Ocwen Financial Corporation (NYSE:OCN) Q3 2023 Earnings Call Transcript

Ocwen Financial Corporation (NYSE:OCN) Q3 2023 Earnings Call Transcript November 7, 2023

Operator: Good morning, ladies and gentlemen, and welcome to the Ocwen Financial Corporation Third Quarter Earnings and Business Update Conference Call. [Operator Instructions] This call is being recorded on Tuesday, November 7, 2023. I would now like to turn the conference over to Mr. Dico Akseraylian, Senior Vice President, Corporate Communications.

Dico Akseraylian : Good morning, and thank you for joining us for Ocwen’s third quarter 2023 earnings call. Please note that our earnings release and slide presentation are available on our website. Speaking on the call will be Ocwen’s Chair and Chief Executive Officer, Glen Messina; and Chief Financial Officer, Sean O’Neil. As a reminder, the presentation and our comments today may contain forward-looking statements made pursuant to the Safe Harbor provisions of the federal securities laws. These forward-looking statements may be identified by reference to a future period or by use of forward-looking terminology and address matters that are at different degrees uncertain. You should bear this uncertainty in mind and should not place undue reliance on such statements.

Forward-looking statements, which speak only as of the date they are made, involve assumptions, risks and uncertainties, including the risks and uncertainties described in our SEC filings. In the past, actual results have differed materially from those suggested by forward-looking statements and this may happen again. In addition, the presentation and our comments contain reference to non-GAAP financial measures, such as adjusted pre-tax income, among others. We believe these non-GAAP financial measures provide a useful supplement to discussions and analysis of our financial condition because they are measures that management uses to assess the financial performance of our operations and allocate resources. Non-GAAP financial measures should be viewed in addition to and not as an alternative for the company’s reported GAAP results.

A reconciliation of the non-GAAP measures used in this presentation to their most directly comparable GAAP measures as well as management’s view on why these measures may be useful to investors may be found in the press release and the appendix of the investor presentation. Now, I will turn the call over to Glen Messina.

Glen Messina: Thanks, Dico. Good morning, and thanks for joining our call. Today, we’ll review a few highlights for the third quarter and take you through our actions to address the market environment and deliver long-term value for our shareholders. Now please turn to Slide 3. I’m excited to report our third quarter results, which reflect continued progress against our key initiatives and the benefits of our balanced and diversified business. Adjusted pre-tax income for the third quarter of $10 million was primarily driven by our servicing segment. Both originations and servicing were profitable in the quarter. Adjusted pre-tax income for the quarter has improved materially versus the same quarter last year and slightly better than the second quarter, excluding the reverse whole loan transaction gain realized during that quarter.

Our third quarter results achieved a 9% annualized adjusted pre-tax return on equity. Net income of $8 million or $1.10 per share is above consensus, but lower than the second quarter, again, largely driven by the reverse whole loan transaction gain reported in 2Q. Notable items for the quarter were roughly zero, largely resulting from our increased hedge coverage ratio and our market-based MSR valuation and benchmarking process. In the third quarter, total servicing UPB was up 2% versus the second quarter and up 5% versus the prior year, driven by growth in subservicing UPB. Subservicing UPB with MSR capital partners and mortgage banking clients increased 6% versus the second quarter and 10% versus prior year. We’re pleased to report that we and Oaktree have mutually agreed to extend the commitment period for MAV through May of 2025.

In addition, we and Rithm have mutually agreed to extend our subservicing agreement through December of 2024. We greatly appreciate our relationships with Oaktree and Rithm and the confidence they’ve placed in us. We take their trust seriously and are committed to helping them achieve their objectives. We continue to focus on enterprise-wide cost management. Third quarter annualized operating expenses, excluding expense notables are materially lower than our second quarter ’22 baseline and lower than the second quarter 2023. During the third quarter, we opportunistically repurchased $14 million of our PHH notes at attractive prices and are prioritizing continued corporate debt reduction as excess liquidity is available. Total liquidity of $194 million is down versus prior year end due to the allocation of capital to reduce our corporate debt and the higher liquidity demands of our increased hedge coverage.

We’re very pleased with our results this quarter. The business is performing in line with our adjusted pre-tax return on equity guidance, we’re executing well against our key initiatives and we believe we’re on track to achieve our return objectives for the remainder of 2023 and 2024. Please turn to Slide 4. The execution of our strategy and key business initiatives have helped us to reposition the business to operate profitably in the current industry environment. While the originations environment remains challenging, it’s a favorable environment for servicing, and we expect the current industry dynamics to persist for the foreseeable future. We’ve continuously improved adjusted pre-tax income over the past 5 quarters. The business is delivering financial performance in line with our ROE guidance without relying on a material income contribution from our originations segment.

