Rithm Capital Corp. (NYSE:RITM) Q4 2022 Earnings Call Transcript

Rithm Capital Corp. (NYSE:RITM) Q4 2022 Earnings Call Transcript February 8, 2023

Operator: Good day, and welcome to the Rithm Capital Fourth Quarter and Full Year 2022 Earnings Conference Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Phil Sivin. Please go ahead.

Phil Sivin: Thank you, and good morning, everyone. I’d like to thank you for joining us today for Rithm Capital’s fourth quarter and full year 2022 earnings call. Joining me today are Michael Nierenberg, Chairman, CEO and President of Rithm; and Nick Santoro, Chief Financial Officer of Rithm Capital. Throughout the call, we are going to reference the earnings supplement that was posted to the Rithm Capital website, www.rithmcap.com this morning. If you’ve not already done so, I’d encourage you to download the presentation now. I’d like to point out that certain statements 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 supplements regarding forward-looking statements and 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. Reconciliation 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 Mike.

Michael Nierenberg: Thanks, Phil. Good morning, everyone, and thanks for dialing in. 2022 was a transformational year for us in many ways. First, on the market, our broad experience in financial services investing served our shareholders well as we navigated some of the more difficult fixed income markets we’ve seen in a few years. With the Federal Reserve raising rates seven times for a total of 425 basis points, the mortgage basis widening between 70 and 100 basis points, high yield index wider by almost 200 basis points and investment grade bond spreads wider by at least 25 basis points, capital markets essentially shut down during different periods. We managed to grow our book value by 5% during 2022, generated a GAAP return on equity of 15%, 11% on our core business and an economic return of 14%.

This doesn’t happen by chance. With a disciplined approach to investing, spending time with our partners, positioning the company and our balance sheet for higher rates, we generated a very good result during these difficult times. Unfortunately, the equity does not reflect the performance with the stock price trading at too large of a discount, in my opinion, to book, and we’ll continue to do all we can to see us normalize towards book. During the year, in June, the company rebranded to Rithm Capital as the management contract was internalized. The results of these actions were to drive more earnings to our shareholders and begin the transition to an alternative asset manager. In the fourth quarter of 2022, we launched our private funds business with the intent of raising third-party funds.

Our funds business will be a subsidiary of Rithm Capital with all management fees and performance fees flowing through the parent. This will enable us to generate more earnings for our shareholders and ensure we are aligned with our shareholders and our employees. We are currently marketing a financial services fund and look forward to working with partners to take advantage of the wonderful opportunities we are seeing and expect to see in 2023 and beyond. We will also be opening Rithm Europe, very excited about this. This will enable us to take advantage of dislocations in the EU and U.K. This should happen in Q2, and I’m very excited about the what-if here. In December of 2022, we acquired a 50% stake in a private equity commercial real estate platform, formerly known as Normandy Partners and renamed as GreenBarn.

This gives us real depth and expertise in conjunction with our Rithm employees to be opportunistic investors in the commercial real estate space, both on the debt and equity side. Regarding our operating business units, we right-sized our mortgage company, our G&A overall in the company by over 50% year-on-year. We are now in the position to drive higher earnings as a result of the actions taken. Our MSR portfolios, which totaled $600 billion have been fantastic, generating tons of cash flows into the higher rate markets we’ve seen. We’ve been very vocal we will not fight the Fed. And at this point, we will continue not to fight the Fed. Our average gross WACC in our portfolio is 3.7%, and that includes new production. We continue to explore different ways to engage our customer base of 3.1 million consumers by offering other products and are very focused on our customer retention.

As you think about the housing and mortgage market, the weighted average mortgage rate for Fannie Mae and Freddie Mac loans in the United States is 3.62%. The weighted average mortgage rate for Ginnie Mae borrowers is 3.57%. I bring this up as the refi opportunity is way out of the money with mortgage rates currently north of 6%. This should continue to lead to great performance in the MSR sector. Our Genesis business, which is our builder business, had a great year, originating a little shy of $2.5 billion in loans. Average coupons on that portfolio right now are approximately 10%, and we look forward to growing the business in 2023 and beyond. On the single-family rental space, our Adoor business had a good year as our occupancy rates continue to €“ or as our lease-up rates continue to increase.

