Onity Group Inc. (ONIT) Earnings Call Transcript

Hello, and welcome, everyone, joining today's Onity Group's Second Quarter Earnings and Business Update Conference Call. [Operator Instructions] Please note, this call is being recorded. [Operator Instructions] It is now my pleasure to turn the meeting over to Valerie Haertel, Vice President, Investor Relations. Please go ahead.

Good morning, and welcome to Onity Group's Second Quarter 2026 Earnings Call. Please note that our earnings release and presentation are available on our website at onitygroup.com. Speaking on the call will be Chair, President and Chief Executive Officer, Glen Messina; and Chief Financial Officer, Sean O'Neil. As a reminder, our comments today may contain forward-looking statements made pursuant to the safe harbor provisions of the federal securities laws. These statements, which speak only as of the date they are made, may be identified by reference to a future period or by use of forward-looking terminology and address matters involving assumptions, risks and uncertainties, including those described in our SEC filings. In addition, the presentation and our comments contain references to non-GAAP financial measures, such as adjusted pretax income. We believe these non-GAAP measures provide a useful supplement to discussions and analysis of our financial condition because they are measures that management uses to assess the performance of our operations and allocate resources. Non-GAAP measures should be viewed in addition to and not as an alternative for the company's reported GAAP results. A reconciliation of these non-GAAP measures to the most directly comparable GAAP measures and management's reasons for including them may be found in the press release and the appendix to the investor presentation. We made changes to our non-GAAP methodology this quarter and encourage you to review the presentations note regarding non-GAAP financial measures. Now I will turn the call over to Glen Messina.

