Rithm Capital Corp. (RITM) Q2 2018 Earnings Report, Transcript and Summary

Good morning. My name is Beth and I will be your conference operator today. At this time, I would like to welcome everyone to the New Residential Second Quarter 2018 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Mandy Cheuk, you may begin your conference.

Thank you, Beth, and good morning, everyone. I would like to welcome you today to New Residential’s second quarter 2018 earnings call. Joining me here today are Michael Nierenberg, our CEO; and Nick Santoro, our CFO. Throughout the call we’re going to reference earnings supplement that was posted to the New Residential website this morning. If you have not already done so, I would suggest that you download it now. Before I turn the call over to Michael, I would like to point out that certain statements made today will be forward-looking statements. These statements by their nature are uncertain and may differ materially from actual results. I encourage you to review the disclaimers in our press release and earnings supplement regarding forward-looking statements and to review the risk factors contained in our annual and quarterly reports filed with the SEC. In addition, we’ll be discussing some non-GAAP financial measures during today’s call. A reconciliation of these measures to the most directly comparable GAAP measures can be found in our earnings supplement. And now, I would like to turn the call over to Michael.

Thanks Mandy. Good morning, everyone and thank to joining our Q2 earnings call. I'd say on the quarter our portfolios performed as expected, which I think is great as there were really no surprises during the quarter. Overall investment activity for us was fairly low similar to Q1, with a little bit more capital deployed in the loan business. As we think about the investing environment, we continue to be cautious as the amount of capital in the market remains plentiful, and coupled with tightness in spread; we continue to be prudent as we deploy capital across the different financial services sectors that we invest in. Our investment portfolios and rate use remained the same. And we believe the current portfolio is fantastic for the current rate environment that we are in, and should continue to create great value for our shareholders. On the financing front, I wanted to highlight the MSR financing market. At this time, 90 plus percent of our financing around our MSR business is financing the capital market which takes REIT term financing. For example, this week were priced to $560 million MSR note at a 460 cost to fund at an average life of about six years. Our call businesses where we own a $140 billion of call rights remain very strong. During the quarter, we collapsed 32 different mortgage trust for $1.1 billion of mortgage loans. Our capital and access to liquidity remains very strong and puts us in a wonderful position to take advantage of any opportunities we see. I'll now refer to the supplement which has been posted online. And I am going to begin on Page 2. Page 2 is really just our new residential overview. Looking at the right side of the page, a couple things to highlight here. Again, back to the MSR market. So far year-to-date we invested $2.1 billion of term MSR notes, or fixed rate coupon, so as rate continue to rise that cost to fund is locked in. On a year-to-date basis, our total return is 10%. Our year-over-year book value is increased 17%. Our year-to-date book value is increased 10%. And from an MSR perspective, we acquired $54 billion of new MSRs during the year. From a financial performance perspective, as I pointed out earlier, in our view as expected the portfolio is continue to perform extremely well, while there wasn't a ton of investment activity earnings continue to be very good. GAAP net income for the quarter $175 million, or $0.51 per diluted share. Our core earnings a $198 million, or $0.58 per diluted share, and our dividends of a $170 million, or $0.50 per diluted share. On Page 4, this is just a snapshot of our net equity as of 630 invested in the various sectors of our investment portfolio. Again, pointing out MSR our investment, MSR is one of the few fixed income assets that will rise in value as rates continue to increase. Today we have a $3 billion net investment after financing in MSRs that's both access MSR and full MSR. As you can see our servicer advance equity is down to $123 million. I refer to -- I'll talk a little bit about that further