Rithm Capital Corp. (RITM) Q3 2013 Earnings Report, Transcript and Summary

Good morning, my name is Darla and I will be your conference operator today. At this time, I’d like to welcome everyone to the New Residential Third Quarter 2013 Earnings Call. [Operator Instructions]. Thank you. I would now like to turn the call over to Sarah Waterson, Investor Relations. Please go ahead.

Thank you, Darla and good morning. I’d like to welcome you to New Residential’s third quarter 2013 earnings call. With me today I have Wes Edens, our Chairman of the Board; Ken Riis, our Chief Executive Officer; Michael Nierenberg, our incoming Chief Executive Officer and Jon Brown, our Chief Accounting Officer. Before I turn the call over to Wes, I’d like to point out that certain statements made today may be forward looking statements. Forward looking statements are not statements of fact, instead these statements describe the company’s current believes regarding event that by their nature are uncertain and out of the company’s control. The company’s actual results may differ materially from the estimates or expectations expressed in the forward looking statements. We caution you not place undue reliance on any forward looking statements. I also encourage you to review the disclaimers in our earnings release regarding forward looking statements and expected returns as well as review the risk factors contained in our quarterly reports filed with the SEC. I’d now like to turn the call over Wes.

Great, thanks Sarah and welcome everyone. Let me just give a few introductory remarks and I’ll turn over to the other folks to speak. The quarter we just finished is a very good one, GAAP income $63 million, $0.24 per share; core earnings $38 million, $0.15 per share; uninvested cash on average over the quarter was just about a $100 million. So had that cash been invested, our core earnings would have been about $0.01 or $0.02 higher. We declared the common dividend of $44 million or $0.175 per share. One of the questions, I am sure that folks have is that obviously given the difference between GAAP earnings and common dividend our anticipation is we’ll have some kind of a top up dividend at the end of the year. Our taxable income is in between the two, right because we don’t pay, some of the GAAP income is not a taxable event and we have to pay out 100% of our tax income. So it’s probably a few cents differential but Jon Brown will talk about that when he goes through the remarks in his segment. So I am going to refer to the supplement that we posted here recently. So just starting with Page 4, investment highlights for the quarter, we funded approximately $250 million of investments throughout the quarter, generated over $140 million of cash free investment from the existing portfolio, the excess MSR investments which are about 1/2 of our capital, we invested $216 million including $198 million to fund, previously committed investments and then another one small investment of $18 million to acquire 40% interest in another excess MSR related to a $5 billion pool of non-agency loans. The performance of those investments has been terrific. We are very optimistic about their prospects going forward, when I get to the investment part of it actually Mike Nierenberg is with us here this morning will talk about that a little bit. The consumer side, also a very good quarter. Just to refresh the numbers a little bit, we invested a total of $241 million in capital into this portfolio of loans that is also invested in and serviced by Springleaf which is one of our sister company here at Fortress. During the quarter we sold down a piece of subordinate financing to reduce our capital, so our capital in the investment went from $241 million down to $133 million. The performance of that portfolio has been terrific. When we bought it we were estimating an unleveraged return on the portfolio of low double digits, about 11%. It looks like the current performance of it is actually mid double digits so about 15%. So with 80% financing at 3 ¾% on an unleveraged investment of 15% it is a terrific investment. I think our current estimate is it will end up being something between 35% and 40% returns. So it’s been a terrific investment, we took out a chunk of capital and did so at very good rates on that. On the non-agency side, a very active quarter. We sold and bought securities. Mike will talk about specifically in terms of what our thoughts about that, but we are always looking for opportunities to harvest what we think are more mature investments and invest in things that we think have more upside and so that generated some gains for us for the quarter. Page 5, subsequent to the quarter end, we invested or committed to an additional $200 million, so again a very, very busy quarter. One thing I would say just generally speaking is that although the markets have gotten increasingly competitive in a number of our core products, these are very, very large markets and we think that there is lots of interesting things to do. So excess MSR investments, obviously non-agency which we talked about. The last thing on the list non-performing loans, we made our first investment in that sector, that is something we think is going to be a very active sector in the market, generally and we do think that there is going to some good opportunities there. Page 6 just if you look at the business snapshot and you can add it up by capital. So excess MSRs $667 million of the $1.2 billion in total capital. Obviously the non-agency is a big investment for us, we have our consumer loans and then we had a bunch of cash on balance sheet at the end of the year. Our expected life time returns on the portfolio is just under 20%, on the portfolio that is actually quite under leveraged. So we think that that’s a great profile and responsible for a lot of the other terrific results we had. The potential for growth, in terms of these different products, excess MSRs, non-agencies, the non-performing mortgage loans and other investments is something I'll hold that dialog till the end. I think it's safe to say that there still there is lots and lots of interesting opportunities out there. So, with that let me take a pause and turn it over to Mike Nierenberg to go through the portfolios. Mike?

