Rithm Capital Corp. Q4 FY2020 Earnings Call

Good morning, and welcome to the New Residential Investment Corp.'s Fourth Quarter and Full Year 2020 Earnings Conference Call. I would now like to turn the conference over to Kaitlyn Mauritz, Investor Relations. Ms. Mauritz, please go ahead.

Great. Thank you, Anita, and good morning, everyone. I'd like to thank you for joining us today for New Residential's Fourth Quarter and Full year 2020 Earnings Call. Joining me here today are Michael Nierenberg, our Chairman, CEO, and President; Nick Santoro, our Chief Financial Officer; and a number of members of the NewRez management team, including Baron Silverstein, President of NewRez; Cathy Dondzila, CFO; Josh Capell, Head of Strategy; and Jack Navarro, President and CEO of the Servicing division of NewRez.

Thanks, Kait. Good morning, everyone, and thanks for joining us. Obviously, we have a big team on the call this morning, and we are excited to take you through a little bit of last year and, more importantly, how we think about the company going forward. Baron is going to take you through some of the presentation around the mortgage company. I'll kick it off by giving you some comments here. As we look back at last year and reflect on the very difficult period we had when the pandemic first hit, I'm proud of the efforts of our team and excited for the future of our company. The steps we took, while initially painful, have put us in a great position to continue our march towards returning our earnings to pre-COVID levels. Our liquidity has never been stronger, and our portfolios have never been better financed. Our mortgage company, NewRez, is just hitting its stride, and the future looks bright. With rates plummeting to historic lows last year, our 2018 acquisition of NewRez, formerly known as Shellpoint Partners, put us in a position to consolidate our servicing and grow our origination business. This has helped to offset some of the amortization we have seen in our MSR portfolio and help grow earnings for our company. From a macro view, we believe interest rates will rise, which will be great for our company. This will enable us to recover the lost value we saw as a result of the faster speeds in our MSR portfolio over the past year. As you think about slower speeds, that will result in more cash flow from our MSR portfolio and higher recapture rates. The combination of those two should more than offset the likely decline you’re going to see in mortgage origination.

I thought you were ending with this one.

Fine. We'll talk a little about our origination and servicing business, and then I'll turn it over to Baron, who'll take you through a little more detail. Q4 summary shows $247.9 million of pretax income, down 21% quarter-over-quarter as volume is a little bit lower and gain on sale margins tightened during the quarter. We funded $23.9 billion of origination, which is up 32%. Pull-through and adjusted lock volume were up 18% in the quarter at $25.8 billion. As we look at the 2020 summary, the origination business pretax income was $801.6 million, up 447% year-over-year, funded origination of $61.6 billion, up 176% year-over-year; and our pull-through adjusted lock volume of $69.8 billion was up 178% year-over-year. Again, our growth has been really important, especially in our DTC channels, which Baron will discuss shortly. Looking at Page 20, across every channel, direct-to-consumer was up 25% quarter-over-quarter or 169% year-over-year, wholesale was up 18% quarter-over-quarter or 57% year-over-year, our joint venture business, which is an origination channel we work on through different real estate brokers, was up 2% quarter-over-quarter and 93% year-over-year, and then finally, our correspondent business was up 40% and up 133% year-over-year. I highlighted my opening remarks that we're in the early to middle innings for this company. I'm thrilled with our management team who I believe will lead us to new heights. On the servicing side, Q4 servicing pretax income was $47.8 million, up 58% quarter-over-quarter. We transferred a lot of servicing into the company from other third-party servicers, continue to consolidate our servicing providers, bring servicing back in-house, and try to increase our recapture percentages relating to them. We ended the year with $297.8 billion of UPB, up 4% quarter-over-quarter, serving approximately 1.7 million customers, which is up 5% quarter-over-quarter. We estimate that at the end of Q1, our servicing portfolio will be about $300 billion.