Thanks, Valerie. Good morning and thank you for joining our call. We're looking forward to sharing our results for the second quarter, as well as reviewing our strategy and financial objectives to deliver long-term value for our shareholders. Let's get started on Slide 3. In the second quarter, our sound strategy and strong operating fundamentals delivered double-digit year-over-year revenue growth and record origination volume. Our balance business performed well with rising interest rates driving increased adjusted pretax income and servicing, offsetting declining adjusted pretax income and origination. We're excited to report we've completed the reverse asset sale to Finance of America, as well as transferred most of the legacy subservicing back to Rithm. We believe these transactions simplify the business, improve profitability and focus an increased strategic flexibility. The second quarter net loss includes roughly $33 million of pretax costs related to these transactions, as well as market-driven unfavorable asset fair value adjustments. Finally, considering persistent geopolitical instability, inflation and market volatility, we expect our full year 2026 adjusted ROE to be at the low end of our guidance range. Let's turn to Slide 4 to review a few key financial highlights. We again delivered double-digit year-over-year revenue and servicing UPB growth, as well as record origination volume with improved revenue margins versus last quarter. Total servicing additions were up 2.8x versus prior year, driven by our strong originations and subservicing additions, which exceeded our first half expectations. Consumer Direct continued to perform well, delivering funded volume up about 3x over last year with improved refinance recapture rates. Our net loss includes $9 million of pretax costs related to the reverse asset sale and legacy subservicing transfer, as well as $24 million of pretax asset fair value change, of which about half is related to reverse. John will provide more details on these costs later in the presentation. Origination adjusted pretax income increased over 3x versus last year, reflecting lower interest rates driving higher industry volume levels, as well as improved execution. Servicing adjusted pretax income decreased over 60% versus last year as lower interest rates drove an increase in MSR runoff of almost 80% versus prior year levels. Our presentation of adjusted pretax income now reflects MSR runoff based on actual servicing UPB runoff and all changes due to rates, inputs and assumptions are classified as notables. We believe this approach is consistent with certain of our peers and addresses feedback from investors. Let's turn to Slide 5 to discuss the actions we're taking that we believe will improve long-term ROE performance. We are taking focused and deliberate actions to improve ROE long term that we organize into 3 categories: servicing scale, portfolio optimization and technology-driven productivity. Regarding scale, every $50 billion in servicing can reduce fixed cost per loan by 13%. We continue to target a roughly 50-50 mix of owned servicing and subservicing to grow our portfolio on a capital-efficient basis, as well as balance EPS growth and ROE. Our organic growth strategy focused on delivering positive outcomes for customers has driven steady servicing portfolio growth. Next is optimizing our own servicing and subservicing portfolios. We've reduced our investment in reverse MSRs because yields are 2 percentage points lower than forward and are not easily leveraged and they have a higher relative volatility. We are leveraging machine learning using client assets and consumer data to identify what we believe are the most profitable MSRs to focus our origination activities and improve returns. In subservicing, we've largely exited the Rithm subservicing and are growing in commercial and reverse, which is more profitable and requires specialized skills and systems, which we have. Finally, technology-driven productivity has been a foundational element of our strategy embedded in our business culture. We've significantly reduced expenses since the acquisition of PHH, while delivering servicing portfolio growth and building a top 10 nonbank originations platform from scratch. Robotic process automation, intelligent document processing and natural language processing have reduced manual effort, as well as transform document management and customer engagement. Future investments are focused on driving additional productivity, improving recapture and enhancing the customer experience. Let's turn to Slide 6 to review what I believe differentiates Onity from our peers. We've built a strong foundation and a growing customer-focused business by consistently delivering positive and differentiated outcomes for our customers. We're a top 10 nonbank originator servicer and subservicer with a balanced and resilient business built to perform through business cycles. Our award-winning technology-enabled platform has been recognized as a top-tier servicer by Fannie Mae, Freddie Mac and HUD for 5 consecutive years. Our platform delivers superior operating outcomes for our customers, which when combined with our enterprise sales model, expansive product suite and diverse capabilities fuels meaningful portfolio growth. We've built a strong foundation by shedding in profitable assets and relationships, investing in talent and technology and building trust with clients by delivering a positive experience and