Business Context and Reporting Period
New Residential Investment Corp. (now Rithm Capital Corp.) filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2019. The company operated as an externally managed REIT focused on mortgage servicing rights and related assets, residential securities and loans, consumer loans, and mortgage origination and servicing through NewRez and other subsidiaries.
The company reported four segments: Servicing and Originations, Residential Securities and Loans, Consumer Loans, and Corporate. It had 415.5 million common shares outstanding as of October 28, 2019.
Financial Performance and Key Metrics
| Metric | Three months ended September 30, 2019 | Three months ended September 30, 2018 | Nine months ended September 30, 2019 | Nine months ended September 30, 2018 |
|---|---|---|---|---|
| Interest income | $448.1 million | $425.5 million | $1.303 billion | $1.213 billion |
| Net interest income | $202.2 million | $262.7 million | $616.3 million | $791.8 million |
| Servicing revenue, net | $53.1 million | $175.4 million | $133.4 million | $538.8 million |
| Gain on sale of originated mortgage loans | $100.5 million | $45.7 million | $194.0 million | $45.7 million |
| Income before income taxes | $239.2 million | $199.0 million | $394.5 million | $989.7 million |
| Net income | $244.7 million | $195.5 million | $375.6 million | $995.7 million |
| Net income attributable to common stockholders | $224.6 million | $184.6 million | $338.2 million | $963.6 million |
| Diluted EPS | $0.54 | $0.54 | $0.83 | $2.86 |
| Core earnings | $207.3 million | $214.7 million | $631.4 million | $606.9 million |
| Core earnings per diluted share | $0.50 | $0.63 | $1.55 | $1.80 |
- Third-quarter net income rose 25.2% year over year, but nine-month net income fell 62.3%, primarily reflecting unfavorable servicing fair-value changes and higher operating and financing costs.
- Third-quarter net interest income declined 23.0%; nine-month net interest income declined 22.2%, as interest expense grew faster than interest income.
- Operating expenses increased to $250.6 million in the third quarter and $632.8 million for the nine months, compared with $192.1 million and $419.7 million, respectively, in the prior-year periods.
- The company declared a $0.50 per common share dividend for the third quarter. It also declared preferred dividends after issuing Series A and Series B preferred stock during the quarter.
Balance Sheet, Cash Flow, Debt, and Liquidity
- Total assets were $41.35 billion at September 30, 2019, up from $31.69 billion at December 31, 2018.
- Total stockholders’ equity was $7.18 billion, and total equity including noncontrolling interests was $7.26 billion, compared with $6.00 billion and $6.09 billion, respectively, at year-end 2018.
- Key September 30 carrying values included $5.24 billion of MSRs and MSR financing receivables, $16.85 billion of real estate and other securities, $7.17 billion of residential mortgage loans, and $881.2 million of consumer loans.
- Total debt obligations were $30.52 billion, consisting primarily of $23.11 billion of repurchase agreements and $7.41 billion of notes and bonds payable. Weighted-average funding cost was 3.08%.
- Borrowing capacity was $13.29 billion, with $4.87 billion of reported available financing. The company was in compliance with all debt covenants at quarter-end.
- Cash and restricted cash totaled $901.4 million at September 30, 2019, compared with $415.1 million at December 31, 2018.
- Net cash used in operating activities was $2.32 billion for the nine months, compared with $75.8 million used in the prior-year period. Net cash used in investing activities was $5.25 billion, while financing activities provided $8.05 billion.
- Management stated that cash on hand, operating cash flow, asset sales and repayments, and the ability to roll repurchase and servicer-advance financings were expected to satisfy anticipated liquidity needs over the next 12 months, but emphasized the dependence on continued financing access and refinancing.
Material Changes Versus the Prior Comparable Period
- Servicing revenue, net fell by $122.3 million in the third quarter and $405.4 million for the nine months. The decline was driven mainly by negative MSR fair-value adjustments from higher prepayment rates and increased amortization, partially offset by higher servicing fees from acquired portfolios.
- Gain on sale of originated mortgage loans increased by $54.8 million in the third quarter and $148.3 million for the nine months, primarily due to higher MSRs retained on loan sales and increased origination activity.
