Business context and reporting period
Rithm Capital Corp. was then named New Residential Investment Corp. and operated as an externally managed Delaware REIT focused on residential mortgage-related assets. The filing covers the three and nine months ended September 30, 2016; financial statements are unaudited and amounts are generally in thousands, except per-share data.
Core investments 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.
Financial performance and condition
| Metric | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Interest income | $282.4 million | $182.3 million | $749.9 million | $444.9 million |
| Interest expense | $96.5 million | $77.6 million | $278.4 million | $193.4 million |
| Net interest income | $185.9 million | $104.8 million | $471.5 million | $251.5 million |
| Income before taxes | $152.0 million | $55.8 million | $358.8 million | $187.8 million |
| Net income | $131.1 million | $61.8 million | $340.7 million | $182.8 million |
| Net income attributable to common stockholders | $98.9 million | $54.6 million | $279.3 million | $165.7 million |
| Basic EPS | $0.41 | $0.24 | $1.19 | $0.87 |
| Dividend declared per share | $0.46 | $0.46 | $1.38 | $1.29 |
Net interest income represented approximately 65.8% of interest income in Q3 2016, compared with approximately 57.5% in Q3 2015. Core earnings, a non-GAAP measure, were $123.9 million, or approximately $0.51 per share, in Q3 2016 and $355.9 million, or approximately $1.52 per share, for the first nine months. The filing does not provide a quarterly or year-to-date reconciliation of core earnings per share.
- Total assets were $17.7 billion at September 30, 2016, up from $15.2 billion at December 31, 2015.
- Equity was $3.4 billion, including $3.1 billion attributable to New Residential stockholders and $289.2 million of noncontrolling interests.
- Cash and cash equivalents were $388.7 million, with restricted cash of $153.1 million.
- Excess MSRs were carried at $1.4 billion directly and $195.9 million through equity-method investees. Servicer advances were $6.0 billion.
- Real estate securities were $5.0 billion, including $1.4 billion of Agency RMBS and $3.6 billion of Non-Agency RMBS. Consumer loans were $1.8 billion.
- Residential mortgage loans held for sale were $705.5 million and REO was $60.5 million.
- Repurchase agreements were $4.9 billion and notes and bonds payable were $7.8 billion. Total debt obligations were $12.8 billion, with a weighted-average funding cost of approximately 3.02%.
- Available financing capacity was $3.1 billion, subject to eligible collateral and other borrowing conditions. Management stated that the company was in compliance with its debt covenants.
Cash flow, leverage and liquidity
- Net cash provided by operating activities for the first nine months was $524.0 million, compared with $362.1 million in the prior-year period.
- Investing activities provided $76.3 million, compared with using $117.2 million in the prior-year period, reflecting substantial purchases and repayments of servicer advances and RMBS.
- Financing activities used $461.6 million, primarily reflecting net debt repayments, dividends and noncontrolling-interest distributions, partly offset by borrowings and a $279.6 million stock issuance.
- Cash increased by $138.7 million during the first nine months, ending at $388.7 million.
- The company had approximately $4.9 billion of repurchase-agreement margin exposure. Management expected cash on hand, operating cash flow and the ability to roll or refinance borrowings to satisfy anticipated needs for the next 12 months, but cautioned that liquidity could deteriorate rapidly if assumptions proved incorrect.
Material changes versus the prior comparable period
- Interest income increased 54% in Q3 and 69% for the first nine months, while net interest income increased 77% and 87%, respectively, primarily from portfolio growth and the consumer-loan consolidation.
- Income attributable to common stockholders increased 81% in Q3 and 69% for the first nine months.
- Impairment and valuation charges increased materially: Q3 charges were $20.0 million versus a $1.8 million reversal in the prior-year period; nine-month charges were $49.7 million versus $5.7 million.
- Excess MSR fair-value changes were unfavorable, with losses of $17.1 million in Q3 and $24.4 million for the first nine months, primarily because projected prepayment speeds increased on the Non-Agency portfolio.
- Servicer-advance fair-value changes improved to a $21.6 million gain in Q3 and a $4.3 million gain for the first nine months, compared with losses in the prior-year periods.
- General and administrative expense declined, largely because 2015 included HLSS acquisition-related expenses and a bondholder settlement. Affiliate management and incentive compensation increased to $17.6 million in Q3 and $43.8 million for the first nine months.
