Welcome to Sadotti September Small Cap Conference. My name is Brendan McCarthy. I'm an analyst here at Sadotti, and I'm pleased to welcome Onity Group. The ticker is O-N-I-T. Joining us from the firm, we're pleased to welcome Executive Vice President and CFO, Sean O'Neil, as well as VP of Investor Relations, Valerie Haertel. Before I hand it over, a quick reminder: the Q&A button is located right at the bottom of your screen. Feel free to type in any questions throughout the presentation, and we can save time for Q&A at the end. With that said, I'll pass it over to Sean.
Hello, everyone. Good morning and thanks for joining. I want to give you a brief overview of Onity. We are an independent or non-bank mortgage servicer and originator. This is kind of a placemat with a lot of key statistics for our company that, you know, if you can only think of one or two pages, this might be somewhat useful to you. On the left, it shows you the businesses we're in. We're a servicer. We both service our own MSRs, Mortgage Servicing Rights. This is a servicing right that's created when you take a mortgage and typically you deliver it into a mortgage-backed security like Fannie, Freddie, Ginnie, or a non-agency security, think Jumbo Mortgages, for example. In addition to servicing and subservicing, we originate mortgages. It shows you here where we, the channels we originate in.
It's primarily consumer direct, which means we're going direct to our MSR owners to see if we can refinance them. Bulk means we purchase directly in the market. Correspondent means we deal with other businesses. That's B2B, where you're buying loans to issue, you're buying the MSR. The only place we do wholesale channels is in the reverse market. At the bottom of that, you can see the suite of products we operate in. The fact that we're both a servicer and originator gives us what we call a balanced business model. It means it reacts favorably to interest rate moves up or down, and we have a slide on that. Also, part of our balance is within our servicing book. We have about $307 billion of UPB. UPB means unpaid principal balance. That's the value of the mortgage at any point in time, added up across all the mortgages.
We service about $307 billion, and that's a pretty even split between what we own, that would be the owned servicing. That means we're responsible for the MSR. We have to make servicing advances if the loans go delinquent. You also generate more net income and cash flow off that asset versus subservicing. Subservicing, you have far fewer responsibilities. You don't have as much risk. You don't have to hedge the asset, but you get a thinner margin on the business. Off to the right, you can see our industry rank. We're a very large servicer, subservicer, top ten correspondent lender, and a fairly large player in the reverse originations market. This is measuring us against non-bank players. Think names like Rocket, Mr. Cooper, PennyMac. Adjusted ROE year to date, 18%. Our guidance is 16% to 18%.
We also show you our GAAP-diluted earnings per share and our book value per share. If you go to the next page, you'll see our strategy that's been fairly consistent for the last couple of years. Capital-like growth is an important point, so I'm just going to touch on that for a second. Capital-like growth means if we want to pick up assets and we don't have enough capital to buy all those assets ourselves, we partner with other companies. We call them our capital partners. Some are public, like Oaktree, and others we don't disclose. That gives us the opportunity to buy assets like an MSR with their assistance, and we either retain some ourselves or we subservice the whole book. That allows us to grow, scale in our business without exerting the capital or expending the capital.
I'll talk about the other asset aspects like industry leading cost structure in a little bit. For this current year, our focus is on accelerating growth. We do that with retaining MSRs, adding new products, getting better at recapture. Recapture just means you're reaching out to the mortgage servicing right borrowers that you oversee today and ensure that if they're looking to refinance their loan, sell their house, buy a new house, you're kind of first in line and talking to them early. Operating performance is critical for us. This is an operational business, both in the servicing and the origination side. Anything we can do, either using technology, predictive analytics to help us grow revenue, reduce costs, is something we're focused on. We've got a couple of slides on that. Finally, elevate the customer experience. We both have individual retail customers, think borrowers, and B2B or business customers.
We deal with both servicing clients that are companies and correspondent partners in the origination space that are companies. We spend a lot of time trying to ensure that their experience is top-notch. Here's a view at the mortgage market. The middle circle in green is probably what you're maybe possibly, sorry, the smallest circle in the dark blue is the mortgage market that you're going to hear about. Typically, over the last couple of years, the mortgage market's been in the $2 trillion to $1.7 trillion a year range. It's been as high as $4 trillion back in 2021. $2 trillion is kind of where it's at recently. That in turn, if you think of a mortgage having a six to seven-year life, that drives the big circle, the $14 trillion. That's the entire servicing market.