Looking forward to the balance of 2023 and 2024, our financial objectives start with sustaining the financial and operating performance improvements we’ve achieved to date. This will require a continued focus on cost improvement, disciplined MSR investing and maintaining a prudent risk and compliance management approach, which we have demonstrated are core competencies for us. Next, we’re focused on increasing return on equity and we have 3 levers to do this. First, by growing our subservicing portfolio, while we hold our owned MSR UPB in the $115 billion to $135 billion range. We’re laser-focused on converting our subservicing opportunity pipeline and working with our MSR capital partners to fund new originations and win both purchase opportunities.

Second, as our excess liquidity permits, we expect to continue to delever the business through opportunistic debt repurchases to further improve ROE as well as decrease enterprise risk and earnings volatility. Third, we believe we can further enhance ROE by improving the profitability of our legacy owned MSRs. Roughly $18 billion or 14% of our owned MSR UPB is comprised of pre-crisis subprime and Ginnie Mae loans originated prior to 2015. This portfolio segment has a total delinquency of over 15% and is not delivering returns consistent with our target levels. Lastly, we are continuously scanning the market to identify and capitalize on market cycle asset opportunities that match our unique skill sets. This includes positioning for distressed asset transactions as well as special and commercial subservicing transaction and disruption resulting from consolidation in other areas where we have expertise.

As always, we remain flexible and committed to considering all options in this dynamic market to maximize value for shareholders. We’re pleased with the performance improvements we’ve driven and are committed to executing on our financial objectives to further deliver value for our shareholders. Please turn to Slide 5. Our balanced and diversified business offers several benefits in the current market cycle. We are, first and foremost, a servicer and our servicing business enables us to navigate current market conditions from a position of strength. Our servicing business is delivering strong earnings and cash flow performance driven by slow MSR run-off, higher float earnings and continuous cost improvement. Despite current market conditions, our originations business serves well its purpose to replenish our owned MSR portfolio as well as drive growth in subservicing.

Our diverse capabilities in commercial and reverse subservicing, and within those niches, strong default management and loss mitigation capability is giving rise to unique earnings opportunities to invest in distressed assets. In the second quarter, our purchase and securitization of reverse whole loans was enabled by our special servicing skills and reverse mortgages. This same expertise is also driving cash flow performance in these assets well above projected levels. We’ve also been able to carefully grow performing and delinquent small balance commercial loan subservicing over the past 2 years. We’re optimistic about the potential growth in this higher margin subservicing niche. We are seeing increased opportunities in these areas and remain focused on acting on high-return transactions where we can add value to investors, clients and consumers.

Lastly, we believe our diversified servicing portfolio with the growing mix of subservicing helps mitigate business risk in the event of a recession. Over 85% of our servicing portfolio is subservicing and GSE owned MSRs with a materially lower exposure to advances in the event of a recession as compared to PLS and Ginnie Mae owned servicing. Now please turn to Slide 6. We remain focused on driving organic growth in our higher margin origination channels and products as well as growing subservicing. In the third quarter, our mix of originations volume from higher margin channels and products increased 21 percentage points versus prior year. We increased volume from our higher margin channels and products by 50% on a sequential quarter basis.

However, mix was down 2 percentage points due to an overall increase in total originations volume. Our enterprise sales team delivered strong growth versus the second quarter in both owned MSRs and subservicing. However, total servicing additions were down roughly 10% versus the prior year due to the contraction in total industry originations volume. Subservicing additions and subservicing retained MSR sales to capital partners of $15 billion for the third quarter was up 50% versus the second quarter and more than double prior year levels. Our subservicing growth with mortgage banking clients and our MSR capital partners has allowed us to significantly grow our subservicing business more than offsetting run-off in the Rithm subservicing portfolio.

Our subservicing portfolio excluding Rithm is up 9% on a sequential quarter basis and up 20% versus the third quarter of last year. We’ve boarded $111 billion in subservicing additions in the last 24 months, including over $8 billion in subservicing additions in the third quarter. While interest remains strong, we continued to see potential subservicing clients extend RFP processes and decision making or selling MSRs due to the difficult originations market. Our MSR capital partner relationships can be helpful in these situations. We can bid on MSRs with a capital partner, giving us the ability to retain the business or win incremental subservicing if our capital partner wins the MSR bid. This is an optionality that several of our more traditional subservicing competitors do not have.

Considering the client environment, we’re targeting roughly $15 billion to $25 billion in new subservicing additions through the second quarter of 2024. Based on expected subservicing additions, we expect our mix of subservicing to increase to approximately 60% over the next 2 quarters with total servicing UPB in the range of $305 billion to $315 billion. Please turn to Slide 7. Our servicing platform continues to deliver industry top-tier operational performance, while maintaining a highly competitive cost structure. Our breadth of capabilities is unmatched in the industry. And we have been recognized by Fannie Mae, Freddie Mac and HUD for delivering industry-leading operating performance for investors. We have also been named 2023 Affiliate Company of the Year by the National Association of Mortgage Brokers for our expertise in reverse mortgages.

