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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good morning. My name is Beth and I will be your conference operator today. At this time, I would like to welcome everyone to the New Residential Second Quarter 2018 Earnings Call. [Operator Instructions] Mandy Cheuk, you may begin your conference.
Thank you, Beth, and good morning, everyone. I would like to welcome you today to New Residential's Second Quarter 2018 Earnings Call. Joining me here today are Michael Nierenberg, our CEO and Nick Santoro, our CFO. Throughout the call, we're going to reference the earnings supplement that was posted to the New Residential website this morning. If you have not already done so, I would suggest that you download it now. Before I turn the call over to Michael, I would like to point out that certain statements made today will be forward-looking statements. These statements by their nature are uncertain and may differ materially from actual results. I encourage you to review the disclaimers in our press release and earnings supplement regarding forward-looking statements and to review the risk factors contained in our annual and quarterly reports filed with the SEC. In addition, we will be discussing some non-GAAP financial measures during today's call. A reconciliation of these measures to the most directly comparable GAAP measures can be found in our earnings supplement. And now, I would like to turn the call over to Michael.
Thanks, Mandy. Good morning, everyone, and thanks for joining our Q2 earnings call. I'd say on the quarter, our portfolio has performed as expected, which I think is great as there were really no surprises during the quarter. Overall investment activity for us was fairly low, similar to Q1 with a little bit more capital deployed in the loan business. As we think about the investing environment, we continue to be cautious as the amount of capital in the markets remains plentiful and coupled with the tightness in spreads, we -- we continue to be prudent as we deploy capital across the different financial services sectors that we invest in. Our investment portfolios and [ rate views ] remain the same and we believe the current portfolio is fantastic for the current rate environment that we're in and should continue to create great value for our shareholders. On the financing front, I wanted to highlight the MSR financing market. At this time, 90-plus percent of our financing around our MSR business is financed in the capital markets with fixed rate term financing. For example, this week we priced a $560 million MSR note at a [ 4.50% ] cost of fund and an average life of about 6 years. Our call business, where we own $140 billion of call rights, remains very strong. During the quarter, we collapsed 32 different mortgage trusts for $1.1 billion of mortgage loans. Our capital and access to liquidity remains very strong and puts us in a wonderful position to take advantage of any opportunities we see. I'll now refer to the supplement which has been posted online and I'm going to begin on Page 2. Page 2 is really just our New Residential overview. Looking at the right side of the -- right side of the page, a couple of things to highlight here. Again, back to the MSR market. So far year-to-date, we've issued $2.1 billion of term MSR notes, all fixed rate coupons. So as rates continue to rise that cost of funds is locked in. On a year-to-date basis, our total return is 10%. Our year-over-year book value has increased 17%. Our year-to-date book value has increased 10%. And from an MSR perspective, we acquired $54 billion of new MSRs during the year. From a financial performance perspective, as I pointed out earlier, in our view as expected, the portfolios continued to perform extremely well. While there wasn't a ton of investment activity, earnings continued to be very good. GAAP net income for the quarter, $175 million or $0.51 per diluted share, our core earnings, $198 million or $0.58 per diluted share, and our dividend of $170 million or $0.50 per diluted share. On Page 4, this is just a snapshot of our net equity as of 6/30 invested in the various sectors of our investment portfolio. Again, pointing out our MSR investment, MSRs are one of the few fixed income assets that will rise in value as rates continue to increase. Today, we have a $3 billion net investment after financing in MSRs, that's both excess MSRs and full MSRs. As you can see our servicer advance equity is down to $123 million. I'll refer to -- I'll talk a little bit about that further in our presentation. Our residential security portfolio with call rights is $1.7 billion. On the loans side, $668 million of net equity in our loan business. And then on the consumer loan, $129 million of net equity, most of that is due to our SpringCastle investments and then we have cash as of 6/30 of $193 million. Page 5 is just a snapshot of New Residential. We'd like to use this as a kind of like a teaser for what we're about. The main things to focus on here is $520 