New Residential Investment Corp. (now Rithm Capital Corp.) — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; comparative period was the three months ended March 31, 2018. The company was externally managed by FIG LLC, an affiliate of Fortress Investment Group, and operated as a residential mortgage-focused REIT through Servicing and Originations, Residential Securities and Loans, Consumer Loans, and Corporate segments.
Business context and financial position
- The portfolio primarily comprised mortgage servicing rights, mortgage servicing rights financing receivables, Excess MSRs, servicer advance investments, Agency and Non-Agency RMBS, residential mortgage loans, and consumer loans.
- Total assets were $33.4 billion, up from $31.7 billion at December 31, 2018. Total equity was $6.9 billion, including $6.8 billion attributable to New Residential stockholders.
- Cash and cash equivalents were $340.9 million; cash, cash equivalents, and restricted cash totaled $509.0 million at quarter-end.
- Common shares outstanding increased to 415.4 million from 369.1 million, primarily reflecting a February public offering of 46.0 million shares.
Key financial metrics
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Interest income | $438.9 million | $383.6 million | +$55.3 million |
| Interest expense | $212.8 million | $124.4 million | +$88.4 million |
| Net interest income | $226.0 million | $259.2 million | -$33.2 million |
| Servicing revenue, net | $165.9 million | $217.2 million | -$51.4 million |
| Gain on sale of originated mortgage loans | $44.0 million | — | +$44.0 million |
| Other income (loss), net | $(40.8) million | $264.5 million | -$305.3 million |
| Income before income taxes | $201.9 million | $607.5 million | -$405.5 million |
| Net income | $155.9 million | $614.4 million | -$458.5 million |
| Net income attributable to common stockholders | $145.6 million | $604.3 million | -$458.7 million |
| Diluted EPS | $0.37 | $1.81 | -$1.44 |
| Dividends declared per share | $0.50 | $0.50 | No change |
| Core earnings | $204.3 million | $194.5 million | +$9.8 million |
Margins and earnings quality: Net interest income represented approximately 51.5% of interest income in Q1 2019, versus approximately 67.6% in Q1 2018. The decline in GAAP earnings was driven primarily by substantially lower fair-value and settlement gains, higher funding costs, higher operating expenses, and a $46.0 million income tax expense versus a $6.9 million benefit in the prior-year quarter. Core earnings increased despite the decline in GAAP net income.
Cash flow, debt, and liquidity
- Net cash used in operating activities was $300.4 million, compared with $513.7 million provided in Q1 2018. Operating cash flow reflected significant mortgage loan purchases and originations, including $2.0 billion of originated loans.
- Net cash used in investing activities was $2.75 billion, principally due to purchases of Agency RMBS, Non-Agency RMBS, servicer advance investments, and MSRs.
- Net cash provided by financing activities was $3.15 billion, including net repurchase-agreement borrowings and $752.1 million of common-stock issuance proceeds.
- Debt obligations totaled approximately $25.4 billion, consisting of $18.4 billion of repurchase agreements and $7.0 billion of notes and bonds payable. Weighted-average funding cost was approximately 3.53%.
- Available financing capacity was approximately $3.5 billion, subject to eligible collateral and other borrowing conditions. Management stated that the company was in compliance with all debt covenants.
- Management expected cash on hand, operating cash flow, asset repayments and sales, and continued access to financing to meet anticipated liquidity needs over the next 12 months. This outlook depends materially on the ability to roll short-term borrowings and satisfy margin requirements.
Material changes versus the prior comparable period
- Portfolio expansion and leverage: Real estate and other securities increased to $9.75 billion from $9.63 billion in the portfolio presentation, while repurchase-agreement debt increased to $18.4 billion from $15.6 billion at year-end 2018. Interest expense rose 71% year over year.
- Originations platform: Following the 2018 Shellpoint acquisition, NewRez originated more than $2.0 billion of mortgage loans during the quarter and generated $44.0 million of gain on sale of originated loans. Shellpoint contributed $110.6 million of revenue and $38.9 million of net income in Q1 2019.