targeted solutions that create measurable value. We're now growing from a position of strength with a more focused and simplified business with increased strategic flexibility. Let's turn to Slide 7 to review our balanced business model. While there may be variability in any given quarter due to evolving market dynamics, our balanced business continues to demonstrate long-term resiliency to changes in interest rates. The complementary profitability dynamics of origination and servicing balance each other as interest rates have declined in the 12 months ended the second quarter of 2026 versus the 12 months ended second quarter of 2025. And with interest rates increasing in the second quarter, servicing adjusted pretax income has improved, offsetting declining origination income. We continuously optimize operations capacity and scalability, as well as our MSR investment profile to enable our balanced business model to operate as intended through interest rate cycles. Let's turn to Slide 8 for more about our growth focus and actions. Our enterprise sales approach and focus on delivering value for clients is producing terrific results. In the second quarter, our originations grew 64% versus prior year, outpacing industry volume growth and achieving record levels since we built our platform. We've improved our refinance recapture rate to 51% in the second quarter, up 3 percentage points versus the prior year, with a roughly 3x increase in refinance payoff volume. Our recapture performance has continued to exceed the ICE industry average for the last 12 months, and we believe we're delivering top-tier recapture performance versus our third-party origination-centric peers. With mortgage interest rates increasing, we've seen a doubling of home equity product volume versus the second quarter of last year. We believe this is a valuable product for consumers and one that helps us manage operating capacity and improve customer retention. As a reminder, we do not include home equity volume in our refinance recapture rates. Our originations team is performing very well, and we're continuing to invest in technology and process optimization to enhance the customer experience, reduce costs and improve scalability and competitiveness. Let's turn to Slide 9 to see what we're working on. We're embedding AI, analytics and automation across our lending platform to improve our recapture rate by increased capacity and improving human performance. We are using voice agents to support customer communication across several aspects of the lending and servicing process. Voice agents create historically unparalleled capacity to engage borrowers seeking to refinance or access their home equity and generate actionable leads for our sales team. This is driving improved connectivity with customers and increasing engagement, which in turn drives increased locks and fundings. AI call monitoring analytics provide insights to optimize marketing, improve opportunity identification, fine-tuned value propositions and improve sales performance. Real-time agentic AI integration through our partnership with Blend is aimed at optimizing customer and employee workflows and providing a faster more guided experience. Technology allows us to turn interactions, borrower signals and workflow events into intelligence that drives superior recap performance and customer experience. It's clear that our investments are delivering tangible results, and we remain excited about the future potential of our investment pipeline. Let's turn to Slide 10 to discuss subservicing. The disruption created by industry consolidation among subservicers continues to create opportunities. We are winning new clients with strong platform performance and a compelling value proposition. First half subservicing additions of $35 billion exceeded our guidance with key wins with capital partners, banks and independent mortgage banks, and we continue to have an active opportunity pipeline across all 3 segments. We're excited about the growth we're seeing in business purpose residential and commercial subservicing driven by our expanded product offerings. UPB is up 25% versus prior year, and we were named the servicer on our first single-family rental securitization for a top-tier client in that space. We continue to invest in technology to improve transparency, increase turn times and client service functionality. Our efforts are yielding results as evidenced by our client Net Promoter Score of 70 in the first half of 2026, a level raggling some of the best service organizations. Let's turn to Slide 11 to talk about how we've grown our servicing portfolio. Total servicing UPB ended the quarter up 10% year-over-year versus total industry servicing growth of 3% with growth in both owned MSR and subservicing. Year-over-year servicing additions net of runoff of $76 billion was largely driven by organic growth and more than offset planned transfers to Rithm and other client asset sale-driven deboardings. With MSR demand keeping prices elevated, we continue to see clients monetize their older MSRs, while replenishing their portfolio with new originations. There should be no question as to our ability to compete for business and grow our servicing portfolio. Our double-digit portfolio growth despite the Rithm transfer and client MSR sales highlights the strength of our value proposition and the power of our origination capability. Now I'll turn it over to Sean to discuss our financial results in more detail.