billion of MSRs. Truly I don't think this portfolio could be recreated based on the characteristics of the underlying portfolios. $140 billion of call rights. We believe that the outstanding balance of the legacy mortgage market to be something around $400 billion. So when you think about that that is a sizable amount of collateral that we have access to. And then when we think about opportunistic investments, things that we've done in the past, we closed on Shellpoint Partners, that is the acquisition of Shellpoint, the mortgage company and that was -- that closed early July. And then going back in time, we highlight the HLSS acquisition and then some of our consumer loan activities. Page 6 is really, again, it's a little bit of a [ highlight-reel ], but taking you back in time to 2013. At that time, our book value was $10. Today, our book value is $16.80. Our market cap in 2013 was $1.5 billion and today our market cap is $6.2 billion. So we've seen some very good growth in our business. We made some, what we believe are, very good strategic investments in acquisitions during that time period. And as I pointed out earlier, we continue to look for opportunities in the marketplace. Page 7 is, again, [ is ] a snapshot of Shellpoint. There is a mortgage servicer. The one thing I want to point out about Shellpoint on the mortgage servicing side that is truly a third party servicer. What I mean by that is, if we're bidding on pools of collateral, we will get the same pricing as would a third party client of Shellpoint. Today Shellpoint is at $69 billion. They continue to add third party servicing to the portfolio. It's really more of a special servicer than it is overall [ in just adding ] a ton of what I would call clean assets. The origination business, New Penn Financial should do about $8 billion this year and then we have a title and appraisal business called Avenue 365 and eStreet Appraisal. The servicer is rated by S&P, Moody's, and Fitch, approved by all 3 agencies Fannie, Freddie, and Ginnie and those guys do a terrific job and we're very excited and happy with the investments so far. Page 8 is really -- it talks about interest rates and what we believe and what we hear what some of the experts in the market say. We do believe that the Fed is going to increase rates another 2 to 3x this year. A lot of that depends, I think, on what happens in the -- with our tariffs and the economy, et cetera. But the way our portfolio is set up, again, we believe it should be terrific for our shareholders. I think the normalized Fed funds rate is projected to be 3.25% as we go forward. Today, again, with -- the way that we're set up with our financing arrangements, whether it would be on our servicer advance portfolio or MSR portfolio, some of the things we're doing in the capital markets, we believe we're in -- we're perfectly situated for the current and future environment. What higher rates mean for our business, we've put a [ sliding ] on Page 9, MSR values will likely continue to increase. Servicer advances, again equity is very low there, but what we expect there is for servicer advances to continue to decline as a percentage of the outstanding unpaid principal balance of the mortgage loans. And then our non-agency securities, 93% of our portfolio or so is floating rate. So as rates go up, you're going to get higher coupon income. And then on the loan portfolio, we put hedges on again fixed rate assets to make sure that we are protected in a higher rate environment. Overall, again, I think we're in a good -- we're good shape. ' I'll now flip through and give you some portfolio highlights, talk a little bit about our investment activities in the quarter. On Page 11, during the quarter, we acquired $20 billion of MSRs, $245 million of gross capital and that was done with 5 different counterparties. We also acquired some flow MSRs and we priced 2 fixed rate MSR notes totaling $1.2 billion at a weighted average cost of funds of 4.5%. Again, those -- that cost of funds is fixed and those securitizations are callable. Non-agency securities, we executed cleanup calls on 32 different deals, $1.1 billion of collateral, we completed a loan securitization in May for $435 million and we purchased a little under $700 million of non-agency RMBS during the quarter. Net equity in that is approximately $1.6 billion now. Again, most, if not all, of the purchases in the non-agency sector around floating rate securities are linked to our call rights. Servicer advances, when we first did this, got into the business back in approximately 2015, our advance balance, just to frame it for everybody, was a little over $8 billion. Today that's down to $3.8 billion, or down 21% year-over-year. We expect future upside. Advance balances as a percentage are down to approximately 2.8%. When we did that -- when we first got involved in the business [ they were a little ] north of 4%. So overall performance has been great [ there ]. Shellpoint, I mentioned before, we closed that early July and then on the consumer