Rithm Capital Corp
NYSE:RITM
Earnings Call Analysis
Q3-2023 Analysis
Rithm Capital Corp
The company's liquidity remains strong, with around $2 billion in cash and liquidity by the end of the quarter, which has slightly increased as the fourth quarter begins. Management has expressed confidence in their capital management strategy and hinted at the introduction of private capital from third parties to bolster their financial flexibility.
The company's book value has seen an improvement from $12.16 to $12.32 by the end of Q3, and it is expected to modestly increase further. However, this is subject to the influence of interest rate fluctuations and the mortgage market's dynamics, particularly the 'basis' between agency mortgages and benchmarks, which is as wide as it has been since the SBB crisis. The management anticipates some pressure in this area due to government debt sales but remains optimistic about the book value trend.
MSR investments are typically leveraged at rates between 60 to 65%, with funding costs around SOFR Plus 250 to 300 basis points. The company also benefits from lower-cost term financing on existing MSR due to previous capital markets issuances.
With the filing of the S1, the company is exploring alternatives for taking a mortgage company public, amidst challenging market conditions. Their approach includes the possibility of setting up funds specifically for mortgage servicing, and they aim to transform into a global alternative asset manager with around $50 billion in assets under management (AUM) by year-end. They plan to achieve this through growth in the private capital realm rather than public markets because of the relatively poor performance of REIT stocks. The company envisions a structure similar to leading asset managers, encompassing a C Corp, a REIT, and a private capital business, possibly expanding into insurance in the future.
The acquisition of Sculptor is seen as a pivotal move to grow the asset management business, and they are also working on another significant transaction expected to close by the end of the year. The mortgage company provides substantial cash flows and is projected to contribute $0.35 to $0.45 per share to the core business run rate. Although the retail segment is under review due to low profitability, the company aims to generate more capital to capitalize on favorable investment conditions, signaling an aggressive pursuit of global opportunities especially in private capital markets. The quarter's performance indicates a net return on equity (ROE) of about 15%, with aspirations for an annual ROE of approximately 30%.
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Good morning, ladies and gentlemen, and welcome to Rithm Capital Corp. Conference Call. [Operator Instructions] I would like now to turn the conference over to Emma Bolla, Associate General Counsel. Please go ahead.
Thank you, and good morning, everyone. I would like to thank you for joining us today for Rithm Capital's Third Quarter 2023 Earnings Call. Joining me today are Michael Nierenberg, Chairman, CEO and President of Rithm Capital; and Nick Santoro, Chief Financial Officer of Rithm Capital.
Throughout the call, we are going to reference the earnings supplement that was posted this morning to the Rithm Capital website, www.rithmcap.com. If you've not already done so, I'd encourage you to download the presentation now.
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. Reconciliations of these measures to the most directly comparable GAAP measures can be found in our earnings supplement. And with that, I will turn the call over to Michael.
Thanks, Emma. Good morning, everyone. Thanks for joining us. Really exciting times for our company. From an earnings perspective, and just overall operations in the quarter, a very, very solid quarter. Core business lines continue to perform extremely well. The positioning we put in place over the course of the past couple of years has continued to pay dividends as they create solid earnings, book value growth and high levels of liquidity. We expect it to continue into the future with the Fed signaling higher rates for a longer period of time.
The global macro backdrop for investing puts our company in a great place to take advantage of where we believe the markets are headed. As you know, we have been very vocal about repositioning the company into more of an alternative asset manager. Before I go there, I want to be clear. The core business lines, which have gotten us to this point are crucial to the future of our company. We believe Rithm 1.0, which is our existing core business, plus Rithm Private Capital will be a huge lift for our investors, shareholders and our employees.
With this culture announcement, we add great investment talent to our already terrific team. This expands our capabilities globally into all areas of credit, real estate, consumer and other strategies that I'm sure we'll launch at some point here in the near future.
We're also working on another transaction that upon consummation grows our asset management business to $50 billion of AUM. These transactions are transformational for us and continue our narrative towards being a leading global asset management business. We are extremely excited by the prospects of growing our business in the private sector and most importantly, adding partners who want to win with us and grow with us as growing with our partners will increase revenue, earnings, benefit our shareholders and our LPs who invest with us.
At year-end, we estimate the following that our business will look like this. Now these are all projections, assuming that everything closes and the deals happen, we'll have $50 billion of AUM in the Asset Management business, $7.2 billion of equity capital, a $35-ish billion balance sheet and plenty of liquidity with a bunch of new partners in the private capital business.
Back to the core business. During the quarter, we announced the acquisition of SLS. SLS is a mortgage company with $135 billion of servicing, of which $85 billion or so is through third-party servicing. Consistent with our REIT view, this deal will bolster our servicing business, add capacity and clients in our third-party business, grow our special servicing business and increase earnings.
