Earnings Call Transcript - ONIT Q2 2022

Operator, Operator

Good morning, and welcome to the Ocwen Financial Corporation Second Quarter Earnings and Business Update Conference Call. Please note this event is being recorded. I would now like to turn the conference over to Dico Akseraylian, Senior Vice President, Corporate Communications.

Dico Akseraylian, Senior Vice President, Corporate Communications

Good morning, and thank you for joining us for Ocwen's second quarter earnings call. Please note that our earnings release and slide presentation are available on our website. Speaking on the call will be Ocwen's Chief Executive Officer, Glen Messina; and Chief Financial Officer, Sean O'Neil. As a reminder, the presentation or 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 to different degrees uncertain. You should bear this uncertainty in mind and should not place undue reliance on such statements. Forward-looking statements involve assumptions, risks and uncertainties, including the risks and uncertainties described in our SEC filings, including our Form 10-K for the year ended December 31, 2021, and our current and quarterly reports since such date. In the past, actual results have differed materially from those suggested by forward-looking statements, and this may happen again. Our forward-looking statements speak only as of the date they are made, and we disclaim any obligation to update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. In addition, the presentation and our comments contain references to non-GAAP financial measures, such as adjusted pre-tax income and adjusted expenses, 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 results under accounting principles generally accepted in the United States. A reconciliation of the non-GAAP measures used in this presentation to their most directly comparable GAAP measures as well as additional information regarding why management believes these measures may be useful to investors may be found in the press release and the appendix to the investor presentation. Now I will turn the call over to Glen Messina.