Thanks Wes. Good morning. I'm going to begin with Slide #9 or Page #9 in the supplement. I'll take you through the excess MSRs to talk a little bit about performance. So far we as taking a look at the top of the page, we have $715 million either invested currently or committed. If you go to the line below we have $659 million which is currently funded and $59 million in forward commitments. When you look on the quarter, we are thrilled with the performance of the portfolio. Speeds actually slowed down to CPR in the quarter. When you look at how the portfolios were underwritten at the time of purchase, we assumed a 15% IRR is currently running at approximately a 16% IRR and overall recapture rates are pretty much in-line with what we thought they would be. If we go to Page 10, on the $659 million initial investments, we have generated a $146 million of life-to-date cash flows including $35 million in Q3. That is a 22% of investment over the average of 12 months. We're currently carrying those at $667 million and we expect potential future lifetime cash flows of $1.2 billion, which implies the multiple of approximately 2. On the quarter, we took a gain of – on a mark-to-market basis of approximately $13 million and that’s just reflecting current market conditions and current performance of the underlying portfolios. I am going to skip Page 11 and then we're going to go right to Page 12 to talk a little bit about the non-agency business, just some thoughts there and some of the things that we're seeing. We currently have $852 million current face carrying those assets at $582 million. They are all season non-agency RMBS, almost entirely floating rate which for the way that we're looking at the world and thinking about our portfolio from a duration standpoint there was very little duration in those assets. We're very excited about that sector while spreads have come in a bunch, we continue to look for opportunities to increase our yields in that portfolio as you've seen in some of the other slides. We did do a little bit of what I call tweaking of our balance sheet, selling some lower yielding assets and reinvesting in higher yielding assets. And when we look at the non-agency sector we’ll continue to focus on and I think the total return aspect and trying to again source higher yielding assets that we think from a credit perspective are very attractive and then sell what we think are going to be lower yielding assets going forward. Subsequent, I’m on page 13. In the quarter we purchased $108 million for $83 million or $0.77. We sold $148 million for $118 million which produced a gain of approximately $11 million. The portfolio increased $12.8 million or 1.5 points. When you take a look in what’s alluded to subsequent to the third quarter, we had a pretty active month in October. Again we think this sector has a lot of value. And we think from a levered return perspective, we are going to be able to put up IRRs anywhere from 12% to 16% on current purchases. I’m going to turn back to the consumer loan portfolio which is Page 14. Wes went through that, I’ll turn it over to Wes again.

Well, the presentation on Pages 14 and 15 and 16 give you some sense of both the overall snapshot of the portfolio and what its performance has been. One thing that we’ve tried to do on page 16 is trying to show you the difference in value and what we think kind of implicit difference in value is between where our investment is currently performing and what we think market value is kind of, it’s kind of a crude proxy for kind of hidden book value as it were. And so the difference obviously is that to the extent that we have 10% discount rate on the investment and look at the difference between 12% CDR and an 8% CDR in fact that ends up working could be a difference of couple of $100 million in value. So obviously a very substantial asset for us one that unfortunately is an idiosyncratic one. We don’t currently any other investments like this lined up, we’re always looking for new opportunities, but this is our attempt to try to layer that out for you. And with that turn maybe turn over to John Brown to walk through the financials.