All right. Thanks, Mike. Good morning, everybody. On the next few slides, I wanted to provide a brief overview of what makes NewRez different. A lot of news about mortgage companies in the market of late and I thought it would be helpful to differentiate NewRez from the pack. I felt it appropriate to say a big differentiator for us is, of course, our parent company, NRZ, and the relationship with NRZ is a critical part of our strength, including capital, market knowledge, visibility, and a core foundation of the mortgage industry. I cannot stress enough the importance of this partnership. Turning to Slide 23, it's a quick summary overall of how we plan to position our operating platform for the future, including profitability and scale, market share growth, recapture that Michael discussed, non-agency products, and, of course, our special servicing strength. Moving to Slide 24, two or three years ago, you weren't really hearing about NewRez. But since that time, we've established ourselves as a significant competitor in the origination and servicing market with growing profitability, origination footprint, servicing portfolio, customer base, and market share. This is also a reminder that our platform originated $7 billion in 2018. You can really see the impact of the acquisition of the Ditech assets and the importance of the partnership with NRZ and the MSR portfolio. We may be the new guy in town, but we still have a lot of work to do, and we are a well-rounded diversified mortgage platform with plenty of room to grow. Turning to Slide 25, just to highlight the market share growth, which is agnostic to market conditions. All mortgage companies have grown originations, production, and profitability in 2020. We've demonstrated our ability to successfully grow not only our origination volumes but also our market share. As Michael said earlier, our focus is to continue capturing more market share across our platform and channels. At the end of 2020, our market share was approximately 1.7% with two-year growth of about 130 basis points that we picked up. Small changes in market share can have a big impact on overall profitability, and that's what we're playing for. We also have one of the largest servicing portfolios with about 1.7 million homeowners that we want to retain as customers of NewRez. As we continue to build out our brand and improve our recapture efforts, the plan is to execute on that goal. Turning to Slide 26, as Michael discussed earlier, MSR valuations will benefit as interest rates rise. We believe our platform is well positioned to perform across different rate environments. From a historical perspective, our multichannel origination strategy allows us to adapt to either refinance or purchase markets. In anticipation of higher rates, we have a plan to position our channels to take advantage of the changing markets. Our direct-to-consumer channel is a huge focus for NewRez as well as NRZ, and it's a long-term opportunity for our company. Within the next few months, we'll launch our new brand strategy to enhance brand awareness and recognition to build customer loyalty. The focus being as we improve our connection to consumers, our DTC platform will continue to grow. We're also planning to restart a lead acquisition strategy to shift some of our capabilities if and when the refinance market slows down. Regarding our retail joint venture business, we have 18 partnerships with different realtors and preferred partners across the country. These partnerships are purchase-focused and provide sticky origination volumes where we will continue to grow our capture rates. Our wholesale channel, which has historically been purchase-focused, continues to grow with a record funding month in December by closing approximately $820 million, with plans to expand our platform by adding new broker relationships to build out our direct-to-broker channel. In our correspondent loan channel, we'll continue to evaluate market dynamics opportunistically by buying MSRs and expanding our customer base. We had record growth in the fourth quarter, purchasing $16 billion in mortgage loans, which grew our platform by 40% quarter-over-quarter as we continue to develop our capabilities and attract new customers. Turning to Slide 27. We have proven the ability to originate non-agency products for borrowers that meet our credit and underwriting criteria. While we paused this production channel in March of last year, we relaunched our non-agency jumbo product in the third quarter and originated over $150 million in the fourth quarter, which is already back to pre-crisis levels. Last month, we also announced the relaunch of our proprietary non-QM program, a core competency for NewRez. While we’ve done this before, we are cautiously re-entering originations to gauge borrower demand, credit profiles, and pricing, but we expect momentum to pick up in the months ahead. Turning to Slide 28. We've talked a lot about origination, but it’s important to recognize our incredible servicing division, particularly our special servicer, Shellpoint Mortgage Services. Jack Navarro and the entire servicing division do an outstanding job and are well-recognized in the industry as one of the best special servicers. In addition to growth in the changing environment, we helped over 200,000 homeowners impacted by the COVID pandemic with support and solutions. The chart on the right provides quarterly information for the number of homeowners impacted. Approximately 58% of those homeowners have had their forbearance and their hardship resolved. 28% still have their forbearances outstanding, and approximately 14% are in active loss mitigation with Shellpoint, helping homeowners move into permanent solutions such as repayment plans, deferments, and loan modifications. Turning to Slide 29, we’re extremely focused on our technology platform and are working towards innovative changes to improve our company. Our changes include optimizing our customer journey by combining lead generation and marketing with predictive analytics, which will drive our conversion rates. We are also making changes to our fulfillment operations to improve employee efficiency, timelines, and reduce overall costs. We've seen some improvements already with DTC fulfillment capacity, achieving new funding milestones month after month, culminating in our largest funding month ever in December 2020, closing $1.6 billion in loans. Loan servicing has also added borrower portals to assist consumers facing COVID hardships while ensuring connectivity between the origination team to secure the best customer outcomes, which includes our partnership with Salesforce, set to launch by the end of the first quarter. Customer experience is critical to our company, and we aim to deliver solutions that produce exceptional customer satisfaction along the homeownership journey. Now I'll turn it back to Michael.

