Business Context and Reporting Period
Rithm Capital Corp. was then named New Residential Investment Corp. and operated as an externally managed Delaware REIT focused primarily on residential mortgage-related assets. The filing covers the quarter and nine months ended September 30, 2015, with comparative periods ended September 30, 2014. The portfolio included excess mortgage servicing rights (MSRs), servicer advances, Agency and Non-Agency RMBS, residential mortgage loans, REO and consumer-loan investments.
The company completed the acquisition of substantially all of Home Loan Servicing Solutions, Ltd. (HLSS) assets and assumed substantially all of its liabilities on April 6, 2015. Total consideration was approximately $1.49 billion, including $434.1 million of New Residential stock, $622.0 million of cash, $385.2 million of seller financing and contingent consideration. The related merger was completed on October 23, 2015.
Key Financial Metrics
| Metric | Three months ended September 30 | Nine months ended September 30 |
|---|---|---|
| Interest income | $182.3 million | $444.9 million |
| Interest expense | $77.6 million | $193.4 million |
| Net interest income | $104.8 million | $251.5 million |
| Net income | $61.8 million | $182.8 million |
| Net income attributable to common stockholders | $54.5 million | $165.7 million |
| Diluted EPS | $0.24 | $0.85 |
| Core earnings | $112.6 million | $268.3 million |
| Dividends declared per share | $0.46 | $1.29 |
For the quarter, net interest margin before impairment was approximately 57.5% of interest income; for the nine-month period it was approximately 56.5%. These percentages are calculated from reported interest income and interest expense and are not management-defined portfolio margins.
- Total assets were $15.36 billion at September 30, 2015, compared with $8.09 billion at December 31, 2014.
- Total equity was $3.03 billion, including $2.81 billion attributable to New Residential stockholders, versus total equity of $1.85 billion at year-end 2014.
- Cash and cash equivalents were $348.3 million, supplemented by $165.0 million of restricted cash.
- Investments included $1.46 billion of direct excess MSRs, $213.3 million of excess MSRs held through equity-method investees, $7.50 billion of servicer advances, $2.43 billion of real estate securities and $754.7 million of residential mortgage loans and REO.
- Debt obligations totaled $11.02 billion, consisting of $3.77 billion of repurchase agreements and $7.25 billion of notes payable. Weighted-average funding cost was 2.48% and weighted-average debt life was 0.8 years.
- Borrowing capacity was reported at $13.24 billion, with $5.76 billion of available financing subject to eligible collateral and other conditions.
- Operating cash flow was $362.1 million for the nine months, compared with cash used in operations of $413.2 million in the prior-year period. Investing cash flow used $117.2 million and financing cash flow used $109.6 million. Cash increased by $135.3 million.
Material Changes Versus the Prior Comparable Period
- Quarterly net income attributable to common stockholders declined to $54.5 million from $126.4 million; nine-month earnings declined to $165.7 million from $298.6 million. Diluted EPS fell to $0.24 from $0.88 for the quarter and to $0.85 from $2.16 for the nine months.
- Interest income increased 87% for the quarter and 70% for the nine months, primarily due to the HLSS acquisition and the expansion of servicer-advance and excess-MSR investments. Interest expense also increased substantially, reducing the benefit to earnings.
- Other income declined to a $17.8 million loss for the quarter and $32.1 million of income for the nine months, versus $122.1 million and $335.0 million, respectively, in the comparable periods. Key unfavorable items included lower MSR fair-value gains, servicer-advance fair-value losses, derivative losses and the absence of consumer-loan equity earnings recorded in 2014.
- Servicer-advance carrying value increased from $3.27 billion at year-end 2014 to $7.50 billion, while direct excess-MSR carrying value increased from $417.7 million to $1.46 billion, primarily reflecting the HLSS acquisition and additional investments.
- General and administrative expenses rose to $19.6 million in the quarter and $49.4 million for the nine months, partly because of HLSS integration, employee retention and severance costs, legal expenses and transaction-related costs.
- The company issued approximately 85.4 million common shares during the first nine months, including shares issued in the HLSS acquisition and public offerings. Shares outstanding increased to 230.5 million from 141.4 million at December 31, 2014.
Guidance, Outlook, Risks and Unusual Items
- Management identified an opportunity for continued purchases of MSRs and servicing assets, noting that MSR supply could remain elevated as banks reduce servicing exposure. No quantitative earnings or dividend guidance was provided.
- Management expected cash on hand, operating cash flow and continued access to repurchase and servicer-advance financing to satisfy anticipated liquidity needs over the next twelve months, but cautioned that liquidity could deteriorate rapidly if financing cannot be rolled or margin requirements increase.
- On October 1, 2015, an Ocwen master-servicer rating downgrade caused a specified default under the HSART indenture and accelerated $2.5 billion of term notes. HSART repaid the term notes on October 2 using draws on variable funding notes; approximately $2.9 billion of HSART variable funding notes remained outstanding immediately afterward.
- The company reported $3.8 billion of repurchase-agreement margin exposure. Collateral declines could require additional cash postings and adversely affect liquidity.
- Interest-rate and credit-spread sensitivity was material. A 100-basis-point increase in short-term rates was estimated to increase next-twelve-month cash flows by approximately $17.0 million and net book value by approximately $255.2 million; a 25-basis-point widening in credit spreads was estimated to reduce net book value by approximately $63.6 million.
- Fair values of excess MSRs and servicer advances depend heavily on modeled assumptions, including prepayment speeds, delinquencies, recapture rates, discount rates and advance recoveries. The company recorded a $18.7 million quarterly decline in servicer-advance fair value and a $3.3 million nine-month OTTI charge on securities.
- Management disclosed a material weakness in internal control over financial reporting related to review and validation of assumptions used in new valuation models following the HLSS acquisition. Remediation was in process through additional personnel, systems and controls.
- Legal and regulatory exposures inherited from HLSS included shareholder class actions, Ocwen-related derivative actions, regulatory inquiries and a $1.5 million SEC settlement obligation. The company stated that material losses were not probable and reasonably estimable as of September 30, 2015.
- The company remained dependent on Nationstar, Ocwen and other servicers and counterparties. Servicer downgrades, termination, bankruptcy, servicing deficiencies, delayed foreclosures or unrecoverable advances could materially impair asset values, financing and liquidity.
- The company intended to maintain REIT qualification and its exclusion from investment-company registration. Failure to satisfy applicable REIT, tax or Investment Company Act requirements could materially increase taxes, restrict operations or require asset sales.
Most Important Facts for Investors to Verify
- Whether the HLSS acquisition has produced the expected cash flows and whether assumed HLSS litigation, regulatory and other liabilities remain contained.
- The status and refinancing terms of HSART, HSART II and other servicer-advance facilities after the Ocwen rating downgrade and October 2015 acceleration.
- Servicer-advance recovery rates, delinquency trends, foreclosure timelines and the impact of performance-fee arrangements on realized returns.
- The sensitivity of excess-MSR and servicer-advance valuations to prepayments, delinquencies, recapture rates, discount rates and LIBOR assumptions.
- The company’s remediation of the disclosed material weakness and whether valuation-model controls become effective.
- Actual liquidity after margin calls, debt maturities, restricted cash releases and refinancing activity, rather than relying solely on reported borrowing capacity.
- Future dividend sustainability relative to taxable income, GAAP earnings, operating cash flow and required REIT distributions.
- Concentration and conflicts involving the external Manager, Fortress affiliates, Nationstar, Ocwen and Springleaf, including related fees and co-investments.