Thank you, Wes. I’m going to provide a quick overview of our financial results. For the third quarter we generated GAAP income of $63 million or $0.24 per diluted share. Core earnings this quarter was $38 million or $0.15 per diluted share. On September 18th, we declared a common dividend of $44 million or $0.175 per share. Our average un-invested cash balance for the third quarter was $96 million. If this cash was invested at a 15% return in the beginning of the quarter, fourth quarter earnings would have increased by $4 million or $0.01 per diluted share. As today, our cash balance is approximately $170 million. Our cash position pro forma for closings of committed funding and sales is approximately $70 million. Also as Wes mentioned, we do anticipate paying a small top-up dividend say us to a few cents per share due to gains included in our taxable income. To provide more information on our third quarter, we posted our third quarter supplemental disclosures on our website. You will notice we included detailed asset performance data for each of our primary business lines. We look forward to updating you on our progress in the coming quarters. I would now like to turn over the call to Sarah.

Great. And I think Michael Nierenberg if you want to talk about a few market opportunities?

Sure. I just want to go back to our page 17 for one quick sec just to talk about our agency business. When you look at that portfolio of assets, I think one of the things that we really try to do is again stay as short duration as possible on our agency securities. If you look at that slide for this quarter, we put in our estimated duration to be something approximately a year. So we are not going out on the curve and taking a lot of duration risk on those assets. And those are strictly for ’40 Act compliance. I think looking forward when we think about our pipeline and opportunities we are looking at a lot of different things in the market. While the markets are fairly competitive and there is a fair amount of cash out there in the marketplace, we do think there are some opportunities. As Wes pointed out, we did purchase our first pool of non-performing loans and that was out of a HUD auction. I think in the next couple of days HUD is going to announce another auction of approximately $2.5 billion, so we’re excited at the opportunity there. We are looking at a lot of the large money center banks who continue to sell large amounts of non-performing loans and re-performing loans. And when you look at the market size there, there should be some great investment opportunities for us there. Obviously in the MSR space, when you look at the pipeline, there’s give or take about $200 billion to $300 billion that we see going forward. We’ll be selective quite frankly in our purchases, but we are pretty optimistic on that business as well. And then to the extent that there will be some one-off trades whether it be on the consumer side or some of the other types of assets that we tend to take a look at, we are very encouraged at the future prospects of growing the company prudently and trying to increase returns for our shareholders.

And last thing before we turn over to questions, just a couple of thoughts on the mortgage servicing businesses and industry generally. The last couple of years have been tremendous period of time for the non-bank mortgage servicers. The handful of companies that have had the most success have gone from small servicers to very large servicers. So the land grab over the last several years of some of the large portfolio sales and some of the bankruptcy options and what not have resulted in a handful of companies, Auckland, Nationstar, Walter among them that have gone from being small servicers to very large ones. I think you are entering a new phase for those businesses which is also going to be a very productive one, which has less to do maybe with the windfall and opportunities to grow those things to the dimensions that they grown. We’ve had 100% year-over-year growth for a number of years, that’s not sustainable in my view. But what I do think there are the opportunities for are very substantial opportunities for kind of the industrialization of the businesses. So, and what I mean by that it's just simply getting better at the processes that they put in place. Anytime you take a business that's grown a 100% a year for a handful of years in a row, there is likely to be some gaps in terms of the best practices on just getting things sorted and wringing the most money out of the business. I’d tell you other big opportunity in the sector and it's one that we are very focused on is just capital structure efficiency. And what I mean by that is that before all the run up in the mortgage servicing businesses there was not a lot of alternatives in terms of capital structures. Obviously with the formation of a company like New Residential with the announcement of formation of other companies which you see in the news kind of recently the people are looking at owning MSRs and REIT structures like independently. The next obvious element to that is to look at the balance sheet and the operations of the servicers themselves and see if they can be structured more efficiently to be more effective from a tax standpoint. Because to the extent they own lots of assets that would be well served to be in a REIT, there are some big opportunities on the capital efficiency side and that is something that we are thinking about and focused on substantially and may have some interesting things to talk about in the future. So with that, operator let me turn it over to the panel for questions.