Our total servicing portfolio of investments from a notional perspective grows to $840 billion upon the settlement of the SLS deal. This includes mortgages that we service, investment in what we call excess MSRs and legacy MSRs, which are serviced by others. To be clear, this is not a race for us about size. We care about servicing our customers and making money for our shareholders and LPs.
Regarding the mortgage company, we continue to be vigilant on expense reduction initiatives, particularly in the Origination segment. We expect the origination business to remain under extreme pressure with mortgage rates at 8%. So how do we think about this? It's great for our servicing business. As I pointed out, we have $840 billion on a notional basis of mortgage servicing assets. Lower prepayments equals one thing for our servicing business, that's more earnings and more cash flow.
On the commercial real estate side, that space remains a very big focus of ours going forward. With no legacy assets and very attractive valuations, you could expect us to allocate more capital to the sector going forward. If you recall, we acquired GreenBarn, which was formerly known as Senlac/Normandy Partners at the end of last year. Since then, we've made some opportunistic investments, and we'll continue to do so. Right now, we see the debt side extremely attractive.
There's so much more I could talk about, and we're really excited for our company and the prospects ahead. So what I'll now do is I'll flip to Page 3 in our supplement, and I'll take you through the deck, and then we'll open it up for Q&A.
Rithm, from an overall focus standpoint, $35 billion of assets after our dividend payment tomorrow of $4.9 billion of dividends paid in 10 years. $7.2 billion of book equity and a 23% total year-to-date shareholder return. When we look at our expertise, I would think of us as an asset management business in all areas of mortgage, real estate. And as we add expertise around the housing credit, there's no business line that we shouldn't be in, number one. Number two is there's no business line that we will be in unless we have the expertise in-house.
The right side of the slide, powered by partnership. We want to deploy opportunistic capital. We want to create more partners. Now this is a very different thing from where we grew the company in the public markets as we go forward. Again, we're going to grow more in the private markets because our equity trades at a substantial discount to book. And we think it's a better opportunity for us to deploy capital in the private markets.
Page 4, just talking about our financial highlights in the quarter. GAAP net income of $193.9 million or $0.40 per diluted share, earnings available for distribution, $280.8 million or $0.58 per diluted share. This includes a realized gain of $0.15 related to the sale of excess MSRs during the quarter, dividend $0.25; cash and liquidity at the end of the quarter, $1.9 billion and again, total equity of $7.2 billion. I do want to point out to the right side of the page here, the book value growth from the end of Q4 2020, which at that time, it was $10.87 to where we are now, which is $12.32, in spite of the 10-year note rising from 91 basis points to the end of the quarter where it was 4.60% to where today, it's almost 5%.
The evolution of Rithm, Page 5, you can see the company was started while we were all at Fortress in 2013. It began with $1 billion of equity. Today, we have $7.2 billion of equity. And as you look at the timeline and you look at our acquisition pipeline, we've grown substantially over the years. Everything has been targeted around what I would call mortgage and real estate. The addition of the Sculptor transaction and some of the other things we're working on will grow not only our real estate presence but also our credit presence, and we look forward to continued growth as we go forward.
Page 6. This talks about our private capital business. This is a slide you've seen before. The thing I want to point out on the right side of the page, private capital is going to help us generate recurring earnings and performance fees for Rithm shareholders, and also for the folks that we manage capital for at the LP level. We want to create partnerships with investors through specific SMAs, co-investment as well as the funds that we continue to work on, and we'll continue to roll out. The other thing to point out is the business continues to benefit from all the work that's been done over the years as we've created our own in-house origination and servicing platforms. And those will continue to grow as we go forward.
Page 7, the Sculptor transaction update. Obviously, a lot of press around that. We're super excited to bring this deal to a close and bring it in-house. What I would say on this deal, there is very little to no overlap between Sculptor and our business, and we're super excited to get this thing wrapped up. The expertise that we bring in-house is, in my mind, it's going to be second to none. If you think about it, our existing investment team, coupled with the Sculptor investment team, is going to create an asset management business that is going to be extremely formidable in the space.
Page 8. This talks about the SLS deal. Really what it is, is a servicing deal. There's very little on the origination side. The idea here is, again, it's not about so-called scale. This increases our third-party special servicing business to almost $200 million -- $200 billion. So it's a real fee-for-service business. The other thing what it does for us is it increases our capacity in the special servicing space. So as we go forward and you think about the global macro picture, if the economy in the U.S. does slow down and the need for more special servicing, there's going to be nobody better than, call it, Newrez in our business to take to work with homeowners and consumers around that.
