating RightPath on to Mr. Cooper's platform, and then we're going to take them out to market as part of our existing subservicing capabilities. as well as a stand-alone option for investors whose current servicers may not have the capability to manage high touch loans. Now if we do experience recessionary conditions as many of you expect, there will be a very strong demand for RightPath. But even if the credit cycle is less severe, we think there's an opportunity to expand our capacity and market share.

Now let's turn to Slide 10 and discuss the originations segment, which produced results basically in line with our expectations. Pretax income for the second quarter was $63 million on funded volume of $7.8 billion. Now you will notice the margin was down to 103 basis points, but that was due strictly to mix shift as the ratio corresponded to DTC increased in the quarter. Obviously, this is well below the profits we generated in 2020 and 2021. But I think the good news is that we've pretty much gotten our capacity in line with current market conditions. And so as long as we don't see further swings in rates or a real deterioration in economic conditions, this should be our new run rate for the foreseeable future at, let's say, plus or minus $50 million of pretax income. Now you all know that adjusting capacity is one of the key challenges in running our originations platform and the big swings in demand make it especially difficult to sustain the pace of investment and innovation that's needed to continuously evolve.

So let's turn to Slide 11, and let's talk about how we're continuously improving our DTC platform. As you'd expect, our primary focus right now are on projects that drive efficiencies and reduce cost to originate, like Project Flash, which you've heard us talk a lot about on past calls. As a reminder, Flash involves automating what we call the middle office of originations, and it includes not only digitizing various fulfillment-related tasks, which used to be performed manually, but also using autonomous assistance to optimize workflow and to allocate tasks to specialize low-cost resources.

As you can see from the chart on the left, we've steadily increased the percentage of loans that are processed through Flash, from 14% of total fundings a year ago to 57% today, and our team expects to hit 70% by year-end. This is critically important because Flash has already driven a very meaningful 18% reduction in the total cost to originate for our DTC channel. And if you think about gain on sale and EBT margins, that's a very important efficiency gain, which will help us sustain margins during this difficult part of the cycle. And efficiency per se is not the only benefit that comes from Flash as we're creating a faster and a more consistent experience for our customers, which is lifting our satisfaction metrics. Finally, Flash is vastly more scalable than our legacy processes. So you should expect that when the originations market improves, whenever that may be, we'll be in an excellent position to ramp up volumes and maximize our margins.

In addition to Flash, we've been working to optimize several customer-facing processes with the goal of improving response times. These include improvements in some basic functionalities like rolling out much more sophisticated text and chat capabilities and improving our online application technology, all of which are driving a better digital experience for our customers and our team members. Now if you're wondering if these investments are paying off, you can turn to the right side of the page, where you'll see some of our most important KPIs. First, as Jay mentioned, we hit our strategic target of 60% refi recapture, which we established a year ago, and we kept improving in July when we hit 68%. For customers with whom we have a retail relationship, meaning borrowers who have already gone through a transaction with us, recapture is now 92%, which is best in class. So we have a very good reason to think we're as good as, if not better, than anyone in this industry.

Now I'd like to talk about purchase recapture, which historically wasn't the focus because it requires a very different sales process. But it's something we started working on about a year ago when the rig was only about 2%. As you can see from the second chart on the right, we're making slow but steady progress, and we're very pleased to be now running at about 7.2%. Now this isn't a level of brag about as many of our peers have distributed branch networks report much higher numbers. But for a centralized DTC platform, it's a meaningful first step and importantly equates to about $500 million in funded volumes per quarter, which is material for us. We're going to update you from time to time on purchase as we get closer to our near-term target of 15%. But the more important point here is that our DTC platform can be adapted to a variety of different products and approaches, and it provides optionality for us in new channels such as organic new customer acquisition and white label partnerships.

And finally, I'd mention that our cash outperformance is excellent, accounting for 81% of DTC volumes, which shouldn't be a surprise given our long history with this product, as well as the special technology we've developed and a huge amount of equity available to our customers. It may interest you to know that during the second quarter, our cashout customers had on average $140,000 in equity and $60,000 in consumer debt, which should give you a sense of the opportunity we have here.