Glen Messina, Chief Executive Officer

Thanks, Dico. Good morning, everyone, and thanks for joining us. We're looking forward to sharing our progress with you today. I'd like to start by reviewing a few highlights for the second quarter and take you through our actions to address the challenging and dynamic mortgage market. Please turn to Slide 3. We believe our balanced business model is working as intended, as expected for the first half of this year: servicing appreciation and profit improvement is offsetting originations decline. Our second quarter results reflect the impact of continued rising rates, widening spreads and previously disclosed strategic asset sales as well as the benefits from our actions to address the market environment. MSR values increased and we improved profitability and forward originations versus the first quarter. This was partially offset by losses and transaction costs of the EBO and MSR sales we discussed last quarter as well as the market value decline of servicing assets other than MSRs. Our origination team drove meaningful profit improvement in forward originations, while reverse origination profitability was impacted by a steep increase in interest rates and severe spread widening. We improved our mix of higher-margin products and services. We had strong subservicing additions and a growing potential opportunity pipeline. We're reducing our cost structure enterprise-wide and targeting roughly $60 million in annualized run-rate expense reduction by the fourth quarter of this year versus the second quarter. We've executed our identified actions to achieve at least 90% of that target, and we expect to complete all actions in the third quarter and realize the full run-rate benefit of cost reduction actions in the fourth quarter. We closed the second quarter with $266 million in total liquidity. This is a result of dynamically managing our owned MSR portfolio, driving growth in subservicing over owned MSRs, and optimizing MSR, warehouse, and advance financing facilities and our custodial arrangements. To support our capital-efficient growth strategy, we're making progress in expanding our relationship with MAV and other MSR funding partnerships. Our prudent liquidity management supports our objective to allocate capital to share repurchases, debt repurchases and opportunistic MSR investments to deliver value for shareholders. Consistent with the surge in bulk MSR trading activity we're seeing, we believe there will be an increase in M&A activity within the industry, and we're maintaining flexibility to consider all value-creating alternatives. As we look forward to the second half of the year, our focus will be continuing to leverage our balanced and diversified business model. We expect the third quarter will continue to be a transitional period as we complete our cost reduction actions and other key business initiatives. We are assuming reverse origination margins remain tight and volumes depressed and nominal reduction in forward servicing prepayments. With successful execution of our key initiatives and assuming no further adverse market developments, we expect to deliver after-tax ROE before notable items at or above our minimum target of 9% by the fourth quarter. I believe we're well positioned for the risk of a recession in the near term. We've taken decisive action to derisk our Ginnie Mae portfolio, particularly with our EBO and sale of our most severely delinquent loans. Additionally, more than 50% of our portfolio is subservicing with reduced exposure to advances and we're a proven industry leader in special servicing as well as the Ginnie Mae Tier I servicer. I'm pleased with the results in navigating this business cycle and remain confident in our ability to execute those items that are in our control. Let's turn to Slide 4 to discuss the environment and our key initiatives to address the market conditions. Continued rising rates and rate volatility in the second quarter drove further deterioration of industry forward originations. The MBA industry forecast for 2022 was revised down again in July. We continue to see competitive pressure in forward originations and the volume and margin environment is impacting our subservicing clients as well. We expect the timing of servicing additions to be delayed as potential clients deal with origination challenges and/or monetize their MSRs. As we and the industry reduced origination capacity, the competitive pressures may subside, though we're not expecting that to be meaningful this year. A recent reversal in interest rates suggests rates may have peaked. However, the probability of a recession has also increased. With the heightened probability of a recession in the near term, we believe our special servicing skills will be increasingly valuable and may present new growth opportunities for us. The reverse market has been adversely impacted by the interest rate environment as well. Reverse mortgage interest rates are up over 125 basis points in the second quarter after increasing about 25 basis points in the first quarter. And in the second quarter, reverse spreads widened to roughly four times our observed levels in 2021. This has adversely impacted refinance opportunity in the reverse mortgage industry and the industry overall is pivoting to new customer acquisition. Regarding reverse subservicing, we believe prospective clients are excited about our entry into the market, our end-to-end capabilities and proven servicing skills. Long term, we still like the reverse market. Demographic