Thanks, Baron. Great job. Operator, we'll now turn it back to you for some Q&A.

The first question today comes from Kevin Barker with Piper Sandler.

I appreciate all the disclosure on NewRez. Hey Michael, it's very helpful to see all the different channels and the progress you made over the last couple of years specifically within these channels and the growth in the business. To follow up on some of the disclosures on NewRez, could you talk about where you stand on the filing of the S-1, given the confidential filing back in November and where that stands in regards to the separation of the two?

So without getting too specific, we continue to evaluate what a total separation would mean for the company, meaning NRZ and NewRez. If we think that a separation will create more value for shareholders by bringing the company into the public markets, it's absolutely on the table. As you've seen from some recent attempts or IPOs that have emerged from our peers in the mortgage sphere, some have gone well, while others have not. We are considering this, but we want to ensure that when we do this, it's going to add value for shareholders, create higher book value, and more importantly, ensure higher earnings and dividends. To be clear, being part of the Fortress family, given our substantial experience in taking public companies, is beneficial. When you look at NRZ today, with approximately $1 billion of cash, and the mortgage company making over $900 million, we are poised to see slower amortization. For example, in the fourth quarter, amortization was $450 million. As that decreases, expect to see lower production. So evaluating the MSR side with the origination side is something we're currently engaged in every day.

Okay. And when you think about the separation of the two companies, given the disclosure of about $900 million of equity in the operating subsidiaries, should we expect a spin-off where existing shareholders go with that equity or should we expect new capital at the operating companies to separate the two? How should we think about that equation?

There's enough capital in the company to go either direction honestly. Our main objective is to determine the value of separating the two companies to create shareholder value. For now, assume there’s enough capital in the system, and it might result in a spin.

Okay. And you were part of a SPAC created. Is there anything preventing that SPAC from having some type of transaction with the operating subsidiaries given the current structure?

Yes. The SPAC doesn't have anything to do with NRZ. What it does is enable our management team to look at several companies and evaluate opportunities in the financial services space. We've indeed been approached by various SPACs about taking NewRez public through a SPAC-type vehicle. However, at this point, I would say that I would exclude the SPAC from taking this company public and want to focus on either a spin-off, an IPO, or keeping it as part of NRZ.

Our next question comes from Eric Hagen with BTIG.

A couple of questions on the MSR and another on origination. Can you share how you're thinking about hedging the MSR with rates potentially on the move? Also, can you provide clarity on how financing terms in the securitization market differ from term notes for MSRs currently? Lastly, on the origination side, do you feel comfortably staffed? Are you looking to add loan officers or underwriters? Also, which non-agency cohorts do you believe you can be more competitive against? I believe you mentioned single-family rental.

Sure. On the first question, about hedging the MSRs, we are long mortgages against our MSRs. We also have hedges against the mortgages we hold. Net-net, we are positioned favorably in a higher-rate environment to realize value that we lost in 2020. Overall, we have a strong bias towards protecting the MSRs while also preparing for higher rates. As for the non-agency opportunities in the SFR space, reperforming loans trade between 2.75% to 3% yields, which currently isn't viable for us financially. Our SFR space is something we are aiming to expand into, currently holding around 500 homes and adding roughly 50 a week with an unlevered overall cap rate of about 5.75% which, with financing, potentially gives us a 15% return.

