Earnings Call Transcript - LDI Q2 2022

Gerhard Erdelji, Senior Vice President, Investor Relations

Good afternoon, everyone, and thank you for joining our call. I'm Gerhard Erdelji, Investor Relations Officer at loanDepot. Today, we will discuss loanDepot second quarter 2022 results. Before we begin, I would like to remind everyone that this conference call may include forward-looking statements regarding the company's operating and financial performance in future periods. All statements other than statements of historical fact are statements that could be deemed forward-looking statements, including but not limited to guidance to our pull through weighted rate lock volume, origination volume, pull through weighted gain on sale margin and expenses. These statements are based on the company's current expectations and available information. Actual results for future periods may differ materially from these forward-looking statements due to risks or other factors that are described in the Risk Factors sections of our filings with the SEC. A webcast and a transcript of this call will be posted on the company's Investor Relations website at investors.loandepot.com under the Events and Presentations tab. On today's call, we have loanDepot President and Chief Executive Officer, Frank Martell, and Chief Financial Officer, Patrick Flanagan, to provide an overview of our quarter, as well as our financial and operational results, outlook, and to answer your questions. We are also joined by our Chief Capital Markets Officer, Jeff DerGurahian, and LDI mortgage President, Jeff Walsh, to help address any questions you might have after our prepared remarks. With that, I'll turn things over to Frank to get a start. Frank?

Frank Martell, President and Chief Executive Officer

Thank you, Gerhard. Thank you all for joining us on today's call. I look forward to sharing my perspective on market conditions, our results, and the company's Vision 2025 plan. Our second quarter results reflect some large items, which Pat will elaborate on shortly, as well as the challenging market environment that continued in our industry, which resulted in declines in our mortgage volumes and profit margins. As we discussed a few weeks ago during our public announcement of our Vision 2025 plan, like other mortgage companies, we scaled our organization during 2020 and 2021 to meet the demands of unprecedented mortgage volumes, especially refinancing transactions. After two years of record-breaking volumes, the market has contracted sharply and abruptly so far this year. We anticipate market conditions will remain challenging over the short to medium term, with mortgage originations projected to decline by roughly 50% in 2022 from 2021, including an accelerated decline in the second half of 2022. At this point, we expect to see further declines in volumes in 2023. Despite this environment and formed by our Vision 2025 plan, we continue to believe loanDepot is positioned for long-term success, built on the support of a strong balance sheet and ample liquidity. Our recently announced Vision 2025 plan is designed to address current and anticipated market conditions, achieve run rate profitability exiting 2022, and position the company for long-term value creation. The four primary strategic pillars of Vision 2025 are, first, raising our focus on purchase transactions while serving increasingly diverse communities across the country. As the company pivots to increasingly purpose-driven origination, we expect to increase our focus on addressing persistent gaps in equitable housing while advancing the goal of growing our share of lending for purchase transactions and maintaining responsible management of credit risk. Second, meaningfully progress our previously announced growth generating initiatives including launching a digital HELOC product later this year and continuing to leverage our investment in our servicing business. Third, centralizing management of loan originations and fulfillment, increasing operating leverage, and achieving best-in-class quality and service levels. And fourth, aggressively right-sizing our cost structure for current and expected mortgage origination volumes. Over the past several months, we have taken aggressive actions to realize the goals outlined in our Vision 2025 program. We made substantial progress in a number of critical areas, including, one, pivoting our origination organization toward a unified and purpose-driven unit. Two, reducing organizational layers and increasing management spans to create operating efficiencies. Three, centralizing our operations compliance and support efforts. Four, cutting third-party and facilities-related spending. And five, reducing staffing levels. In a few minutes, Pat will provide additional detail on our progress resetting our cost structure. Importantly, I believe the progress we've made over the past several months clearly supports the achievement of our goal of achieving run rate operating profitability exiting 2022. Earlier, I mentioned pivoting our originations business to a unified and purpose-driven organization. One of the main goals of Vision 2025 is to delight our customers during one of the most important financial transactions of their lifetime. To meet this goal, we want to provide a superior standard of customer service throughout the home ownership journey from marketing to underwriting and closing, to providing ancillary and complementary products and services to servicing the loan for its duration. Working through third-party mortgage brokers makes it more difficult for us to control the customer experience and adds a layer of expense that reduces our profitability. Therefore, as part of the Vision 2025 plan, we have initiated the exit of our wholesale business channel. This will enable us to further reduce expenses, consolidate operations, and better meet our goals of becoming a purpose-driven organization with direct customer engagement throughout the entire lending process. In summary, despite challenging market conditions, we remain laser-focused on aggressively implementing Vision 2025 and we expect to exit 2022 achieving run rate operating profitability. As we look ahead to 2023 and beyond, I believe loanDepot is well positioned to succeed through leveraging and expanding our unique lending and servicing solutions, driving first quartile cost productivity and process efficiency, and harnessing the collective energy and innovative spirit of the company's dedicated team. With that, I will now turn the call over to Pat Flanagan, who will take you through our financial results in more detail.

