If closed as expected, the acquisition of Flagstar Bank‘s servicing businesses has the potential to make the mortgage servicing rights (MSR) portfolios of Mr. Cooper Group reach the $1.56 trillion mark in unpaid principal balance (UPB), consolidating the company into the top mortgage servicer in the country.
Mr. Cooper executives are deploying the strategy of increasing their servicing book to take advantage of an extensive customer base that is likely to refinance their mortgages when interest rates drop, which is anticipated in the next few months by monetary policy watchers. This could offset the loss in income with servicing assets when prepayments increase.
With this context in mind, Mr. Cooper on Thursday announced it will pay $1.4 billion in cash for Flagstar’s $77 billion UPB of owned MSRs and $279 billion in UPB of subservicing MSRs. The deal also includes Flagstar’s third-party origination platform (TPO), which in the first quarter of 2024 originated $2.8 billion, up 33% year over year, according to Inside Mortgage Finance (IMF) estimates. Integration and transaction costs related to the deal are estimated at $50 million.
Mr. Cooper chairman and CEO Jay Bray told analysts that the transaction helps Flagstar “solve balance-sheet goals” and simplify its operations as Mr. Cooper will take on its existing subservicing business while servicing first-lien mortgages and home equity lines of credit (HELOCs) that remain on the balance sheet. Flagstar’s owner, New York Community Bancorp (NYCB), expects the transaction to add 60 basis points to its CET1 capital ratio.
For Mr. Cooper, meanwhile, the deal provides “excellent returns on capital, thanks to the fee income from subservicing,” and the company “gets a major step up in scale and the opportunity to realize additional operating leverage,” Bray added.
According to filings with the Securities and Exchange Commission (SEC), Mr. Cooper had 5.3 million customers and $1.2 trillion in UPB at the end of June. Its portfolio brought in $288 million in pretax operating income in Q2 2024, compared to $273 million in the prior quarter.
“We expect most of the [Flagstar] purchase price is ascribed to the owned MSRs, although we also see value in a sticky rolodex of relationships in the Flagstar subservicing portfolio,” BTIG analysts Eric Hagen and Jake Katsikas said in a report. According to them, the deal “adds to Mr. Cooper’s significant scale, making it the top servicer over JPMorgan by roughly $100 billion.”
The Flagstar deal will increase Mr. Cooper’s customer base to 6.6 million, with the migration process expected to be completed by early 2025. Regarding refinance opportunities, Mr. Cooper’s servicing portfolio includes an 18% share of loans with a coupon rate of 6% or higher, totaling $117 billion. Flagstar’s MSR assets add $15 billion to this balance.
Mr. Cooper President Mike Weinbach told analysts that he expects the Federal Reserve to start cutting rates in September, which puts pressure on the company’s interest income. But it also brings an “opportunity to scale up originations in 2025.”
Loan originations
Through its origination business — which focuses on acquiring loans from correspondent originators and refinancing existing loans through its direct-to-consumer channel — Mr. Cooper delivered $38 million in pretax operating income in Q2 2024, near the high end of guidance, compared to $32 million in the previous quarter.
Mr. Cooper’s funded volume increased to $3.8 billion in Q2 2024, up from $2.9 billion in the previous quarter. Its correspondent channel volume grew from $1.5 billion to $2.1 billion during the period. Meanwhile, direct-to-consumer volume rose to $1.7 billion, compared to $1.4 billion in the previous quarter.
Executives said the company’s recapture rate went from 70% to 73% during this time due to adjustments in pricing and marketing strategies.
Part of the reason the deal with Flagstar is possible is because of Mr. Cooper’s profitability and liquidity in the context of lender struggles due to a higher mortgage rate environment. The Dallas-based company delivered $204 million in net income from April to June, compared to $181 million in the previous quarter.
Mr. Cooper said it has strong liquidity to support its acquisition model. At the end of June, it had $3.2 billion in liquidity, including $642 million in unrestricted cash.
Kurt Johnson, Mr. Cooper’s chief financial officer, told analysts that prior to the deal, the company’s capital ratio was 28.4%, well above the target range of 20% to 25%.
“We expect to pay for the acquisition by drawing down on our MSR lines, which will utilize some of our excess liquidity, although we will still be comfortably in compliance with our internal guidelines,” Johnson said.
Looking ahead, the company expects gains for the origination side of the business in the range of $35 million to $45 million in the third quarter, assuming current mortgage rates. Servicing earnings should be flat in the third quarter, in the $280 million to $300 million range.
Regarding new acquisitions, Bray said that “we still think there’s going to be a lot of MSRs coming to market. But again, as always, we’re going to be disciplined and we’re going to take care of this transaction first.”
Mr. Cooper shares were trading above $94 on Thursday afternoon, up roughly 8% from the previous day.
