Business Context and Reporting Period
Rithm Capital Corp., formerly New Residential Investment Corp. and identified in the filing as “New Residential,” filed its Form 10-K for the fiscal year ended December 31, 2013. The company was spun off from Newcastle Investment Corp. on May 15, 2013 and began operating as an independent, externally managed REIT under Fortress Investment Group’s affiliate, FIG LLC. Its strategy focused on residential mortgage-related assets, including Excess MSRs, servicer advances, Agency and Non-Agency RMBS, residential mortgage loans and consumer loans.
Comparisons with 2012 are limited because pre-spin-off financial statements were prepared on a carve-out basis and do not reflect the costs, financing structure or liquidity needs of a stand-alone public company.
Financial Performance and Key Metrics
| Metric | 2013 | 2012 |
|---|---|---|
| Interest income | $87.6 million | $33.8 million |
| Interest expense | $15.0 million | $0.7 million |
| Net interest income | $72.5 million | $33.1 million |
| Impairment | $5.5 million | None reported |
| Other income | $241.0 million | $17.4 million |
| Operating expenses | $42.5 million | $9.2 million |
| Net income | $265.6 million | $41.2 million |
| Net income attributable to common stockholders | $265.9 million | $41.2 million |
| Basic diluted earnings per share | $1.05 / $1.03 | $0.16 / $0.16 |
| Core earnings | $130.0 million | $37.5 million |
| Dividends declared per share | $0.495 | None reported |
Other income included $53.3 million of direct Excess MSR fair-value gains, $50.3 million of fair-value gains from Excess MSR equity-method investees, $82.9 million of earnings from consumer-loan investees and a $52.7 million gain on securities settlements. The company also recorded $5.0 million of other-than-temporary impairment on securities and a $0.5 million valuation allowance on loans.
| Balance-sheet metric at December 31 | 2013 | 2012 |
|---|---|---|
| Total assets | $6.0 billion | $534.9 million |
| Total debt | $4.1 billion | $150.9 million |
| New Residential stockholders’ equity | $1.27 billion | $378.4 million |
| Total equity, including noncontrolling interests | $1.51 billion | $378.4 million |
| Book value per common share | $5.00 | Not clearly provided |
| Cash and cash equivalents | $272.0 million | None reported |
Cash flow from operating activities was $152.9 million. Investing activities used $993.5 million, primarily for acquisitions of servicing-related assets and real estate securities, while financing activities provided $1.11 billion. The company stated that unrestricted cash and Agency ARM RMBS were sufficient to satisfy short-term recourse liabilities and that expected operating cash flow and cash on hand should meet anticipated needs for the next twelve months, subject to market and financing conditions.
Portfolio, Debt and Liquidity
- Investment portfolio carrying value was approximately $5.56 billion, consisting primarily of $2.67 billion of servicer advances, $1.40 billion of Agency RMBS, $570.4 million of Non-Agency RMBS and $676.9 million of Excess MSRs.
- Excess MSRs referenced mortgage pools with approximately $252.6 billion of aggregate unpaid principal balance. The portfolio’s weighted-average discount rate was approximately 12.5%.
- In December 2013, the company’s consolidated joint venture acquired approximately $3.2 billion of servicer advances and related basic-fee MSR interests from Nationstar. Approximately $2.7 billion had settled by year-end, funded with approximately $2.4 billion of debt. The company’s equity investment was $115.7 million, representing approximately 32% of the Buyer.
- Debt consisted of $1.62 billion of repurchase agreements and $2.49 billion of notes payable, with a weighted-average funding cost of approximately 2.70%. All reported debt maturities fell in 2014, although subsequent financing activity extended portions of the servicer-advance debt.
- The company had approximately $1.75 billion of unused borrowing capacity at year-end, subject to eligible collateral and other funding conditions. Debt was subject to margin calls, covenants and refinancing risk.
- Agency ARM RMBS had a 0.94% net interest spread; Non-Agency RMBS had a 2.83% net interest spread as of December 31, 2013.
Material Changes Versus the Prior Comparable Period
- Total assets expanded from $534.9 million to $6.0 billion, primarily through the spin-off, new financing and acquisitions of servicer advances, RMBS, Excess MSRs and consumer loans.