Commercial real estate, Page 9. This really just talks about our expertise in-house. Currently, we have 25 to 30 investment professionals. As many of you know, we don't have any -- we have not traditionally been a large player on the commercial real estate space as the company was built more around the residential space and consumer side. With the opportunity set that we see right now in the marketplace extremely what I would call, robust and having no legacy assets, we're extremely excited to grow that business and put up what I would call great returns for our shareholders and LPs.
On the loan side, the residential whole loans side, keep in mind, as I pointed out before, our manufacturing capability in our mortgage company as well as in our Genesis business, which provides loans to builders, gives us I think, a very, very good competitive advantage over just a traditional asset manager as we're able to manufacture our own assets.
When we look at -- as we think about deploying opportunistic capital, the rate environment and the macro environment for what we do is probably -- it hasn't been this good in probably 25 or 30 years. I'm going to take you through a slide in 2 pages which talks to where yield levels are. And when you look at that and you think about unlevered returns of something between 8% and 12% on senior cash flow, we think it's a great time to deploy capital, and will continue to be a great time to deploy capital in the very assets that we manage money for.
Page 12 just talks about a number of different strategies. I'm not going to spend any time on this. But as we think about mortgage loan servicing rights, commercial real estate, debt, et cetera, everything -- not everything, but most things look very attractive to us.
Page 13, if you just have a look to the right side of the page, over the course of the past couple of years, look at the yield profiles on the different asset classes that we invest capital in. Everything -- not everything again, but most things look extremely attractive to us. And as we raise more and more capital around our funds business, we're hopeful that we're going to be able to generate, what I would call real outsized returns in the asset classes that we have expertise in.
And then finally, without -- I'm not going to take you through the segment performance. You could have a look at that. But I think the net of where we are as an organization is we're a very different company than where we were a couple of years ago. We will remain true to our core business, the roots that got us here, but overall performance has been very, very good. And with that, I'm going to turn it back to the operator, and we'll open it up for Q&A.
[Operator Instructions] The first question comes with Tim Chiang with BTIG.
This is Eric Hagen from BTIG. All right. So I don't mean to be so short-term focused, but how have MSR valuations maybe trended in October? Are there any bulk packages, maybe even some opportunities that you feel like could emerge between now and like year-end or kind of early next year, how we're just looking at the MSR market right now?
Yes. Here's what I would say on MSRs. We were -- I think we were modest in how we thought about our gains in the quarter. As many of you know, we are bias short. MSRs have negative duration. At some point, what you're going to see is multiples being capped on what I would say is some of the legacy MSRs. So the short answer is modest movement in marks. I think our weighted average MSR multiple is 5.1% at this point. There's still room to go. We are still bias short and we're going to remain that way until we think the -- we see things change. The Fed has signaled that higher for longer. The economic data has been reasonably what I would say, okay to probably not as soft as the Fed would like it to be. So we're going to stay the course.
Regarding other packages, there's always going to be things that come up. As we all know, the banks from a capital perspective, there's a lot of regulation and rules running around right now. The banks are -- nobody is really happy about it from a banking perspective. I think this will create more opportunity as banks have to hold more capital against certain assets. That could create opportunities for us. But again, Eric, I just want to point out, as we think about capital deployment, we do things strategically where we think we're going to earn 15% to 20% returns on our capital. If we see a package of MSRs that we think we could achieve those returns, we'll have a hard look at it. If not, we're likely not going to play in that sector because like I pointed out, we have $840 billion notional amount of MSRs that we can manufacture our own.
Yes. That's great color. So from a financing standpoint, like how much headroom did you have to borrow more on the secured MSR funding? And what's like your tolerance level going forward as you look to Sculptor and you look at closing Computershare? How much headroom do you guys have on all that?
Cash and liquidity at the end of the quarter was, give or take, about $2 billion. I think that's increased a little bit as we go into Q4. Candidly, I think the capital markets folks -- my partner, Charles and Sanjiv, do a great job around our balance sheet and working with our lenders around certain things. So there's plenty of room to go. We're not looking to over-lever our balance sheet, though, right here. I think you'll see other sources of capital come in, including private capital from third parties.
The next question comes with Bose George with KBW.
Just wanted to follow up on the performance quarter to date. Can you give -- in terms of book value, can you just give us an idea where that is now?
We reported book value at the end of Q3 at $12.32, which was up from $12.16. It's probably modestly higher, with rates up a little bit. Like I said, we're bias short on our overall business. So depending upon what happens with rates here, part of this calculus is as a REIT, we have to out agency mortgages. So you have a little bit of a basis thing from a whole pool perspective, depending upon what happens with the basis. The basis today is as wide as it's been since the SVB crisis, and we expect that to remain under a little bit of pressure here with the deficit where it is and the government continuing to have to sell a lot of debt. I think the refunding announcement will be a little bit of a catalyst where the mortgage market goes. As we know, obviously, mortgages are -- there's a lot less supply that comes into play. The challenge is the banks are not really able to buy anything just based on where they are from a capital perspective. But overall, I would say we're trending higher, and it just depends on where we go with some of our marks around the MSR business.