Across numerous servicing metrics, we delivered superior performance versus other servicers. In previous quarters, we spoke about the improvement in customer experience we’ve delivered for clients, our ability to cure 60-plus day delinquencies, our superior HUD assignment claims performance and our ability to maximize REO sales price versus appraised value, while selling properties within the timeframe allowed by HUD. Here again, you can see we also consistently achieved lower delinquency levels compared to the industry average, as reported by Inside Mortgage Finance. In addition, since the fourth quarter of 2020, more of our borrowers have exited forbearance either as current, paid in full or with an active loss mitigation plan than the industry average as reported by the MBA.

Our focus on continuous cost improvement has positioned us with a highly competitive cost structure even when measured against competitors over twice our size. Based on the results of the MBA’s annual Servicing Operations Study for 2022, our fully loaded forward residential servicing cost in basis points of UPB are 27% lower than our large bank peers and on par with our large independent mortgage banking peers. The large independent mortgage banking peer group includes 3 of the industry’s largest servicers and 2 of the industry’s largest pure-play subservicers. This group has an average forward residential servicing UPB more than twice our size. Moreover, our servicing cost and basis points of UPB are inflated relative to large servicer peers due to our relative high concentration of PLS servicing.

If we compare cost per loan for performing and non-performing loans versus this group, we’re materially lower in every comparison. Our cost competitiveness does not rely upon sheer size and scale. It comes from continuous process improvement, strategic investments in technology and our global operating capability. With roughly 30% of our cost structure, servicing cost structure, fixed or semi variable, we believe we can further improve efficiency as we grow our total servicing UPB. I believe this along with the other metrics I discussed demonstrate that we are one of the strongest operators in the industry. Please turn to Slide 8. While we’re delivering improved efficiency, we’re also delivering improved borrower and client experience. Our Net Promoter Scores were up 6 percentage points over last year and subservicing client Net Promoter Scores are up 18 percentage points.

Over the last several years, we’ve continued to invest in client and bar facing technology and automation to improve the customer experience by reducing cycle time, enhancing access to information, enabling 24/7 assistance and reducing process variation. We’re using multiple digital interface channels such as our chatbots and mobile app and additional enabling technologies like robotic process automation. Our AI-powered chatbot has hosted 800,000 sessions with an 80% success rate. Our mobile app has over 100,000 log-ins per month. And we have 26 bots supporting 156 processes with 8 new bots under development. These technologies work together to improve access, speed, accuracy and responsiveness, while enabling further productivity as we scale up our platform.

A woman signing a mortgage loan in a modern banking hall.

To support our subservicing clients, we have a robust and holistic infrastructure with 40 individuals dedicated to addressing client needs. This team has an average tenure in the industry of 20 years in response to over 4,000 client inquiries per year, most of which are addressed in less than 24 hours. We’ve invested in technology to build our LoanSpan Discovery platform to provide transparency to clients about their portfolio and our operational performance as well as enable self-service data mining for clients. We’re committed to investing in people, process and technology to deliver a superior experience to both borrowers and clients. Please turn to Slide 9. We continue to focus on expanding our capital partner relationships to support our growth objectives on a capital-light basis.

The most successful of these relationships is our joint venture with MAV, which has purchased $78 billion of MSR UPB since its inception. As I previously mentioned, we and Oaktree have mutually agreed to extend the investment period for MAV to May of 2025 and we have capacity to support $20 billion to $25 billion in additional servicing acquisitions. Over the past 2 years, we’ve grown total servicing UPB supported by capital partners to $89 billion using a variety of transaction structures. Over the last 12 months, we have leveraged active relationships with 4 capital partners to nearly double our UPB funding. All our capital partners have long-term conviction about owning MSRs. Nearly all of them currently have individually more capacity for investment than MAV.

With multiple investors, we can fund MSR purchases through either our originations channels or the bulk market dependent on partner requirements. Our investor-driven approach to MSR purchases enhances our ability to generate capital-light growth and helps manage our exposure to MSR valuation changes due to interest rates as well as introduces an added level of price discipline for the originations business. Looking ahead, we’re focused on developing additional investor relationships and evaluating a diverse range of potential structures to support our growth and scale objectives across multiple asset types. I want to thank Oaktree and our other MSR investor partners for the trust and confidence they have placed in our team to help them achieve their growth and profitability objectives.

Now I’ll turn it over to Sean to discuss our results for the third quarter.