trends remain favorable with 12,000 people turning age 65 every day. Senior home equity is at record levels with over $11 trillion at the end of the first quarter, an increase of over $500 billion versus the fourth quarter of 2021. We believe the legacy stigma is diminishing around reverse mortgages and they are becoming more accepted as a retirement planning tool. In this business environment, we're focused on a deliberate strategy comprised of five initiatives to drive business performance and deliver value for our shareholders. We're leveraging the strength of our balanced and diversified business model, driving prudent growth adapted for the environment, reducing our cost structure across the organization, optimizing liquidity, diversifying financing sources and repositioning for higher rates, and allocating capital to maximize value for shareholders. Now please turn to Slide 5. We believe there are three main profitability drivers for us in this environment. First, our balanced business model is working. Servicing GAAP pretax income in the quarter is up significantly versus the second quarter last year due to MSR value appreciation, slower amortization, expense productivity and portfolio growth. The improvement in servicing profitability and MSR value gains more than offsets the decline in profitability in forward originations as well as the impact of our strategic asset sales to derisk the servicing portfolio and harvest MSR value appreciation. In this part of the market cycle, originations will be a less important driver of earnings, but it is a critical element of our business to replenish and grow our servicing portfolio. The second driver is subservicing. We've made great progress in growing our forward servicing business supported by our global technology-enabled scalable platform. Our success here reflects our proven industry-leading operating performance that has been recognized by Fannie Mae, Freddie Mac and HUD with top honors in their respective servicing performance recognition programs. We continue to be a leader in special servicing, supporting borrowers and investors and outperforming MBA and Moody's industry operations benchmarks. We have earned our clients' trust as evidenced by meaningful subservicing additions, renewal of our contract with Rithm, formerly NRZ, and other potential new opportunities. We've added $79 billion in subservicing UPB in the last 12 months. We have $14 billion in scheduled subservicing additions in the next six months, and our opportunity pipeline for forward and reverse is over $400 billion in potential additions. Our recognized special servicing skills position us to deliver value to clients, investors and consumers in an economic downturn. And with over 50% of our servicing portfolio comprised of subservicing, our exposure to higher costs and advances in a recession is reduced versus a 100% owned servicing portfolio. The third driver is our reverse business. We are the only large-scale, full-service end-to-end reverse mortgage provider in the industry. While origination volume and margins have been adversely impacted by record spread widening and rate increases, we continue to believe the long-term industry opportunity is attractive. Margins have been and continue to be superior to the forward originations market, and we are taking actions to adjust our cost structure to address recent margin compression. Our reverse subservicing business is gaining scale, profitability is improving, and we have a robust potential opportunity pipeline. Overall, we're excited about the potential for our business and do not believe the recent share price is reflective of our financial position, our earnings power or the strength of our business. Now let's turn to Slide 6. Our growth strategy has evolved for the current environment. This time last year, we were focused on driving MSR additions at attractive multiples. However, this year, we opportunistically sold MSRs at attractive levels, and we've been prudent in selectively investing in new MSRs in the first half of the year. Our focus has been driving growth in subservicing additions through new clients, MAV and other MSR investment partners. We believe the emphasis on subservicing versus owned servicing in this part of the cycle supports our capital allocation flexibility and helps manage the risk of increased servicing advances and servicing profitability deterioration with increased delinquencies. We're growing in higher-margin products and services and forward originations, including Ginnie Mae, Best Efforts and non-delegated deliveries and direct-to-consumer in both forward and reverse. We've increased the percentage mix of these products and services by six percentage points this year, year-over-year, driven in large part by continued growth in our client base. In forward consumer direct, we continue to shift to cash-out and our refinance recapture rate continues to improve, achieving a record level for us at 51% during the second quarter. More recently, we have begun to focus on purchase originations in consumer direct. We are in the very early stages of building our capabilities there. In reverse, we also continue to grow direct-to-consumer retail originations, which have the highest revenue margins. With increased competition expected in reverse from legacy forward originators as well as traditional reverse originators, the market transition to customer acquisition and the larger correspondent clients who may be shifting to direct HMBS issuance, growing reverse direct-to-consumer