side, quite frankly, not that interesting, although returns continue to be very good. Prosper, we continued to buy loans in partnership with our 3 partners in that consortium. And then on the residential loans side, just to give you a snapshot there, during the quarter there were $37 billion of loans sold. In the quarter spreads overall remained very, very well bid. On the MSR portfolio, $520 billion, I'm not going to spend a lot of time on this page. You could have a look at some of the different characteristics. Remember going back in time, our investment thesis was to buy credit impaired, very seasoned MSRs. Over the course of the past year or so, we bought more newer production MSRs, which will continue to do better in a rising rate environment. Page 13 just talks about our financing activities. Again, around the MSR business, everything -- essentially all of our MSRs are financed with fixed rate financing. In the capital markets, we have a little bit more to do and we have undrawn capacity on our MSR lines of a little bit over $600 million. [ I bring ] that up, so when you think about our cash position plus our liquidity as of the end of the quarter, we're in great shape to take advantage of any potential dislocations, I think, that we need to do in the market. Page 14 is really again a snapshot of our overall business. I'm going to -- I'm not going to spend a lot of time on this page. Page 15, our non-agency securities portfolio with call rights. I'll look this morning to give you a snapshot, $140 billion of call rights, so essentially what that means is we control $140 billion of collateral as everything was callable today and it was economical to do so. Of the $140 billion of call rights today, $45 billion of that could be callable if delinquencies decline and advance balances decline. So we continue to work hard to figure out a way to accelerate that and I've been pretty vocal on that on multiple earnings calls. The non-agency securities bond portfolio on Page 16, again, most of this is floating rate that's linked to our call rights, in most cases performs extremely well. There is a slight gain in the quarter, and again spreads continue to be well bid. On the servicer advance portfolio, which I referenced earlier, again, today $3.8 billion of outstanding balances. Go back to 2015 when we first began the business, I think the numbers were a little bit north of $8 billion. Everything is funded in the term markets, either at the capital markets or on bank balance sheets with fixed rate term financing. And we continue to work on lower advance balances, which will help our call business. Consumer loan portfolios, Prosper, not a lot of capital deployed there. So I'm not going to spend a lot of time. Essentially we buy loans from Prosper, we then turn around and securitize those and retain equity interest in some of the different portfolios. SpringCastle is one of our legacy portfolios that continues to perform better and better. And then on the loan portfolio side, a little bit of growth in our business during the quarter. As I mentioned, $37 billion of loans came out for the bid. We participate in a very small amount as we think spreads continue to -- while we see spreads very well bid, we'll continue to focus and see if we could deploy some capital there should returns work well. Then on Page 21, really our goal is to continue to try to maintain our dividends, grow our company and create great value for our shareholders. With that, I'll turn it back to you to the operator for questions.
[Operator Instructions] Your first question comes from the line of Tim Hayes, B. Riley.
The first one, it just looks like the MSRs you acquired this quarter were marked above 120 basis points, which is a bit higher than historical levels. And just wondering if you can talk about the characteristics of those and the strategy more generally. Are the returns on MSRs still more attractive than other assets even with valuations that high?
Yes, what I would say valuations and MSRs are high, there, quite frankly, overall investments in, what I would call, flow MSRs are probably not that interesting for us right now. While saying that, we see multiples on what I would call conventional MSRs anywhere from 4.5 to 5.5 type multiples. Our overall MSR portfolio is marked today at a 3.7 multiple. So we'll deploy capital what we -- where we think strategically over time. The other thing I would say in a rising rate environment, you are going to see multiples go up and the MSR portfolios do provide a great hedge for our call business. So net-net, there [ isn't a ] strategy there, but I think going forward you are not going to see a ton of capital deployed in the MSR market unless we think we can create good value there. The other thing to point out is MSR financing has become a lot more efficient. You're seeing higher advance rates, more term financing. So you'll -- I think you'll continue to see MSR values likely increase. As a result of the financing markets unlevered returns still look very good to us.