Thanks, Glen. Let's turn to Slide 12, where we describe the impact to GAAP pretax income. The main story here is that the bulk of the decline in pretax income, about $24 million, is due to nonrecurring transaction costs or fair value marks on reverse assets. Ongoing operations and servicing was the strongest contributor to the $6 million increase in GAAP pretax income quarter-over-quarter. The Finance of American transaction and to a lesser extent, costs associated with the Rithm deboarding created a $9 million negative onetime impact in the quarter. This was further exacerbated by a decline in the fair value of the reverse assets due to mark-to-market impacts, primarily less favorable HECM spreads. The majority of these assets, about 80% of the fair value, have been sold to Finance of America. Thus, the impact of fair value changes on the remaining portfolio will be greatly reduced. Furthermore, the assets we are retaining are older and have less sensitivity to spread movements given their shorter duration. The remaining mark-to-market impacts were due to a mild increase in delinquency as well as hedge costs. Regarding delinquencies, if you refer to the appendix page on MSR valuation, you will see the 30-plus delinquency bucket on GSEs deteriorated. However, the Ginnie Mae delinquency buckets improved quarter-over-quarter. The 30-plus category is the most volatile measure, so we focus more on the longer periods, such as the 60 and 90 plus. We are closely monitoring the portfolio for any indications of longer-term stress on borrowers. The final impact is $4 million due to both hedge costs and fair value inputs, which is a small percentage of the $2.5 billion fair value MSR book that we hedge. Please turn to Slide 13 for a perspective on MSR fair value impacts. This graph shows 3 different drivers of MSR fair value broken into runoff, rates net of hedge and inputs and assumptions. Runoff is the actual MSR value of unpaid principal balance that either paid in full or amortized during the quarter. Then we show the impact of interest rates net of hedge and finally, MSR fair value changes from inputs and assumptions. This last category includes changes in loan characteristics such as delinquency status, borrower escrow payments, assumptions for prepayments, loan defaults, servicing costs, ancillary income, discount rate and changes in bulk market MSR prices, all of which impact modeled cash flows and MSR fair value. Runoff is always detrimental to net income and can increase due to several variables, including higher prepayment speeds due to lower interest rates. You can see this impact from Q4 '25 through the current quarter when we had several refinance surges due to a temporary but meaningful drop in mortgage rates. Another driver of runoff is portfolio size, which has been increasing. With respect to the other categories, both interest rates net of hedge as well as input and assumptions become smaller drivers when considered across multiple quarters in a cumulative fashion. The average of either of these categories shows a volatility of about plus or minus 3 basis points. That's why we showed these impacts in notables, which impacts net income, but do not include them in adjusted pretax income, given the periodic volatility or swings, we believe this is similar to several large competitors in our space. Please turn to Slide 14 for a similar view of Reverse. Here, you can see that the Reverse book experiences far more volatility than the forward book. The impact from interest rates and inputs and assumptions are both materially greater as a percentage of the total balances in Reverse compared to forward on the prior page. This shows how our recent sale of the majority of this book should lessen MSR fair value volatility going forward. Please turn to Slide 15 for a recap of key financial measures. Revenue was up 24%, continuing the strong year-over-year growth trend. Both servicing and originations contributed to the year-over-year growth in revenue due to higher volumes and stronger execution, which included improved recapture, reduced servicing advances and better data analytics. Sequential revenue growth was up slightly as servicing increased more than the origination decline. This is primarily due to growth in the owned MSR volume driving revenues. Operating efficiency continued to improve on a 12-month trailing basis, which reflects our long-term focus on cost-effective growth and book value per share is up significantly, about $13 year-over-year. Please turn to Slide 16 for detail on originations. Originations pretax income grew by over 3x on a year-over-year basis, driven by higher volume across the combined business. The $15.5 billion of funded volume in the second quarter was our largest quarter in history. The strongest contributor was the B2B channel. This is correspondent lending and co-issue. The volume improvement did not come at the expense of margins as those also improved due to our strong enterprise sales efforts and continued improvements on analytics to drive margin management. Consumer Direct remained profitable but generated lower adjusted pretax income from 2 drivers. The first is lower lock volume in the second quarter by 30% quarter-over-quarter. Lock volume is a key metric for recognizing revenue. The second is elevated consumer direct operating expense due to lagging commissions from the first quarter refinance surge. With respect to staffing, our objective is to balance efficiency with flexibility. We optimize our capacity levels to balance current earnings growth and accommodate any future interest rate decline. Hence, our origination staffing is at levels to support higher than current volumes. Both B2B and consumer direct channels benefited from a continued focus on growing new products, including non-QM and second liens. Second liens have more than doubled in volume year-over-year with over $70 million funding in the second quarter. Please turn to Slide 17 for our servicing performance. Starting with the middle graph, strong owned MSR growth helped drive servicing revenues up 13% from the prior year and 3% sequential quarter. Servicing adjusted pretax income improved on a sequential quarter due to better float income and better runoff as mortgage rates stayed elevated in the second quarter. Year-over-year, adjusted pretax income is still lower, driven primarily by higher runoff, which you can see at the bottom of the right graph, which is then partially offset by improved revenues. Please turn to Slide 18 for details on improved advances in servicing. Building on the strong improvements we saw last quarter, servicing continues to improve the advanced balances with a 33% decline over the last 2 years. This comes even as we grow owned servicing UPB as we focus on the small percentage of loans that drive the most advances. As you can see by the dark blue graph, the bulk of our advances are linked to delinquencies in our non-agency owned MSR book. We have been deploying various strategies such as AI-enabled agents that assist our contact center in quickly providing the most effective range of solutions for the borrower. As we scale AI-powered solutions for our contact center, we are targeting an annual savings of about $3 million at our current portfolio size. Slide 19 gives our approach to capital allocation. Our considerations for capital deployment focus on organic growth, liquidity and returning capital to investors. Organic growth includes adding owned MSR via profitable originations activity. Other examples include broadening our product offering for both originations and servicing. In parallel, we maintain sufficient liquidity to ensure we meet both regulatory and lender requirements, as well as holding enough buffer for various stress scenarios. We also consider ways to return capital to investors. Our 10-Q provides information on the recently completed $10 million share buyback, as well as the ongoing $20 million buyback, which reflect the value we see in acquiring shares that are priced materially lower than book value. On Slide 20, we provide our updated view on 2026 guidance. As Glen mentioned earlier, we are guiding to the lower end of the adjusted pretax income range of 10% to 15% based on current market conditions and the first half results. The other areas we provide guidance on are unchanged. We continue to grow our total servicing book with strong growth this most recent quarter, improve our operating efficiency and maintain strong hedging performance. Back to you, Glen.