retail is a critical component of our growth strategy. Notwithstanding the unfortunate but necessary downsizing we initiated, we're pleased with our team's progress to reposition us to optimize performance for the current market environment. Now please turn to Slide 7. Mortgage application volume recently dropped to levels not seen in 20 years. In this part of the mortgage industry cycle, any industry participant who has exposure to mortgage originations needs to make the difficult choice to aggressively reduce expenses to maintain profitability. We've demonstrated our ability to reduce costs materially during the PHH integration. Cost optimization, productivity enhancement and continuous improvements are all part of our core DNA. We're committed to reduce costs to support market demand and business needs in this part of the industry cycle, while continuing to deliver on our commitments to customers, clients and investors. We're targeting annualized cost reduction of over $60 million across originations, servicing and overhead functions, measured by the fourth quarter versus the second quarter of this year. We've executed our identified actions to achieve 90% of our annualized targets and expect to complete the remaining actions in Q3, so we are well underway. We expect to realize the full impact of our cost reduction actions in the fourth quarter, and our focus is to drive sustainable cost reduction by driving demand management, supporting the most essential activities and maintaining a prudent risk and compliance management framework. The key actions include rationalizing staff levels and vendor and contract costs. We continue to leverage our seasoned global operating capabilities. Our proprietary global operating platform has been in place for the last 20 years and provides services to support all aspects of our business. Lastly, we continue to drive automation, digital migration and other systemic process improvements consistent with our technology roadmap and focus on continuous process improvement. Please turn to Slide 8. We're optimizing liquidity, financing sources and custodial arrangements to support the needs of our business during this part of the market cycle. Total liquidity has improved since year-end 2021. This is a function of capital-efficient growth and liability management actions. As we mentioned earlier, we're actively managing our growth with a bias to capital-light subservicing. We are dynamically managing our own MSR portfolio to selectively harvest value appreciation. We expect we will continue this approach going forward, and we're focused on all of our asset-based financing arrangements to ensure we have the optimum capacity, aligning indices and improved spreads on warehouse borrowings. We expanded our MSR financing facilities, improved spreads, advance rates and aligned interest rate indices to match custodial arrangements. Similarly, in our warehouse lines, they've been right-sized, mitigating rate increases through optimized utilization and we've negotiated better terms. We've also restructured advance lines to duration match interest indices to align with our custodian arrangements. We've improved our custodial earnings rate by nearly 75 basis points with more expected in the third quarter, and we're tying our accounts to SOFR going forward. We're making progress negotiating our MAV upsize. We're targeting an incremental $250 million in equity capacity and targeting to complete that upsize in Q3. In addition, we're in discussions with two potential MSR funding partners and are targeting to complete at least one transaction with these potential partners in the second half of this year. Please turn to Slide 9. As we said last quarter, given the current share price, we are optimizing our capital allocation to deliver value for shareholders. In the second quarter, we opportunistically purchased $25 million of PHH notes at 94.5% of par. This delivered one-time earnings of almost $1 million and has a positive effect on our leverage ratios. Under our authorization for up to $50 million in share repurchases, we've purchased $17 million through July 31 at an average price of just under $30 per share, which translates to roughly 574,000 shares retired. We continue to repurchase stock as laid out in our repurchase plan. We do not believe our recent share price is reflective of our financial position, our earnings power or the strength of our business. And with the book value per share of roughly $59, we believe repurchasing our shares at a substantial discount to book is a prudent value-added investment. We expect the authorization to remain in place until completion or expiration in November of 2022, subject to market and business conditions. Recently, we have reengaged in the bulk MSR market opportunistically, given improved pricing that we're seeing. We are pursuing a current opportunity pipeline of roughly $15 billion of potential deals at various stages of evaluation. We would expect to fund potential bulk MSR purchases largely through MAV, though we also expect some may be funded by PHH directly. In addition to a robust bulk market, we believe the market headwinds may drive increased M&A opportunities. As we have said before, management and the Board remain flexible to consider all actionable and value-creating alternatives. Now I'd like to introduce Sean O'Neill, who recently joined Ocwen as our Chief Financial Officer. Sean, welcome to your first Ocwen earnings call. I will pass the mic to you to discuss our results for the quarter.