in our presentation. Our residential security portfolio with call rights is $1.7 billion. On the loan side $668 million of net equity in our loan business, and then the consumer loan a $129 million of net equity, most of that is due to our SpringCastle investment and then we have cash as of 630 of $193 million. Page 5 is just a snapshot of the new residential. We like to use this as a kind of like a teaser for what we're about. The main things to focus on here $520 billion of MSRs, truly I don't think this portfolios could be recreated based on the characteristics of the underlying portfolios, $140 billion of call rights, we believe that the outstanding balance of the legacy mortgage market to be something around $400 billion. So when you think about that is -- that is a sizable amount of collateral that we have access to. And then when we think about opportunistic investments, things that we've done in the past, we close down Shellpoint Partners that is the acquisition of Shellpoint the mortgage company. And that was --that closed early July and then going back in time we highlight HLSS acquisitions and then some of our consumer loan activity. Page 6 is really again it's a little bit of a highlight real but taking you back in time to 2013. At that time, our book value is $10, today our book value is $16.80. Our market cap in 2013 was $1.5 billion, and today our market cap is $6.2 billion. So we've seen some very good growth in our business. We made some what we believe are very good strategic investments and acquisitions during that time period. And as I pointed out earlier, we continue to look for opportunities in the marketplace. Page 7 is again a snapshot of Shellpoint. There's a mortgage servicer. The one thing I want to point out about Shellpoint on the mortgage servicing side that is truly a third-party servicer. What I mean by that is if we're bidding on pools of collateral, we will get the same pricing as with a third-party client of Shellpoint. Today, Shellpoint is at $69 billion. They continue to add third-party servicing to the portfolio. It's really more of a special server so than it is overall in just adding a ton of what I would call cleans assets. The origination business, new penn Financial should do about $8 billion this year, and then we have a Title/ Appraisal business it's called Avenue365 and EStreet Appraisal. The servicer is rated by S&P, Moody's and Fitch, approved by all three agencies Fannie, Freddie and Ginnie, and those guys do a terrific job, and we're very excited and happy with the investment so far. Page 8 is really -- it's talked about interest rates and what we believe and what we hear what some of the experts in the markets say. We do believe that Fed is going to increase rates another 2x to 3x this year. A lot of that depends I think on what happens in the --with our tariffs and the economy et cetera, but the way our portfolio set up, again, we believe it should be terrific for our shareholders. I think the normalized Fed Funds rate is projected to be 3.25 as we go forward. Today, again the way that we're set up with our financing arrangements, whether it is on our servicer advanced portfolio or MSR portfolio, and some of the things we're doing in the capital markets. We believe we're perfectly situated for the current and future environment. What higher rates means for our business? We put a slide on page 9, MSR values will likely continue to increase servicer advances, again equity is very low there, but what we expect there is for servicer advances to continue to decline as a percentage of the outstanding unpaid principal balance of the mortgage loans. And then our non-agency securities 93% of our portfolio or so is floating rate. So as rates go up you're going to get higher coupon income. And then on the loan portfolio, we purchases on against fixed rate assets to make sure that we are protected in a higher rate environment. Overall, again I think we're in good shape. I'll now flip through on our -- give you some portfolio highlights, talk a little bit about our investment activities in the quarter. On Page 11, during the quarter, we acquired $20 billion of MSRs, $245 million of gross capital. And that was done with five different counterparties. We also acquired some flow MSRS and we priced two fixed -rate MSR notes totaling $1.2 billion at weighted average cost of funds of 4.5%. Again those --that cost of funds is fixed and those securitizations are callable. Non-Agency Securities, we