Rithm Capital Corp. quarterly report, Q1 FY2014

Full document

Rithm Capital Corp. (formerly New Residential Investment Corp.) — Q1 2014 Form 10-Q

Business context and reporting period

The filing covers the three months ended March 31, 2014. At the time, New Residential was an externally managed REIT focused on residential mortgage-related assets, including Excess MSRs, servicer advances, Agency and Non-Agency RMBS, residential mortgage loans and consumer loans. The company became independent from Newcastle Investment Corp. on May 15, 2013; therefore, the March 31, 2013 comparison reflects a predecessor and spin-off basis and is not fully comparable to standalone results.

Key financial metrics

  • Total assets increased to $7.0 billion from $6.0 billion at December 31, 2013, primarily reflecting growth in servicer advances and real estate securities.
  • Interest income was $71.5 million, up from $16.2 million; interest expense was $39.0 million, up from $0.9 million. Net interest income increased to $32.5 million from $15.3 million.
  • Other income was $35.1 million, compared with $2.8 million, including Excess MSR fair-value gains of $13.0 million, consumer-loan equity-method earnings of $16.4 million, and a $4.4 million gain on settlement of investments.
  • Net income was $56.9 million, compared with $13.1 million. Net income attributable to common stockholders was $48.8 million, or $0.19 per diluted share, compared with $13.1 million, or $0.05 per diluted share.
  • Core earnings, a non-GAAP measure, were $41.8 million, or approximately $0.16 per share based on basic weighted-average shares. Core earnings were $15.3 million in the prior-year quarter.
  • Impairment charges totaled $0.5 million, consisting of $0.3 million of OTTI on securities and a $0.2 million loan valuation allowance.
  • Cash and cash equivalents were $140.5 million, down from $272.0 million at year-end. Operating cash flow was $2.1 million; investing cash flow was negative $1.4 billion; financing cash flow was positive $1.3 billion.
  • Total debt, comprising repurchase agreements and notes payable, was $5.4 billion versus $4.1 billion at December 31, 2013. Weighted-average funding cost was approximately 2.33%.
  • Available financing capacity was approximately $1.75 billion, subject to eligible collateral and other borrowing conditions. Management stated that the company was in compliance with all debt covenants and had sufficient liquid assets to satisfy short-term recourse liabilities.
  • Total equity was $1.56 billion, including $1.28 billion attributable to New Residential stockholders and $284.3 million of noncontrolling interests. Accumulated other comprehensive income increased to $9.9 million.
  • The company declared a quarterly dividend of $0.175 per common share, payable in April 2014.

Portfolio and material changes versus the prior comparable period

  • Servicer advance investments increased to $3.46 billion from $2.67 billion at December 31, 2013. The portfolio generated $45.7 million of interest income and was financed with approximately $3.14 billion of notes payable.
  • Real estate securities increased to $2.35 billion from $1.97 billion. The company purchased approximately $1.4 billion face amount of Non-Agency RMBS and sold Agency and Non-Agency securities, recording approximately $4.5 million of realized gains.
  • Direct Excess MSRs were carried at $341.7 million, compared with $324.2 million at year-end. Excess MSRs held through equity-method investees were $338.3 million, compared with $352.8 million. Combined Excess MSR fair value increased by approximately $3.6 million during the quarter.
  • The consumer-loan investment increased to $231.4 million from $215.1 million, reflecting $16.4 million of equity-method earnings. The underlying consumer-loan companies had approximately $1.8 billion of debt and recognized a $34.2 million provision for finance receivable losses in the quarter.
  • Management reported Agency ARM RMBS net interest spread of 1.19%, up from 0.94% at December 31, 2013. Non-Agency RMBS net interest spread was 2.67%, down from 2.83%.
  • The company expanded its servicer-advance financing through the NRART Master Trust, which issued variable funding notes with borrowing capacity of up to $1.1 billion and approximately $1.0 billion of term notes.
  • Compared with Q1 2013, the increase in earnings primarily reflected the larger investment portfolio, new servicer-advance and consumer-loan investments, additional Excess MSR fair-value gains and realized securities gains. The comparison is affected by the company’s May 2013 spin-off and predecessor-period accounting.

Guidance, outlook, commentary, risks and unusual items

  • Management expected MSR and mortgage-related investment opportunities to remain available, citing structural changes in mortgage servicing and potential future MSR sales. No formal earnings or dividend guidance was provided.
  • Management expected cash on hand and operating cash flow to meet anticipated needs for the current portfolio over the next twelve months, while noting reliance on additional borrowings, equity offerings, asset sales or refinancing for longer-term requirements.
  • The company had a call right to acquire additional servicer advances; the remaining call-right balance was approximately $1.4 billion at March 31, 2014, with expiration on June 30, 2014. The filing stated that completion was not assured.
  • Subsequent to quarter-end, the company funded additional servicer advances, acquired additional RMBS, issued approximately 27.75 million common shares for net proceeds of approximately $164.1 million, and granted the Manager options to purchase 2.875 million shares at $6.10 per share.
  • Principal risks include valuation uncertainty for Level 3 Excess MSRs and servicer advances, prepayment and delinquency volatility, non-recoverability or delayed recovery of advances, counterparty and servicer concentration in Nationstar and Springleaf, financing rollovers and margin calls, credit-spread changes, illiquidity, and regulatory changes affecting mortgage servicing and GSEs.
  • The company is highly leveraged and exposed to short-term and floating-rate financing. A 100-basis-point increase in short-term rates was estimated to increase annual earnings by approximately $9.7 million but reduce net book value by approximately $12.9 million, based on stated exposures. A 25-basis-point credit-spread movement was estimated to affect net book value by approximately $16.9 million.
  • The company intended to qualify as a REIT and maintain its exclusion from registration under the Investment Company Act. Failure to satisfy either regime could materially increase taxes, restrict operations and impair distributions.
  • No material litigation was reported as of the filing date. Management concluded that disclosure controls and procedures were effective and reported no material change in internal control over financial reporting.

Important facts for investors to verify

  • Reconcile Q1 2014 earnings and core earnings to cash available for dividends, recognizing that fair-value gains and equity-method earnings are not equivalent to cash received.
  • Review the maturity, refinancing and margin-call exposure of the $5.4 billion debt balance, particularly debt maturing in 2014 and the servicer-advance facilities maturing in 2014–2015.
  • Evaluate the sensitivity of Excess MSR and servicer-advance valuations to prepayments, delinquencies, recapture rates, discount rates and advance recoveries.
  • Assess concentration risk involving Nationstar, Springleaf, Fortress-managed entities and the limited group of repurchase-agreement counterparties.
  • Confirm the effect of the April 2014 equity issuance, option grants and subsequent servicer-advance funding on per-share earnings, book value and leverage.
  • Verify REIT qualification, taxable-income distribution requirements and the treatment of Excess MSRs, TBAs, consumer loans and taxable REIT subsidiaries.