Now if you'll turn to Slide 12, I'll share an update on Xome. During the second quarter, Xome was roughly breakeven, which was right in line with our guidance. Another positive was the growth in our inventories, which reached a new high, and we continue to see the business on track for 40% market share by year-end. Now having made these points, we're still experiencing some variability with inflows as servicers continue to take a very cautious stance relative to regulatory guidance, which is something we've talked about in recent calls. As you may have heard during April, the government mandated a 60-day pause for borrowers seeking additional assistance, which led to an overall slowdown in foreclosure activity. However, in July, with that 60-day period having expired, our inflows are now running at nearly 2x the level they were in June.

We continue to monitor the backlog of delinquent customers coming out of the pandemic. According to the latest FHA data, there were 309,000 borrowers who are 90 days or more delinquent with many still on forbearance plans that will soon expire. As we get closer to year-end, we'd expect to see a much faster rate of migration to foreclosure status. To put this data in perspective, so far, there are only 46,000 FHA foreclosures in process, which is less than half of what we'd expect in a normalized market to say nothing about what we'd expect during the recession.

Now with that, I'll turn it over to Jaime, who's going to take you through the financials.

Thanks, Chris, and good morning, everyone. If you turn to Slide 13, I'll start with a brief recap of our results. As you heard, net income was $151 million, which included a positive MSR mark of $196 million, $17 million in operating earnings and adjustments totaling $7 million. Adjustments consisted of $3 million in severance charges, $3 million in transaction costs related to the RightPath acquisition and $1 million in facility consolidation. Additionally, you may have noted that our corporate expenses were a little elevated in the quarter. This was driven by approximately $5 million in onetime items that we do not expect to reoccur. Our weighted average diluted share count declined from 76.6 million to 74.3 million shares, and we ended the quarter at 71.7 million shares outstanding, reflecting the impact of stock repurchases. Our remaining authorization now stands at $117 million.

Now turning our focus to return on equity. In the past, you've heard us talk about a range of operating returns between 12% and 20%, that we'd expect to operate in this range during most parts of the cycle. Obviously, this time last year, we were well above this range, just as we are below it now. The message I'd like to leave you with is that we have passed through the trough. From here, operating returns should start to build back towards that target range. Now how quickly we get back above 12% will depend on the pace at which we utilize our excess capital for growth or return it to investors.

Now let's turn to Slide 14 and talk about tangible book value per share, which we believe is an important valuation measure for our stock. Thanks to strong net income, TBV was $54.51 per share, up 46% year-over-year. This was driven primarily by operating income and positive MSR marks demonstrating the power of our balanced business model. In addition, over the last year, we've opportunistically repurchased 15.4 million shares for $587 million. To date, we retired 24% of our common shares through our stock repurchase program. I'd also like to point out that we utilized $44 million of our deferred tax asset in the quarter, bringing the balance down to $750 million or 19% of TBV.

Now let's turn to Slide 15 to discuss the MSR. During the quarter, mortgage rates rose by 103 basis points, leading to a decrease in the lifetime CPR assumption from 8.9% to 7.7%. Additionally, swap rates increased by 72 basis points, which drove higher expectations for servicing interest income. However, as a partial offset, we increased the discount rate from 10.7% to 11.3%. As a result, MSR values increased by 6% to 155 basis points. Recognizing that some people look at servicing valuations in terms of fee multiples. For the second quarter, we were at a multiple of 5x the underlying servicing strip, which should be around the median for our peers.