executed clean-up calls on 31 different deals, $1.1 billion of collateral. We completed a loan securitization in May for $435 million, and we purchased a little under $700 million of non-agency RMBS during the quarter. Net equity and that is approximately $1.6 billion now. Again most if not all of the purchases in the non -agency sector around floating rate securities are linked to our call rights. Servicer advances, when we first did this, got into the business back in approximately 2015, our advanced balanced--just to frame it for everybody with a little over $8 billion. Today that's down to $3.8 billion, or 21% year-over-year. We expect future upside; advanced balances as a percentage are down to approximately 2.8%. When we did that --when we first got involved in the business, they were a little north of 4%. So overall performance has been great there. Shellpoint, I mentioned before, we close that early July and then on the consumer side quite frankly not that interesting, although returns continue to be very good. Prosper, we continue to buy loans in partnership with our three partners in that consortium, and then on the residential loan side just to give you a snapshot there. During the quarter, there were $37 billion of loans sold in the quarter, spreads overall remains very, very well bid. On the MSR portfolio, $520 billion, I'm not going to spend a lot of time on this page. You could have a look at some of the different characteristics. Remember, going back in time, our investment thesis was to buy credit impaired, very seasoned MSRs. Over the course of the past year or so we bought more newer production MSRs, which will continue to do better in a rising rate environment. Page 13 just talks about our financing activities. Again around the MSR business, everything essentially all of our MSRs are financed with fixed rate financing. In the capital markets, we have a little bit more to do and we have [Indiscernible] capacity on our MSR line. So it's a little bit over $600 million. I bring that up so when you think about our cash position across our liquidity as of the end of the quarter, we are in great shape to take advantage of any potential dislocations or things that we need to do in the markets. Page 14 is really again a snapshot of our overall business. I'm going to --I'm not going to spend a lot of time on this page. Page 15, our Non-Agency Security portfolio with calls right. I looked this morning to give you a snapshot. $140 billion of call rights, so essentially what that means is we control $140 billion of collateral if everything was callable today, and it was economical to do so. Of the $140 billion of call rights today, $45 billion of that could be callable if delinquencies decline and advance balances decline. So we continue to work hard to figure out a way to accelerate that. And I've been pretty vocal on that on multiple earnings calls. The Non-Agency Securities bond portfolio on page 16, again, most of this is floating rate. It's linked to our call rights in most cases performs extremely well. There is a slight gain in the quarter, and again spreads continue to be well bid. On the servicer advance portfolio, which I referenced earlier, again today $3.8 billion of outstanding balances go back to 2015 when we first began the business. I think the numbers were a little bit north of $8 billion. Everything's funded in the term markets either the capital markets or in bank balance sheets with fixed rate term financing. And we continue to work on lower advanced balances which will help our call business. Consumer loan portfolios, Prosper, not a lot of capital deployed there. So I'm not going to spend a lot of time. Essentially, we buy loans from Prosper, we then turn around and securitize those and retain equity interests in some of the different portfolios. SpringCastle is one of our legacy portfolios that continue to perform better and better. And then on the loan portfolio side, a little bit of growth in our business during the quarter. As I mentioned, $37 billion of loans came out for the bid. We participate in a very small amount as we think spreads continue to -- or we see spreads very well bid. We will continue to focus and see if we could deploy some capital there. It should return, work well. Then on Page 21, really our goal is to continue to try to maintain our dividends, grow our company and create great value for our shareholders. With that I'll turn it back to you --to the operator for questions.