Subservicing is how much of that market is given out to third parties like ourselves to manage. The subservicing market's been growing a lot. The other thing to take away from this, you see at the bottom of that chart, non-banks are large and growing in this space. Pre-Great Recession, think 2008, the bulk of both the origination and the servicing were banks. Banks have pretty much either moved away or had market share deteriorated by the emergence of non-banks. It's also a growth market. You can see that on the right. On the next page, we give you kind of a couple of the points on why we're an interesting investment thesis. Most importantly, our profitability is comparable to peers. You'll see that on the next page. Yet we trade at a much more attractive valuation. We're a better value play than most of our public competitors.
We have a balanced model, meaning we're not, let me put it this way, we made more money in 2024 than in the prior 10 years for this company, and that was not a period of falling interest rates. We have shown the capability to have a balanced business model that performs in a high rate or a low rate market. We're increasing our market position. We drive organic growth. Finally, we focus on both technology and process improvements and have created a servicing platform that's highly recognized by all the agencies and some other players. The next page will show you our profitability. Our adjusted return on equity is actually equal to or better than many of our large competitors. IMB is an independent mortgage bank. These are public companies that compete with us. We have similar results and similar guidance.
Yet, if you look at the far right, we still trade at a discount to book. We're somewhere around 65% to 70% discount to book at any point in time. We tend to measure this for us and our peers on the day they announce earnings or we announce earnings versus our most recent stock price. That's a couple of drivers there. One could be our size. We're a small cap. We have a smaller float. It means it's an opportunity for people who are interested to buy and hold a strong value play. In the past, we had had less than favorable reviews in the late 2015 to 2018 period from some of the regulators and agencies.
We've cleared up all of that, totally overhauled the company, changed out the leadership, changed out the technology platforms, and really resolved all the outstanding issues that were, you know, regulatory, compliance, or litigation related. Finally, we're viewed as a smaller player, but as I'll show you in the slides to come, we can compete not just on ROE with our larger peers, but we can compete on cost as well. Scale is important, but it's not the only driver. We've used ongoing process improvements and technology over the last five to seven years to improve our cost position. The next page shows you the balanced business model. This is quite simply just giving you a glimpse of a period where originations was very strong. Second quarter of 2021, 2021 was a boom year for originators versus the most recent quarter. The light blue is the servicing book.
Servicing is performing quite well in the current market when refinances are high and mortgages are turning over, think post-COVID when rates plummeted. Servicing has lower pre-tax income because it's showing higher runoff or amortization. MSRs amortize naturally every month, but when you have high refinance periods, MSRs literally disappear. If you're not recapturing your own MSR, you will see that in your P&L as a non-cash negative. Origination is exactly the opposite. That's a story that probably most of you understand. Origination thrives when rates are falling. We also give you some views of our reverse book, which is exactly the opposite of our forward book. That's a story of, as rates decline on a reverse MSR, the duration actually extends. Prepayment is not the driver. It's overall duration of the MSR. Subservicing is kind of indifferent because you're just getting paid a fee there.
You can make more money on a delinquent book, but other than that, it's not overly rate dependent. On the next page, you'll see us showing organic growth, winning new clients, both in correspondent and co-issue. That's one type of business client or in subservicing. We actually scrubbed our subservicing book, exited a number of small clients who were just not very profitable, and then have added roughly 56 larger clients over the last four years. Growing the servicing portfolio, we measure that with UPB, or unpaid principal balance, as I measured earlier. You can see those statistics on the right. Page 10 shows you recapture. This is something that we've really just developed over the last three or four years. We've only been an originator for five and a half years now.
Our recapture wasn't that strong during the last low interest rate environment, which would have been 2020, 2021, because our origination business was pretty much brand new at that point in time. Our recapture has gotten quite better. You can see that as you look at our consumer direct volume, which is up substantially year over year. On the right, you can see how we perform either for the last 12 months. Those are the bars, or the little dots show you the most recent quarter. Those are recapture statistics as publicly reported by three of our large competitors and ourselves. For the quarter, we were the best. Over the last 12 months, we are second best. We're quite happy with our recapture performance and continue to improve that. That's one of the areas where machine learning, generative AI, can really help us.