Thanks, Sean. Let's turn to Slide 21 for a few comments before we open the call for questions. Onity is a top 10 nonbank mortgage originator, servicer and subservicer with a balanced and resilient business that is winning and growing in our target markets. Our second quarter results demonstrate that our growth strategy is sound and our operating fundamentals are strong. We've built a technology-enabled award-winning platform that is efficient, delivers differentiated performance and excellent service. We are taking focused and decisive actions to improve ROE over the long term organized into 3 categories: increasing servicing scale, portfolio optimization and technology-driven productivity. To that end, we believe the reverse asset sale to Finance of America and the legacy subservicing transfer simplify the business, improve profitability and focus and increased strategic flexibility. With a strong foundation, simplified business and greater flexibility, we believe we are well positioned to navigate the current environment, capitalize on attractive opportunities and continue delivering sustainable, prudent growth. All of this adds up to a business that delivers adjusted ROE comparable to our peers with increasing scale and market position at a more attractive valuation. With that operator, let's open the call for questions.

[Operator Instructions] We will take our first question from Bose George with KBW.

This is Frank Labetti on for Bose. I just want to start, you guys nicely laid out the goals for your pretax adjusted ROE range. Can you just help quantify what bridges the gap to the lower end of the range given you're in the 9% range currently and the market is pretty volatile. So, yes.

So, look, we -- based on the ROE expansion actions that we laid out in the presentation on Page 5 in terms of driving improving servicing scale, optimizing the servicing portfolio and then obviously continuing to drive productivity. Look, we believe those are going to help us improve the ROE of the business despite some of the volatility that exists in the marketplace where we really saw some of that volatility hit us in the past is the loan origination pipeline hedging, we saw some -- a lot of noise in that during the first quarter of this year, and that's in the second quarter that seemed to behave a lot better. We saw improved margins in the origination space, even though there continues to be market volatility, and we would have record origination volumes as well, too. So, look, we feel good about the actions we're taking to drive improved adjusted pretax ROE. And we feel a little bit better about our ability to manage some of the volatility that we've experienced in the first half of the year. So, yes, those are the actions that we think get us into the ROE range. Sean, anything you want to add?

Yes. Frankie, I'd add that some of the pressure we've seen on adjusted pretax income over the last 3 quarters has been very high runoff. If rates do stay elevated, that theoretically should improve over time. That improves servicing adjusted pretax income, and we continue to show an ability to generate pretax income in originations even a rather difficult quarter like the one that just happened.

Great. That's very helpful. And then just a little more broadly, banks had a pretty meaningful increase in volumes and taking share during the quarter. How do you see them evolving in the market? And then secondly, in the correspondent channel, can you just talk about competition you're seeing there just at the GSE cash would note?

Sure. So, Frankie, look, banks have always been a force to be reckoned with. When they want to play in this space, they typically come in and buy and buy aggressively. And quite frankly, we're seeing a number of bank buyers of MSRs in the marketplace during the first half of this year who have a seemingly insatiable desire for MSR assets. Net-net, we think that's good for valuations, but obviously, creates an interesting competitive dynamic. If the bank capital regulations, proposed relaxing of bank capital regulations for holding MSRs change. Look, I think there's a number of financial institutions, which I should say, banks who have strong mortgage franchises today, they'll continue to grow them. Based on our conversations with experts around the banking industry, it doesn't seem to be a whole lot of folks who would be considering a wholesale change in their strategy of I'm going to go -- I'm not a mortgages today, I'm going to go gangbusters. That's not the predominant thinking. Those who are in will likely get bigger and increase their franchise. That said, it makes businesses like ours more valuable in the sense that if somebody is thinking about getting into the mortgage space, it's hard to start de novo. If you want to get in, you get in with scale. And you look at a business like ours that has billions of dollars of custodial and escrow deposits, which are considered to be sticky deposits, that's an interesting situation. I think maybe how banks think about looking at nonbank mortgage companies. In terms of competition in the correspondent space, look, I think our correspondent team is just doing a phenomenal job. They are focused on value-based selling using an enterprise sales strategy. And look, our ability to achieve record origination volumes where, frankly, industry origination volumes with rates up are not looking as encouraging as they were in the first quarter. The team is just doing a phenomenal job. And again, we -- I think Sean talked about margins increased from 23 to 26 basis points as well. So, look, correspondent has always been competitive and it's the most competitive -- well, maybe compared to broker, but it might be second most competitive space in the industry. But I think our team is just doing a terrific job there. Really proud of them. And again, that's part of why we were able to record origination volumes.

Our next question comes from [ Randy Binner ] with Texas Capital.