Patrick Flanagan, Chief Financial Officer

Thanks, Frank, and good afternoon, everyone. During the second quarter, loan origination volume was $16 billion, a decrease of 26% from the first quarter of 2022. This was within the guidance we issued last quarter of between $13 billion and $18 billion. Volume during that period consisted of $10 billion of purchase loan origination and $6 billion of refinance origination, primarily cash-out refinances. Our strategy to emphasize less interest rate sensitive mortgage products has resulted in an increase in the proportion of purchase transactions from 30% a year ago to 59% in the second quarter, as well as an increase in cash-out and purchase transactions from 59% to 95% during the same period. Our pull-through weighted rate lock volume of $12 billion for the second quarter resulted in quarterly total revenue of $309 million, which represented a 20% or 39% decrease from the first quarter. Rate lock volume came in at the low end of our guidance we issued last quarter of $12 billion to $22 billion. The decrease in revenue is a result of significant margin compression driven by increasingly volatile interest rates and market adjustments as the industry continues to shed capacity. Our pull-through weighted gain on sale margin for the first quarter came in at 150 basis points, which is below the guidance we provided for the second quarter. An increase in provision for repurchase loss reserve also impacted our revenue and gain on sale margin. Our provision for repurchase reserve increased to $82 million during the second quarter from $13 million during the first quarter. The increase was mainly driven by rapidly increasing interest rates, which negatively impacted the fair value of loans subject to repurchase that were originated in prior periods at lower interest rates. Adjusting for the $69 million increase in the provision for repurchase loss reserve, our pull-through weighted gain on sale margin would have been 205 basis points or near the higher end of our guidance for the quarter. Turning now to our servicing portfolio. Customer retention remains one of our primary areas of focus. By controlling the entire customer experience and retaining data in our in-house platform, we improve our operating efficiency by capturing additional revenue opportunities and leveraging our marketing and customer acquisition expenses across multiple products and services. Our preliminary organic recapture rate remained strong at 72% for the 12 months ended June 30, 2022. The unpaid principal balance of our servicing portfolio increased to $155 billion as of June 30, 2022, compared to $153 billion as of March 31, 2022. This increase was primarily due to net additions to the portfolio, offset somewhat by the sale of $4 billion in unpaid balances during the quarter. As of the end of the second quarter, we serviced 87% of our portfolio in-house, compared to 67% at the end of the first quarter, and we're on track to bring all of our agency and Ginnie Mae servicing in-house before the end of the year. By leveraging our in-house infrastructure for this highly scalable business, we've reduced our quarterly cost of servicing from 2.4 basis points of unpaid balance in the first quarter to 2 basis points in the second. Reflecting the net growth of the portfolio, servicing fee income increased from $111 million in the first quarter of 2022 to $117 million in the second quarter of 2022. We hedge our servicing portfolio so we do not record the full impact of the increase in fair value in a rising interest rate environment in the results of our operations. We believe this strategy protects against volatility in our earnings and liquidity. Our strategy for hedging the servicing portfolio is dynamic and we adjust our hedge positions in reaction to changing interest rate environments. During our Vision 2025 call in July, we discussed our market outlook for the remainder of 2022. We continue to forecast the market will come in below an annualized $2 trillion. A significant component of this plan is to align our expense base with lower origination volume and create efficiencies we believe will result in improved operating leverage and financial performance over time. Looking ahead to the third quarter and assuming no material changes in the interest rates or the competitive landscape, we expect both pull-through weighted rate lock volume and origination volume between $6.5 billion and $11.5 billion, reflecting the current interest rate environment weighing on demand. We expect third quarter pull-through weighted gain on sale margin to increase from the second quarter margin to between 175 and 225 basis points, reflecting ongoing competitive pressures. Our total expenses for the second quarter of 2022 decreased by $88 million or 8% from the prior quarter, driven primarily by lower personnel expenses, including both salaries and volume-based commissions, and lower marketing expenses. The second quarter included charges of $41 million for goodwill impairment, $6 million of real estate and other intangible asset impairment, $4 million of severance benefits, and $3 million of consulting and other professional expenses related to Vision 2025. Net of these items and the $69.2 million increase in the provision of purchase loss reserves, our adjusted second-quarter pre-tax loss would have been $130 million. We continue to aggressively reduce our cost structure to return to run rate profitability by the end of 2022. We reduced our headcount from approximately 11,300 at year-end 2021 to approximately 8,500 at the end of the second quarter and expect to end the third quarter with our headcount below our previously stated year-end goal of 6,500. We plan to achieve our cost reduction goal by further reducing management spans, consolidating redundant operational functions, reducing marketing expenditures, real estate costs, and other third-party charges. We also continue to evaluate all aspects of our business for potential additional expense reduction as the market continues to evolve. As a reminder, we expect to recognize additional charges during the second half of 2022 as part of our Vision 2025 Plan, including severance and benefits related charges, currently anticipated between approximately $25 million and $28 million, charges related to the exit of real estate now approximately $6 million to $8 million, and approximately $7 million to $9 million of outside service costs. Approximately 75% of these expenses will be recognized in the third quarter with the remainder expected in the fourth quarter of the year. The plan is being executed against the backdrop of a strong balance sheet with $1.2 billion of tangible equity, ample liquidity with over $950 million of unrestricted cash and equivalents, and what we believe are excellent relationships and the support of our financing partners, the agencies, and other investors. With that, we're ready to turn it back to the operator for questions and answers.

