Mr. Cooper Group Inc.

Moat: 2/5

Understandability: 2/5

Balance Sheet Health: 4/5

Mr. Cooper Group Inc. is a leading mortgage loan servicer and originator in the U.S., focused on providing solutions for homeowners and institutional investors.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Mr. Cooper, through its servicing segment, earns fees from managing mortgage loans for lenders and investors, while its originations segment generates revenue from originating and selling mortgages.

Business Overview:

Mr. Cooper Group Inc. (COOP) operates primarily in the U.S. mortgage industry, with two distinct yet interconnected segments: servicing and originations. Understanding their interaction is key to valuing COOP.

Servicing: This segment forms the heart of COOP’s business. It involves managing mortgage loans on behalf of other companies (mortgage lenders and investors). When COOP services loans, it handles payments, escrow accounts, customer communications, and foreclosure processes. The company receives a servicing fee for each loan. Its largest servicing clients include Freddie Mac and Fannie Mae.

  • Revenue Stream: The servicing business generates revenue through recurring fees tied to the size and number of loans it manages. This creates a relatively stable revenue stream, making it less susceptible to rapid fluctuations compared to other parts of the mortgage business.
  • Scale Advantage: The ability to manage a large portfolio of mortgages with a relatively small operational cost gives COOP a slight edge over smaller competitors. Its servicing business benefits from economies of scale.
  • Counter Cyclical Nature: The servicing business has some counter-cyclical properties, as it becomes more lucrative when interest rates rise or when there is an increase in foreclosures or loan delinquencies.

Originations: This segment is where Mr. Cooper creates and funds new mortgages, primarily for the purpose of selling them to other entities. They have been growing their origination business over the past few years.

  • Revenue Stream: Originations depend heavily on the volume of new mortgages, which is sensitive to the level of interest rates and also the home buying demand.
  • Cyclical Nature: Originations typically thrive in low interest-rate environments and when home-buying demand is high. That makes this segment very cyclical.
  • Growth focus: While still growing, the originations segment was designed to fund their servicing portfolio.

Competitive Landscape:

  • Servicing: The servicing segment is competitive, with many financial firms trying to get into mortgage servicing. However, incumbents like COOP are well positioned to manage their operations well, using data analytics.
  • Originations: This segment is highly competitive, because banks, credit unions, and nonbank mortgage lenders are all competing for the same homebuyers.

What Makes the Company Different?

COOP is trying to be a vertically integrated mortgage company. They service the loans they originate. As such, they make more profit during the lifetime of each mortgage.

  • Scale: They are one of the largest mortgage servicer companies, giving it size economies.
  • Vertical integration: Most companies in the mortgage space only do either origination or servicing but not both. Having both under one roof allows them to have more control.
  • Technology Investments: Management has a clear vision of using their technology to gain operational efficiencies.

Financial Analysis:

Recent Earnings Calls and 10-Q/K reports show mixed results.

  • The company reported a net income of $161 million, or $2.71 per diluted share for the fiscal quarter ended September 30, 2023. For the nine months ended September 30, 2023, Mr. Cooper had a net loss of $65 million, or $0.81 per diluted share.
  • As a result of reduced rates, the company reported a decline in originations income for the recent months. The income from originations is more volatile than income from the servicing business.
  • The recent rise in interest rates has caused a lot of mortgage firms to struggle because they have to pay a high price for acquiring mortgages, while at the same time home buying demand has significantly fallen.
  • The servicing side of the business has been doing well and has generated profits, helped by higher interest rates and delinquencies.
  • During the 2020-2022 period, the business has rapidly grown but that growth has stalled in 2023 and they are projecting similar performance for the rest of 2023.

The most recent report revealed that they are seeing an increase in credit losses, which is a result of economic slowdown. This is a key area to monitor over the next couple of quarters as it could affect the ability of the company to pay interest expenses.

  • They have been very proactive in buying back company debt at discounts to the par value, thus reducing liabilities in the long run.
  • Mr. Cooper recently extended its debt facilities, giving it more financial flexibility to navigate the current market challenges.
  • They have over $1.7 billion in cash.
  • Key Metrics: * ROA: Their ROA has decreased significantly over the past couple of years. As of recent reporting, their ROA is in the single digit, compared to well above 10 percent before. * ROE: It mirrors the ROA pattern, declining over the past few years.

Moat Rating: 2/5

Mr. Cooper possesses a narrow moat primarily stemming from its established position in the mortgage servicing sector and cost efficiencies. However, its exposure to fluctuating interest rates and economic cycles, as well as their reliance on technology investments, weakens the sustainability of that moat to a certain degree. The following points contribute to this rating:

  • Scale and Distribution: Their large size gives economies of scale in mortgage servicing.
  • Switching Costs: There are also some switching costs in the servicing side of the business.
  • Cyclicality: Their originations business has a lot of cyclicality to it, and their reliance on external funding and interest rate risk is significant.
  • Technology: Their moat depends on them continually upgrading their technology to get more and more efficient.
  • No Pricing Advantage: The company doesn’t have much pricing power in both the servicing and originations sides of the business, thus limiting ability to generate large profits.
  • Competition: Both the servicing and origination segments have strong competitors.

Moat Risks and Business Resilience:

  • Interest Rate Risk: Changes in interest rates can drastically affect both origination volumes and servicing profitability. A rise in interest rates can significantly slow originations and increase servicing profitability, while falling rates does the opposite. Their revenue and profits will see big fluctuations according to the economic environment.
  • Economic Cycles: Economic downturns can increase mortgage defaults and hurt their core operations and cause credit losses. The housing market downturn can significantly impact profitability.
  • Regulatory Risks: Mortgage regulation is continuously changing at all levels.
  • Technological Disruption: Rapid technological innovation could disrupt their services. They need to continually invest in new technologies to stay competitive.
  • Loss of Contracts: They are dependent on a select few large entities such as Fannie Mae and Freddie Mac to provide them mortgage servicing contracts.
  • Competition: There is a lot of competition in the mortgage servicing and originations businesses.

Business Resilience:

  • They do have an established history of operations.
  • The business is geographically diverse, but concentrated on the U.S.
  • Their core servicing segment offers a more stable stream of revenue that other businesses in the mortgage space, so it will protect them from sharp declines.
  • Their management has experience in navigating economic downturns.

Understandability Rating: 2 / 5

Understanding the business requires understanding both mortgage servicing and origination. But also the interactions between the two, and how different economic variables and market dynamics impact profitability.

The business model is relatively complex, making it difficult to value for the average person. A solid understanding of mortgage markets, macroeconomics, and how different accounting variables influence the company’s financial data is needed to understand the company well. Therefore, the complexity gives this business a 2. Some of these aspects are:

  • Understanding of mortgage servicing and origination businesses.
  • Understanding the complexity of mortgages and the various related risks.
  • Understanding of how changes in macro-economic factors and interest rates affect their profitability and value.

Balance Sheet Health: 4 / 5

COOP’s financial position is strong with a strong liquidity position and they are deleveraging their debt by buying bonds at discounted prices.

  • The company has a low debt to equity ratio compared to other financial companies, and their interest coverage ratios are decent.
  • They are actively deleveraging their balance sheet.
  • Their current ratio is at 1.8, and they have a good amount of cash, demonstrating adequate liquidity.