Sean O’Neil : Thank you, Glen. Please turn to Slide 10 for our financial highlights. I’m very pleased with the performance in the third quarter from both the financial and operational perspective. Servicing and originations are profitable. And after removing the positive impact of the opportunistic reverse whole loan transaction gain in the second quarter, we showed continued improvement in both GAAP net income and adjusted pre-tax income. Our results continue to reflect the hard work and resilience of our dedicated employees, the strength of our operations as well as our balanced business model. Going to the blue column, in the third quarter of 2023, we recognized GAAP net income of $8 million. GAAP net income at several significant drivers last quarter that did not occur this quarter, primarily a $15 million gain in the whole loan transaction and a $28 million positive impact from legal and regulatory settlements.

After adjusting for those, we’re pleased with the $8 million of GAAP net income, which reflects an improvement of over $3 million from our originations and servicing businesses quarter-over-quarter as well as $1 million gain from the repurchase and retirement of $14 million of corporate debt. The adjusted pre-tax income of $10 million closely aligns the GAAP, indicating no material notables this quarter as well as reflecting the lower volatility in our P&L due to a higher hedge coverage ratio. As Glen pointed out, liquidity is down slightly this quarter due to the debt repurchase, the hedging instruments and the higher cash used in originations to support the higher volume. Our liquidity remains well in excess of the new FHFA and Ginnie Mae liquidity requirements.

With the positive GAAP net income result, you can see that our effective tax rate for the quarter is only about 11% due to our existing portfolio of tax net operating loss carryforwards. We do expect to continue to deliver 9%-plus adjusted pre-tax income ROE going forward with some seasonal impacts throughout 2024 and we will provide more robust guidance assumptions for 2024 on our year end earnings call. For a more detailed view of the quarter-over-quarter changes in adjusted pre-tax income, please turn to Page 11. The all segment view on the upper left clearly shows the positive and growing trend in adjusted pre-tax income when the positive $15 million impact for the whole loan transaction is removed for consecutive quarter comparison. This indicates our balanced business model is delivering net income growth, and the blue bar at the bottom shows the growth in adjusted PTI ROE as well.

The total segment view on the upper right shows the impact of the improving profitability of both origin, servicing offset with some corporate impacts, and I will cover the segments in more detail in a few pages. Page 12 highlights the debt repurchase we initiated in the third quarter. The transaction actually bridged the quarter in early October, so we are showing the total impact for both quarters as well as the Q3 impact alone. In my comments, I’m going to be referring to the total impact that bridges Q3 and Q4. We used excess liquidity to repurchase $15 million of corporate debt held at the PHH entity. This debt now stands at $360 million, down from $400 million 18 months ago. Our payment obligations have been reduced as well as our ongoing interest expense.

We bought the debt into discount and thus recorded a gain of $1.3 million on retirement of the debt. This is in line with the guidance we have provided, which is to delever the balance sheet to bring our debt-to-equity metric in line with our publicly-traded competitors. On Page 13, I will describe our hedging approach and the impact of our capital-light strategy on interest rate risk. The graphs on the left shows the difference between what appears on our balance sheet for MSR assets. We show here both in UPB and fair value for the third quarter. The fair value of $2.86 billion in the third quarter represents the GAAP balance sheet, but due to transactions that didn’t achieve accounting through sale, which is $1.1 billion of the fair value, and the excess servicing spread transactions, which is an additional $255 million of fair value, that leaves us with about $1.5 billion of fair value of MSR assets.

This represents the amount of our net MSR exposure that we actually hedge. This illustrates our capital-light strategy where we intend to maintain a consistently sized book in the range of $115 billion to $135 billion UPB of owned MSR to reduce our interest rate risk. As we’ve discussed, our MSR valuation is based upon input from 2 independent valuation experts that use market observed trading levels as well as comparisons to public filings, PwC and KPMG surveys and our own model output. Our mark-to-market approach is different than a mark-to-model approach. The right graph shows the last 3 quarters of our hedge coverage ratio and the consistently higher hedge coverage ratio mitigates the earnings volatility from both rising and falling interest rates.

The last 2 quarters coming in at 73% and 92% of hedge coverage ratio are above the target of 60% that we set in the second quarter of this year. Now we will cover a more detailed segment information on Page 14 where we start with the servicing segment. This is both data on forward and reverse. The upper left chart of adjusted pre-tax income shows an improvement in reverse servicing from $3 million to $4 million quarter-over-quarter due to lower operating expenses from process improvements. Forward servicing PTI, which excludes asset sales and mark-to-market, was down slightly quarter-over-quarter due to higher run-off in the third quarter as well as lower revenues from the migration of some assets to subservicing. Float income continues to improve as balances grew and the forward subservicing volume grew across quarters by $9 billion or 7% and 10% year-over-year.