Operator, Operator

Our first question will be from James Faucette with Morgan Stanley. Please go ahead.

Unidentified Analyst, Analyst

Thanks. This is Sandy on for James. Exiting the wholesale channel and mindful of your outlook just on gain on sale margins, how are you thinking about the cadence? You only provide quarterly guidance here, but the cadence of GOS margins over the coming quarters and will exiting that channel provide some support or upward pressure? Really how are you thinking about that?

Frank Martell, President and Chief Executive Officer

So, we think, net of the adjustments for the provision increases as we mentioned, margins are expected to be higher in the third quarter within the range that we talked about, and exiting the wholesale business actually provides some upward lift to margins.

Unidentified Analyst, Analyst

Got it. Thank you. And then just one follow-up, you walked through the cost structure. Any areas where you're leaning in or maintaining investments that you'd like to call out? I'm thinking technology and a few other things, anything to flag there?

Frank Martell, President and Chief Executive Officer

No, I believe that if you examine the full-year run rate cost savings of $375 million to $400 million, around 65% of that will come from personnel reductions, while the remaining amount will be a mix of other third-party and infrastructure-related costs. We will make some investments that will partially offset this reduction, mainly focused on our customer-facing organization, tools, and quality systems. Overall, the breakdown is approximately two-thirds related to staffing and one-third to other areas.

Unidentified Analyst, Analyst

Got it. Thank you, guys.

Operator, Operator

Your next question will come from the line of Doug Harter with Credit Suisse. Please go ahead.

Douglas Harter, Analyst

Thanks. Just on your commentary that you expect to be breakeven by the end of this year, what are you expecting on the revenue side there? How much contribution from home equity are you expecting, or is it mainly on the cost side that gets you back to breakeven?

