Rithm Capital Corp. quarterly report, Q1 FY2017

Business Context and Reporting Period

This filing is the Form 10-Q of New Residential Investment Corp. (now Rithm Capital Corp.) for the quarter ended March 31, 2017. The company operated as an externally managed REIT focused on mortgage servicing rights, excess mortgage servicing rights, servicer advances, residential mortgage securities and loans, and consumer loans. The filing was signed May 4, 2017.

Financial Performance and Position

Metric	Q1 2017	Q1 2016 / Prior Period
Interest income	$292.5 million	$190.0 million
Interest expense	$98.2 million	$81.2 million
Net interest income	$194.3 million	$108.8 million
Net servicing revenue	$40.6 million	None reported
Net income	$137.2 million	$115.9 million
Net income attributable to common stockholders	$121.4 million	$111.7 million
Diluted EPS	$0.42	$0.48
Core earnings	$154.9 million	$112.4 million
Dividend declared per share	$0.48	$0.46

Income before taxes was $142.8 million, compared with $105.7 million in the prior-year quarter. Income tax expense was $5.6 million versus a $10.2 million benefit in Q1 2016.
Impairment and valuation charges totaled $20.0 million, including $2.1 million of securities OTTI and $17.9 million of loan and REO valuation provisions.
Operating expenses increased to $68.4 million from $25.0 million, primarily due to higher incentive compensation, loan servicing expense and subservicing expense.
Total assets were $20.0 billion at March 31, 2017, compared with $18.4 billion at December 31, 2016. Total equity was $4.3 billion versus $3.5 billion.
Cash and cash equivalents were $236.6 million; cash, cash equivalents and restricted cash totaled $394.9 million at quarter-end.
Repurchase agreements totaled $6.3 billion and notes and bonds payable totaled $7.6 billion. Weighted-average funding cost for total debt was approximately 3.0%, with a weighted-average life of 1.6 years.
Available financing capacity was reported at $2.4 billion, subject to eligible collateral and other borrowing conditions. The company was in compliance with its debt covenants.
Operating cash flow was negative $378.8 million, investing cash flow was negative $1.0 billion, and financing cash flow was positive $1.3 billion. The quarter-end decrease in cash, cash equivalents and restricted cash was $58.8 million.

Material Changes Versus the Prior Comparable Period

Net income attributable to common stockholders increased $9.6 million, but diluted EPS declined from $0.48 to $0.42 because the weighted-average share count increased to 286.6 million from 230.5 million.
Interest income increased $102.5 million, primarily from the consolidated consumer-loan portfolio acquired through the SpringCastle transaction and growth in real estate securities. Net interest income increased $85.5 million.
Net servicing revenue increased by $40.6 million due to MSR acquisitions completed after March 31, 2016.
Other income declined to a $3.7 million loss from $31.9 million of income in Q1 2016, which included a $71.3 million gain from remeasuring the previously held consumer-loan investment and a $9.9 million consumer-loan investment gain.
Fair-value results improved for servicer advances, producing a $2.6 million gain versus a $31.2 million loss in Q1 2016. Excess MSR fair-value gains were lower, while equity-method Excess MSR investments recorded a small loss.
Core earnings increased to $154.9 million from $112.4 million, although this non-GAAP measure excludes or adjusts for several recurring and nonrecurring items and should not replace GAAP net income or operating cash flow.
New Residential issued 56.5 million common shares in February 2017 for net proceeds of approximately $834.5 million. MSR carrying value increased to $1.7 billion from $659.5 million at year-end, reflecting approximately $1.1 billion of MSR purchases during the quarter.

Portfolio, Outlook, Risks and Unusual Items

At March 31, 2017, the portfolio included approximately $1.6 billion of Excess MSRs, $1.7 billion of MSRs, $5.0 billion of servicer advances, $5.9 billion of real estate securities, $1.2 billion of residential mortgage loans and REO, and $1.7 billion of consumer loans.
The company entered into transactions involving MSRs and related advances from Citi, United Shore and Residential Credit Solutions. The Citi portfolio covered approximately $92.5 billion of UPB; transfers of servicing to Nationstar began in April 2017.
The proposed PHH transaction covered approximately $67.0 billion of UPB, with expected purchase prices of approximately $520 million for MSRs and $252 million for related advances. Closing remained subject to regulatory, GSE, third-party and other conditions.
In February 2017, the company entered a 25% co-investment in PF LoanCo Funding LLC, which may purchase up to $5.0 billion of newly originated consumer loans over two years. The company recorded a $41.3 million equity-method investment at quarter-end.
Management expected cash on hand, operating cash flow, and the ability to roll repurchase and servicer-advance financing to satisfy anticipated liquidity needs over the next 12 months. This outlook depends materially on continued access to short-term financing and the absence of significant margin calls.
Management expected net recoveries of servicer advances to exceed net fundings for the foreseeable future, but acknowledged that an economic downturn, higher delinquencies or longer foreclosure timelines could reverse this position and pressure liquidity.
Key sensitivities include interest rates, prepayment speeds, credit spreads, delinquencies, default rates, servicer performance and recoverability of servicer advances. A 50-basis-point increase in short-term rates was estimated to increase next-12-month cash flows by $32.9 million and net book value by $252.2 million; a 50-basis-point decrease was estimated to reduce them by $30.0 million and $309.0 million, respectively.
A 25-basis-point widening in credit spreads was estimated to reduce net book value by approximately $135.3 million, while a 25-basis-point tightening was estimated to increase it by approximately $140.1 million.
The company relied heavily on Nationstar, Ocwen, Ditech and OneMain. Servicer termination, bankruptcy, regulatory action, servicing deficiencies or rating downgrades could reduce asset values, delay advance recoveries, increase costs or trigger financing problems.
After quarter-end, the CFPB and multiple state regulators initiated actions against Ocwen. The company stated that it was evaluating the potential impact and could not assure investors what effect the actions would have.
Fortress announced a pending merger with SoftBank. The independent directors approved consent to the deemed assignment of the management agreement on April 19, 2017. The filing noted that the transaction could affect the company’s relationship with its external manager.
The company had ongoing litigation and assumed HLSS-related liabilities. No losses were accrued for the disclosed legal contingencies because management did not believe a loss was probable and reasonably estimable, but adverse outcomes could materially affect results.

Important Facts for Investors to Verify

Whether the PHH transaction and other pending MSR transactions closed on expected terms and received all required regulatory and GSE approvals.
The continuing financial, regulatory and servicing condition of Ocwen, Nationstar, Ditech and OneMain, including the effect of Ocwen’s post-quarter-end regulatory actions.
Repurchase-agreement renewal terms, margin requirements, available collateral and the company’s ability to refinance near-term maturities.
Actual recovery rates and timing for the $5.0 billion servicer-advance portfolio, including exposure to foreclosure delays and nonrecoverable advances.
Changes in MSR and Excess MSR valuation assumptions, particularly prepayment, discount, delinquency and recapture rates.
The effect of continued equity issuance, manager options and incentive compensation on per-share earnings, book value and shareholder dilution.
Reconciliation of core earnings to GAAP results and operating cash flow, given the substantial differences created by fair-value marks, accretion, deferred taxes and loan-sale activity.
Compliance with REIT qualification requirements, the Investment Company Act exclusion, debt covenants and applicable servicing licenses.