[Operator Instructions] Your first question comes from the line of Tim Hayes, B. Riley. Your line is open.

Hey, good morning, Mike. Thanks for taking my questions. The first one, it just looks like the MSRs you acquired this quarter were marked above a 120 basis points, which is a bit higher than historical levels. And just wondering if you can talk about the characteristics of those and strategy more generally? Are the returns on MSRs still more attractive than other assets with valuations that high?

Yes. What I would say valuations and MSRs are high. There are quite frankly overall investments in what I would call flow MSRs are probably not that interesting for us right now, while saying that we see multiples on what I would call conventional MSR is anywhere from 4.5 to 5.5 type multiples. Our overall MSR portfolio is marked today at a 3.7 multiple. So we'll deploy capital what we think strategically over time. The other thing I would say in a rising rate environment, you're going to see multiples go up and the MSR portfolios do provide a great hedge for our call business. So net -net, there is some strategy there, but I think going forward you're not going to see a ton of capital deployed in the MSR market unless we think we can create good value there. The other thing to point out is MSR financing has become a lot more efficient. You're seeing higher advance rates, more term financing. So, look, I think you'll continue to see MSR values likely increase as a result of the financing market elaborate returns still look very good to us.

Right, okay. And then you mentioned the expected new penn volumes for the year. Just wondering if those are in line with where you thought they'd be at the time of agreeing to the acquisition, or if the mortgage banking backdrop has been more challenging than you expected?

We spend a lot of time with our new penn partners who do a great job. The origination volumes last year I think they did something around between $6 billion and $6.5 billion. We believe this year or I think they're on target to do something around $8 billion. I would tell you gain on sale when you look at the mortgage banking origination business is very, very difficult. The amount of money to be made in the origination business is very low in our opinion right now. And it's a hard business. There's no doubt about it. We have rolled out some other kind of prime non-agency products that have created some reasonable P&L for the new penn segment of our origination business. But overall I wouldn't expect a ton there. The other thing it does is it provides some clean MSRs for our balance sheet. So I would anticipate over time that we continue to grow a holistic creation of MSRs as a result of our mortgage banking activities, but net-net gain on sale is very low and very hard in that business.

Got it, okay. And you'd previously mentioned that you expected to potentially be in the market with a non-QM securitization this upcoming quarter or this current quarter. Is that still your expectation or do you see that you may be getting pushed out at all?

Yes. I think we're going to try to do one this quarter, third quarter. It's not huge. I think we have a give or take a couple hundred million of collateral. And whether we do it at the end of this quarter which I think is likely, if now they'll probably be early fourth quarter, again as we acquire more collateral.

Got it, okay. And then one more question around Shellpoint, just now that the deal is closed do you expect to get kind of more aggressive in building that platform or around that platform? Would you be focusing on the origination or the servicing side or both? And then how would you gauge your appetite to execute on additional M&A just around this business?

We as I pointed out earlier Bruce Williams who leads that business along with Jack Navarro and Kevin Harrigan do a great job. I said --we will continue to --we've dedicated a lot of resources there, a lot of brain power. We're going to continue to try to grow it collectively together only if it makes sense. I mean we're in the money making business, and we want to create value for shareholders. So I would expect that business to continue to grow. As it relates to M&A, if there are things that fit what we're trying to do in our portfolios or with our partners we will continue to acquire whether it be companies and/or assets that we think makes sense for shareholders.

Got it, okay. And then what one just last one for me just the profitability on the call right this quarter.

I think our execution was give or take around 1.5 overall, and then we also have hedges that we put on against some of our fixed-rate collateral. So net -net it was a very good quarter for the call business.

Your next question comes from the line of Bose George, KBW. Your line is open.

Hey, Mike. Can you talk about it the drivers of the change in the valuation of the MSR this quarter? It looked like there was a negative mark.

Yes. I'll turn it over to Nick. There's --some of this has to do with some of our legacy around the HLSS and Ocwen transactions. The net number around access and our MSRs away from what I would call some of the accounting adjustments was about positive $25 million on the quarter. Essentially rates weren't changed. We made some tweaks to the model where we saw speeds up a little bit, a little bit higher I think than expected, but overall gain was about $25 million. And then as it relates there was an up and down adjustment that Nick will just talked to on some of the GAAP accounting stuff.

Sure. It relates to the Ocwen transaction and in summary it has to do with the amortization of the fair value. So as the fair value gets pulled down, as we begin to create the asset into income, we flipped from unrealized to realized, so that has to do -- and you'll see the negative come through on the unrealized MSR line.

Okay. So I mean just conceptually it's not a fair value markets really sort of the-- it's more of an amortization mark is that --

That's correct.

Okay and then in terms of the contract with Altisource. Has that been finalized?

Not yet. We extended an LOI with them, and we hope to get that wrapped up this quarter.

Okay. Are there any changes there that could impact the MSR valuation going forward?

No, not that we're aware of.

Nothing material, okay. And then just in terms of the pipeline for MSR acquisitions, you noted earlier just on the pricing being somewhat steep, but can you just talk about the pipeline out there. Is there a stuff that could be compelling?