Now turning to Slide 16, let's review liquidity, which remains very strong. Steady state discretionary cash flow was $23 million in the quarter. And given the strong outlook for servicing income, we guided you to expect robust cash flow in the third and fourth quarter. At quarter end, unrestricted cash was $514 million. This plus undrawn capacity on our warehouse lines left us with $1.9 billion of liquidity. One of the benefits of our balanced business model is that markups in the MSR portfolio translate into additional collateral available for liquidity. This quarter, we increased MSR capacity by $600 million, which included a new multiyear $400 million facility and a $200 million upsize of an existing facility. Now we used a small portion of this increase in liquidity in the second quarter as we drew down $115 million to fund acquisitions, bringing our total line utilization to $950 million. Now we're very mindful of the mix of debt we use to fund our assets. As you can see in the lower right-hand chart, MSR lines ended the quarter at 25% of total debt. Finally, I'd like to remind you that we have a 5-year liquidity runway with no maturities until 2027, which is a nice position to be in given the concerns about the economic outlook.

I'm going to wrap up my comments on Slide 17 by talking about our robust capital. Our capital ratio at quarter end, as measured by tangible net worth assets was 30.6%, up from 26.8% last quarter and double our initial target of 15%. Excluding deferred tax assets and EBOs, which is a metric that some debt investors focus on, our capital ratio was 29.7%, reflecting both strong capital generation in the quarter and the utilization of the DTI. I would like to add that a threshold for Ba3 rating is 17.5%. So we see the company remaining on its path to higher ratings. A second ratio, which is important to debt investors is the ratio of debt to tangible net worth, which has remained consistently below 1x.

To wrap up our prepared remarks, these capital ratios mean that we have a great optionality, having the best operating platform in the industry, backed by huge capital and liquidity, allows us to patiently watch the market to see how recessional fears play out. Our ability to significantly boost ROTCE through our owned and subservicing growth, combined with our stock repurchase capabilities truly highlights the flexibility of our balanced business model.

With that, I'd like to thank you for listening to our presentation. And now I'll turn the call back to Ken for Q&A.

Thanks, Jaime, and I'd like to ask Justin now to start the Q&A process.

(Operator Instructions) And our first question comes from Kevin Barker from Piper Sandler.

I wanted to follow up on the MSR. I noticed that you have 5x servicing fee, you marked it up this quarter, but you had some hedging offsets that I believe it was equal to about 29% of the markup in the MSR. Given the valuations today and the uncertain outlook, would you consider potentially increasing the hedge on the MSR to protect book value here, given it's an important metric that you're looking at?

It's a very timely question, Kevin. And I think the answer is, overall, longer term, we consider that. If you remember back a couple of years ago, we had no hedge in place Today, we hedge about 25% of the portfolio, which really reflects the part of the portfolio that's leveraged, and that's really to protect liquidity and avoid margin calls. I think longer term, yes, we will consider that, and we've had lots of debates about it. Right now, there's so much volatility in rates that the #1 priority for us is making sure we maintain our liquidity and don't see anything unusual happen. Now that unusual period may pass in 30 days, and we'll rethink it. But longer term, we think it is important to always be considering preserving book value given current valuations, but liquidity is, it will always be priority #1 for us.

Considering your liquidity today, would you have the capacity to put on a hedge that would be the majority of the value of the MSR just given your liquidity position with $1.9 billion of cash.

Yes. at 100%. If we hedged our entire portfolio, I want to say given a realistic rate shock. I mean we've got $1.9 billion of liquidity. So I don't want anyone to misunderstand my comments that we've got concerns about that. The liquidity is the best it's ever been in the company. But it's also we're in a period where there are very unique opportunities, and we want to make sure we keep every bit of dry powder to take advantage of that. But having said that, if we were hedging the entire portfolio and we had maybe a 100 basis point shock, it would cost us several hundred million dollars of liquidity. And that's not a huge number compared to $1.9 billion. But again, there's a lot of near-term volatility, a lot of uncertainty in the economy. We want to make sure we preserve that dry powder to take advantage of some of the dislocation that's happening. To your question, absolutely, over the long term, we will probably move to have more of a hedge.

And can you expand upon those comments a bit about opportunities in the market? I mean you've been active in the MSR space, right? You're buying back your stock, both supporting earnings in the near term and over the long term. But there's been some dislocation across the market. Are you seeing other opportunities maybe in M&A? I know you guys haven't been active for quite some time, but is that a possibility as well?