Right. Okay. And then you mentioned the expected New Penn volumes for the year. Just wondering if those are in line with where you thought they'd be at the time of agreeing to the acquisition or if the mortgage banking backdrop has been more challenging than you expected.
We spend a lot of time with our New Penn partners who do a great job. The origination volumes last year I think they did something around between $6 billion and $6.5 billion. We believe this year, I think they're on target to do something around $8 billion. I would tell you gain on sale when you look at the mortgage banking origination business is very, very difficult. The amount of money to be made in the origination business is very low in our opinion right now and it's a hard business. There is no doubt about it. We have rolled out some other kind of prime non-agency products that have created some reasonable P&L for the New Penn segment of our origination business. But overall, I wouldn't expect a ton there. The other thing it does is it provides some clean MSRs for our balance sheet. So I would anticipate over time that we continue to grow [ or a ] holistic creation of MSRs as a result of our mortgage banking activities, but net-net gain on sale is very low and very hard in that business.
Got it. Okay. And you had previously mentioned that you expected to potentially be in the market with a non-QM securitization this upcoming quarter or this current quarter. Is that still your expectation or do you see that maybe getting pushed out at all?
It's -- yes, I think we're going to try to do one this quarter, third quarter, it's not huge. I think we have a, give or take, a couple of hundred million of collateral and whether we do it at the end of this quarter, which I think is likely, if not, it'll probably be early fourth quarter as -- again, as we acquire more collateral.
Got it. Okay. And then one more question around Shellpoint. Just -- now that the deal is closed, do you expect to get kind of more aggressive in building that platform or around that platform? Would you be focusing on the origination or the servicing side or both? And then how would you gauge your appetite to execute on additional M&A around this business?
We, as I pointed out earlier, Bruce Williams, who leads that business along with Jack Navarro and Kevin Harrigan, do a great job. I said -- we will continue to -- we dedicate a lot of resources there, a lot of brain power. We're going to continue to try to grow it collectively together only if it makes sense. I mean, we are in the money-making business and we want to create value for shareholders. So I would expect that business to continue to grow. As it relates to M&A, if there's things that fit what we're trying to do in our portfolios or with our partners, we'll continue to acquire, whether it would be companies and/or assets that we think makes sense for shareholders.
Got it. Okay. And then one just last one for me, just the profitability on the call rights this quarter?
I think our execution was, give or take, around [ 1.5 ] overall and then we also have hedges that we put on against some of our fixed rate collaterals. So net-net, it was a very good quarter for the call business.
Your next question comes from the line of Bose George, KBW.
Can you talk about the drivers of the change in the valuation of the MSRs this quarter? It looked like there was a negative mark.
Yes. I will turn it over to Nick as this -- some of this has to do with some of our legacy around the HLSS and Ocwen transactions. The net number around excess and our MSRs, away from what I would call, some of the accounting adjustments, was about positive $25 million in the quarter. Essentially rates were unchanged. We made some tweaks to the model where we saw speeds up a little bit -- a little bit higher I think than expected, but overall gain was about $25 million. And then as it relates, there was an up and down adjustment that Nick will just talk to on the -- on some of the GAAP accounting stuff.
Sure. It relates to the Ocwen transaction and in [ summary ] it has to do with the amortization of the fair value. So as the fair value gets pulled down as we begin to accrete the asset into income, we flipped from unrealized to realized. So that has to do -- and you'll see the negative come through on the unrealized MSR line.
Okay. So -- I mean just conceptually, it's not a fair value mark. It's really sort of the -- it's more of an amortization mark, is that --?
That's correct.
Okay. And then the -- in terms of the contract with Altisource, has that been -- has that been finalized?
Not yet. We extended an LOI with them, and we hope to get that wrapped up this quarter.
Okay. Are there any changes there that could impact the MSR valuation going forward?
No, not that -- not that we're aware of.
Nothing material, okay.
No.
And then just in terms of the pipeline for MSR acquisitions, you noted earlier just on the pricing being somewhat steep, but can you just talk about the pipeline out there? Is there a stuff that could be compelling?
