Rithm Capital Corp. quarterly report, Q2 FY2018

Rithm Capital Corp. (formerly New Residential Investment Corp.) — Q2 2018 Form 10-Q Summary

Business context and reporting period

The filing covers the three and six months ended June 30, 2018. The company operated as a publicly traded REIT focused primarily on mortgage servicing rights, excess mortgage servicing rights, servicer advances, residential mortgage assets, RMBS and consumer loans. It was externally managed by FIG LLC, an affiliate of Fortress Investment Group. The filing identifies the registrant as New Residential Investment Corp.; the company is now known as Rithm Capital Corp.

Key financial metrics

Metric	Three months ended June 30, 2018	Comparable 2017 period	Six months ended June 30, 2018	Comparable 2017 period
Interest income	$403.8 million	$472.0 million	$787.4 million	$764.5 million
Net interest income	$269.9 million	$356.8 million	$529.1 million	$551.1 million
Net income	$185.8 million	$337.4 million	$800.2 million	$474.6 million
Net income attributable to common stockholders	$174.8 million	$321.7 million	$779.0 million	$443.1 million
Diluted EPS	$0.51	$1.04	$2.32	$1.48
Core earnings	$197.7 million	$317.7 million	$392.2 million	$472.6 million

Six-month results include significant realized and fair-value items, including a $113.0 million gain related to the Ocwen transaction and a $151.97 million increase in the fair value of MSR financing receivables. Core earnings, a non-GAAP measure, excludes various fair-value, impairment, transaction, incentive compensation and tax items and should not be viewed as a substitute for GAAP earnings.

Servicing revenue, net: $146.2 million in the second quarter and $363.4 million for the first six months, compared with $170.9 million and $211.5 million, respectively, in 2017.
Impairment: $16.3 million in the second quarter and $42.0 million year to date, including $19.3 million of other-than-temporary impairment on securities for the six-month period.
Operating cash flow: $196.8 million for the six months, compared with an outflow of $343.5 million in the 2017 period.
Investing cash flow: an outflow of $55.7 million; financing cash flow was an outflow of $232.5 million.
Cash and restricted cash: $354.7 million at June 30, 2018, down from $446.1 million at December 31, 2017.
Total assets: $22.94 billion; total equity: $5.80 billion, including $5.71 billion attributable to New Residential stockholders.
Debt: $8.76 billion of repurchase agreements and $6.71 billion of notes and bonds payable, or approximately $15.46 billion of debt obligations at carrying value.
Available financing: approximately $2.74 billion of reported unused borrowing capacity, subject to eligible collateral and other conditions.
Dividend: $0.50 per common share for the second quarter, declared June 21, 2018 and paid July 27, 2018.

Portfolio and balance-sheet changes

MSRs increased to $2.23 billion from $1.74 billion at December 31, 2017.
MSR financing receivables increased to $1.90 billion from $598.7 million, primarily reflecting the Ocwen and other MSR-related transactions.
Servicer Advance Investments declined sharply to $843.4 million from $4.03 billion, largely because of the Ocwen transaction and related reclassification of assets.
Servicer advances receivable increased to $3.22 billion from $675.6 million.
Non-Agency RMBS represented $6.85 billion of fair value, compared with $5.97 billion at year-end 2017; total real estate and other securities were $8.08 billion.
Residential mortgage loans held-for-sale increased to $2.02 billion from $1.73 billion.
Common shares outstanding increased to 339.9 million from 307.4 million, including a January public offering of 28.8 million shares that generated approximately $482.3 million of net proceeds.

Material changes versus the prior comparable period

Second-quarter net income attributable to common stockholders fell $147.0 million, or approximately 46%, primarily because of lower net interest income and substantially weaker fair-value results on MSR financing receivables and servicer advance investments.
Six-month net income attributable to common stockholders increased $335.9 million, or approximately 76%, primarily because of the Ocwen transaction gain, higher servicing revenue and favorable fair-value changes in MSR financing receivables.
Second-quarter interest income declined $68.1 million, while interest expense increased $18.8 million, compressing net interest income.
Six-month servicing revenue increased $152.0 million, driven by MSR acquisitions completed after June 30, 2017 and favorable valuation changes, partly offset by higher amortization.
Fair-value changes in MSR financing receivables were a $119.1 million loss in the second quarter versus a $5.6 million gain in the prior-year quarter, but a $152.0 million gain for the first six months versus a $5.6 million gain in the prior-year period.
Fair-value changes in servicer advance investments were losses of $1.8 million for the quarter and $81.2 million year to date, compared with gains of $57.0 million and $59.5 million in the respective 2017 periods.