Please turn to Page 15 for an overview of our origination segment also both forward and reverse. The origination business improved adjusted pre-tax income by $3 million quarter-over-quarter, but lagged versus prior year when correspondent margins were significantly higher. Correspondent lending and co-issue saw significantly higher volumes this quarter than the prior quarter. They’re up 63% for a quarterly total of $7.2 billion of UPB. We continue to price this product for an appropriate yield linked to our corporate cost of capital. Consumer direct or the retail channel continues to increase volumes and experienced margin declines to stay slightly below breakeven. This channel has shifted from a rate term refinancing, trade purchase cash-out focus.

It will be the key driver of future profitability when mortgage rates do decline. Reverse had flat origination volumes and the HMBS spreads continue to be wider than recent historical averages, which suppresses gain on sale. We continue to ensure that the origination segment is sized appropriately for the prevailing market volumes, which can be seen by our better cost to originate both year-over-year and quarter-over-quarter. This data in the lower right corner is even more impressive when you consider the year-over-year volume is essentially flat. Please turn to Page 16 for a view on our stock price. Using the same starting point of year end 2020, our stock is now performing in line with the Russell 2000 Index, but slightly underperforming a group of our peers.

The discount to book also gave back some recent progress, likely due to the strong increase in the 10-year treasury yield, which can have a negative impact on an origination-centric company. However, the bulk of our profits have come from the servicing business for the last 6 quarters. The discount to book in the lower graph is measured as the share price following our earnings release versus at quarter end book value. We continue to assert that our positive growth trends in profitability, big growth in our servicing book, the ability to run originations at a profit during a difficult market period and our willingness to reduce our senior secured debt, all support a stronger stock price than we currently receive. Back to you, Glen.

Glen Messina : Thanks, Sean. Please turn to Slide 17 for a few wrap-up comments before we go to Q&A. I’m proud of how our team is executing. In the third quarter, we delivered results and achieved our annualized adjusted pre-tax ROE target. Our balance and diversified business creates opportunities, mitigate risks and supports our ability to perform across multiple business cycles. We’re executing a focused, prudent growth strategy, leveraging our superior operating capabilities to grow subservicing across multiple investor and product types. Through our investment in technology and global operating capability, we’ve built an efficient and mature platform with capacity for growth that delivers industry-leading performance and measurable improvements for clients, bars and investors.

We remain steadfast in our pursuit of industry servicing cost leadership by driving continuous cost and process improvement. Our investment in people, process improvements and technology are driving improved borrower and client satisfaction and remain committed to delivering a superior experience to borrowers and clients. We continue to expand our capital partner relationships to enable subservicing growth and capitalize on unique investment opportunities. With the support of these relationships, we are prudently managing capital and liquidity for economic and interest rate volatility and deleveraging our balance sheet as excess liquidity permits to further improve financial performance and mitigate capital structure-related risks. Overall, we’re excited about the potential for our business and do not believe our recent share price is reflective of our strong financial position, growth opportunities and the strength of our business.

As we continue to execute our business strategy, we believe we are well positioned to navigate the market environment ahead and deliver long-term value for our shareholders. And with that, Laura, let’s open up the call for questions.

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Q&A Session

Operator: [Operator Instructions] We have our first question coming from the line of Bose George from KBW.

Bose George: First wanted to just ask about the cost of service. With your servicing UPB now growing by, I guess, you said about 20% or a little more over the next couple of quarters, how do you see your cost of service trend over the course of the next year?

Glen Messina: Bose, thanks for your question. As I said, we’ve got about 30% of our servicing costs that are fixed and semi variable. And obviously, those costs don’t scale directly as we grow our business. So you can think about we’re going to continue to drive, call it, 3% to 5% variable cost productivity in our servicing platform. We expect to deliver that on a go-forward basis. And to the extent that we are successful in delivering our growth objectives, that 30% of our servicing cost base gets leveraged quite nicely. So we think we’ll continue to compare quite favorably against our peers and believe that puts us in a strong competitive position.

Bose George: Okay, great. That’s helpful. And then actually switching to the HECM, the mark on that. Is that on wider spreads? Like, what are the drivers that move the valuation of the HECM servicing? And also, I assume there’s no hedging on that piece?

Glen Messina: Yes. So our HECM servicing just generally acts as a hedge against our forward servicing. So HECM MSR, so to speak, react in an inverse way to interest rates than forward MSRs. So if rates go up, HECM MSRs actually lose value. And then obviously, that value can change as well by spreads widening or contracting. If spreads widen, all other things being equal, the HECM MSR value would be lower. And if they tighten, the HECM MSR value would be wider. So we look at it as a — the reverse MSRs as a yielding hedge against our forward MSRs and as part of our overall hedging strategy.

Bose George : Okay. That makes sense. And actually, just one small one. The share count — the diluted share count looks like it went up quarter-over-quarter. What drove that?

