Rithm Capital Corp. (formerly New Residential Investment Corp.) — Q1 2016 Form 10-Q
Business context and reporting period
Unaudited quarterly results for the three months ended March 31, 2016, compared with the three months ended March 31, 2015. The company was a publicly traded REIT focused on residential mortgage-related assets, including Excess MSRs, servicer advances, Agency and Non-Agency RMBS, residential mortgage loans, REO and consumer loans. It was externally managed by FIG LLC, an affiliate of Fortress Investment Group.
Key financial metrics
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Interest income | $190.0 million | $84.4 million | +$105.7 million |
| Interest expense | $81.2 million | $34.0 million | +$47.2 million |
| Net interest income | $108.8 million | $50.4 million | +$58.4 million |
| Impairment and valuation provisions | $10.0 million | $2.0 million | +$8.0 million |
| Income before taxes | $105.7 million | $38.4 million | +$67.3 million |
| Net income | $115.9 million | $41.8 million | +$74.1 million |
| Net income attributable to common stockholders | $111.7 million | $36.0 million | +$75.8 million |
| Basic and diluted EPS | $0.48 | $0.25 | +$0.23 |
| Core earnings | $112.4 million | $63.5 million | +$48.9 million |
| Dividend declared per share | $0.46 | $0.38 | +$0.08 |
Net income attributable to common stockholders represented approximately 48.5% of interest income in Q1 2016, compared with approximately 42.6% in Q1 2015. The filing does not provide a conventional company-wide net interest margin.
- Net cash provided by operating activities was $169.4 million, versus $15.4 million used in Q1 2015.
- The cash flow statement reported $221.9 million of net cash provided by investing activities, compared with $1.1 billion provided in Q1 2015.
- Net cash used in financing activities was $382.6 million, compared with $854.5 million used in Q1 2015.
- Cash and cash equivalents ended at $258.6 million, compared with $459.3 million at March 31, 2015.
- Total assets were $17.6 billion, up from $15.2 billion at December 31, 2015. Total equity was $3.1 billion, up from $3.0 billion.
- Debt obligations consisted of $4.0 billion of repurchase agreements and $8.9 billion of notes and bonds payable, or $12.8 billion in aggregate carrying value.
- Available financing was $2.3 billion, subject to eligible collateral and other borrowing conditions. The company had $4.0 billion of repurchase-agreement margin exposure.
- Management stated that cash on hand, operating cash flow and the ability to roll repurchase and servicer-advance financings were expected to satisfy anticipated liquidity needs for the next 12 months, subject to market and financing conditions.
Material changes versus the prior comparable period
- Interest income and net interest income more than doubled, primarily due to the HLSS-related servicer-advance portfolio acquired in 2015, growth in real estate securities and accelerated accretion on certain Non-Agency RMBS.
- Interest expense increased with the larger financed portfolio, particularly servicer advances and real estate securities.
- Servicer-advance fair value losses increased to $31.2 million from $7.7 million, primarily because of a lower performance-fee adjustment related to the HLSS servicing advances and a lower forward LIBOR curve.
- The company recorded a $71.3 million gain from remeasurement of its previously held consumer-loan investment following the SpringCastle Transaction. This was a significant nonrecurring contributor to reported earnings.
- Gain on settlement of investments declined to a $14.5 million loss from a $14.8 million gain, reflecting lower gains on securities and mortgage-loan sales, higher derivative settlement losses and other changes.
- Accumulated other comprehensive income declined from positive $3.9 million at year-end 2015 to negative $12.9 million at March 31, 2016, primarily because of a $20.0 million net unrealized loss on securities.
- Core earnings increased to $112.4 million from $63.5 million. Core earnings is a non-GAAP measure and excludes or adjusts for fair-value changes, impairments, certain transaction costs, incentive compensation and other items.
Strategic transaction, outlook and unusual items
On March 31, 2016, the company completed the SpringCastle Transaction, acquiring an additional 23.5% interest in the Consumer Loan Companies and increasing its ownership to 53.5%. The company obtained control and began consolidating approximately $2.0 billion of consumer loans and $1.8 billion of related notes and bonds payable. The transaction also created $110.4 million of noncontrolling interests and generated the $71.3 million remeasurement gain. The purchase-price allocation was preliminary and may change.
Management described continued opportunities in mortgage servicing assets, including potential MSR sales and flow arrangements, but cautioned that competition, pricing, regulatory approvals and financing conditions could make future investments less attractive than prior transactions. The company expected future investment levels and its Non-Agency RMBS portfolio to vary with risk-adjusted yields, market conditions and alternative opportunities.
In April 2016, the company entered into a $225.0 million corporate loan secured by Agency Excess MSRs, bearing interest at one-month LIBOR plus 4.75% and maturing in April 2018.
Key risks include interest-rate and credit-spread volatility, prepayment and delinquency assumptions, servicer-advance recoverability, margin calls and refinancing risk, counterparty concentration in Nationstar, Ocwen and OneMain, servicer regulatory or operational failures, illiquidity of investments, consumer-loan credit losses, REIT qualification, maintenance of the 1940 Act exclusion, affiliate conflicts and legal proceedings assumed or inherited through HLSS.
The company reported compliance with debt covenants at March 31, 2016. It had not accrued losses for disclosed HLSS-related litigation and other contingencies because management did not believe losses were probable and reasonably estimable; however, the filing states that adverse outcomes could materially affect results.
Important facts for investors to verify
- Separate recurring operating performance from the $71.3 million SpringCastle remeasurement gain and other fair-value and settlement items.
- Reconcile the reported $112.4 million of core earnings to GAAP net income and assess whether the non-GAAP adjustments remain appropriate.
- Review the sustainability of the $0.46 quarterly dividend relative to taxable income, operating cash flow, financing requirements and REIT distribution obligations.
- Monitor the $12.8 billion debt structure, near-term maturities, repurchase-agreement rollovers, collateral haircuts, margin requirements and available financing.
- Evaluate sensitivity to interest rates, credit spreads, prepayment speeds, delinquencies and recapture rates, especially for the Level 3 Excess MSR and servicer-advance valuations.
- Assess concentration and counterparty exposure to Nationstar, Ocwen and OneMain, including servicing performance, regulatory matters and potential termination or bankruptcy scenarios.
- Review the quality and performance of the newly consolidated consumer-loan portfolio, including its 7.0% 30-plus-day delinquency rate and 5.6% annualized default rate.
- Review the status and potential exposure from HLSS-related litigation, regulatory inquiries, assumed liabilities and the ongoing integration of acquired assets and controls.