Okay. Great. And then actually on the sheet that you showed the yields. So the -- on the conventional MSR, you showed 9% to 10%. What's the leverage that you use on that? And like what are the funding costs, what's kind of the levered ROEs on that investment?
It's typically something around 60 to 65 kind of advanced rates, what I would say. And right now, funding costs in and around certain things, depending on -- we have termed funding and they're likely around SOFR plus 250-ish, so for 250 to 300 million. The other thing is we have a bunch of termed financing that's already existing on our MSR business that's been outstanding for a few years based on capital markets issuance that we've done, which is lower, obviously.
The next question comes with Kevin Barker with Piper Sandler.
I just wanted to follow up on the plans for Sculptor and the mortgage spinoff. Obviously, there's a lot of moving parts there, and there's different things that need to come into place. But ideally, how do you see this playing out as far as a timing perspective? And then how much capital you think will remain in the mortgage company? I know you addressed it previously, but I just love to refresh there as all that plays out.
So we have the S-1 on file. We continue to evaluate alternatives. As we all know, taking a mortgage company or, quite frankly, any company public right now is a little bit of a challenging task. The idea around the mortgage company is a way -- the thought is to try to figure out a way to recycle capital. I think one of the things we're going to do when you think about MSRs, for example, we're working on different funds, not necessarily just specific to MSRs, but really more specific to what I would call the mortgage company as a capital vehicle. And what I mean by that is you have the origination business and the MSR side, as rates -- if rates do rally at some point in our careers going forward, you want the folks that are deploying capital in these funds to be able to realize the what I would call either recapture or not give up that MSR. So I would say the mortgage company and the recycling of the capital there is fluid. As it relates to the bigger picture, I've been pretty vocal. We are going to -- and I alluded to this in my opening comments, I truly believe by the end of Q4 that there is a possibility we'll have $50 billion of AUM as an asset manager. You think of like the biggest and best alternative asset managers out there. They have their C Corp, they have a REIT and then they have their private capital business. That's ultimately where I think we'll be. And then hopefully, at some point down the road, we'll have an insurance leave. So we're working on all of these things. The capital formation around our business is going to be, as we know, our stock is $9, book value is $12.30. The capital formation side will likely be more in the private capital business than it will be in the public markets at this point just based on how poorly I think REIT stocks trade. But it's safe to say, based on our ambitions and where we're headed, and I think the progress that we've made that we will be a real global alternative asset manager by the end of the year.
Okay. And so are there any specific points that we should look for to see that this really has legs and you -- we start to see like it really playing out, is it the S1 in the mortgage company or the closing of Sculptor? Is there certain particular points that you're looking for to really say this is going to play out as expected?
Sure. So I think Sculptor obviously is an important piece as we go into the -- grow our asset management business. I'd also say that we are an asset manager. We just operate under the wrapper of a REIT. Sculptor is very important in the asset management side. We're working on another what I would call, sizable transformational transaction that we expect to get done by the end of the year as well. And that gets you on the asset management business to where we want. On the mortgage company side, it's -- the cash flow that we get from that as a corporation or at the Rithm level is awesome. So if you think about it, you look at our earnings for the quarter were $0.42 or whatever it is, plus $0.43 plus $0.15 for the excess. When I look at the mortgage company overall and I look at our ROE, and I look at where we were minus the one timers, I think actual return on equity for the quarter is something around net-net, 15%, is that right, on an annual basis, I think we're trending towards annual ROE of about 30%. So we're not looking to give up any of these assets because on a go-forward basis, in this rate environment, the mortgage company will help as well as all the other things that we have going, probably contribute to something between $0.35 and $0.40, $0.45 run rate on our core business. We don't want to give that up. We just want to figure out a way to manufacture more capital at the cheapest basis and then figure out how we could deploy that capital in what I would call today's great investing environment. But overall, it's -- we're not giving up on the mortgage company. Things that we're looking: our expenses, we're looking at retail, clearly, because that business really doesn't make any money right now when you think about true volumes and cost to run that business. But overall, we're really happy with the asset that we have. We just have to figure out a way to generate more capital because we think the investing environment is that good. That's why we're running around the globe, quite frankly, on our private capital business.
Thank you all very much. And with that, we -- and this concludes our question-and-answer session. I would like to turn the conference back over to Michael Nierenberg for any closing remarks. Please go ahead.
Great. So thanks for dialing in, everybody. Stay well, and we look forward to updating you on more developments as things change in our company. Have a great day. Thank you.
This conference has now concluded. Thank you for attending today's presentation. You may now disconnect. Have a good day.