New Residential Investment Corp. (now Rithm Capital Corp.) — Q2 2019 Form 10-Q Summary
Business context and reporting period
Quarterly report for the period ended June 30, 2019, filed August 1, 2019. The company was an externally managed REIT focused primarily on mortgage servicing rights (MSRs), excess MSRs, servicer advances, residential mortgage securities and loans, and consumer loans. Operations were reported through Servicing and Originations, Residential Securities and Loans, Consumer Loans, and Corporate segments.
Financial performance and key metrics
| Metric | Three months ended June 30, 2019 | Three months ended June 30, 2018 | Six months ended June 30, 2019 | Six months ended June 30, 2018 |
|---|---|---|---|---|
| Interest income | $416.0 million | $403.8 million | $854.9 million | $787.4 million |
| Interest expense | $228.0 million | $133.9 million | $440.8 million | $258.3 million |
| Net interest income | $188.0 million | $269.9 million | $414.1 million | $529.1 million |
| Servicing revenue, net | $(85.5) million | $146.2 million | $80.3 million | $363.4 million |
| Gain on sale of originated mortgage loans | $49.5 million | — | $93.5 million | — |
| Income before income taxes | $(46.6) million | $183.2 million | $155.3 million | $790.7 million |
| Net income attributable to common stockholders | $(31.9) million | $174.8 million | $113.7 million | $779.0 million |
| Basic EPS | $(0.08) | $0.52 | $0.28 | $2.34 |
| Core earnings | $219.8 million | $197.7 million | $424.1 million | $392.2 million |
Results are presented in dollars except per-share data. The filing does not provide a single consolidated revenue figure or a meaningful consolidated operating margin; reported results are heavily affected by fair-value changes, financing costs, and servicing-asset valuation adjustments.
- Total assets were $36.8 billion at June 30, 2019, versus $31.7 billion at December 31, 2018.
- Total equity was $6.8 billion, including $6.7 billion attributable to New Residential stockholders, versus $6.1 billion and $6.0 billion, respectively, at year-end 2018.
- Major portfolio carrying values included MSRs of $3.0 billion, MSR financing receivables of $1.9 billion, real estate and other securities of $12.1 billion, residential mortgage loans of approximately $7.4 billion across categories, and consumer loans of $939.0 million.
- Total debt obligations were $28.8 billion, consisting primarily of $21.5 billion of repurchase agreements and $7.3 billion of notes and bonds payable. Weighted-average funding cost was 3.46%.
- Cash and cash equivalents were $406.0 million; cash, cash equivalents, and restricted cash totaled $565.2 million.
- Available financing capacity was $3.35 billion against total stated borrowing capacity of $11.39 billion. The company reported compliance with all debt covenants.
- Operating cash flow was $(2.8) billion and investing cash flow was $(3.5) billion for the first six months of 2019. Financing cash flow was $6.4 billion, producing a net increase in cash and restricted cash of $150.1 million.
- The company declared a common dividend of $0.50 per share for the second quarter, consistent with the prior-year quarter.
Material changes versus the prior comparable period
- Second-quarter net loss attributable to common stockholders was $31.9 million, compared with income of $174.8 million in the prior-year quarter. First-half income declined to $113.7 million from $779.0 million.
- Net interest income declined 30% in the quarter and 22% in the first half, as interest expense grew substantially faster than interest income due to increased leverage and financing of securities, loans, MSRs, and servicer advances.
- Net servicing revenue shifted to a loss of $85.5 million in the quarter, primarily because of a $229.3 million negative change in MSR valuation inputs and assumptions, driven largely by faster prepayment rates. First-half servicing revenue declined $283.1 million year over year.
- General and administrative expense increased to $118.9 million in the quarter and $217.8 million in the first half, primarily following the Shellpoint acquisition and related compensation, origination, occupancy, and integration costs.
- Gain on sale of originated mortgage loans contributed $49.5 million in the quarter and $93.5 million in the first half, reflecting the expanded mortgage origination business obtained through Shellpoint.
- Core earnings increased to $219.8 million in the quarter and $424.1 million in the first half, but this non-GAAP measure excludes or adjusts for significant fair-value, impairment, derivative, incentive compensation, transaction, and tax items.
- Common shares outstanding increased to 415.5 million at June 30, 2019 from 369.1 million at December 31, 2018, principally due to a February offering of 46.0 million common shares that generated approximately $751.7 million of net proceeds.
Guidance, outlook, commentary, risks, and unusual items
- Management expected cash on hand, operating cash flow, and the ability to roll repurchase agreements and servicer-advance financings to meet anticipated liquidity needs over the next 12 months, while warning that this outlook depends on continued access to short-term financing and stable collateral values.
- Management expected net recoveries of servicer advances to exceed net fundings for the foreseeable future, but noted that an economic downturn could reverse this relationship and materially pressure liquidity.
- The company entered into a stalking-horse agreement to acquire substantially all forward assets of Ditech Financial, including MSRs tied to approximately $63 billion of unpaid principal balance, subject to bankruptcy-court approval and other conditions. A $70.0 million deposit was recorded.
- On July 2, 2019, after quarter-end, the company issued 6.2 million Series A preferred shares for approximately $150.0 million of net proceeds. On July 26, it paid the second-quarter common dividend of $207.8 million.
- On July 10, 2019, Ditech’s stalking-horse bid was deemed successful after the auction was canceled, but the acquisition remained subject to court approval and other conditions.
- Key market risks include faster mortgage prepayments, changes in interest rates and credit spreads, mortgage and consumer-loan defaults, servicer performance, counterparty concentration, margin calls, refinancing risk, and illiquidity of MSR-related assets.
- A 50-basis-point increase in short-term rates was estimated to reduce next-12-month cash flows by approximately $42.4 million. Separately, a 25-basis-point widening in credit spreads was estimated to reduce net book value by approximately $291.8 million.
- Servicing partners included Nationstar, Ocwen, LoanCare, PHH, Ditech, and Flagstar. Ditech had filed for Chapter 11 bankruptcy, increasing counterparty, servicing-transfer, and recovery risks.
- The company recognized $16.4 million of other-than-temporary impairment on securities in the first half and $35.1 million of total impairment and loan/REO valuation provisions.
- The filing states that litigation, regulatory inquiries, indemnification obligations, mortgage repurchase and representation-and-warranty exposure, and future servicer-advance commitments could produce material losses, although management did not identify a currently probable material unasserted claim.
Most important facts for an investor to verify
- Whether the Ditech acquisition ultimately closed, the final purchase price, financing terms, and resulting MSR and servicing exposure.
- Whether the negative MSR valuation trend caused by faster prepayments continued and how it affected book value, core earnings, and dividends.
- The sustainability of the $0.50 quarterly common dividend given GAAP losses, required REIT distributions, large financing maturities, and margin-call exposure.
- Actual renewal and pricing terms for the company’s short-term repurchase and servicer-advance financing, particularly the $18.6 billion of debt contractually maturing in the second half of 2019.
- Exposure to Nationstar, Ocwen, Ditech, and other servicing counterparties, including servicing transfers, bankruptcy claims, recoverability of advances, and regulatory or legal actions.
- The sensitivity of MSR and excess-MSR valuations to prepayment, delinquency, discount-rate, recapture-rate, and credit-spread assumptions.
- The distinction between GAAP net income, cash flow, and management’s non-GAAP core earnings, including all adjustments used in the core-earnings reconciliation.
- REIT qualification, taxable REIT subsidiary taxes, continued exclusion from the Investment Company Act, and the effect of future LIBOR replacement on assets, liabilities, and hedges.