New Residential Investment Corp. (now Rithm Capital Corp.) — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018. The filing is under the historical name New Residential Investment Corp.; the company is now Rithm Capital Corp. The company operated as an externally managed Delaware REIT focused on mortgage servicing-related assets, residential securities and loans, and consumer loans.
Key financial metrics
| Metric | Q1 2018 | Q1 2017 / prior period |
|---|---|---|
| Interest income | $383.6 million | $292.5 million |
| Interest expense | $124.4 million | $98.2 million |
| Net interest income | $259.2 million | $194.3 million |
| Net interest income after impairment | $233.5 million | $174.3 million |
| Servicing revenue, net | $217.2 million | $40.6 million |
| Other income, net | $264.5 million | $(3.7) million |
| Income before income taxes | $607.5 million | $142.8 million |
| Net income | $614.4 million | $137.2 million |
| Net income attributable to common stockholders | $604.3 million | $121.4 million |
| Diluted EPS | $1.81 | $0.42 |
| Core earnings | $194.5 million | $154.9 million |
| Dividend declared per share | $0.50 | $0.48 |
| Net cash provided by operating activities | $513.7 million | $(378.8) million |
| Cash, cash equivalents and restricted cash at period-end | $412.9 million | $394.9 million |
Balance sheet, portfolio and leverage
- Total assets were $22.0 billion versus $22.2 billion at December 31, 2017.
- Total equity was $5.8 billion versus $4.8 billion at year-end; common stockholders’ equity was $5.7 billion.
- Common shares outstanding increased to 336.1 million from 307.4 million, primarily following a January public offering of 28.8 million shares that generated approximately $482.3 million of net proceeds.
- Major investments at March 31 included $4.0 billion of MSRs and MSR financing receivables, $7.6 billion of real estate and other securities, $2.1 billion of residential mortgage loans, $1.3 billion of consumer loans, and $955.4 million of servicer advance investments.
- Debt consisted of $7.6 billion of repurchase agreements and $7.0 billion of notes and bonds payable, or approximately $14.7 billion in carrying value. Weighted-average funding cost was 3.39% and weighted-average debt life was 1.4 years.
- Reported available financing was $1.9 billion against total stated borrowing capacity of $5.0 billion. The company reported compliance with all debt covenants.
Material changes versus Q1 2017 and year-end 2017
- Net income attributable to common stockholders increased by $482.9 million, driven primarily by growth in servicing-related earnings, fair-value gains, and realized gains associated with the Ocwen transaction.
- Servicing revenue increased by $176.6 million, reflecting MSR acquisitions and favorable valuation changes associated mainly with higher interest rates and lower projected prepayments.
- Mortgage servicing rights financing receivables generated a $271.1 million fair-value gain and increased to $1.9 billion from $598.7 million at year-end, including approximately $1.0 billion recognized under the New Ocwen Agreements.
- Direct Excess MSRs declined to $515.7 million from $1.17 billion, while servicer advance investments declined to $955.4 million from $4.0 billion, principally because Ocwen-related assets were reclassified into MSR financing receivables and related receivables.
- Repurchase agreements declined by approximately $1.0 billion from year-end, while equity increased by approximately $1.0 billion, reflecting the common stock issuance and comprehensive income.
- Net cash provided by operating activities improved substantially from an outflow of $378.8 million in Q1 2017 to an inflow of $513.7 million in Q1 2018. Investing activities provided $216.2 million, while financing activities used $763.0 million, including debt repayments and dividends.
- Impairment increased to $25.7 million from $20.0 million, including $6.7 million of other-than-temporary impairment on securities and $19.0 million of valuation and loss provisions on loans and REO.
Guidance, outlook, commentary and unusual items
- Management expected cash on hand, operating cash flow, and the ability to roll repurchase agreements and servicer advance financing to satisfy anticipated liquidity needs for the next 12 months, including potential margin calls and operating expenses. This outlook depends heavily on continued access to short-term financing.