Couple of things there. One is, we’ve halted our acquisitions very early in the year with the expectation that home prices would decline and cap rates would increase. We are seeing that. However, transactions have been very slow. As we go forward in 2023, and with home prices at this point down approximately 10% from peak, we think that housing supply shortages, home prices being less affordable where mortgage rates are, we’ll be back acquiring units at some point later in the year. As you can tell a lot to do here super-excited for our future and super-excited for the growth prospects for our business. With opportunities in the market across many asset classes and companies, we look forward to putting up great returns for shareholders and our partners in the private credit business.

I’ll now refer to the supplement, which we posted online, and I’m going to open up on page 3. Just a couple of things here. On the Rithm side, currently 70 full-time employees here in the offices in New York. Balance sheet is approximately $32 billion as of the end of the year, a little under $7 billion of total equity. When you look at the portfolio of operating companies, keep in mind, this business was started in 2013 to be an asset manager of excess MSRs. Today, if you look across the board, we have a number of different operating companies in financial services, whether it be on the residential side, the commercial side, making loans to builders, we have property preservation businesses. We have a single-family rental business, and we have title and appraisal.

So very, very proud about of the work that the team has done to build out these operating companies, which at all times is not the easiest place to be. Financial highlights, page 4. GAAP net income, $81.8 million or $0.17 per diluted share. Earnings available for distribution $0.33 per diluted share or $156.9 million. Our dividend is $0.25. Cash and liquidity at the end of the year was $1.4 billion. Today is $1.3 billion. That includes all the payments made to fortress. Total equity $6.9 billion. That’s for Q4. Full year GAAP net income, $864.8 million or $1.80 per diluted share. Earnings available for distribution $633 million or $1.31 per Diluted Share. Total economic return, 14%, GAAP return on equity 15%. Earnings available for distribution, return on equity 11% and book value growth 5%, ended the year at $12.

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Book value right now, we’re probably something between 11.75% and 12%. Page 5, business highlights, Internalized Manager, Rebranded to Rithm Capital, launched our private credit business, bought 50% of the operating entity of GreenBarn and then we successfully rightsized our mortgage company. Very, very good year, a lot of work — a lot of hard work by the team across the board. Page 6, the evolution of Rithm. Again, started in 2013 as a manager of — or to acquire Excess MSR rights. As we progressed through the past 10 years, we drove growth through many different business lines, including becoming operators of different business lines, a lot of what I would call large-scale M&A, where we bought Caliber, for example, in 2021 for book value that was $1.6 billion.

We bought Genesis Capital in 2021, that was $1.4 billion. Everything we do when we think about acquiring assets and/or companies is around trying to acquire these assets at book value with a view towards a real value in the underlying assets in the event that, for example, in the Caliber business, we see rates go up and the origination side go down. As we go forward, 2023 and beyond, the growth of our private funds business been running around the globe a little bit, meeting with different LPs and look forward to really developing the private credit business as we think it’s going to give us the opportunity to deploy capital more opportunistically when those situations arise. Page 7, Rithm 2.0. Operating companies, I pointed out on the left side.

Investment portfolio, no surprise what we have going on there plus our private capital business. I think it puts us in a very, very good place. And again, really excited about what the future looks like for our business. Page 8, the economic landscape. This year is going to be hard. I mean, the rate market is going to be a little bit more challenging than I think what we saw in 2022. 2022 is very clear, the Fed was going to keep their foot on the pedal and raise rates extremely aggressively. We saw, as I pointed out, Fed funds rise by 400-plus basis points, bond yields back up and we positioned the company extremely well going into that. As we look at this year, the yield curve continues to remain inverted, big employment print on Friday. The consumer seems like they are in very good shape.