I'll talk about that in a few minutes. It's being able to get second and third-order data sets on your customers and give you a leading advantage on when to approach them and what to talk about. Next page shows you some of the awards we've won. We consistently win awards from the GSEs. The GSEs are Fannie and Freddie. We're also a HUD Tier 1 servicer. To do this, it's not just about size. You're compared with people of comparable size, and they measure you on a number of metrics. To win awards from the GSEs consistently is a very difficult thing. Plus, the bar goes up every year. We have technology awards we've won recently. We're giving an example of one right there. Every year, the MBA, the Mortgage Bankers Association, does a cost survey.
In large servicer categories, of which we're one of the smaller ones, actually, we're very competitive on both the performing loan, which means it's current, not delinquent, or delinquent loans, which is special servicing or non-performing loans. We're actually quite good there because we've been doing that for probably 20 years. The customer experience on the retail side, you can see over on the right, B2B clients, that would be a subservicing client. You can see a net promoter score. Net promoter score in the 50s is actually very strong. That's probably equivalent to some of the brand names you're used to as a retailer. On the next page, we give you the direction that AI, generative AI, and maybe old school technology is being used in our company. We basically bucket where we're using the, what the technology is on the left.
Something like robotics or RPA, that's a technology we've been leveraging for six or seven years and have probably replaced over 50,000 monthly people hours with that technology over the last five years. Natural language processing, machine learning, a little newer. OCR, or intelligent data processing, is an older technology that's seen leaps and bounds in the last two or three years. We use all of these technologies, but they have to drive something on the right. They either make us in a better cost position, they help us accelerate revenue growth. That's the recapture I was mentioning. They make either our corporate or retail customers happy, or they make us operationally superior, which can either be reflected in your cost to serve, or it can just mean fewer errors, fewer problems. That's where we try and lever technology and drive those results.
You can see that in much more detail on this page. We give you some examples where we try and do this today in the middle. This could be either chatbots or other agents. We use something called Lassie 2.0. That's a B2B agent that goes and grabs the data for our correspondent clients and really frees up a lot of time for them and us. Machine learning, where we're trying to use payment patterns to predict delinquency before it happens and reach out to the borrower and see how we can help them, whether it's through a mod or some other activity. Really a broad suite of activities, not one big driver, but many smaller drivers. Next page shows how we think about capital allocation strategy. Our highest emphasis is prioritizing organic growth.
When we have excess capital, how do we use that to either expand assets that we hold, go into more products and services, which in turn expand assets? Quite frankly, if you originate more mortgages, it costs money or takes capital to retain the mortgage servicing rights. The MSR isn't free. When you deliver the loan to the MBS, you can sell the MSR or you can retain the MSR. We've been leaning into retaining more and growing our own book over time to keep pace with the growth in the subservicing book. Plus, then we have additional investments we have to make in, for example, like the technology that I just mentioned. We also like to optimize liquidity. You want to have enough cash, but not too much cash. All that should drive our long-term returns.
This is a continuous discussion and set of analytics we run all the time for every investment decision we make. The next page shows you our guidance for 2025, as well as our financial objectives. Our guidance is an adjusted return on equity of 16% to 18%. We gave that at the beginning of the year, and we still maintain that. Growing our servicing book, measured in UPB, by 10% or more this year. Maintaining a high hedge effectiveness rate. That's really important, especially as rates are dropping. MSRs are incredibly interest rate sensitive on the forward side. If you have an effective hedge, that allows you to minimize the impact. A high efficiency ratio just means that we don't grow costs faster than we grow revenue.
We've also mentioned that we're going to be releasing some or all of a valuation allowance that's offsetting our deferred tax asset by year-end. To close out, we think we have a very strong outlook for the year. We have a balanced and diversified business model that has performed well through various market cycles. We're interested in where the rates are going to go today, like the rest of the world. We're very confident that our business does well in a high increasing interest rate or a decreasing or a stable interest rate environment. We're doing that because we're driving growth, winning new clients, continuing to grow the businesses we have, using technology as well as operational improvements to get differentiated performance, service excellence. The point I made earlier is we're comparable to our peers for profits, yet our valuation is much more attractive.