Kevin, this is Jay. I mean what you're seeing happen in the marketplace is exactly what we predicted and discussed. You're seeing more and more MSR assets come to market. Like I'd say we're seeing probably double the activity currently that we saw same time last quarter. And a lot of that's coming from independent mortgage banks. And frankly, the purchase price there is attractive. I mean the yields are very attractive and there's going to be a lot of opportunity. So we're actively looking at that, but we're being patient there as well. From a platform standpoint, it's unlikely. I mean it would have to be a platform that would bring something differentiated to the table, whether that was technology or something that we don't have today. I mean we simply believe we have the best servicing platform and the direct-to-consumer platform in the marketplace from a retention standpoint. So it has to be a really exceptional platform for us to take a look at. But look, I think we think there's going to be more disruption. We think there's going to be more opportunities. And I think the prudent thing to do is continue to keep the dry powder to Chris' point to be ready when that comes.

And our next question comes from Bose George from KBW.

Just on the servicing. It looks like your base servicing fee was up to 16.3 basis points from 14.5. Was that just driven by the increase in the owned MSR or anything else to call out there?

Yes, exactly right. We did, as you remember, some large acquisitions in the first quarter, so that's all it's a reflection of. The mix has changed a little bit. But I'd remind everyone that while we're saying there's some great opportunities, we grew the portfolio 23% year-over-year. And although we didn't have as much growth this quarter, we actually sold some MSR, but you should expect that that number will move around a little bit, but just as a function of mix. I mean so we actually retain them a subservicing basis and are growing that service relationship. So it was a win-win.

Okay. Great. Makes sense. And then just the increased discount rate on the MSR. Was that just a reflection of increase in market rates or anything else there? And then just on a related note, just with the move down in rates, any take on just how the reduction of the MSR value this quarter?

I think that was just a little bit of conservatism on our part of those. We try to have a little bit of conservatism all time in the MSR marks. But there was a lot of product in the market. And so we just thought it was prudent to expect that there might be product trading at higher returns. And so we just did that proactively, I guess. So it wasn't dramatic, but we thought it was the right thing to do.

Okay. And then just in terms of the impact on the MSR from rates declining this quarter, is that meaningful yet?

It's not significant, but it will be what it is at the end of the quarter, right?

And our next question comes from Jay McCanless from Wedbush.

I guess the first question we have is if we think about the third quarter, do you think that USD 50 million to USD 60 million guidance that you had provided for the second quarter on volumes of USD 5 billion to USD 6 billion, do you think that's replicable in the third quarter?

We're saying that over the balance of the year, $50 million plus or minus is about where we expect to be every quarter. It could be 60, it could be 40. it's going to be in that range. Right now, we feel good about the production we have. It's only a month into the quarter, but we feel good about it. So yes, we definitely think we'll replicate that. And at the same time, we're going to see servicing income double in the quarter, if not more than double in the quarter. So I think the second quarter, you're going to really see when we talk about a balanced business model, I think when the second quarter is over, that's going to jump off the page. In the third quarter... I mean third quarter, excuse me.

Yes. And I think, Jay, I mean, we feel good about originations, and we think it's settled in at a level where we're seeing locks and leads kind of come in where we expected. I think we've rightsized to the right place. So we're seeing pretty stable consistent performance there, even a slight improvement in the last couple of weeks. So I think the long answer is we feel good.

Great. And then our second question, if you talk about Slide 12 in the deck. I know you guys are using the historical average of where foreclosures have gone on the delinquency book. But I guess, looking at maybe what's happened on the conforming side that when the moratoriums have rolled off where the forbearance has rolled off, you didn't really see a big spike in the foreclosures that I think we would have anticipated. I guess what do you think is different in this FHA book? And how is that going to benefit the Xome exchange?

