Rithm Capital Corp. (formerly New Residential Investment Corp.) — Q2 2016 Form 10-Q Summary
Business context and reporting period
The filing covers the quarter and six months ended June 30, 2016. At that time, the registrant was New Residential Investment Corp., a publicly traded, externally managed REIT focused primarily on residential mortgage-related assets. Its portfolio included excess mortgage servicing rights (Excess MSRs), servicer advances, Agency and Non-Agency RMBS, residential mortgage loans, real estate owned and consumer loans. The company was managed by FIG LLC, an affiliate of Fortress Investment Group.
The filing was signed August 3, 2016. Approximately 230.5 million common shares were outstanding as of July 28, 2016. The company intended to maintain REIT qualification and its exclusion from registration under the Investment Company Act of 1940.
Financial performance and key metrics
| Metric | Three months ended June 30, 2016 | Three months ended June 30, 2015 | Six months ended June 30, 2016 | Six months ended June 30, 2015 |
|---|---|---|---|---|
| Interest income | $277.5 million | $178.2 million | $467.5 million | $262.6 million |
| Interest expense | $100.7 million | $81.9 million | $181.9 million | $115.9 million |
| Net interest income | $176.8 million | $96.3 million | $285.6 million | $146.7 million |
| Impairment and valuation provisions | $19.6 million | $5.4 million | $29.6 million | $7.5 million |
| Income before taxes | $101.1 million | $93.6 million | $206.9 million | $132.0 million |
| Net income | $93.6 million | $79.3 million | $209.6 million | $121.1 million |
| Net income attributable to common stockholders | $68.7 million | $75.1 million | $180.4 million | $111.1 million |
| Diluted EPS | $0.30 | $0.37 | $0.78 | $0.63 |
| Core earnings | $119.6 million | $92.2 million | $232.0 million | $155.6 million |
Net interest margin, calculated as net interest income divided by interest income, was approximately 63.7% for the quarter and 61.1% for the six-month period. These are analytical calculations rather than a company-reported margin measure.
- Comprehensive income attributable to common stockholders was $132.4 million for the quarter and $227.3 million for the six months, aided by unrealized securities gains.
- Operating cash flow was $342.9 million for the six months, compared with $517.3 million in the prior-year period.
- Investing cash flow was $94.1 million for the six months, while financing cash flow was negative $453.1 million.
- Cash and cash equivalents declined to $233.8 million at June 30, 2016, from $249.9 million at December 31, 2015.
- Total assets increased to $17.9 billion from $15.2 billion; total equity increased to $3.1 billion from $3.0 billion.
- Repurchase agreements were $4.6 billion and notes and bonds payable were $8.3 billion at June 30, 2016. Total debt obligations, including both categories, were approximately $12.9 billion.
- Reported available financing capacity was approximately $3.2 billion, subject to eligible collateral and other borrowing conditions.
- The company declared a quarterly dividend of $0.46 per share, or approximately $106.0 million. Dividends declared for the first six months totaled $0.92 per share.
Portfolio and balance-sheet composition
| Investment | Carrying value at June 30, 2016 |
|---|---|
| Excess MSRs, directly held | $1.5 billion |
| Excess MSRs through equity-method investees | $199.1 million |
| Servicer advances | $6.5 billion |
| Real estate securities | $4.6 billion |
| Residential mortgage loans held-for-sale | $824.0 million |
| Real estate owned | $61.9 million |
| Consumer loans held-for-investment | $1.8 billion |
Excess MSR investments were linked to approximately $371.0 billion of underlying mortgage UPB. The company used a 9.9% weighted-average discount rate to value Excess MSRs. Servicer advances had a 5.4% weighted-average discount rate, a 5.2% weighted-average yield and a 4.5-year weighted-average life.
The real estate securities portfolio included $1.7 billion of Agency RMBS and $2.8 billion of Non-Agency RMBS at carrying value. Reported net interest spreads were 0.95% for Agency RMBS and 3.27% for Non-Agency RMBS.
Material changes versus the prior comparable period
- Interest income increased 55.7% for the quarter and 78.0% for the six months, primarily from portfolio growth, the addition of consumer loans, larger real estate securities holdings and accelerated accretion from called RMBS trusts.
- Net interest income increased 83.6% for the quarter and 94.7% for the six months, despite higher financing costs.
- Net income attributable to common stockholders declined 8.6% in the quarter but increased 62.4% for the six months. Quarterly EPS declined because of higher noncontrolling interests and the enlarged share base; six-month EPS increased.