Guidance, outlook, risks and unusual items

Management stated that, for the next 12 months, cash on hand, operating cash flow and the ability to roll repurchase agreements and servicer advance financings were expected to be sufficient for anticipated liquidity needs. This outlook depends materially on continued access to short-term financing.
Management expected net recoveries of servicer advances to exceed net fundings for the foreseeable future, while acknowledging that a significant economic downturn could reverse this position and materially pressure liquidity.
Market opportunities remained available because banks and non-bank servicers continued to sell MSRs and related assets, but management noted that competition had tightened spreads, raised asset prices and made accretive investments more difficult to source.
The company had $8.8 billion of repurchase agreements subject to margin exposure, with many maturities in July through September 2018. Failure to roll or refinance these facilities, or collateral declines requiring margin, could materially affect liquidity.
Portfolio valuations depend heavily on prepayment, delinquency, default, recapture, discount-rate and servicing-cost assumptions. A 25-basis-point widening in credit spreads was estimated to reduce net book value by approximately $177.3 million.
A 50-basis-point increase in short-term interest rates was estimated to increase net book value by approximately $275.0 million, while a comparable decrease was estimated to reduce net book value by approximately $345.6 million.
Counterparty and servicer concentration was significant. Nationstar serviced or master serviced approximately 99.2% of the UPB underlying Excess MSRs and 97.0% of Servicer Advance Investments; Ocwen, Nationstar, Ditech, PHH and Shellpoint were the principal MSR subservicers.
The January 2018 New Ocwen Agreements included a $279.6 million fee restructuring payment. Required third-party consents for transferring remaining Ocwen MSR interests had not all been obtained; failure to obtain consents could result in continued arrangements, repurchase by Ocwen or third-party sale.
On July 3, 2018, after the reporting date, a subsidiary acquired all equity interests of Shellpoint Partners LLC for approximately $212.0 million, subject to customary adjustments, with potential earnout payments of up to $60.0 million. Shellpoint operates mortgage origination and servicing businesses, adding operational, regulatory and integration risks.
The company maintained its intention to qualify as a REIT and to remain excluded from registration under the Investment Company Act. Failure to satisfy either regime could materially increase taxes, restrict operations or require asset sales.
Management reported effective disclosure controls and procedures as of June 30, 2018 and no material changes in internal control over financial reporting.

Most important facts for an investor to verify

Whether the company can continue rolling or refinancing approximately $15.5 billion of debt, particularly short-term repurchase agreements, without materially higher funding costs or additional margin requirements.
The sustainability of earnings excluding the $113.0 million Ocwen-related realized gain and other volatile fair-value adjustments.
Actual performance of MSR and MSR financing receivable portfolios relative to assumptions for prepayments, delinquencies, recapture rates, discount rates and servicing costs.
Recovery timing and ultimate recoverability of the $3.2 billion servicer advances receivable and the company’s ability to fund future advances during stressed housing or foreclosure conditions.
Exposure to Ocwen, Nationstar, OneMain, Ditech, PHH, Shellpoint and other counterparties, including regulatory actions, servicer-rating changes, defaults, bankruptcy or servicing termination.
Completion and economics of pending MSR transfers and required third-party, GSE and rating-agency consents.
Integration costs, liabilities, earnouts and operating performance of the Shellpoint acquisition after July 3, 2018.
REIT qualification, taxable-income and cash-distribution requirements, including potential mismatches between taxable income and cash received.
Credit quality and valuation of the $6.85 billion Non-Agency RMBS portfolio, including the $19.3 million of year-to-date OTTI and exposure to concentrated geographic markets.