Glen Messina: Yes. Typically, we certainly didn’t issue any shares. So typically, the only thing that would drive the diluted share count would be the maturation of share-based compensation plans for our employees.

Operator: Our next question comes from the line of Kyle Joseph from Jefferies.

Kyle Joseph : On the correspondent channel, obviously, you guys saw good volumes, a little bit of margin compression. But if you could just give us an update on the competitive dynamics there. Obviously, you had some banks pulling out rising mortgage rates in the quarter, but just give us an update on where things are competitively in that channel?

Glen Messina: Sure. Look, the correspondent channel continues to be fiercely competitive, I would say. We are not the market price leader. We don’t aim or strive to be the market price leader. There are other players who I think we all know well, PennyMac, AmeriHome and others who have a very strong correspondent presence and are fiercely competitive in that channel, even though some other people have either de-emphasized or exited the channel. So with industry volume contracting as it has in 2023, and frankly, the MBA and Fannie Mae forecast for 2024, wouldn’t suggest there’s going to be a material rebound in volume levels. We expect it’s going to continue to be a competitive — highly competitive channel. And again, we expect to remain disciplined and continue to focus on originating MSRs as opportunity permits consistent with our cost of capital.

Kyle Joseph: Got it. Helpful. And then staying on the banks more on the servicing side, or what are we, 7 months out since Silly Valley. And obviously, there’s — we’ve seen a lot of headlines on capital requirements. But just in terms of behavior you’re seeing in terms of net selling from that industry and potential opportunities for Ocwen on a go-forward basis?

Glen Messina: Yes. Look, I think Wells Fargo was the most prominent in announcing they’re downsizing their MSR portfolio. We are seeing other smaller banks as well really think long and hard about do they want to own MSRs on a go-forward basis. And we are seeing some MSR packages enter the bulk market from the banking community. We expect, unfortunately, the Basel III Endgame rules are likely to put further pressure on banks who own MSRs and don’t have the capacity within the Basel III Endgame rules to hold MSRs. So we do think the bulk market is going to continue to be fairly robust for the coming several quarters as a result of just a really tough originations market affecting largely IMBs and the constraints – increasing constraints that banks are facing holding MSRs and mortgage assets.

Operator: Next question comes from the line of Eric Hagen from BTIG.

Eric Hagen: So the outlook for a 9% pre-tax ROE next year, how do you feel like that would maybe change in response to interest rates being both higher or lower? And how much of that return do you feel like is coming from the forward versus reverse origination and servicing side of the business?

Glen Messina: Yes. Right now, I’d say, it’s pretty obvious looking at our results, the majority of the returns are coming from our servicing platform. We expect on a go-forward basis that we’ll continue to see, if interest rates stay steady, strong performance out of our servicing platform. That said, if rates do change in a material way, again, I think that profit dynamic, we expect would shift. We’d see more profitability coming from originations, less coming from servicing as MSR run-off would go up. And increasing originations volume typically would mean more opportunity for originations as well as — historically, margins have typically widened as interest rates have go down and refinancing volume picks up. In terms of relative performance of reverse versus forward, Sean, you laid out that.

Look, our reverse servicing and subservicing platform continues to be profitable and generates good returns. But reverse originations is struggling just like forward is. So look, it’s the benefits of our balanced business model. Having both forward and reverse servicing and originations allows us to balance and balance out the impact of the interest rate environment. And we expect that will continue to serve us well on a go-forward basis.

Eric Hagen: Yes. A follow-up on that. I mean, if marks — mark-to-market and other one-time items contribute to the ROE exceeding 9% or something thereabout or do you think that would change your approach to buying back either stock or debt?

Glen Messina: So this quarter, I think as you saw, there was really zero neutral impact from any notable items. There wasn’t any opportunistic transaction gains and distressed assets and MSR values, we’re essentially fully hedged throughout the quarter. Our priority continues to be focused on deleveraging the balance sheet as we think about it. Look, our higher financial leverage relative to peers does contribute to higher earnings volatility. And we do think our stock — the trading price of our stock reflects the fact that we have a higher leverage against the company, which creates more capital structure risk and increased potential earnings volatility. So our preference here in the near-term is really to allocate excess liquidity when it’s available to repurchase debt. And as our debt ratios become more consistent with our peer group average, then we can think about a variety of different applications for our capital.

Eric Hagen: Yes. No, that makes sense. Just a couple of questions around subservicing. I mean, how should someone think about the gross margin on like incremental subservicing? Like, is there a rule of thumb for every $1 billion of subservicing you add from here? What’s the kind of pre-tax profit margin? And I think I heard you guys talk about commercial subservicing. Can you talk about the nature of what you’re subservicing there? And kind of how the cost may be compared to forward resi servicing?