- Other income declined materially. The company recorded negative fair-value changes on Excess MSRs, negative six-month fair-value changes on servicer advances, larger derivative losses and lower settlement gains.
- Impairment and valuation provisions increased substantially, including $6.1 million of securities OTTI and $23.6 million of loan and REO valuation provisions for the six months.
- Operating cash flow fell by $174.4 million year over year, notwithstanding higher reported net income, partly because of changes in noncash accretion, fair-value adjustments and working-capital movements.
- Total assets grew by approximately $2.7 billion, while debt increased by approximately $2.6 billion from year-end 2015.
SpringCastle transaction and unusual items
On March 31, 2016, the company acquired an additional 23.5% interest in the Consumer Loan Companies for its share of an aggregate transaction price of $111.6 million paid by the buyers. Its ownership increased from 30.0% to 53.5%, resulting in consolidation of the consumer loan assets and related debt.
- The transaction added approximately $1.9 billion of consumer loans and $1.8 billion of notes and bonds payable to the consolidated balance sheet.
- The company recognized a one-time $71.3 million gain from remeasuring its previously held 30% equity-method investment.
- Consumer loans contributed $78.3 million of interest income and $30.9 million of income before taxes after the acquisition date during the six-month period.
- Consumer loan provisions were $16.0 million in the quarter and six months following consolidation, including net charge-offs and provision expense.
- Noncontrolling interests increased because third parties retained 46.5% of the Consumer Loan Companies and other consolidated subsidiaries.
Guidance, outlook, management commentary and risks
Management did not provide formal earnings guidance. It stated that cash on hand, operating cash flow and the expected ability to roll repurchase agreements and servicer-advance financings were expected to satisfy anticipated liquidity needs over the following 12 months, including potential margin calls and operating expenses. This expectation was expressly subject to market, financing and counterparty risks.
- Management expected continued opportunities in MSRs and related servicing assets, but noted increased competition, higher pricing and lengthier regulatory and GSE approval processes.
- Excess MSR fair value declined during the second quarter because of higher projected prepayment rates and delinquencies. Servicer-advance fair value benefited from lower discount-rate assumptions and recoveries but was negatively affected by a lower forward LIBOR curve.
- The company had $4.6 billion of repurchase agreements subject to margin exposure. A decline in collateral values could require substantial additional cash or collateral.
- Debt maturities totaled approximately $5.0 billion from July through December 2016 and $5.0 billion in 2017. The filing states that July 2016 maturities were refinanced, extended or repaid.
- Interest-rate sensitivity was significant: a 50-basis-point increase in short-term rates was estimated to increase next-12-month cash flows by $13.1 million and net book value by $128.0 million; a 50-basis-point decrease was estimated to reduce cash flows by $5.1 million and net book value by $130.8 million.
- A 25-basis-point widening in credit spreads was estimated to reduce net book value by $94.1 million, while a comparable tightening was estimated to increase it by $96.2 million.
- Material risks included prepayment and delinquency assumptions, recovery of servicer advances, servicer performance and termination, counterparty concentration in Nationstar, Ocwen and OneMain, short-term refinancing, margin calls, illiquid assets, regulatory changes, REIT qualification and Investment Company Act compliance.
- The company disclosed litigation and regulatory matters inherited or associated with HLSS and Ocwen. No loss was accrued because management did not believe a loss was probable and reasonably estimable, but an adverse outcome could materially affect results.
- Management reported effective disclosure controls and procedures and no material change in internal control over financial reporting, while noting that controls were broadened to include the SpringCastle assets, liabilities and processes.
Most important facts for an investor to verify
- Whether the $71.3 million SpringCastle remeasurement gain and other nonrecurring items are excluded when assessing sustainable earnings.
- The quality, recovery timing and financing eligibility of the $6.5 billion servicer-advance portfolio.
- Exposure to Nationstar, Ocwen and OneMain, including servicer termination, regulatory, bankruptcy and counterparty risks.
- Near-term refinancing and margin-call requirements on approximately $12.9 billion of debt obligations.
- The sensitivity of Excess MSR valuations to prepayment rates, delinquencies, recapture rates and discount rates.
- Credit performance of the $2.8 billion Non-Agency RMBS portfolio and the $1.8 billion consumer-loan portfolio.
- Whether operating cash flow and taxable income support the $0.46-per-share quarterly dividend after debt service and required REIT distributions.
- Potential exposure from pending HLSS-related litigation, regulatory inquiries and assumed liabilities.