And I think you’re going to see a fair amount more volatility in the rate market this year. And where we are now is we’re much closer to home than I think where we were a year ago, and we’ll continue to monitor rate moves and at some point, likely put on some mortgages and hedge out some of our MSR portfolios. Page 9, the Rithm playbook. Again, some of this is a little repetitive. The investment portfolio, we’re going to continue to seek opportunities to deploy capital, not just to deploy capital, but there must be at good risk adjusted returns, monitor the credit performance of the existing portfolio. What happens if we go into recession, how do we think about our business and make sure that we’re ready for that. Servicing and origination, the hard work that Baron and his team did in 2022 puts us in a very different place, I think, as we enter 2023 to be able to grow that business again.

From an employee standpoint, we are right sized right now and look forward to growing our business throughout the course of the year. Private capital business. Again, really excited, going to be a lot of hard work there and look forward to really growing a proper funds business. Genesis Capital on the building side, we’re going to grow that business. We love 10% unlevered yielding assets on our balance sheet. Adoor, the single-family business. Again, we’ll enter the market when we deem it appropriate with higher cap rates and when we think HPA or HPD has leveled off. And then on the commercial real estate side, we’re going to be more opportunistic as we think about deploying equity and/ or debt in that business. Page 11, just our experience.

I’m not going to spend a lot of time on this across different asset classes, the ranges from residential mortgage loans to commercial real estate to consumer loans. Obviously, we’ve been involved in what I would call distressed debt situations, even buying the assets from Ditech out of bankruptcy. So a lot of experience and a great team that’s in the office every day working their tails off to put up very good results for our shareholders. Mortgage company overview, page 12. For the fourth quarter, $24 million in pre-tax income. What I would caution everybody, as you look at our — look at these numbers make sure if you compare us or other organizations to us, make sure you look at everything apples-to-apples. Nick Santoro, our CFO, and Baron are happy to walk you through any of the math in and around that.

Year-over-year decline in G&A, down 53%. Unfortunately, with rates rising, head count reductions were very aggressive for us in 2022. Hopefully, we’re done with that as we go forward. There are some interesting opportunities in the mortgage space around MSRs and other potential entities that we’re currently working on as we go forward here. Focus on 2023, profitability, customer retention, and that leads into our recapture business. Page 13, our servicing business. Very, very strong business. Right now, we have $500 billion that we currently service in-house. That doesn’t include assets that we service with third parties, either on the Rithm side or in some of the legacy mortgage company stuff that we have on the exit side. As you can see gain on sale margins, Q4, 1.81%.

Big focus is on us. We’ve right sized our retail organization. It’s going to be driven — real earnings will be driven around, in our view, new home sales, which plays extremely well for the retail side and then the recapture business around DTC. On the non-QM front, just to point out a couple of things there. We continue to try to grow that business, not the easiest business to grow. Our credit team has taken measures now in light of our expectations that home prices continue to come down a little bit to lower LTVs, which may make us a little bit less competitive in what I would call some of the higher-risk products, which we’re more than happy to be able to take these actions. Page 14, the MSR portfolio, $600 billion, 3.7% gross WACC. On the excess side 4.4%.

On the excess side, those are legacy credit-impaired MSRs. Love where we sit here, a lot of cash flow. As I pointed out before, with lower mortgage rates well north of 6%, we expect those portfolios to perform extremely well as we go forward. MSR values, we took them down a little bit in the fourth quarter. A weighted average multiple is 4.9. We think that’s a little bit on the conservative side. As you can see at the right side of the slide here, amortization has dropped from fourth quarter of 2020 from 30 CPR, down to 5 CPR in the fourth quarter of 2022. Servicer advances, nothing to talk about here. We continue to monitor performance on the underlying homeowner, effectively year-over-year, everything is unchanged. Should we see a material pickup in delinquencies and/or the need to cut servicer advances, our capital markets team led by Sanjeev Khanna has done a great job not only now, but over the years, having plenty of capacity in that space.