Sean O'Neil, Chief Financial Officer

Thank you, Glen. Please turn to Slide 10 for our financial highlights. In the second quarter, we realized GAAP net income of $10 million for $1.12 earnings per share outcome and a 22% year-over-year increase in book value per share to $59. We saw higher rates positively impact MSR appreciation in our own servicing book as well as strong performance in our correspondent origination business which offset the two negative drivers that I will now describe in the walk on the right side of the page. This graph shows a Q1 to Q2 walk for adjusted pretax income, which is a non-GAAP measure. The second quarter result was a $26 million loss and the change from the $11 million loss in the first quarter was due to three primary items. First, a strong income improvement in forward origination of $11 million over the first quarter due primarily to higher volume and margins in correspondent lending. Second, spread widening and reverse origination drove the bulk of a $9 million quarter-over-quarter reduction as well as lower volume due to rising rates. So while still a positive income contributor, it was down from the first quarter; more on these items in the segment portion after this slide. The final driver were impacts from strategic asset sales and mark-to-market items. Collectively, these factors caused a $17 million income drop quarter-over-quarter primarily due to a previously disclosed sale of the delinquent EBOs bought out of Ginnie Mae securitizations. The second quarter sale posted a $9 million loss, but derisked the portfolio by avoiding claim losses and servicing advances going forward. The other items are transaction costs and foregone pretax income from the MSR sale discussed in the first quarter, which reduces servicing revenues in the second quarter plus some adverse one-time marks on loans held for sale. These three items collectively bridge the decline from first to second quarter income. I'd like to recap the notable items that connect our adjusted pretax income to GAAP net income. We provide adjusted pretax income for greater investor transparency, and it is a metric we use in managing the business. Notables are composed primarily of $34 million of MSR fair value adjustments net of hedge. This is due to changes in interest rate or valuation inputs. $2 million in other notables mostly from positive impact in litigation reserve release due to favorable outcomes and a negative impact of severance and other items in the quarter. For more detailed segment information, please turn to Page 11, where we will start with forward servicing. Let's begin with adjusted pretax income in the upper left chart. Excluding the asset sale and mark-to-market impacts previously mentioned, the income was a positive $13 million. Of the remaining negative $14 million servicing income in Q2, the majority of that is nonrecurring. And as previously mentioned, the asset sales either reduce future risk or provide liquidity to support debt and equity repurchases in the quarter as well as support new originations and MSR acquisitions. Moving to the right, subservicing growth in our forward business has been strong year-over-year and quarter-over-quarter driven both by MAV and other subservicing accounts. Speeds continue to come down as rates rise, thus lowering runoff and creating less drag on servicing revenue quarter-over-quarter as well as preserving more custodial deposits for float income. As Glen mentioned, we've begun to see improvements in float income in the second quarter and anticipate more increases as we aggressively migrate balances to what I call best-in-class banks who desire deposits as well as the impacts from the forward curve. Finally, in the bottom right, we have one of the most controllable functions for any successful servicer: continuously improving our cost structure. Regardless of the interest rate environment, our servicing team is always seeking out improvements via automation, shift to paperless and other process improvements. You can see in the lower right graph that improving trend with a target to lower cost by the fourth quarter. I would add here, our cost structure includes all foreclosure and other liquidation expenses, which other servicers may exclude. So keep that in mind if you're making direct comparisons. Please turn to Page 12 for forward origination segment details. Forward origination had a slight loss in adjusted pretax income for the second quarter and shows improvement due to both cost control and strong correspondent performance. Correspondent lending is the big story this quarter with a strong income growth of $10 million from last quarter, driven by both higher funded volume and better margins. This is from adding active clients in high-margin areas such as Best Efforts, non-delegated, Ginnie Mae and DTC. As an example, in Best Efforts, active clients increased by 72% from the first quarter. The consumer direct volume declined quarter-over-quarter, but was able to offset most of that income decline with cost reductions. These efforts will be more apparent in the third quarter using headcount as a leading indicator. Consumer direct headcount was down 58% from end of year to the end of this quarter. We anticipate total forward origination costs will continue to improve significantly into the fourth quarter even as we are keeping a strong focus on both serving our correspondent and direct retail customers and maintaining a high standard for compliance and risk. Please turn to Page 13 for segment details on the reverse business. On this page, we look at both reverse origination and reverse servicing. While the long-term reverse mortgage opportunity remains attractive due to borrower demographics and the reverse MSR counter-cyclical behavior during a home price downturn, there are near-term headwinds in this business. First, mortgage rate increases reduced existing HECM refinance opportunities. Secondly, the spreads on HMBS have widened rapidly in the last quarter as discount margins went from 70 to 105. This impacts gain on sale and overall margins in that business. Rate-driven volume declines are further compounded by large correspondent sellers who transition to direct HMBS issuance. All of these headwinds are reflected in the drop in second quarter income relative to the first quarter and the accompanying margin decline. It is still a profitable business, but a smaller income contribution this quarter. Over in reverse servicing, this is an income growth story as subservicing balances have increased. The contribution to income is growing and a strong pipeline of servicing additions is evident for the rest of 2022, along with the same laser focus on controlling costs as well as integrating the RMS team from our recent 2021 transaction. Please turn to Page 14 for an updated path to our targeted returns by the fourth quarter. Here, we would like to walk you from the second quarter adjusted pretax income results of negative $26 million to a projected fourth quarter pretax income that we expect will deliver a 9% ROE before notable items. The first improvement of approximately $13 million is driven by nonrecurring items linked to the prior strategic asset sales and mark-to-market impacts that we just discussed. Second, we move to our productivity and rightsizing actions, which impact all of our business segments and corporate functions that Glen discussed on Page 7. Combined, these first two actions will move us to a positive pretax income. We then anticipate a return to profitability for origination, primarily due to the shift to higher-margin products. Finally, our other net income contribution from servicing will increase due to higher volumes, especially in subservicing such as via MAV, reduced runoff as speeds decline and a focus on cost control and improved processes. Collectively, these corporate-wide efforts will propel Ocwen to a strong fourth quarter. Back to you, Glen.

