Rithm Capital Corp. annual report, FY2018

Business Context and Reporting Period

This filing is New Residential Investment Corp.’s Form 10-K for the fiscal year ended December 31, 2018. The company is now known as Rithm Capital Corp. It operates as an externally managed residential real estate investment trust, focused on mortgage servicing rights, excess MSRs, servicer advances, residential mortgage securities and loans, consumer loans, and mortgage origination. The company acquired Shellpoint Partners LLC on July 3, 2018, adding mortgage origination, servicing and recapture capabilities.

The filing includes full-year 2018 results and unaudited quarterly information. Fourth-quarter results were affected by lower interest rates, wider credit spreads, faster prepayments and valuation losses on servicing-related assets.

Key Financial Metrics

Metric	2018	2017	Change
Interest income	$1.664 billion	$1.520 billion	Up 9.5%
Interest expense	$606.4 million	$460.9 million	Up 31.6%
Net interest income	$1.058 billion	$1.059 billion	Down 0.1%
Servicing revenue, net	$528.6 million	$424.3 million	Up 24.6%
Gain on sale of originated mortgage loans	$89.0 million	—	New in 2018
Impairment	$90.6 million	$86.1 million	Up 5.3%
Operating expenses	$609.4 million	$422.6 million	Up 44.2%
Net income attributable to common stockholders	$964.0 million	$957.5 million	Up 0.7%
Diluted EPS	$2.81	$3.15	Down 10.8%
Core earnings	$815.2 million	$861.4 million	Down 5.4%
Dividends declared per share	$2.00	$1.98	Up 1.0%

Net income was supported by a $73.4 million income-tax benefit in 2018, compared with $167.6 million of tax expense in 2017. The benefit primarily reflected the release of valuation allowances and deferred-tax benefits in taxable REIT subsidiaries. Consequently, reported net income and EPS were affected by tax items that may not recur.

Balance Sheet, Liquidity and Leverage

Total assets were $31.7 billion, up from $22.2 billion at December 31, 2017.
Total debt was $22.7 billion, up from $15.7 billion. Debt carried a weighted-average funding cost of 3.58% and a weighted-average life of 0.9 years.
Total equity was $6.1 billion; New Residential stockholders’ equity was $6.0 billion.
Book value per common share was $16.25, compared with $15.26 at year-end 2017.
Cash and restricted cash totaled $415.1 million, including $251.1 million of cash and cash equivalents.
Outstanding repurchase agreements were $15.6 billion and notes and bonds payable were $7.1 billion.
Available financing capacity was $2.6 billion, subject to eligible collateral and other borrowing conditions.
Approximately $17.0 billion of debt obligations were contractually due in 2019, including $15.6 billion of repurchase agreements, creating substantial refinancing and margin-call exposure.
Management stated that cash on hand, operating cash flow and the ability to roll repurchase agreements and servicer-advance financing were expected to cover anticipated needs for the next 12 months.

Portfolio and Cash Flow

At December 31, 2018, the investment portfolio had $23.2 billion of carrying value, including $9.0 billion of Non-Agency RMBS, $4.5 billion of residential mortgage loans, $4.5 billion of MSRs and MSR financing receivables, and $2.7 billion of Agency RMBS.
Mortgage servicing-related assets included $2.9 billion of MSRs, $1.6 billion of MSR financing receivables, $447.9 million of direct Excess MSRs and $148.0 million of Excess MSRs held through equity method investees.
The company held interests in MSRs and MSR financing receivables tied to approximately $389.0 billion of underlying mortgage unpaid principal balance.
Net cash used in operating activities was $1.229 billion, compared with $899.7 million used in 2017. Operating cash flow was affected by substantial mortgage-loan purchases and $3.4 billion of loan originations.
Net cash used in investing activities was $5.171 billion, primarily reflecting purchases of securities, MSRs, servicer advance investments and loans.
Net cash provided by financing activities was $6.369 billion, primarily from debt borrowings and equity issuances, partially offset by debt repayments and dividends.