Just to frame something going back, I think it was to like $14 billion or $15 billion. We had $11 billion of capacity in the servicer advance business. And as you look at this, there’s really not much going on there. Genesis Capital I pointed out before, a little under $2.5 billion of origination, love the business, love the coupons, tightened up underwriting guidelines, and we expect some really good growth here as we go forward into 2023 and beyond. And then finally, on the single-family rental space 3,700 units. We are small in what I would call, a sea of big fish to the extent that we see cap rates at attractive levels and we are able to grow that business when we think home prices have leveled off, we will do so. We’re not seeing a ton of opportunity there now.

And our main focus continues to be on re-lease €“ getting assets re-leased. Current lease rates are, give or take, about 96% right now. And as we go forward, we’ve seen rent growth in and around 4%. So with that, that’s my wrap right now. I’ll turn it back to the operator for Q&A, and let’s open up the lines.

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Q&A Session

Operator: We will now begin the question-and-answer session. The first question today comes from Bose George with KBW. Please go ahead.

Bose George: Hi, everyone. Good morning. Wanted to ask just about the potential cadence for growth in alternative assets, and there’s obviously a lot of chatter in the MSR market about Wells potentially selling, et cetera. I mean, is there a potential for something meaningful kind of happening in that area?

Michael Nierenberg: So €“ good morning, Bose. Yeah, on the private capital business, when you look at where our equity trades, we trade at, give or take, 20 to €“ I’m sorry, roughly out of 80% of book. When you think about where we are in the marketplace now with the investment opportunities, typically, what happens is the investment opportunities will present themselves at a time when your equity is trading at a discount, which is really where we are now. Couple that with our pivot from Fortress into being internally managed, we think the private credit business is going to be a big win for shareholders, and it’s going to be a big win for all of us, as we’re able to deploy capital more opportunistically and have access to those large pools overall throughout the financial services landscape that we invest capital in.

As you think about wells and MSR opportunities, yes, I mean, to the extent that wells or anybody else comes out with large pools of MSRs that we think the risk-adjusted returns are attractive, we’re going to pounce on those opportunities. The one thing I would say, counter to that is we do have $600 billion of MSRs. We manufacture our own MSRs every day. So we’re in a really good place in that business. But to the extent that things come out a little bit cheaper than where we are able to create them, we’re going to be all over that. And we are starting to see some opportunities there.

Bose George: Okay. Great. Thanks, And then actually, I wanted to ask about the servicing technology. You’ve mentioned a couple of times that there might be some opportunities to monetize that or move up internally. Just any update there?

Michael Nierenberg: Currently, our servicing plan is we have a bunch of servicing that’s moved to Service Director, which is our own software. We continue to have dialogue and explore other ways to create value for shareholders with other — either third-party software or third-party servicing systems. I would say right now, we’re steady as she goes.

Bose George: Okay. Great. Thanks.

Michael Nierenberg: Thanks, Bose.

Operator: The next question comes from Doug Harter with Credit Suisse. Please go ahead.

Michael Nierenberg: Hey, Doug.

Operator: Doug, your line

Doug Harter: Good morning. You mentioned talking about potential opportunities in Europe. Do you envision that kind of being on balance sheet, or would that be through the private capital?

Michael Nierenberg: Most likely through the private capital, could be a little bit on balance sheet. We’ll be pretty selective there. I mean, what I would say over the years and how long I’m doing this in some of my partners, Charles and others, managing businesses in Europe and having identified an individual to run our European business, who should come online in Q2, I think we’re going to look for more situations around distressed debt, and we’ll likely raise some capital around that business, more likely in private funds. But I think initially it could come out of the public company. Doug? Doug?

Operator: It looks like we lost Doug. The next question comes from Eric Hagen with BTIG. Please go ahead.

Michael Nierenberg: Hey, Eric.