- Net income increased to $265.6 million from $41.2 million, but the increase was heavily influenced by fair-value gains, securities gains and the newly acquired consumer-loan investment; therefore, it should not be viewed as a recurring earnings run rate.
- Core earnings increased to $130.0 million from $37.5 million, reflecting portfolio growth and new investment platforms. Core earnings is non-GAAP and excludes fair-value changes, realized gains and losses, incentive compensation and certain deal costs.
- The company added consumer-loan exposure through a 30% interest in SpringCastle-related entities. The investment had a $215.1 million carrying value and generated $82.9 million of equity-method earnings in 2013.
- Management fees and incentive compensation were new or materially higher following the spin-off: $11.2 million of management fees and $16.8 million of incentive compensation were recorded in 2013.
- The fourth-quarter dividend was $0.175 per share plus a $0.075 special dividend, for a combined $0.25 per share paid in January 2014.
Guidance, Outlook, Commentary and Risks
Management targeted average returns on invested equity in the mid-teens and reported a 16.0% weighted-average underwritten internal rate of return for Excess MSRs owned at year-end. These targets were not guarantees. Management viewed continued bank sales of MSRs, structural changes in mortgage servicing and opportunities in Non-Agency RMBS as favorable market conditions.
Subsequent to year-end, the company exercised part of a call right for approximately $1.1 billion of additional servicer advances and expected to settle additional advances during the second quarter of 2014, although full settlement was not assured. It also committed to purchase approximately $625 million of Non-Agency securities for approximately $553 million from a Springleaf-sponsored securitization, subject to financing and settlement conditions.
- Nationstar concentration: Nationstar serviced all Excess MSR and servicer-advance portfolios and the majority of the Non-Agency RMBS collateral. Servicer termination, bankruptcy, regulatory action, servicing deficiencies or rating downgrades could materially impair asset values and financing.
- Servicer-advance recovery risk: Advances are non-interest-bearing and depend on borrower payments, recoveries, foreclosure timelines and available financing. Delays or lower recoveries could increase capital needs and reduce returns.
- Valuation risk: Excess MSRs and servicer advances were Level 3 assets valued using models with significant assumptions regarding prepayments, delinquencies, recapture rates, advance balances and discount rates.
- Leverage and refinancing risk: Repurchase agreements and servicer-advance facilities were short-term, floating-rate and subject to margin calls, renewal risk and early amortization provisions.
- Credit and market risk: Non-Agency RMBS included substantial subprime and Alt-A exposure. Changes in credit spreads, interest rates, defaults, prepayments and housing values could affect earnings, book value and liquidity.
- Affiliate conflicts: The Manager, Nationstar and Springleaf were affiliated with Fortress-managed funds, creating potential conflicts in investment allocation, servicing, fees and related-party transactions.
- REIT and Investment Company Act status: Failure to maintain REIT qualification or the company’s exclusion from registration under the Investment Company Act could materially increase taxes or require significant changes to operations.
- Consumer-loan risk: The consumer-loan portfolio had an 18.3% weighted-average coupon, a 9.8% three-month charge-off rate and exposure to regulatory, servicing and borrower-credit risks.
Investor Verification Priorities
- Reconcile 2013 GAAP net income with core earnings and identify the portion attributable to recurring cash generation versus fair-value gains, securities gains and equity-method accounting.
- Review the terms, advance rates, maturities, covenants and refinancing status of the servicer-advance facilities and repurchase agreements.
- Assess Nationstar’s servicing performance, financial condition, regulatory matters and ability to recover advances and maintain required servicing standards.
- Test sensitivity of Excess MSR and servicer-advance valuations to higher prepayments, delinquencies, defaults, lower recapture rates and wider discount rates.
- Verify the company’s current ownership and funding obligations in the servicer-advance Buyer, including the uncalled equity commitment and any additional advances purchased after year-end.
- Review REIT qualification, taxable REIT subsidiary exposure and compliance with the Investment Company Act exclusion.
- Evaluate related-party transactions and management economics, including the 1.5% management fee, 25% incentive compensation formula and termination fee.
- Confirm the sustainability of the $0.175 quarterly dividend and distinguish regular distributions from the $0.075 special dividend paid for REIT distribution requirements.