- MSR investments: The company acquired approximately $21.9 billion of Agency MSR unpaid principal balance for $276.2 million during the quarter. MSRs carried at fair value increased to $3.02 billion from $2.88 billion at year-end; MSR financing receivables increased to $1.72 billion from $1.64 billion.
- Fair-value volatility: Fair-value income from MSR financing receivables fell to a $36.4 million loss from a $271.1 million gain in Q1 2018. Servicer advance fair-value results improved to a $7.9 million gain from a $79.5 million loss.
- Expenses: General and administrative expense increased to $98.9 million from $20.0 million, primarily due to Shellpoint-related compensation, origination, occupancy, and other operating costs.
- Comprehensive income: Total comprehensive income was $290.6 million, supported by a $192.4 million unrealized gain on securities, compared with $669.2 million in Q1 2018.
Guidance, outlook, commentary, risks, and unusual items
- Management viewed continued consolidation among non-bank mortgage servicers and potential MSR sales as creating acquisition opportunities, but noted that strong demand had tightened spreads, increased asset prices, and made accretive investments more difficult to source.
- Management stated that lower interest rates during the quarter generally supported MSR valuations through lower discount rates, while higher prepayment speeds adversely affected MSR-related values. The company reported a 0.95% net interest spread on Agency RMBS and a 1.95% spread on Non-Agency RMBS at March 31, 2019.
- A 50-basis-point increase in short-term interest rates was estimated to reduce next-12-month cash flows by approximately $33.1 million. The same increase was estimated to increase net book value by approximately $452.9 million, while a 25-basis-point widening in credit spreads was estimated to reduce net book value by approximately $230.4 million.
- Key exposures include short-term repo refinancing and margin-call risk, interest-rate and credit-spread volatility, prepayment and delinquency assumptions, recoverability and timing of servicer advances, illiquid Level 3 valuations, and dependence on counterparties and subservicers.
- Ditech Financial, one of the company’s subservicers, filed for Chapter 11 bankruptcy on February 11, 2019. The filing identifies potential risks to servicing performance, financing, asset values, and recovery of advances from servicer distress or termination.
- The Ocwen transaction remained subject to third-party consents and other conditions. Approximately $64.4 billion of related MSR unpaid principal balance had transferred by March 31, 2019; the company continued to face risks concerning the remaining transfers and its ability to become named servicer.
- Contingent consideration related to the Shellpoint acquisition had a fair value of $42.9 million at quarter-end, against a possible aggregate earnout of up to $60.0 million.
- The company declared and subsequently paid a $0.50 per-share first-quarter dividend; the $207.7 million dividend was paid on April 26, 2019.
- Material contingencies included mortgage origination representations and warranties, an estimated $6.6 million liability for loan-sale recourse, $140.1 million of Ginnie Mae repurchase-related loans and liabilities, approximately $1.2 billion of unfunded mortgage loan commitments, and $384.0 million of unfunded consumer-loan revolving availability.
- The company stated that disclosure controls and procedures were effective and that no material change had occurred in internal control over financial reporting.
Investor verification points
- Verify the sustainability of $204.3 million of core earnings and reconcile it to GAAP earnings, including the treatment of fair-value marks, deferred taxes, incentive compensation, and loan-sale gains.
- Monitor repo rollovers, margin requirements, available collateral, counterparty concentration, and the $17.45 billion of debt maturities scheduled from April through December 2019.
- Assess whether MSR and Excess MSR valuation assumptions—particularly prepayments, discount rates, delinquencies, recapture rates, and subservicing costs—remain supportable.
- Track Ditech, Ocwen, Nationstar, PHH, and other servicing-partner developments, including regulatory actions, servicing transfers, bankruptcy risks, and potential impacts on advance recoveries.
- Evaluate the effect of Shellpoint integration, mortgage origination volumes, gain-on-sale margins, repurchase obligations, and operating expenses on future results.
- Review the company’s ability to maintain REIT qualification, its exclusion from the Investment Company Act, and sufficient taxable-income distributions without impairing liquidity.
- Consider the concentration of collateral and servicing exposure in California, Florida, Western U.S. Non-Agency RMBS, and other regions vulnerable to housing-market or natural-disaster stress.