Frank Martell, President and Chief Executive Officer

Yeah, I think that the primary focus is adjusting our cost structure to the market forecast that both Pat and I talked about. I think HELOC will be a very modest contributor, really, frankly, a minuscule part.

Douglas Harter, Analyst

And then just to make sure I understand the volume guidance in the context of exiting wholesale, I guess when do you expect to kind of stop funding volumes and how much of the 3Q volume guide is from wholesale?

Patrick Flanagan, Chief Financial Officer

Hi. The plan is to fund out the remaining wholesale pipeline, which is approximately $1 billion, and have the entire pipeline wrapped up by the end of October of this year.

Douglas Harter, Analyst

Got it. Makes sense. Thank you.

Operator, Operator

Your next question will come from the line of Trevor Cranston with JMP Securities. Please go ahead.

Trevor Cranston, Analyst

Hey, thanks. Follow-up on the question about the plan to exit 2022 being profitable. Can you comment on what's kind of baked into that projection in terms of where you need to see volume and gain on sale levels? Is it kind of steady from what you're expecting in the third quarter, is there any improvement at all baked into the expectation to get back to profitability?

Frank Martell, President and Chief Executive Officer

Yeah, I think broadly speaking, of course, we're looking at a market that looks more like in the low $2 trillions for the year, so that implies a slowdown through the second half of the year. And then as I mentioned in my prepared remarks, we're looking at a decline into 2023. So I think it's important to recognize that our plans incorporate a run rate that will allow us to overcome that, expect a downdraft as well. I think if you look at '23, we're kind of thinking in line with most of the other externally available MBA forecasts that are out there. We saw a bit more applied conservatism on our part.

Patrick Flanagan, Chief Financial Officer

As far as gain on sale margins, the plan that we've been talking about, the Vision 2025 plan ending the year with run rate profitability assumes that the fourth quarter gain on sale margins should be relatively consistent with the guidance we provided for Q3.

Trevor Cranston, Analyst

Okay, got it. And then you mentioned the impact of higher rates on the repurchase provision in the second quarter. I guess when we look at how rates have moved so far in the third quarter, if they were to stay relatively steady from here, would it be reasonable to expect some of that provision to come back in 3Q just based on our rates of move?

Frank Martell, President and Chief Executive Officer

Well, we think that the provision levels are accurate for what we see in the future. We think that over time, as rates continue to rise at a slower pace or remain stable, that that gap will come back and the provision will look similar to historic levels. So this was an anomaly around the differential between the rate when the loans are originated and the rates that we have at market when we repurchase.

Trevor Cranston, Analyst

Okay, thank you.

Operator, Operator

Your next question will come from the line of Kevin Barker with Piper Sandler. Please go ahead.

Kevin Barker, Analyst

Thank you, thank you for taking my questions. So how much of OpEx or operating expenses will decline from the exit in the broker channel? And is this fully embedded in your guidance for $375 million to $400 million of expenses?

Frank Martell, President and Chief Executive Officer

Yeah, Kevin, it's included as part of the overall run rate reductions in the $375 million to $400 million.

Kevin Barker, Analyst

Okay. And then how much is coming from directly from the exit of the broker channel, are you able to provide that or?

Frank Martell, President and Chief Executive Officer

No, we don't provide that level of specificity.

Kevin Barker, Analyst

Okay. And then in regards to the expenses, how much is already embedded within the second quarter operating expenses, excluding the goodwill impairment?

Frank Martell, President and Chief Executive Officer

So in terms of the $375 million to $400 million of expense reduction, that's really not in that number, just to be clear. So we've identified substantially all of that and have action plans against all of that. There's still a bit to solve for, but I'd say that we're very close to identifying the entire target and actually have action plans in place. A large portion of that, well over half of that has actually been actioned or is in the process of being actioned as of today.

Patrick Flanagan, Chief Financial Officer

A significant portion will be realized in Q3; a significant amount of headcount reductions were made in July and August, and there are a couple of months of severance expenses that will trail as a result of those terminations.

Kevin Barker, Analyst

When we look at the decrease in operating expenses from $606 million in the first quarter to $520 million in the second quarter, how much of this reduction is attributed to the cost-saving measures you implemented compared to declines in production? Is there a different perspective we should consider regarding potential future expectations?