Glen Messina: Yes. So let me go in reverse order. So commercial and reverse subservicing has a much higher cost structure than resi forward. The requirements are more complex, particularly at the, I’ll call it, end of life for reverse assets. So more complex loss mitigation and conveyance process or conveying loans back to HUD. And there’s more things you have to do; occupancy certs, property inspections to make sure that they’re — the properties are kept in good stead and the like. So the servicing costs are a lot higher for small balance commercial and multifamily as well as for the reverse portfolio. If you look at our last quarter’s presentation, we did show that for our typical subservicing contract on a marginal basis, so we continue to grow, we would expect that profitability would average between 2 to 3 basis points on subservicing growth as we go forward.

Obviously, depending upon the size of the relationship, scale of the relationship, if it’s a plain vanilla portfolio that’s largely current, that can have a pretty broad range of 1 to 3 basis points. But generally, call it, 2, 2.5 to 3 basis points of profitability on a marginal basis for a typical servicing portfolio – subservicing relationship.

Operator: [Operator Instructions] We have our next question coming from the line of Matthew Howlett from B. Riley.

Matthew Howlett: Congrats on all around good quarter. I want to focus on the debt repurchases, obviously, $15 million. I think you said it included in October. Glen, you mentioned taking down leverage to the peer group. My question is sort of how much can you knock down that senior debt? Is that the area you want to focus on in terms of deleveraging? And then in terms of liquidity, you did some of those synthetic transactions last quarter. Clearly, there’s going to be some seasonality with the origination business. What could you do? What steps could you do to generate more cash for deleveraging?

Glen Messina: So Matt, look, as we said, our growth is primarily going to be — or we would expect our growth to primarily be in subservicing and leveraging our MSR capital partners. We do need to maintain a target level of owned MSR UPB. Our target level is between $115 billion and $135 billion to maintain what we believe are appropriate debt service coverage ratio. So while we do have our corporate debt balances, we focus on debt service coverage as well. So look, as excess liquidity permits on a go-forward basis, we would expect to continue to allocate that excess liquidity to pay down our debt. So far in the last 18 months or so, it’s about $40 million of corporate debt reduction. The easiest debt to reduce is the PHH senior secured notes in the marketplace.

Obviously, we’ll continue to focus on various stratifications of our debt as opportunities permit to further reduce. At this stage of the game, we’ve not set a specific target of how much debt we want to reduce by quarter. We do think we need to maintain a prudent and flexible approach to allocating our capital against the priority of maintaining our own servicing UPB and as well allocating excess liquidity when available to reduce debt.

Sean O’Neil: Yes. Matt, it’s Sean. The other thing you mentioned was engaging in more synthetic subservicing transactions to promote liquidity to do something else, whether it be delever, et cetera, the constant tension we have to measure is we make significantly more — we and any other servicer make significantly more on an owned MSR than a subservice MSR. You can see all that in the Q. And so it’s kind of a — it’s a relevant target to watch where the market is. And so when the market rewards us to sell into subservicing, then it could be a useful transaction. But it frees up cash today, it’s with the commensurate lower cash flows in the future. So that’s something you have to take a 2 to 4-year kind of NPV on and understand what you’re doing to your total cash production capability if you move in that direction.

Matthew Howlett: Look, I appreciate all the actions you’re taking and I certainly understand the ROEs you’re getting on the owned portfolio, maybe I’ll ask it a different way. Do you feel confident you can take the leverage profile, I think you said down in line with peers, those being what PennyMac and Cooper and Rithm? Do you feel like, Glen, over time — Glen or Sean, that you can bring it down to peer levels over a certain amount of time? Is that sort of the goal here?

Glen Messina: Yes. Look, the goal is to try to have a more normative capital structure and leverage ratio as compared to our peers. And look, we believe that’s the right priority for the business. We believe it’s the right way to allocate our capital on a go-forward basis to eliminate risk, potentially eliminate risk and volatility in our earnings. But look, as of now, look, it’s capital allocated — we review capital allocation all the time with the board. So as the market environment changes, we’ll continuously evaluate our capital allocation priorities and make the decisions that we think are most accretive to shareholders on a go-forward basis.

Matthew Howlett: No, look, you certainly deserve a multiple in line with those folks. So congrats on the progress you’re making. But on the subservicing, I mean, most of that is going to be through your third-party capital partners. I mean, do you have discussions — you’ve entered with subservicing with some banks in the past, sort of some negotiated transactions. Do you still have that in the pipeline where you could do — you could win business without your third-party capital partners, you kind of just go in and subservice a portfolio for a bank, call it?