- NewRez originated approximately $5.7 billion of mortgage loans in the third quarter, a 49% sequential increase and approximately 200% increase from the prior-year quarter.
- General and administrative expense increased by $34.9 million in the third quarter and $212.2 million for the nine months, largely reflecting the Shellpoint acquisition, expanded origination and servicing operations, and higher transaction activity.
- The company expanded its capital base through a $751.7 million net common stock offering in February 2019, a $150.0 million net Series A preferred stock offering in July, and a $273.4 million net Series B preferred stock offering in August.
- Real estate securities increased to $16.85 billion from $11.64 billion at year-end 2018. Agency and Non-Agency RMBS net interest spreads at quarter-end were 0.75% and 1.76%, respectively.
- MSRs increased to $3.43 billion from $2.88 billion, while MSR financing receivables increased to $1.81 billion from $1.64 billion. Direct Excess MSRs declined to $398.1 million from $447.9 million.
- Consumer loans declined to $881.2 million from $1.07 billion, and the company’s equity-method investment in LoanCo and WarrantCo declined to $23.0 million from $38.3 million.
Guidance, Outlook, Risks, and Unusual Items
- Management expected continued opportunities to acquire MSRs as mortgage servicing markets consolidated, but noted tighter spreads, higher asset prices, and greater difficulty sourcing investments with attractive risk-adjusted returns.
- Lower interest rates during the quarter increased prepayment pressure. Management reported that faster prepayments reduced MSR fair values, while lower discount rates partially offset the decline.
- The company’s primary market risks were interest rates, mortgage basis spreads, prepayments, credit, liquidity, and counterparty performance. A 50-basis-point increase in short-term rates was estimated to reduce net book value by approximately $6.2 million; a 50-basis-point decrease was estimated to increase it by approximately $3.7 million.
- Repurchase agreements created $23.1 billion of margin exposure. Declines in collateral values could require significant additional cash or collateral and could impair liquidity.
- Material risks included dependence on Nationstar, Ocwen/PHH, OneMain, LoanCare, Flagstar, Shellpoint and other servicing counterparties; servicing termination or bankruptcy; unrecoverable or delayed servicer advances; regulatory and litigation exposure; prepayment and credit losses; and difficulty refinancing short-term debt.
- The company had $2.7 billion of unfunded mortgage origination commitments and $279.4 million of unfunded and available consumer-loan revolving commitments. It also estimated $9.2 million of liability for mortgage representations and warranties and $168.5 million related to Ginnie Mae repurchases.
- On October 1, 2019, after quarter-end, the company completed the acquisition of Ditech’s forward MSRs and related assets with approximately $62.0 billion of UPB for an approximate purchase price of $1.2 billion, financed with financing facilities and cash.
- On October 4, 2019, the company completed a securitization of approximately $1.73 billion of reperforming residential mortgage loans for net proceeds of $1.67 billion.
- The company continued to intend to qualify as a REIT and maintain its exclusion from registration under the Investment Company Act of 1940. It was also evaluating the impact of the expected 2020 credit-loss accounting standard.
- Disclosure controls and procedures were reported effective. The chief accounting officer resigned effective October 31, 2019, and the chief financial officer and treasurer was appointed chief accounting officer.
Important Facts for Investors to Verify
- Verify the sustainability of core earnings and the $0.50 quarterly common dividend given the decline in GAAP earnings for the nine-month period and the company’s high leverage.
- Assess the sensitivity of MSR and Excess MSR valuations to prepayment speeds, discount rates, recapture rates, delinquencies, and servicing costs.
- Review the maturity profile and refinancing requirements for the $30.5 billion debt portfolio, particularly the $18.8 billion of contractual maturities due during the remainder of 2019.
- Evaluate margin-call exposure and available financing under stressed collateral values and less favorable repurchase-market conditions.
- Assess counterparty, servicing-transfer, regulatory, bankruptcy, and litigation risks involving major servicers and subservicers.
- Review the integration, financing, and operating risks associated with the post-quarter-end Ditech acquisition.
- Reconcile non-GAAP core earnings to GAAP net income and consider the effect of excluding fair-value changes, impairments, incentive compensation, transaction costs, deferred taxes, and other items.