Well, first of all, you got to kind of frame the FHA book versus CSC, right? It's obviously different credit, different profile, different HPI, et cetera. So I think you got to start there. And second, when you think about what's left in forbearance, honestly, a lot of those loans were even delinquent before the pandemic. So I think you're going to see a different outcome than what we've seen in the last few months, especially with the agency book. So I think we don't have any problem whatsoever getting to kind of a normalized rate. When you just really look at the underlying credit characteristics of those borrowers, you had the tail end of forbearance. A lot of those were delinquent previously. So I think that's how we're thinking about it.

Okay. And then the benefits, I guess, just running more of that through this book as well as was adding RightPath on, Is there anything we should think about in terms of accelerated or expanded business opportunities from RightPath in terms of the FHA book?

Yes. Look, I think RightPath has a fantastic reputation in the industry. Obviously, they're at the size and scale that we are today. But we think there'll be some incremental benefit. I don't think it will be overly material, but there will definitely be some benefit. And we think we'll grow that business. Obviously, if the environment gets worse, I think there's an opportunity to grow that business in a meaningful way.

Our next question comes from Giuliano Bologna from Compass Point.

One thing I'd be curious about is, obviously, we've all heard your commentary around surety purchases. You obviously have a tremendous security position. We should obviously be building even more capital going forward as earnings improve and cash flow improves as CPRs come down. I'm curious if there's an incentive to lock in book value and repurchase more stock or how you think about the balance between the 2 because you obviously have shares trading at a pretty substantial discount to book value, there's a great return in buying back your stock and there are also potential accretive things that could happen over time that could even be significantly more accretive to book value. So I'm curious how you think about repurchasing stock as more of a near term next couple of quarters or on a forward basis maybe look timing forward to the 2- or 3-year outlook when you think about the accretion potential.

Well, it's a great question, Giuliano. It's something we had a Board meeting yesterday. We had a long debate on that. We've always said that the most important priority for us is to grow the portfolio when we can get the right returns. And right now, we see an opportunity to get some pretty good returns. Now we're extremely disciplined. And so that's another element of why we didn't buy as much, even though there's more product in the market. In the first quarter, we completed a lot of acquisitions at what we consider to be excellent returns. We could do the same thing this quarter. And we are looking at some pools and we will do that. But at the same time, we just bought back $100 million worth of stock. We think the stock is cheap. So I don't want to confuse anyone about that. Now locking in the value of the portfolio and buying back the shares almost implies like we've just decided, right? It's game over. We reached the maximum and we're now going to liquidate. And that's not our plan. But your question is a good one, just like Kevin asked, look, values are high. And we don't want to see those values just dribble away from us. I think what we have is what we consider to be the right position for a period of extreme volatility. And it's just not rates going up or down. If you look at the correlation of the 10-year and mortgage rates over the last month, there's been some pretty weird behavior there. And actually, to go back to Bose's question, I'd say quarter-to-date, the mark may be a negative mark because the move down maybe $100 million. I think some of that's going to normalize between now and the end of the quarter, and things should be a little bit more predictable. But making any big strategic change right now when there's such uncertainty around the economy, and there's a lot of potential for more product, even better prices come to market. We just don't want to jump too soon. We want to be smart and very opportunistic. And if the best returns for our shareholders come by buying more shares back, we'll do that. So...

It's a real benefit of having the balanced business model. I mean I think you'll see more of the same, right? We've been very consistent, and we've been buying portfolios. We've been buying back shares, been making investments in the company where we think we can drive a better, more efficient process and a better customer experience. And we've also been increasing our hedge position. So I think balance is the order of the day and frankly, prudence and being cautious going into this environment is that's the way we're thinking about it.

That makes sense. And then somewhat related topic. Last quarter, you guys mentioned having some initial preliminary discussions with bankers about potentially monetizing the auction exchange platform. here as there's been a lot of volatility. We're also moving into a cycle where that business could outperform if we're going into a recession. I'm curious if there's been any progress and discussions or at least if there's any movement in the process there and also interest, obviously, things kind of move in the right direction because this is obviously a very interesting asset that's countercyclical potentially going into a recession there.