- Management described continued opportunities to acquire MSRs and other servicing assets as banks and non-bank servicers sell portfolios, but noted tighter spreads, increased competition, and more extensive GSE and regulatory approval processes.
- The company entered into new Ocwen agreements in January 2018, including a $279.6 million fee restructuring payment. The agreements accelerated the transfer of economic interests in certain MSRs but left substantial consent and servicing risks outstanding.
- The Shellpoint MSR purchase closed for approximately $81.0 million in January. The separate proposed Shellpoint acquisition was expected to cost approximately $150.0 million, plus earnout payments of up to $60.0 million, and remained subject to closing conditions, regulatory approvals and other consents.
- Management reported a $0.50 quarterly dividend, payable April 27, 2018. As a REIT, the company generally must distribute at least 90% of REIT taxable income, but the filing states that future distributions are not guaranteed.
- Q1 results included significant non-cash and fair-value items, including a $319.8 million gross valuation-input gain on MSR financing receivables, a $79.5 million fair-value loss on servicer advance investments, a $45.7 million fair-value loss on direct Excess MSRs, and $113.0 million of realized gains related to the Ocwen transaction.
- Recent accounting standards adopted in Q1 2018, including revenue recognition, financial instruments, and intra-entity transfer guidance, did not have a material impact. The company expected the 2020 credit-loss standard to increase allowances and reduce retained earnings upon adoption.
Principal risks and contingencies
- Liquidity and refinancing risk from $7.6 billion of repurchase agreements, short maturities, margin calls, and reliance on counterparties to renew or extend financing.
- Interest-rate, credit-spread, prepayment, delinquency, default and loss-severity risk affecting asset values, earnings and cash flows. A 50-basis-point increase in short-term rates was estimated to reduce next-12-month cash flows by approximately $4.5 million but increase net book value by approximately $186.6 million; sensitivities were based on a static portfolio.
- Significant counterparty and servicer concentration, particularly involving Nationstar, Ocwen, OneMain, Ditech and other subservicers. Servicer termination, bankruptcy, regulatory action, rating downgrades or poor servicing performance could impair MSRs, advances and financing.
- Pending and unsettled transactions, including approximately $5.7 billion of PHH-related MSRs and advances with a purchase price of approximately $33.6 million, and remaining Ocwen transfers subject to third-party consents and other conditions.
- Mortgage servicing is highly regulated and depends on maintaining licenses, GSE approvals, servicing standards and subservicer compliance. The company also faces risks from foreclosure delays, litigation, regulatory inquiries and assumed HLSS liabilities.
- REIT qualification and exclusion from investment company registration depend on complex asset, income, distribution and structural tests. Failure could result in corporate taxes, delisting, restructuring or forced asset sales.
- The company disclosed ordinary-course litigation and regulatory inquiries but did not believe current inquiries would materially affect the business. A stockholder appeal related to the prior HLSS transaction was scheduled for argument in May 2018.
Investor verification checklist
- Verify the sustainability of the $194.5 million of core earnings separately from the $604.3 million of GAAP earnings attributable to common stockholders.
- Reconcile the large fair-value and realized gains associated with the Ocwen transaction and assess how much represents recurring cash earnings.
- Monitor MSR and MSR financing receivable valuations, including prepayment, discount-rate, delinquency and recapture assumptions.
- Assess short-term refinancing, margin-call and counterparty exposure associated with the $14.7 billion debt base and $7.6 billion of repurchase agreements.
- Track remaining PHH, Ocwen and Shellpoint transaction approvals, settlements, earnouts, servicing transfers and potential termination or purchase rights.
- Review servicer performance and regulatory developments involving Ocwen, Nationstar, Ditech, PHH, Shellpoint and OneMain.
- Evaluate whether cash generation supports the $0.50 quarterly dividend after debt service, required REIT distributions, future servicer advances and investment commitments.