I'll stop there and see if you have any questions.
Great. Thank you, Sean. We appreciate the overview, and we can now open the floor for Q&A. Why don't we start off with the balance sheet? Just curious as to where leverage sits now, if you're comfortable with that level, and ultimately talk about how you fund both originations and the subservicing book.
Sure.
Our leverage right now in the second quarter was about 3.2 to 1. We think that's much improved. In 2024, it was over 4 to 1. We did a restructuring in the fourth quarter of 2024, reduced our total debt by about $140 million, reissued some high-yield loans, collapsed several different debt structures into one much more market normative high-yield issuance. Our high-yield issuance was a 5 non-called to $500 million issuance. At this point, our focus on leverage is to organically improve it through growing net income. It could creep up slightly because as we add MSRs, MSR debt is actually, for our market sector, included in the debt-to-equity ratio, even though it's kind of asset-backed financing. While we don't currently intend to add any high-yield debt unless our equity growth can support that, if we do grow MSRs, we'll let that number creep up slightly.
As we continue to improve equity each quarter, that gives us a little bit of room to do that. Long term, our goal is to get that number down into the 2s. In terms of supporting the businesses, servicing generates cash every quarter. The servicing book tends to be a cash generator. Originations is where you consume cash. What we tend to do is we take the cash we generate over in servicing, bring it over and retain the MSRs that we're creating on the origination side or buy new bulk MSRs independent of origination. That's how we redistribute the capital within the business. We did raise some Series B PREF in the fourth quarter of last year that was specific for an asset acquisition that we made from Waterfall Asset Management. For the right scenarios, we'll consider different structures on the balance sheet.
We also like that because it improved our debt-to-equity ratio at the same time.
Got it. Why don't we circle back to the transformation? I know you mentioned there were some regulatory headwinds in the 2018 timeframe. For investors who may be new to the story, what can we kind of take away from that transformation and where the business is positioned now, heading into what may be a more favorable interest rate environment?
Yeah, so back in late 2018, Onity's prior brand was Ocwen. Ocwen and another company called PHH Mortgage merged. Our current CEO, Glen Messina, used to be the CEO of PHH. He had retired. The Ocwen board asked him to come back and run the combined entity. From 2019 to probably 2020, 2022, the focus of the company was kind of upgrading the management team. A lot of the leaders are new. There are some quite capable leaders who have continued on from the prior companies. Consolidating and upgrading a lot of our platform, we moved to a more market standard mortgage servicing platform. We totally upgraded and changed out all of our technology. Sometimes when you're doing a merger, that's a great time to reinvest in your technology because, quite frankly, sometimes you're dealing with two legacy systems coming together and neither one is cutting edge.
We did that and have continued to do the ongoing process improvements on improving anything we do in servicing and origination, not just through technology and automation, but just standard process analytics. That continues to be a focus. Then reshaping the servicing book, launching an originations book to originally just allow us to replenish MSRs, but now it replenishes MSRs and gives us a growth platform. You pivot from there to a pure growth mentality, which has been in the last year and a half, really. That transformation has occurred. It may be not as relevant to someone who's new to the space, but if someone was active in the space five years ago and then they haven't followed our company, that should be a refreshing upgrade to the story. It helps us bring focus to the company.
That's one of the reasons we rebranded because we had made so many transformative changes and really have a company that looks quite different than it did five to seven years ago.
Great, great. That's helpful. More recently, I believe you mentioned you were more profitable in 2024 than in the previous handful of years. Can you discuss the success in 2024 and how that performance may carry over to 2025 or how it compares looking forward?
Yeah, so 2025 continues to be a strong year. It's just hard to do a full year comparison with only two quarters under my belt. Yeah, 2024 was pivotal for us because we really started to see improvements in recapture, helping to drive origination, pre-tax income, even though we were in a period of higher for longer rates. As you recall, 2024, I think we had a couple of false alarms where people thought rates were going to go down, but they didn't. We were able to, you know, either add products or add capabilities to continue to drive originations profitability. Plus, we had right-sized that business and were able to operate it profitably in that environment. The servicing book was growing and we were also adding owned MSRs, which was helping our profit margin and our hedging capabilities got materially better.