Yes, there's been progress. We have retained 2 banks to help us through this process. Also, as we pointed out, the government did mandate a 60-day pause for borrowers that were seeking assistance from their states. And what that really caused really all services to do is to go back, scrub their portfolio, try to figure out who might be doing that and who those borrowers were. What it really meant was essentially a 60-day pause on all activity. Now that's over. And I think as we pointed out, activity is ramping, and July was double the rate of June, but we're behind where we expected to be. So we thought we would be running a process in the fourth quarter. It's probably the first quarter. It may be, it's going to be when we hit a normalized run rate, and it's very obvious to investors what the revenue and returns of the business are. The other thing is look, to be honest, this is not a run-of-the-mill commodity business. It's a high technology fintech business, it's got very big margins. It's got an emerging leadership position in the market, and we want to get the best value for it. But it takes a little bit of buyer education. So we're going to have probably a longer-than-average period of really putting together the material. Every buyer is going to need to understand the nuances of the FHA market and how the business works and what we've invested in the technology. And I expect this will be a successful process. But we're not going to rush it. This is a valuable business who's just now breaking even. So no reason to try to convince people that it's going to be wildly profitable. Probably better to let them see it is actually wildly profitable if we're going to maximize the proceeds.

That's great. And then I just have one much simpler question. Similar to what the question that was asked earlier on about the service income. If I were in base servicing fees over just simply the owned MSRs and exclude the self-service, it looks like the base servicing fee went up to about 33 basis points from 30.6 last quarter. If I just run on that basis, is there something that would have changed that because historically, Ginnie is accretive, but there hasn't been a big shift in the mix of (inaudible) Ginnie and not agency. I'm just curious what may have gone into that increase? And should that ever back or should it stay around that ZIP code?

Are you talking about the own piece?

Just on base servicing fees compared to the average of owned MSRs, that basis point number (inaudible) as my calculation that years is 33.3 basis points, up from 30.6 basis points last quarter. So I was curious what may have gone into that.

It's got to be the acquisitions that we onboarded would be my guess. Ken and team can get...

Yes. We'll follow up with you on that Giuliano.

And our next question comes from Kyle Joseph from Jefferies.

Most have actually been answered. Just one follow-up on the gain on sale margin. Obviously, I understand the mix shift drove the majority of that. But can you give us a sense for gain on sale margins by channel in the quarter?

They were largely flat. There was a little bit of movement in both, but it's not material. The real driver of the reduction in the overall margin was just DTC coming in where we expected. We did a little bit more correspondent and just that ratio of correspondent was larger this quarter than it was last quarter. That's the only material factor.

Our next question comes from Leon Cooperman from Omega Family Office.

Let me first congratulate you guys. You guys have done a fabulous job for shareholders, being a large shareholder, I'm very appreciative. And I say thank you. So now let me give it to my questions. Given the way you want to run the business, what would you say is your amount of excess capital at the present time?

That's a great question. I think long term, Lee. Our equity to assets is 30%. Our minimum target is 15%. And we have never published a long-term target, but at 3%. We think that's certainly more than we need to run the business. And so we would expect that to manage that down as we acquire more assets to buy back more shares. But I don't think we've said we want to be at 20% or 18% or 22%, but we're certainly above the level that you should expect us to be over the long term.

Right. I'm assuming that if you had a number in mind. Because I think over the long term, your average repurchase price has been something like 30...I got too many numbers. I have 8 conference calls this morning. I apologize, but your average repurchase price has been in the mid-30s and the more recent one is like much higher. If you're bullish in the business which you are and you should be, basically, have you thought about getting out ahead of the curve and buying a lot of stock back like 10 million, 15 million, 20 million shares. My hero in life was this guy Henry Singleton, who regrettably passed away, he was brilliant, but he did 8 self-tender offers and he tied 90% of the stock before anybody talked and understood stock repurchase. So have you thought about doing some large scale rather than onesies and twosies?