Glen Messina: Yes. So we’ve got a variety of different client profile, so to speak, in our subservicing portfolio. So it would include banks, credit unions, independent mortgage banks and financial investors. Those are kind of the 4 towers essentially client profiles that we tend to look at. So yes, we’ve — we do subservicing today for banks. It’s good business, especially if it’s a smaller regional and community bank who’s got a couple of billion dollars in mortgages outstanding, really tough for them to service anywhere near a cost competitive profile to make MSR returns. That would be commensurate with their return objectives. So leveraging our subservicing capabilities with a larger scale platform with a more competitive cost structure is a good way for them to participate in offering a product to their consumers and not have the burden of the operating responsibilities.

Matthew Howlett: And that’s part of the guidance, right? I mean, you have some of those in the guidance or is that — is it also the third-party capital? Just curious whether that mix is going to include?

Glen Messina: It’s all in. So look, we don’t necessarily have established growth targets, so to speak, by each client profile that we discussed publicly. Our guidance on our expected growth in subservicing and what we believe we can achieve includes subservicing transactions from all client profile types.

Matthew Howlett: Got you. Great. And then last question, Sean, for you. It looks like you’re going to end the year profitable. And again, I always focus on that deferred tax asset. Did you release any reserve on that deferred tax asset this quarter? It doesn’t look like you did. And could you give us sort of the estimated size of it? And whether or not the outlook on releasing some of that reserve partially or fully because I know it is substantial?

Sean O’Neil: Yes. So we — to your — I’ll go backwards. To your last question, we don’t update our valuation allowance and total deferred tax asset, which is offset by the valuation allowance, except for annually. So you won’t see that except in the K. As of the last K, it was a little north of $107 million was the deferred tax asset. You’re going to see — you’ll have to see several more quarters of continued profitability before we can release that either partially or fully. So there have been no transactions that involve that other than just offsetting any existing profit with the net operating losses, but the valuation allowance has not been lifted to free up the deferred tax asset at this point.

Matthew Howlett: Got you. I’m sorry. And then you said it was 100 — remind me, you said it was $170 million or $107 million?

Sean O’Neil: I believe — I have to go back and look at our K. It was — the actual valuation allowance includes the deferred tax asset plus some other drivers. I can give you the exact number out of the K. I don’t have it handy on me right now.

Matthew Howlett: Got you. Just — if I’m looking at it right, it could be — what you’re saying, it could be as much as $20 per share. I mean, that could come on theoretically the book value if that reserve was fully released at some point in time?

Sean O’Neil: At some point in time, with input from our external tax council, yes, that could have a significant impact now. The reason it also declines over time because as you produce MSRs, owned MSRs create a deferred tax liability that can offset that, but that’s usually partially. We believe the [Indiscernible] releases it should be a significant improvement to our network.

Matthew Howlett: Yes, exactly, your ratios are going to look completely different and you’re obviously not going to be a taxpayer for a significant period of time. Look, I appreciate that. I look forward to the update. Congrats on really solid results and good guidance.

Operator: [Operator Instructions] We have a follow-up question coming from the line of Eric Hagen from BTIG.

Eric Hagen: I think you mentioned the MSR portfolio that is owned by you is around $1.5 billion. Can you say what the advanced funding is that’s associated with that $1.5 billion? And is the $642 million of net advances, is that — like how is that allocated?

Sean O’Neil : Yes. So if you look near the end of the earnings deck, there’s a page on MSR valuation. I think it is, hang on a second, Page 29 this quarter. And from there, if you look at the third quarter, you can see the GSEs or the Fannie-Freddie column, is fairly normal for delinquencies, it’s pretty low. The 30, 60, 90 buckets, 1.8. And then you can see the PLS or the non-agency column is the other extreme at 15% and the Ginnies are somewhere in the middle. And the Ginnies, as Glen pointed out earlier, actually a mix of newer Ginnies which have low, what I’d call, normal delinquencies and very old pre-2008 crisis Ginnies, which are very delinquent. The delinquent Ginnies and the delinquent PLS drive the bulk of our advances.

So the vast majority of our advances are coming out of that non-agency book. Hence, Glen’s comment that we’ve had a renewed focus for several quarters now to kind of improve resolution on our non-agency book because that will bring our advances down. In terms of our kind of newer book, which would be the newer Ginnies and all the GSEs, that has relatively normative advances aligned with a fairly low delinquencies on that. And we have excess advanced capacity right now to finance in the event that advances do pick up.

Operator: There are no further questions at this time. I’d now like to turn the call back over to Mr. Glen Messina for final closing comments.

Glen Messina: Thanks, Laura. I’d like to thank our shareholders and key business partners for their support of our business. I’d also like to thank and recognize our Board of Directors and our global business team for their hard work and commitment to our success. I look forward to updating everyone on our progress on our next quarter earnings call. Thank you.

Operator: Thank you so much. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Have a lovely day.