Glen Messina, Chief Executive Officer

Thanks, Sean. Please turn to Slide 15. We believe our balanced and diversified business, exemplary servicing performance, proven cost management and track record of execution position us well to navigate the market environment ahead. Consistent with our expectations, first half 2022 earnings were driven by MSR fair value adjustments offsetting origination headwinds and the build-out of our reverse servicing platform. We delivered positive net income, book value per share appreciation and improved liquidity despite the impact of continued rising rates and spread widening and the adverse impact of our planned strategic asset sales. Given the current market conditions, we're focused on a deliberate strategy comprised of five initiatives that permeate everything we do to drive business performance and shareholder value. First, we're leveraging our balanced and diversified business. As we said, servicing profitability improved with higher rates, and we have a strong value proposition as demonstrated by our subservicing boardings and robust subservicing opportunity pipeline. Our recognized special servicing skills position us to deliver value to clients, investors and consumers in an economic downturn, and we have derisked our portfolio. We believe we are uniquely positioned in the reverse mortgage market with end-to-end capabilities and the opportunity for favorable demographics and home price appreciation to drive future growth within the market. Second, we're focused on delivering prudent growth through capital-efficient servicing additions and expansion in higher-margin products, channels and services. Third, we're reducing our cost structure to match market demand and improve profitability. Fourth, we're optimizing liquidity, diversifying financing sources and positioning for higher rates. And finally, we're allocating capital to maximize value for shareholders. Despite the recent headwinds in reverse originations, we believe with the benefits of successful execution of our business initiatives, we can deliver after-tax ROEs before notable items in the fourth quarter at or above our minimum target of 9%. I'm proud of how our team is executing in unprecedented market conditions. We have an established track record of successfully navigating multiple mortgage cycles with a focus on prudent growth, cost management, operational excellence and customer experience. We will be unrelenting in this focus. And with that, Danielle, let's open up the call for questions.

Operator, Operator

We will now begin the question-and-answer session. The first question comes from Eric Hagen of BTIG. Please go ahead.

Eric Hagen, Analyst, BTIG

Maybe a couple on liquidity here. You mentioned harvesting gains in MSR as a driver of earnings. Can you give more detail around what you mean by that and how to think about that relative to the amount of liquidity that you do carry? And maybe more specifically, how you're thinking about repurchasing more stock and debt in light of being able to monetize MSRs at their current value?

Glen Messina, Chief Executive Officer

Eric, thanks for joining us today. We've been dynamically managing our MSR book. Last year, we focused a lot of our growth on MSR acquisitions through correspondent or bulk transactions. MSR multiples were lower last year than where they were earlier this year. In Q1, with MSR values appreciating and multiples getting into the mid-5s, we took the opportunity to harvest value appreciation in our MSR portfolio. We received a strong bid and strong price for MSRs in the first quarter, which helped validate where the market bid was for MSRs. Since then, MSR multiples have come down a bit, so that trade worked out well. Our strategy has evolved. We now have MAV as one of our key MSR funding partners, which allows us to grow on a capital-light basis. Additionally, we're working on developing new MSR funding partnerships and are in discussions with two new providers. That gives us flexibility to dynamically manage our portfolio to optimize profitability as well as optimize our liquidity position for other investments, which could be M&A, share repurchase, or debt repurchases.

Eric Hagen, Analyst, BTIG

Got it. That's helpful. Maybe just one follow-up. I mean is there a minimum level of liquidity that you aim to run the portfolio with over the near term versus the medium to longer term?

Glen Messina, Chief Executive Officer

In the near term, we want to make sure we have sufficient liquidity to support all the initiatives that we have in the business. We want to grow our servicing portfolio and complete our share repurchase program as well. Our cash balances vary greatly throughout the month as custodial balances change and payments move through. At the end of Q4 last year, we closed with roughly $196 million in cash on the balance sheet plus unused lines. We believe our current cash levels provide enough liquidity to support our initiatives. Longer term, we expect increased FHFA capital and liquidity guidelines to be put in place toward the end of this year. Based on our initial work, we think we're in compliance with those capital guidelines and we believe we can meet them. That is one of the things we take into consideration as we manage liquidity.

Eric Hagen, Analyst, BTIG

Got it. If I could sneak in one more. If we were to think about the net equity in the company and how it's allocated, how much equity do you think you have behind the MSR, the forward origination business and the reverse origination business? And how easily would you say you can move capital back and forth between those segments of the business?