We have $30 billion that we have LOIs on right now that I think are likely to get executed on this quarter. I think the pipelines themselves are -- mortgage banking -- Tim asked a good question about the mortgage banking industry and gain on sale, it's very hard. So I think what you're going to continue to see is the need for capital with some of the mortgage bankers as they are not able to, quite frankly, make money in the origination business. If the 10-year treasury continues to back up, I think it's 2.96% or 2.97% this morning, you are going to see less production. There's going to be a little bit of pressure on the system there. Overall that could create some opportunity, but in general, as I pointed out, at current pricing on flow it's just not that interesting to us. When you look at the portfolio, I think, quarter-over-quarter it's down about $20 billion. We could buy more and more of MSRs but the pricing has to be right for the way that we're thinking about it.
Your next question comes from the line of Henry Coffey, Wedbush.
It's good to hear the story again. There are some nice tax advantages associated with direct originations and MSRs. Is that what New Penn is going to create and is that some real nice value or is it possible that it kind of grows into a mortgage banking gain on sale component of the quarterly earnings?
Yes. Henry, it's less relevant for us as we're a REIT, right. So when you think about it from a tax perspective, it's just -- there's really nothing there. The strategy around New Penn -- [ about ] Shellpoint is really to for us grow the third party business, grow originations so we create assets for our own balance sheet that we think are at the right levels and truly create, what I think is, a very good profitable mortgage company. I think the tax stuff, there is really nothing to do there because we are a REIT. There is some tax we have to pay because it's an operating business and not a good REIT asset, but it's just not that the tax stuff doesn't weigh in our decision [ here ].
And then -- and looking at your residential loan portfolio, that's a business that seems to be taking on real legs. We even had one of the regional banks we all follow did a nice non-QM securitization. Does that business grow into a meaningful couple of billion dollars a year for a long time? Do you get into areas like single-family rental lending that could also have a non-QM component to it? What's sort of the growth prospects for that side of the equation?
Couple of things. One is on the asset side, as I pointed out, $37 billion came out for the bid in the quarter. Assets are extremely well bid by whether it be the number of the banks and/or a lot -- some of the total return players in the marketplace, and obviously we'll participate a little bit if in fact we think we can create what I would call good returns for shareholders. The overall landscape of the residential housing market, which is, give or take a $20 trillion market, is interesting. Now we don't want to -- you don't want to be the last person to the party. So when you think about single-family rental, yes, we'll look at that, we'll look at lending against it, we'll look at different potential acquisitions in that market. We do create our own, what I would call, housing stock as a result of our call strategy and there's a bunch of REO that typically comes when you collapse these deals. But I think somebody asked about acquisitions before, we'll continue to look at everything. There is nothing that I could point to right now that's that interesting, but we're looking on a lot of different things right now.
And then this is just kind of a general question because I'm getting new to the story again. When you survey the business, what does pop out as compelling?
Good question. I think our existing portfolio is great. I point ...
Yes, that's a given. Yes, that's obvious.
When you look at -- I look back to our Q1 remarks, I look to Q2 remarks, which I just gave. The story is pretty much the same. We are not deploying a ton of capital there. So the investment environment and the risk return is just not great. While saying that, we got to be diligent and be on it every single day which our team is. There will be things that come our way. Right now, we'll continue to focus on pretty much the same thing if we could acquire non-agency assets that are accretive for our call business, we'll do that. We'll be sporadic around the MSR stuff if it makes sense for us. We are spending time looking at different things away from just the asset side. And I think our growth could be any number of ways. We're in the financial services sector, we've made some good strategic investments in the consumer side, so we continue to look at everything. But net-net, based on capital deployment, we have plenty of liquidity right now. There is not a lot that's really -- really, really interesting right now.
I will now turn the call back to Michael Nierenberg, CEO, for closing remark.
Thanks everyone for joining our call. Appreciate the support. Enjoy the rest of the summer and look forward to updating on Q3 results in Q4, [ not the rest ] time, but have a great summer. Thanks.
This concludes today's conference call. You may now disconnect. Thank you.