Business Context and Reporting Period
New Residential Investment Corp. (NYSE: NRZ), now known as Rithm Capital Corp., filed this unaudited Form 10-Q for the quarter ended March 31, 2015. The company operated as an externally managed REIT focused on mortgage servicing-related assets, servicer advances, Agency and Non-Agency RMBS, residential mortgage loans, real estate owned and consumer-loan investments. Fortress affiliate FIG LLC provided management services.
The company reported 141.4 million common shares outstanding at March 31, 2015 and 198.9 million shares outstanding as of May 1, 2015, reflecting subsequent equity issuance and acquisition-related shares.
Key Financial Metrics
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Interest income | $84.4 million | $71.5 million | +$12.9 million |
| Interest expense | $34.0 million | $39.0 million | -$5.0 million |
| Net interest income | $50.4 million | $32.5 million | +$17.9 million |
| Net interest income after impairment | $48.3 million | $32.0 million | +$16.3 million |
| Other income | $12.3 million | $35.1 million | -$22.8 million |
| Income before taxes | $38.4 million | $57.2 million | -$18.8 million |
| Net income | $41.8 million | $56.9 million | -$15.1 million |
| Net income attributable to common stockholders | $36.0 million | $48.8 million | -$12.8 million |
| Basic and diluted EPS | $0.25 | $0.39/$0.38 | Declined |
| Core earnings, non-GAAP | $63.5 million | $41.8 million | +$21.7 million |
| Dividend declared per share | $0.38 | $0.35 | +$0.03 |
Net income benefited from a $3.4 million income-tax benefit, including a $2.3 million release of previously recorded unrecognized state and local tax benefits. The filing does not provide a single revenue figure or a conventional operating margin; net interest income was approximately 59.7% of interest income in Q1 2015, before impairment and other items.
Balance Sheet and Portfolio
- Total assets were $7.47 billion at March 31, 2015, down from $8.09 billion at December 31, 2014.
- Total equity was $1.81 billion, including $1.57 billion attributable to New Residential stockholders and $246.9 million of noncontrolling interests.
- Cash and cash equivalents increased to $459.3 million from $213.0 million; restricted cash was $28.3 million.
- Portfolio carrying value included $751.8 million of Excess MSRs, $3.25 billion of servicer advances, $2.32 billion of real estate securities, $545.1 million of residential mortgage loans and REO, and no recorded basis in the consumer-loan equity investment.
- Agency RMBS and Non-Agency RMBS net interest spreads were 1.82% and 3.97%, respectively, at quarter-end.
Cash Flow, Debt and Liquidity
- Operating cash flow was negative $18.6 million, compared with positive $2.1 million in Q1 2014.
- Investing activities provided $1.12 billion, primarily from loan and securities sales and repayments, partially offset by purchases of servicer advances and RMBS.
- Financing activities used $854.5 million, primarily reflecting debt repayments and dividends.
- Ending cash increased by $246.3 million to $459.3 million.
- Repurchase agreements totaled $2.34 billion and notes payable totaled $3.00 billion, for total debt obligations of $5.34 billion. Weighted-average funding cost was 1.90%.
- Available financing was reported at $1.73 billion, subject to eligible collateral and other borrowing conditions. The company was in compliance with all debt covenants at March 31, 2015.
- Debt maturities totaled $2.49 billion through December 31, 2015, $2.15 billion in 2016 and $701.2 million in 2017.
Material Changes Versus the Prior Comparable Period
- Net interest income improved materially because interest income increased and interest expense declined, reflecting portfolio growth and lower servicer-advance financing costs.
- Other income fell sharply because Q1 2014 included $16.4 million of earnings from consumer-loan equity method investees and stronger Excess MSR fair-value gains. The company no longer recorded its share of underlying consumer-loan earnings after the October 2014 refinancing and instead recorded a $10.4 million distribution-related gain in Q1 2015.
- Gain on settlement of investments increased to $14.8 million from $4.4 million, driven by gains on sales of RMBS and residential mortgage loans, partly offset by $22.6 million of derivative settlement losses, a $5.6 million REO loss and a $2.9 million debt-extinguishment loss.