Patrick Flanagan, Chief Financial Officer

We experienced a headcount reduction of about 25% during the quarter. Marketing expenses decreased by 40% compared to the previous quarter; 15% of that was related to personnel costs, and 8% was due to volume-based commissions. Overall, adjusted expenses were down 17% quarter-over-quarter. We didn't separate these figures because we anticipated the decline in volume in our model, so I don't have a breakdown between Vision 2025 and the volume decline. All elements were considered together to achieve the appropriate level of expenses.

Kevin Barker, Analyst

Okay. Thank you again for taking my questions.

Operator, Operator

Your next question will come from the line of Stephen Sheldon with William Blair. Please go ahead.

Patrick McIlwee, Analyst

Hey, team. This is Pat McIlwee on for Stephen today. So my first one, what top-of-funnel trends have you been seeing as mortgage rates have pulled back a little bit in recent weeks? Just curious, are you seeing any more organic traffic at all as that's happened?

Frank Martell, President and Chief Executive Officer

Not to a material degree.

Patrick McIlwee, Analyst

Okay. And then how do you think about your ability to gain market share in this declining originations market? Or is this really more about positioning yourself to stabilize the cost structure and then gain market share once volumes do stabilize?

Patrick Flanagan, Chief Financial Officer

Yeah, we're not going to chase market share. So we are very focused on pivoting to a purpose-driven, affordable lending, underserved lending model. It's going to take some time for us to get there. We're very laser-focused on cash flow profitability. Certainly, we have areas that we think we're strong in from a market position standpoint. But in general, trying to drive share in this environment is not something we're trying to do. So it's much more of a focus on trying to get to a model whereby we are intimate with our customers throughout the lifecycle of their transactions. So you're going to see a lot more focus on our talk rack around that kind of mantra. But we're not chasing share in volume at the expense of liquidity and profitability and strategy, frankly.

Patrick McIlwee, Analyst

Okay. That's helpful. Thank you.

Operator, Operator

Your next question will come from the line of Mark DeVries with Barclays. Please go ahead.

Mark DeVries, Analyst

Yeah, couple of questions about the exit of wholesale. One is just a point of clarification: are you just getting out of the broker business or are you also exiting the work with the JVs?

Frank Martell, President and Chief Executive Officer

No, this is simply related to the wholesale and non-delegated correspondent business channel. And in the partnership channel, we'd always separate those entities; the joint venture is still a big part of our focus with new builder and affordable housing and such; and wholesale and non-delegated correspondent is what is being wound up currently.

Mark DeVries, Analyst

Okay. And Frank, could you just talk a little bit more about the decision to exit as opposed to just attempting to take out some of the cost and try and continue to run those businesses?

Frank Martell, President and Chief Executive Officer

We want to stand for something meaningful. When we discuss being purchase-driven, we recognize that shifts in housing and mortgage demographics indicate a future focused on serving a broader audience, especially the diverse millennial demographic and those who follow. This will require significant investment in certain areas over time. Our long-term strategy involves closely examining these demographics and ensuring that we provide the necessary solutions and satisfaction to our customers. Currently, we have four separate go-to-market channels, but we aim to consolidate into one unified operational team. This approach will enable us to take a holistic look at the market and address the needs of our target audience under a purpose-driven lending model. Although it will take some time to reach this goal, transitioning away from wholesale, as mentioned, aims to foster closer relationships with customers rather than relying on intermediaries. While we may still engage in some intermediary actions if they align with our strategy, we are also streamlining our organization in this process.

Mark DeVries, Analyst

Got it. Makes sense. And then just one question about the guidance for Q3: pretty wide range on the two origination ranges. What kind of gets you to the high end and what scenario gets you to the low end of those ranges?

Patrick Flanagan, Chief Financial Officer

I think they're the same dollar ranges we've previously given. We understand the context is wider because of just the shrinking market. So I think it really is dependent on market conditions in the near term. So it's a very fast-moving market. Part of that range is how well our JVs do in completing inventory by year-end. And so the volatility is what makes us need to give a wide range.