We have $30 billion that we have LOIs on right now that I think are likely to get executed on this quarter. I think the pipelines themselves are -- mortgage banking-- Tim asked a good question about the mortgage banking industry and gain on sale. It's very hard. So I think what you're going to continue to see is the need for capital with some of the mortgage bankers as they're not able to quite frankly make money in the origination business. If the 10 year treasury continues to back up, I think its 296 and 297 this morning, you're going to see less production, there's going to be a little bit of pressure on the system there. Overall that could create some opportunity, but in general as I pointed out at current pricing on slow it's just not that interesting to us. When you look at the portfolio, I think quarter-over-quarter it's down about $20 billion. We could buy more and more of MSRs but the pricing has to be right for the way that we're thinking about it.

Your next question comes from online of Henry Coffey, Wedbush. Your line is open.

Good morning. It's good to hear the story again. There are some nice tax advantages associated with direct origination and MSRs. Is that what new penn is going to create and is that some real nice value or is it possible that it kind of grows into a mortgage banking gain on sale component of the quarterly earnings?

Yes, Henry, it's less relevant for us as we are REIT right. So when you think about it from a tax perspective, it's just there's really nothing there. The strategy around new --about Shellpoint is really that for us grow the third-party business, grow origination, so we create assets for our own balance sheet that we think are at the right levels. And truly create what I think is a very good profitable mortgage company. I think the tax stuff-- there's really nothing to do there because we all REIT. There is some tax we have to pay because it's an operating business, and not a good REIT asset, but it's just not that the tax stuff doesn't weigh in our decision here.

And then and looking at your residential loan portfolio that that's a business that seems to be taking on real legs. We even had a one of the regional banks we all follow did a nice non-QM securitization. Does that business grow into a meaningful couple of billion dollars a year for a long time? Do you get into areas like single family rental lending that could also have a non-QM component to it? What's the sort of the growth prospects for that side of the equation?

Couple things. One is on the asset side as I pointed out; $37 billion came out for the bid in the quarter. Assets extremely well bid by whether it be the number of the banks and/ or a lot some of the total return players in the marketplace. And obviously we will participate a little bit if in fact we think we could create what I would call good returns for shareholders. The overall landscape of the residential housing market which is give or takes a $20 trillion market is interesting. Now we don't want -- you don't want to be the last person to the party, so when you think about single family rental, yes, we'll look at that, we'll look at lending against it. We will look at potential acquisitions in that market. We do create our own what I would call housing stock as a result of our call strategy. And there's a bunch of REO that typically comes when you collapse these deals, but I think somebody asked about acquisitions before. We'll continue to look at everything. There's nothing that I can point to right now that's that interesting, but we're looking at a lot of different things right now.

And then this is just kind of a general question because I'm getting new to the story again. When you survey the business what's --what does pop out is compelling?

Good question. I think our existing portfolio is great. I pointed --

Yes, it's a given, yes, it's obvious.

Yes, when you look at --I look back to work to our Q1 remarks, I look to Q2 remarks which I just gave. The story is pretty much the same. We're not deploying a ton of capital there. So the investment environment and the risk return is just not great. While saying that we got to be diligent and be on it every single day which our team. There will be things that come our way. Right now, we'll continue to focus on pretty much the same thing. If we acquired non-agency assets that are accretive for our call business we'll do that. We'll be sporadic around the MSR stuff, if it makes sense for us. We are spending time looking at different things away from just the asset side, and I think our growth could be any number of ways. We're in the financial services sector. We've made some good strategic investments on the consumer side. So we continue to look at everything. But net-net, based on capital deployment, we have plenty of liquidity right now. There's not a lot that's really, really interesting right now.

I will now turn the call back to Michael Nierenberg, CEO for closing remarks.

Thanks everyone for joining our call. Appreciate the support. Enjoy the rest of the summer. And look forward to updating on Q3 results and Q4. Now there is time, but have a great summer. Thanks.

This concludes today's conference call. You may now disconnect. Thank you.