- Operating expenses increased to $22.3 million from $9.9 million. General and administrative expense rose by $6.6 million, including $5.5 million of acquisition and transaction-related costs; loan servicing expense increased by $4.8 million.
- Servicer-advance fair value declined by $7.7 million, while direct Excess MSR fair value declined by $1.8 million. Fair value of Excess MSRs held directly and through equity method investees decreased by approximately $2.7 million during the quarter.
- The company adopted ASU 2014-11, causing formerly linked transactions to be accounted for as secured borrowings and increasing reported assets and liabilities by approximately $86.0 million through a modified retrospective adjustment.
Guidance, Outlook, Commentary and Risks
- Management expected cash on hand, operating cash flow and the ability to roll repurchase agreements to cover anticipated liquidity needs over the next 12 months, but emphasized that liquidity could deteriorate rapidly if assumptions prove incorrect.
- Management viewed continued MSR sales by banks and non-bank servicers as a substantial investment opportunity, while noting that increased competition, higher pricing and lengthier regulatory and GSE approvals could reduce future returns.
- Management stated that credit spreads tightened during the quarter, supporting securities values. It also noted that Excess MSR values are sensitive to interest rates, prepayments, delinquencies and recapture rates.
- A 100-basis-point increase in short-term interest rates was estimated to reduce next-12-month cash flows by approximately $11.9 million and increase net book value by approximately $145.9 million. A 25-basis-point widening in credit spreads was estimated to reduce net book value by approximately $27.7 million.
- Key risks include margin calls and refinancing risk on short-term repurchase agreements, counterparty concentration, dependence on Nationstar and other servicers, possible non-recovery or delayed recovery of servicer advances, valuation uncertainty for Level 3 assets, credit losses, prepayment risk, regulatory changes, REIT qualification and maintaining an exclusion from investment-company registration.
- The company disclosed no material litigation as of March 31, 2015 other than legal proceedings associated with the subsequent HLSS transaction and related parties. Management had not accrued losses because it did not believe a probable and reasonably estimable loss existed.
Subsequent Events and Unusual Items
- On April 6, 2015, the company terminated its proposed $18.25-per-share merger with Home Loan Servicing Solutions and simultaneously acquired substantially all of HLSS’s assets and assumed specified liabilities for approximately $1.007 billion in cash and 28.3 million New Residential shares. The acquisition was not reflected in the March 31, 2015 balance sheet.
- The company subsequently entered into a new HLSS merger agreement at $0.704059 per HLSS share, subject to HLSS shareholder approval and other conditions.
- In April 2015, the company issued 29.2 million shares at $15.25 per share for net proceeds of approximately $436.1 million and granted the Manager options to purchase 5.75 million shares at $15.25 per share.
- After quarter-end, the company repaid the $100.0 million Credit Suisse corporate loan, entered into a $165.0 million Barclays secured loan and issued a $219.4 million secured corporate note.
- Subsequent to quarter-end, the company acquired additional Non-Agency RMBS, sold Agency RMBS, sold additional residential mortgage loans and entered into $500 million of interest-rate swaps.
Facts Investors Should Verify
- Reconcile Q1 2015 GAAP earnings of $36.0 million attributable to common stockholders with non-GAAP core earnings of $63.5 million, including the treatment of fair-value changes, transaction costs, incentive compensation and consumer-loan earnings.
- Assess the liquidity impact of $2.49 billion of debt maturities through year-end 2015, short-term repurchase financing and potential margin calls.
- Evaluate the valuation assumptions and sensitivity of Excess MSRs and servicer advances, particularly prepayment, delinquency, recapture, discount-rate and advance-recovery assumptions.
- Review Nationstar, Ocwen and other servicer performance, regulatory matters, rating changes and counterparty exposure, especially in light of the HLSS acquisition.
- Determine the final accounting, financing, dilution, liabilities and integration costs associated with the HLSS acquisition, which closed after the reporting date.
- Confirm continued REIT qualification, compliance with investment-company exclusions and the company’s ability to fund required dividends from taxable income and available cash.