- Shares outstanding increased to 250.8 million at September 30, 2016 from 230.5 million at December 31, 2015, including a 20.0 million-share public offering that generated approximately $278.8 million of net proceeds.
Major transaction and outlook
On March 31, 2016, the company acquired an additional 23.5% interest in the Consumer Loan Companies through the SpringCastle Transaction, bringing its ownership to 53.5% and triggering consolidation. The transaction added approximately $1.9 billion of consumer loans and $1.8 billion of assumed notes and bonds payable. A $71.3 million gain resulted from remeasurement of the company’s previously held 30% interest. The Consumer Loan Companies contributed $154.3 million of interest income and $60.1 million of pretax income from acquisition through September 30, 2016. The transaction also produced significant noncontrolling-interest income.
Management believed the mortgage-servicing market offered continued opportunities because banks were reducing MSR exposure and non-bank servicers remained capital constrained. However, management also noted increased competition, higher pricing for newer MSRs and lengthier regulatory and GSE approval processes. No quantitative earnings or dividend guidance was provided.
After quarter end, the company completed the purchase of approximately $32.3 billion of Fannie Mae MSRs from Ditech for approximately $240.0 million, including servicing advances, and began holding full MSRs. It also entered into a $345.0 million loan secured by Non-Agency Excess MSRs and refinanced the consumer-loan debt with a new $1.7 billion securitization. A proposed acquisition of approximately $34.2 billion of MSRs and $40.8 million of servicing advances from Walter Capital Opportunity remained subject to definitive documentation and regulatory and Agency approvals.
Risks, contingencies and unusual items
- Results and asset values are highly sensitive to prepayment rates, delinquencies, defaults, recoveries, interest rates, credit spreads and liquidity. A 25-basis-point widening in credit spreads was estimated to reduce net book value by approximately $105.2 million.
- A 50-basis-point increase in short-term rates was estimated to increase next-12-month cash flows by $10.3 million and net book value by $119.1 million; a 50-basis-point decrease was estimated to reduce cash flows by $2.2 million and net book value by $130.4 million.
- Counterparty concentration was significant, particularly in Nationstar, Ocwen, OneMain and, after the subsequent transaction, Ditech. Servicer failure, regulatory action, bankruptcy or termination could impair MSRs, advances, financing and cash flows.
- The company relies heavily on short-term repurchase agreements and servicer-advance facilities. Non-renewal, higher haircuts, margin calls or refinancing constraints could materially pressure liquidity.
- Non-Agency RMBS had a weighted-average rating of CCC- and $7.8 million of OTTI was recorded during the first nine months.
- Legal and regulatory matters inherited or associated with HLSS, Ocwen and related parties remained unresolved. No loss was accrued because management did not believe a loss was probable and reasonably estimable, but the ultimate outcomes could materially affect results.
- The company intended to maintain REIT status and its exclusion from registration under the Investment Company Act. Failure to do so could materially increase taxes, constrain operations or require asset sales.
- Disclosure controls and procedures were deemed effective as of September 30, 2016, with no material changes in internal control over financial reporting.
Investor verification checklist
- Reconcile GAAP net income, core earnings and cash generation, especially the impact of the $71.3 million SpringCastle remeasurement gain and other fair-value items.
- Assess whether consumer-loan performance, provisions, delinquencies and the October 2016 refinancing support the carrying value of the $1.8 billion consumer-loan portfolio.
- Review MSR and servicer-advance valuation assumptions, including prepayment, delinquency, recapture, discount-rate and recovery assumptions.
- Monitor repurchase-agreement maturities, margin requirements, available financing capacity and the company’s ability to refinance or roll short-term debt.
- Evaluate exposure to Nationstar, Ocwen, OneMain and Ditech, including servicing performance, regulatory developments and potential termination or bankruptcy scenarios.
- Verify the financial and regulatory effects of the post-quarter Walter and Ditech transactions and the proposed Walter Capital Opportunity transaction.
- Review pending litigation, HLSS-related liabilities and the status of the proposed Ocwen derivative-action settlement.
- Confirm continued REIT qualification, dividend coverage and the effect of taxable-income and cash-flow mismatches on future distributions.