I didn't talk about that today, but I talked about it in our second quarter earnings tech. There's a slide there you can see where our ability to minimize the volatility of the MSR fair value when you include the hedge improved dramatically. We think our hedge costs are very competitive compared to some of our larger peers. We hedge at far lower costs with similar results than some of our competitors do. We've focused extensively on that in 2023 and early 2024 to improve that capability. Those were all drivers for that improvement.
That makes sense. You mentioned the recapture rate improving. What ultimately impacts that rate, and how does your recapture rate compare to industry peers?
Yeah, so we measure a blended recapture rate, which means we look across all of our channels, which for us are primarily correspondent and consumer direct, also known as direct to consumer, depending on who you're talking to. For any firm, typically your consumer direct channel is going to be very high relative to your correspondent. The reason for that is simple. Correspondent, someone else originated the loan, you bought it from them, you have to take over the relationship and, you know, convince the borrower that, you know, you're the new great originator if they want to recapture or refinance their loan. When you do consumer direct, our recapture rate in the most recent quarter was 88% and our blended rate was in the low 40s. That is, you know, not quite best in, it was actually best in class for the quarter and over the last 12 months.
We like to measure over 12 months because that's a more kind of reliable number given the seasonality of the business. That was, you know, one of the best of the publicly traded firms that released that data. That's a function of a lot of the quantitative analytics we do, as well as the leadership and the originations team and where they're putting the focus and the training on the loan originators, as well as the marketing data and the information you bring to bear.
Great, great. That's helpful. I wanted to touch on M&A in the industry. It's obviously been active as of late, especially with Rocket's acquisition of Mr. Cooper. Just curious as to get your thoughts on M&A in the industry and how investors can think about that.
Yeah, we think the more public, you know, current announcements, think Rocket, Mr. Cooper, Guild, and Bayview, are quite interesting and in some cases create some opportunity for us. Obviously, anytime there's heavy M&A interest in a sector, that can bring attention to your stock. That's always welcome. In addition, not every subservicing client may want their business serviced by Rocket, who could be a competitor. The way to think about this is there's two kinds of people that own MSRs. One might be a financial investor, think like a hedge fund. They may want to own an MSR as a financial asset, but they don't have an operating business. They subservice with someone like us. They also pay someone else, possibly someone like us, to do the originations recapture. They might be quite happy sitting with Rocket because Rocket's probably pretty good at recapture.
Someone who actually owns an origination business, a lot of originators don't service their own loans. They may hold them, but they'll let someone else, like in this case, Mr. Cooper, service them. UWM is a good example. UWM raised their hand and said, "Mm-mm, we're out of here." You don't want a competitor having all the data on your borrowers and servicing them on a monthly basis because that gives them a pretty strong advantage to get in front of you. It creates an opportunity where subservicing books start to move around and, you know, we can compete for those activities.
That's fascinating. One more question. You mentioned your stock is really trading at a discount relative to peers on a price-to-book basis. What are investors, you know, missing here with the story?
I think it takes more than two or three minutes to understand our balance sheet. We've got a couple of what I call GAAP balance sheet gross-ups. Those could be normal to our business, like Ginnie Mae early buyouts. They're grossed up for any holder of those assets, or the reverse assets, which are fairly unique to us and only one other public player. That takes at least 30 seconds for someone to look at our balance sheet and realize there's a very large asset and a very large liability, and that throws off your equity-to-asset ratio. People just doing an automated scan of financials are going to miss us. You have to dig into the balance sheet for a few minutes, read through the Q or the K, ask a couple of questions.
Frankly, in our earnings deck, we show a balance sheet walk that takes out all those aspects. That means you have to get through the appendix of the earnings deck, which some people don't want to get to. Second, we're a small cap. People who need to take very large positions in a stock have to pass on us. That makes us an interesting opportunity for people who can do smaller investments and take a position and see the inherent value.
That's great. Sean and Valerie, we really appreciate the time and the overview today. I will conclude there.
Thanks so much, Brendan. Appreciate it.
Thanks, everybody. Take care.