Glen Messina, Chief Executive Officer

We don't publicly disclose a specific capital allocation framework, but as a rough rule of thumb, the capital behind our originations businesses is basically the equity haircut on our warehouse lines, which is the fundamental equity invested in those businesses. For the MSR portfolio, it's the book value of our MSR minus our MSR liability and our secured borrowings against the MSR. Our corporate debt is allocated across the company. By definition, our servicing business carries the majority of our equity versus our origination businesses, especially now as origination volumes are down and warehouse balances are declining. After the Q is released, we can work with you to dig into the details further.

Operator, Operator

The next question comes from Matthew Howlett of B. Riley. Please go ahead.

Matthew Howlett, Analyst, B. Riley

Glen, first I have to commend you for the repurchases. I think it's going to drive significant shareholder value and both the debt and the equity. When you talk about capital allocation going forward, how much— I mean for the MAV upsizing and these other possible deals, how much capital are we talking about potentially going into these sidecars?

Glen Messina, Chief Executive Officer

For MAV, we are targeting to increase the equity capacity in total by $250 million while maintaining the current ownership structure of 85% owned by Oaktree and 15% owned by Ocwen. If it is fully funded, that would be $37.5 million of equity from Ocwen's perspective. If we chose to put the equity in, that would be our share. For the other potential vehicles, we are not far enough along in discussions to provide exact sizing, but there is robust appetite in the market for MSRs. We offer a compelling value proposition to MSR investors given our servicing capabilities. More to come on that.

Matthew Howlett, Analyst, B. Riley

Got you. Okay. That makes sense. For the repurchases, very quickly you could be done in a couple of months. One, how inclined is the Board to re-up the program once it's through? Two, in the guidance/walk to 9% ROE, how much does that include interest cost reduction and potential share retirements? And three, why didn't we see more improvement in servicing margin from lower prepayments and higher escrow balances— is that all in the walk?

Glen Messina, Chief Executive Officer

On the share repurchase program, the Board and management continuously review our allocation of capital. We stand behind the equity of the company—management and the Board have purchased shares—and we will evaluate reauthorization as we get closer to the program's expiration based on market and business conditions. Regarding the path to our forward projections, we're not assuming any recovery in reverse margins. We're assuming origination volumes remain depressed in the near term and we're not assuming any further prepayment reduction on the forward side. Those assumptions may be conservative versus other views in the market. Two of the biggest items in our walk to the fourth quarter are the nonrecurring losses from the asset sales and mark-to-market impacts from Q2 and our execution on cost reductions; we have already achieved about 90% of the actions. For servicing profitability between Q1 and Q2, MSR fair value changes were positive, but we took $17 million in charges related to strategic asset sales and other unfavorable mark-to-market adjustments in Q2. On a go-forward basis, floating-rate debt interest costs will increase as rates rise and interest earnings on escrows will also increase; our assumption is that these effects generally offset. Because we're not assuming further improvement in prepayment speeds than current levels, the servicing improvement in the walk is modest. If prepayment speeds slow further than current levels, that would be beneficial for servicing economics.

Matthew Howlett, Analyst, B. Riley

Last questions: how much is left on the litigation reserve you mentioned? You noted a release. And how much is the DTA and how much is reserved against the DTA? I'm assuming it's still fully reserved. Any detail there would be helpful.

Glen Messina, Chief Executive Officer

The legal reserves will be detailed in our 10-Q when we release it this afternoon, and we can share that information then. At the end of Q1, 100% of our DTAs were reserved, and we will disclose what that position looks like at the end of Q2 in the 10-Q. Regarding the DTA reserve release, accounting rules require demonstrating three years of profitability before releasing DTA valuation allowances. We have not included any DTA reserve release in our forward returns assumptions.

Matthew Howlett, Analyst, B. Riley

Well, just in terms of the company being guided to be profitable going forward, we should encourage investors to start to look at that DTA as having potential value, correct?

Sean O'Neil, Chief Financial Officer

Three years.

Operator, Operator

The next question is from Tommy McJoynt of KBW. Please go ahead.