Mark DeVries, Analyst

Okay. Got it. Thank you.

Operator, Operator

Your next question will come from the line of Kevin Barker with Piper Sandler. Please go ahead.

Kevin Barker, Analyst

Hey, thanks. I just wanted to clarify and follow up on some of the questions about the gain on sale margin in this quarter, given the decline. You broke up a little bit on the call, so I just wanted to clarify some of those. Was this related specifically to repurchase liability? Or was it due to loans in the pipeline that were unable to be sold or the market moved quickly against you? How should we think about the decline in gains on margin in the second quarter?

Patrick Flanagan, Chief Financial Officer

Yeah, it's almost entirely in repurchase activity and the market price differential from the increase in interest rates.

Frank Martell, President and Chief Executive Officer

Not so a lot really.

Kevin Barker, Analyst

Okay. And so the repurchase liability, is that related to your pipeline from the second quarter? Or is this loans over a long period of time that is related to?

Frank Martell, President and Chief Executive Officer

The loans that were sold as home loans over the last 12 months have returned due to record warrant violations or performance-related issues. It amounted to 3% of loans being repurchased in an environment where the average rate was 6%. There is a difference of almost 300 basis points, along with new yield requirements set by buyers of these types of loans.

Kevin Barker, Analyst

Okay. All right. Thank you for taking my questions. Appreciate it.

Operator, Operator

Your next question will come from the line of Kyle Joseph with Jefferies. Please go ahead.

Kyle Joseph, Analyst

Hey, good afternoon. Thanks for taking my questions and sorry to cover this. I hopped on a little late. But just one follow-up would be on your Q3 guidance and kind of the intermediate-term outlook going into the fourth quarter in terms of breakeven. Can you give us a sense for the cadence and magnitude of MSR sales?

Patrick Flanagan, Chief Financial Officer

So we are trying to accelerate the cost-cutting and expense savings into the third quarter so we can preserve most of the balance sheet and have to sell less MSRs to cover operating losses. We did complete an $18.6 billion MSR sale in July. That was in the June 30 quarter-end marks reflected the value of that MSR sale. So the market was still robust in the second quarter, so we can rely on MSR sales that we have to. But our focus is to shrink operating losses and eliminate the cash burn from operating losses as quickly as possible. And then we'll continue to adjust the mix of both the amount of servicing we sell at the time of origination and couple that with any other bulk sales should we need to, to bolster liquidity. But the goal is to try to minimize the amount of MSR sales going forward.

Kyle Joseph, Analyst

Got it, very helpful. Thanks for taking my question.

Operator, Operator

I will now turn the conference back over to management for any closing remarks.

Frank Martell, President and Chief Executive Officer

Okay. Thank you, Regina. Look, thanks, everybody again for joining us and for some very good questions; we appreciate that. I just want to close by reiterating our Vision 2025 plan is having its intended effect. We have made a tremendous amount of progress both structurally and from an operational point of view. And I think those are the actions needed to achieve our targeted $375 million to $400 million annualized expense savings target going into 2023. And I think we're on our way to achieving that and to hit run rate profitability exiting this year, which has been the goal. As Pat mentioned, we have strong liquidity and we want to preserve that. And so we want to do that without selling MSRs if possible, so that is definitely the goal, and we're making progress there. We do have an eye on the lower volume scenario anticipated for '23 and making sure that's incorporated in our planning. So we do have one eye on '23 as well. I think importantly, looking forward from a business point of view, I think I'm excited about our strategic pivot to a purpose-driven organization. We have a number of new digital solutions that we think, including the HELOC solution, which we think will be innovative and differentiate the company in the marketplace. And I think importantly, we also have a best-in-class servicing operation, which we think we can leverage for growth as well. So those are good growth aspects; it's not just cost-cutting, but there is growth entailed in our plan. And look, on behalf of Pat and the rest of the team, I want to thank everybody and we look forward to continuing to keep you all apprised on our drive to enhance both short-term and long-term shareholder value.

Operator, Operator

Ladies and gentlemen, that will conclude today's call. Thank you all for joining. You may now disconnect.