Material Changes Versus the Prior Comparable Period

Shellpoint acquisition: Shellpoint contributed $177.4 million of revenue and $26.8 million of net income from the acquisition date through year-end. The transaction increased general and administrative expenses by $164.4 million, including $109.7 million of compensation and benefits, and introduced $89.0 million of gain on originated mortgage-loan sales.
Portfolio expansion: MSR carrying value increased from $1.7 billion to $2.9 billion, while MSR financing receivables increased from $598.7 million to $1.6 billion. Real estate and other securities increased from $8.1 billion to $11.6 billion.
Servicer advance repositioning: Servicer Advance Investments declined from $4.0 billion to $735.8 million, primarily because of the Ocwen transaction and transfers into MSR-related assets and receivables.
Ocwen transaction: By year-end, approximately $36.1 billion of underlying UPB had transferred under the Ocwen transaction, including $20.6 billion during the fourth quarter. Remaining transfers depended on third-party consents and other conditions.
Earnings quality: Net income attributable to common stockholders increased slightly, but diluted EPS and core earnings declined because the share count increased and valuation, financing and operating costs rose.
Fourth quarter: Fourth-quarter net income attributable to common stockholders was only $0.3 million, or approximately breakeven per diluted share, compared with $184.6 million in the third quarter. Servicing revenue was negative $10.2 million in the fourth quarter, and other income was negative $128.7 million.
Market-driven valuations: In the fourth quarter, lower rates and faster prepayments reduced the fair value of direct and equity-method Excess MSRs by approximately $4.8 million and reduced MSRs and MSR financing receivables by approximately $126.3 million.
Capital raising: The company issued approximately 57.6 million common shares in 2018 through public offerings and an ATM program, raising approximately $980.6 million before issuance costs. Year-end shares outstanding were 369.1 million, versus 307.4 million at year-end 2017.

Guidance, Outlook, Commentary and Risks

Management did not provide formal earnings guidance in the filing. It described continued opportunities to acquire MSRs and other mortgage assets because of non-bank servicer capital constraints and industry consolidation, but cautioned that competition, tighter spreads and higher asset prices could make new investments less accretive than prior acquisitions.

Management expected net recoveries of servicer advances to exceed net fundings for the foreseeable future, while acknowledging that a downturn could reverse this relationship and pressure liquidity.
The company remains highly sensitive to interest rates, prepayment speeds, credit spreads, delinquencies, defaults, loss severities, recapture rates and servicing costs. A 50-basis-point increase in short-term rates was estimated to reduce 2019 cash flow by approximately $18.4 million but increase net book value by approximately $461.9 million, assuming a static portfolio.
A 25-basis-point widening in credit spreads was estimated to reduce net book value by approximately $220.3 million.
Servicing and counterparty concentration is significant. Nationstar, Ocwen, Ditech and PHH subserviced substantial portions of the MSR portfolio. Servicer termination, bankruptcy, regulatory action, rating downgrades or poor servicing performance could impair MSR values, advance recoveries and financing access.
Ditech filed for Chapter 11 bankruptcy on February 11, 2019. The filing identifies potential risks to servicing arrangements, advance recoveries, asset ownership and financing if a servicing partner enters bankruptcy.
The Ocwen MSR transfer remained subject to third-party consents and rating-agency actions. Failure to obtain consents could require asset sales to Ocwen or other parties and could affect financing.
The company relies heavily on short-term and mark-to-market financing. Failure to roll repurchase agreements, margin calls or covenant breaches could require rapid asset sales or debt repayment.
The company must maintain REIT qualification and its exclusion from registration under the Investment Company Act of 1940. Failure to satisfy applicable tests could materially change its tax burden, operations, leverage capacity and ability to make distributions.
Most servicing-related assets are Level 3 fair-value measurements based on internal models and unobservable assumptions. Actual cash flows may differ materially from estimates.
The company is externally managed by an affiliate of Fortress. The manager receives a 1.5% annual management fee, incentive compensation and expense reimbursements. The management agreement and affiliated co-investments create potential conflicts of interest.
The company reported no material pending legal proceeding that it believed would have a material adverse effect, but it remains subject to ordinary-course litigation, regulatory inquiries and investigations.

Most Important Facts for Investors to Verify

Whether the company can continue rolling or refinancing approximately $17.0 billion of 2019 contractual debt maturities without materially increasing funding costs or collateral requirements.
Actual liquidity available after considering restricted cash, regulatory requirements at NRM, margin calls and collateral eligibility.
Performance of MSRs and Excess MSRs against modeled prepayment, delinquency, recapture and discount-rate assumptions.
Recovery rates and timing for the $3.3 billion of servicer advances receivable and the company’s ongoing obligation to fund future advances.
Exposure to Ditech, Ocwen, Nationstar, PHH and other servicing partners, including servicing transfers, bankruptcies, regulatory actions and termination rights.
Status and economics of the remaining Ocwen MSR transfers and required third-party consents.
Whether Shellpoint’s origination, servicing and recapture operations achieve expected earnings while controlling regulatory, repurchase and integration costs.
Composition and credit performance of the $9.0 billion Non-Agency RMBS portfolio, including impairment trends and reliance on Level 3 valuations.
Reconciliation of GAAP earnings to core earnings, particularly the effects of tax benefits, fair-value changes, impairments, incentive compensation and transaction-related expenses.
Ability to sustain the $0.50 quarterly dividend while satisfying REIT distribution requirements and funding investments, debt service and servicer advances.