Thomas "Tommy" McJoynt, Analyst, KBW

So given the move down in rates in July, can you talk about the magnitude of any downward pressure on the MSR mark? Or is most of the population still out of the money so you wouldn't expect much re-mark?

Glen Messina, Chief Executive Officer

The 10-year Treasury has been very volatile. It's moved materially up and down over recent weeks. Our 10-Q includes the typical rate shock table in the back with plus or minus 25 basis points scenarios. Generally speaking, our portfolio has a lot of low-coupon product in it and not a lot of high-coupon product. As rates have risen, the DV01—the dollar value change for a one basis point change in interest rates—has compressed because prepayment speeds have burned out. In Q1 we saw a larger MSR value improvement, and in Q2 a smaller improvement, which tends to follow the S-curve of prepayments in our portfolio. When the 10-Q is released, we can provide additional DV01 information from our models.

Thomas "Tommy" McJoynt, Analyst, KBW

Okay. One more: on the M&A side, is there anything that would make sense for you to acquire to build scale or enhance capabilities?

Glen Messina, Chief Executive Officer

Scale in this business is helpful since servicing and originations have relatively high fixed cost structures, particularly servicing. We constantly look for acquisitions that would give us scale or enhance our capabilities. We demonstrated our willingness to do that last year with MSR purchases and the RMS transaction. We can't speak about anything specific, but we keep optionality and would retain dry powder for compelling opportunities.

Operator, Operator

The next question comes from Preston Graham of Stonegate Capital. Please go ahead.

Preston Graham, Analyst, Stonegate Capital

You mentioned the FHFA guidelines earlier. Any additional detail on how you're positioned and how that might affect you would be helpful.

Glen Messina, Chief Executive Officer

We've modeled the potential FHFA capital guidelines and believe we have adequate capital and liquidity to navigate those guidelines. In day-to-day operations we track both the old and anticipated new capital guidelines to ensure that when implemented, we will be in compliance. Those guidelines are more punitive on Ginnie Mae assets than on GSE assets. Compared to others in the industry, we have a smaller Ginnie Mae book, which is somewhat beneficial. We are modestly growing our Ginnie Mae business, but based on what we know today, I feel comfortable with our positioning relative to the anticipated guidelines. Of course, this is subject to any changes in the guidelines before implementation.

Preston Graham, Analyst, Stonegate Capital

Got it. That's helpful. Could you provide some general commentary on how you think the business would perform in a recession?

Glen Messina, Chief Executive Officer

In a recession there are positives and negatives. For owned servicing—which is slightly less than 50% of our portfolio—you would expect delinquencies to rise, which increases the cost to service loans, reduces revenue recognition when loans become delinquent, and requires servicer advances. For GSE loans there is a cap on advances after several months, but for Ginnie Mae loans advances can continue until resolution, so owned servicing profitability and MSR values can be compressed in a recession. On the subservicing side—which is slightly more than 50% of our portfolio—we are generally insulated from rising delinquencies. Most subservicing contracts include revenue escalation provisions and incentives that help mitigate increased servicing costs and provide revenue for servicing delinquent loans. We do not advance on subserviced loans, so there are no advance burdens. Given our legacy as a special servicer and our top rankings in servicing performance, we see potential additional opportunities in a recession to add value by purchasing delinquent servicing or providing delinquent subservicing. On the origination side, if the Fed responds with accommodative policy and rates decline, refi incentives increase and originations can rebound, which could boost origination results as occurred in past cycles.

Operator, Operator

Seeing that there are no further questions, I would like to turn the conference back over to Glen Messina for closing remarks.

Glen Messina, Chief Executive Officer

Thanks, Danielle. Everyone, we are operating in a volatile and uncertain environment as it relates to mortgage banking. We're actively monitoring the financial markets, the economic environment and industry conditions closely. We're dynamically managing our operations, our plans and targets and will adjust as necessary to address emerging opportunities and risks. We have a deliberate strategy to address the choppy waters and tough environment that we're operating in, and I'm very pleased with the performance of the business. I'd 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 you on our progress on our next earnings call. Thank you all very much.

Operator, Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.