[Operator Instructions] Your first question comes from the line of Henry Coffey with Sterne Agee.

That is, your last statement this kind of the question of the hour. Nationstar made some allusions in that direction. You have Fortress has a private MSR vehicle, you have NRZ. Is it a universe in which we wake up one morning and Nationstar looks more like a REIT or is it a universe where you in essence separate the 2 businesses Nationstar evolves into a sub-servicer and a disproportionate amount of its existing MSRs transfer into other vehicles whether they’re named in as New Residential or something else?

The short answer to your question Henry is, yes. I think if there are opportunities to do some version of all the things that you describe. And as this businesses again have gotten to place of not maturity but certainly adolescence, that they’re now bigger businesses and they start they continue to evolve, looking naturally at the capital structures that exist and then technology that exists today is a very logical thing to do. A year ago there was not a public REIT like the New Resi REIT, that looked to both how the asset would be held in a public context with the performance of it was and what the investors view and appetite towards it is. A year later today, that’s a very, very different situation obviously. So I think that, I actually think anytime you have a business that owns a lot of assets that would be REIT eligible A and B pays a lot of tax across the board on all those things, without over-engineering things, there are some great opportunities to be more efficient about it. And we have done lots of restructuring types of transactions with lot of the companies we've been involved in have done various things. It’s not a direct comparable obviously but most recently with the spin of Penn Gaming into a gaming REIT as well as an operating company that’s been something which we think has created some value. But it’s more important than simply creating the financial engineering result, it’s a question of creating the right business plan that gives you the highest quality and most transparent results that people can understand, that's what I think actually gives you a lower cost of capital and that actually results in a better outcome for shareholders. So those are the kinds of things we are thinking about and there is nothing that is imminent per se but it is something that I think is obviously worthy of note or I wouldn’t have brought it up so…

New production, high quality MSRs at least if we listen to Two Harbors, it seems like they were talking about a 6% to 12%, ROC, our own model is somewhere like 6% or 7%, whereas legacy servicing is more like a 12% to 15% kind of asset right now. Can you get both of those assets into New Residential that still need to be return hurdles or does that higher quality servicing need to go some places else?

Yes, I mean to date we have made a decision not to leverage the MSRs, I think that, that’s the right decision. It gives us a lot of financial flexibility so that if there ever was, real market turbulence you’d have a very unleveraged balance sheet that allow you take advantage of those things. We've had lots of good experiences during difficult periods as a firm, so that's just I guess the structurally how we think if it all. Obviously an unleveraged return of 6% or 7% or 8% doesn’t meet the thresholds that we think is what we are trying to do. And the markets for the most liquid investments, the new production stuff, the markets had tightened in substantially, that's the bad news. The good news is these are very large markets, there is lots of other things to do. And so I’m very excited to have Mike here as our partner, he will be the CEO of the company next week, I guess once it’s filed. We think that the opportunities in the sector broadly speaking are very substantial. The new production MSR I think is not at the top of list in terms of the most interesting, but MSRs generally speaking we think in lots of forms do make sense for us.

[Operator Instructions]. There are no further questions at this time. I will turn the call back over to Wes Edens for closing remarks.

Great, that’s all. Well, thanks so much for dialing in everyone, look forward to talking to you next quarter.

Ladies and gentlemen, this concludes the New Residential Third Quarter 2013 Earnings Call. You may now disconnect.