Well, we've thought about it. And actually, I started my career working for Henry Singleton. So I appreciate your comment. But there is a limiting factor. When we've had the opportunity to buy a big block of shares at the right price, we did that when we bought back KKR shares and we'd certainly consider that. But you did see us buy back $100 million of shares, which was really double what we were expecting to do in the quarter. Now you're right, we did pay a higher price. We paid $44.22 a share. And when the stock was trading down a couple of days when I thought maybe we should wait a little bit. But on average, or in summary, we are extremely bullish on the shares. We got tangible book value, we feel very confident in. We think that's going to grow. It reflects basically 0 for Xome. So anyone could put their own number on it. But yes, we consider it. It's not like anyone's indicated that there's a big block for us, but we're out in the market. I think in the first quarter, I mean, the second quarter, we bought all the shares we could based on our trading program.

Yes. I'm not telling you what to do because like I said at the outset, you guys have done a masterful job of running the business. But I would just tell you that if you're very bullish on the business, you think your stock is undervalued, you're seeing a lot of excess capital. And I realize we have an uncertain environment, but the uncertainty is what creates the opportunity. And so I would just point out on May 6 of 1984, Teledyne stock was $155.75, and Dr. Singleton, who you worked for, offered $200 a share to buy 5 million shares, 8.7 million shares were tendered, 44% of the company took it all. And basically, it was extremely accretive and stock went up quite a bit. So I just put it on the table, but I'll let you guys run the business.

And my other question is really is the reverse of Kevin Barker's, who asked you a good question about acquisitions. Let me ask your question. Is it a logical buyer of the business? And would you consider selling the company if the right price was offered?

Well, the second question on 100%. I mean you own the shares, you own a bigger piece of the company than Jay and I do, although we're a big shareholders. So if somebody is willing to offer more value than we can deliver to the shareholder, then it would sell tomorrow.

Yes. Well, what is the amount of customer balances you have that you're earning interest on? Is it about $10 billion or more?

This quarter, I'd say it was closer to $12 billion. It will probably because so that includes some prepayment cash that we hold. That will probably continue to decline. And we'll probably settle in with an $800 billion portfolio, we probably will hold about $10 billion of cash at any time.

And you guys earn the interest on that cash, right?

Some of it. Some of it goes back to the borrowers. But yes, we earn certainly the majority of it.

So stepping back and just asking when I look at it in terms of stock repurchase, it makes sense under certain scenarios. First one is most publicly traded companies have 2 values, the so-called auction market value, which is the price we pay for 1 share or 1,000 shares or 100,000 shares. And in your case, that is roughly got to go look at a machine here. We have the last sale is, I get too many numbers, $44.71. That's public market value and the other value is private market value, what were the strategic or financial investor pay for the entire company. And so you guys have a better handle on that than I do, but I think it's well above the last sale and that's the first criteria.

Second criteria is you put your 5-year budget to a given discount model with appropriate assumptions. It spits out a value of X. So if you're 20% below x, and you're confident in X as the second reason to buy back stock. I'm sorry for lecture but you guys understand it all. The third thing is what does repurchase due to book value per share, dividend capacity per share, cash flow per share. And given where we are selling relative to our earnings, it would certainly make sense. And fourth, we have to recognize buying back stock weakens the company. You have less cash, you have more debt relative to your equity. You don't want to buy back soon stock is to basically radically change the risk profile of the company and you want to maintain flexibility. But I would say that if you had $300 million or $400 million, $500 million of excess capital, you might want to think of doing a tender offer when the next trip down the stock when Mr. Market gives you a chance. And that's it, but you guys have done a great job running a company. I'm happy to be in your hands. All the best.

And I am showing no further questions. I would now like to turn the call back over to Jay Bray for closing remarks.

Thank you, everybody. We appreciate you joining the call, and we'll be following up with additional conversations. Have a great day.

This concludes today's conference call. Thank you for participating. You may now disconnect.