Mr. Cooper Group: Prepare for a smooth second quarter (NASDAQ: COOP)

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Investment thesis

This year, the S&P 500 (TO SPY) is down 13%. How did Mr. Cooper behave? That’s up 6.7%! This is not a sell-off in the market, but a targeted rebellion against hyper-valuation. ON FRIDAY, the S&P 500 was down 0.57%, while Mr. Cooper (NASDAQ: CO-OP) increased by 1.71%. Below is a chart showing the performance of COOP against the broader index.

COOP price performance

COOP price performance (Looking for Alpha)

COOP not only beats the market index, but also outperforms its peers. The mortgage origination and servicing business is enjoying spectacular momentum, reflected in SA’s exclusive ranking score below:

Mr. Cooper Group Momentum Score

Coop Price Momentum Score (Looking for Alpha)

What is the secret of COOP’s resilience in the face of the current market turmoil? Answering the question can shed light on the nature of the market selloff and some company-specific characteristics of COOP’s portfolio, helping to set expectations for the rest of the year.

From a macro perspective, COOP offers exposure to renewed interest in the real estate market. Although COOP does not invest in real estate, loan-to-value ratios are falling as real estate prices rise, which bodes well for its business in terms of reduced risk and more refinancing opportunities. high.

This momentum is partially offset by the Fed’s efforts to slow growth by raising interest rates. Mortgage Service Rights (“MSR”) offers counter-cyclical characteristics, offsetting the effect of rising interest rates on its origination business. This is all the more true since COOP derives more than two-thirds of its income from MSRs.

Revenue Trends

MSRs are one of the few fixed income assets that increase in value with rising interest rates. How many of these assets does COOP own? A lot. Below is a breakdown of COOP’s portfolio.

Breakdown of the COOP portfolio

Breakdown of the COOP portfolio (Author’s estimates, quarterly reports)

A quick overview of COOP operations is provided for those new to the business. MSRs are the right and obligation to administer a mortgage by collecting and transmitting payments to lenders. Other services include answering borrowers’ questions, sending payment reminders, collecting late fees, foreclosure and liquidation in the event of default. Lenders, including government-sponsored “GSE” companies, such as Fannie Mae, Ginnie Mae and Freddie Mac, outsource these services to COOP to focus on core operations.

Beyond these services, MSR companies play a vital role in providing liquidity to the market. If you look at COOP’s portfolio, you will see 10% advances and other receivables. What is that? When a borrower is in default or in arrears, COOP will continue to pay mortgage payments and ancillary fees to its banking customers (known as Servicer Advances). Eventually, COOP recovers these payments either from the bank or after seizure and liquidation of the property.

It should be noted that from an operational point of view, this process is a little more complex and includes custodial accounts which also provide a safety net in the event of default. Additionally, third-party maintenance often means faster recoveries, often within thirty days. Beyond these operational details, from a risk/reward perspective, MSRs offer predictable monthly income, with multiple safety nets in the event of default.

Historically, rising interest rates have discouraged prepayment of mortgages, extending the average term of mortgage balances. The longer borrowers extend their loans, the longer they remain COOP customers. For this reason, when interest rates rise, MSRs become more valuable, contributing to COOP’s book value.

Instead of waiting for lenders to ask for help servicing their mortgages, COOP originates loans, using its field offices across the country before selling them to banks and lending institutions while retaining the MSR, rebuilding its business with more assets. It currently holds $3.4 billion in mortgages, most of which are held for sale.

Investors should expect a slowdown in origination activity over the next few quarters as the Fed raises interest rates. The good news is that COOP generates 71% of its revenue from its MSRs, which should benefit from a rising interest rate environment.

Financial situation

Last year, the company sold several non-core segments, including its Title business to Blend Labs (BLND), its Valuation segment at Voxtur Analytics (OTCQB: VXTRF), and its Field Services business to Cyprexx Services, making a gain of $528 million. The divestments helped streamline operations, contributing to Moody’s decision to upgrade COOP’s credit rating to investment grade.

Having a strong balance sheet is particularly important for COOP, which has to pay advances if a borrower defaults, and the recovery process could be lengthy. To finance its working capital, the company opened several short-term credit facilities, with a total drawdown capacity of $17 billion, of which $5 billion is drawn, leaving an additional $12 billion of safety net for finance working capital when and if necessary.

Beyond the credit facilities, all of COOP’s long-term debt is tied to fixed rates, protecting it from rising interest rates until maturity, when it will likely refinance at higher rates. students. All of its outstanding $2.7 billion notes mature after 2026.

Summary

It’s more important than ever to adopt a conservative style of investing. Do not leverage your portfolio and diversify it across different asset classes and industries. The odds of the economy falling into recession are increasing daily as the Fed tightens policy amid a global economic slowdown.

COOP has a superior credit rating, backed by moderate leverage, simplified and streamlined operations, and revenue predictability, unlike most of its peers. MSRs are one of the few categories that increase in value as interest rates rise. These assets make up 56% of COOP’s portfolio and more than two-thirds of revenues. Our holding rating reflects the company’s position to benefit from rising interest rates and a strong labor market, offset by expected weakness in the origination segment and growing recessionary prospects.

About Mary Moser

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