Yes. We are continually hiring, despite the fact that we are currently performing above our weight. Our teams across various channels and servicing continue to outperform relative to the growth we've seen. If rates were to increase, we believe we will be sized appropriately. Nonetheless, we are still hiring employees on both the sales and fulfillment sides.

Our next question comes from Doug Harter with Crédit Suisse.

Michael, could you provide context around the projected earnings for 2021? How much of the anticipated rate increase is factored into that forecast, or are you assuming a steady state?

We anticipate rates to rise. The numbers we’ve projected are based on the belief that we will see tighter margins and lower origination volumes. Specifically, we project 2021 earnings between $700 million to $800 million based on these factors.

Thinking about the dividend, what is your perspective on the right payout ratio? Considering that you seem to cover the dividend today, how do you envision the dividend moving forward?

We’ve raised our dividend for three quarters consecutively. After a difficult period in March, we reduced our dividend from $0.50. Maintaining a dividend between $0.30 to $0.40 is our focus as we look to grow it further. As we boost earnings and if rates rise, I believe you'll see dividends lifted again.

In response to an earlier question, you noted an 8% unlevered yield on MSRs. Is that applicable to just the GSE side, or does it also apply to Ginnie Mae? Are there any other areas you’re considering for investment currently?

Ginnie multiples tend to be lower than conventionals due to the additional credit risks involved. The yield on MSRs ranges between 7.5% to 8.5%. For investment, there aren't many high-yielding opportunities currently, so we're focused on our operating business where returns on equity are strong, especially in a higher rate environment.

On Slide 7, where you’ve shown a $0.50 run rate, can we view the economic return as similar? Since many are focusing on that as opposed to core earnings?

Yes, the economic return is likely to align with that expectation given our profitability projections. As prepayments decrease, we expect a boost in our core earnings, which, in turn, should benefit dividends. Lower amortization at higher rates will be beneficial for both earnings and dividends.

Regarding the potential separation of NRZ, if that proceeds, could it change the hedging model at the REIT due to the origination and servicing relationship?

Currently, the mortgage company hedges its pipeline independently from NRZ. If separated, the companies would function independently, but we anticipate maintaining a relationship where origination would continue to contribute to NRZ's balance sheet.

Could you clarify the interaction between your origination volumes, particularly in reference to Page 6's refi expectations? Additionally, how might this impact your gain on sale margin moving forward?

Focusing on our direct-to-consumer channel, given the size of our servicing portfolio compared to our DTC platform, even in a scenario where rates rise by 50 basis points, we still have a significant number of consumers we service that can benefit from refinancing. Our strategy includes growing our lead acquisition strategy while we expect rates to rise gradually.

Baron, could you elaborate on the quarter-over-quarter growth you're seeing in direct-to-consumer originations?

Certainly, margins compressed from the third to the fourth quarter, which was a key reason for the earnings decline between these quarters. However, in January, we've seen a stabilization of margins compared to December, particularly in our direct-to-consumer and JV channels. Our third-party channels are still under competitive pressure but are holding steady in context to last year. Additionally, we're funding more volume, achieving a record funding month for DTC in December at $1.6 billion and continuing to exceed that in January.

Can you provide a rough estimate of how much of the projected $0.50 core earnings will be retained versus distributed as dividends?

As we reach the projected $0.50, we’ll aim to distribute a dividend reflective of our earnings growth. A significant portion will likely originate from our MSR portfolio, where we expect our core earnings to support that payout.

What’s the anticipated timing for a potential separation or spin-off?

We evaluate this on a daily basis. If we believe a separation is beneficial for shareholders, we will proceed. Our focus remains on driving earnings and dividends back to where they were pre-COVID.

Regarding the separation of operating businesses, what structure may work for the relationship between originator and servicer in terms of MSRs, particularly given recent descriptions of sales versus transfers?

There are several avenues to consider. A flow agreement could be put in place between NewRez and NRZ, or the MSRs could remain on NewRez's balance sheet and grow from there. What really matters is how we create value for shareholders while ensuring the companies continue to function properly.

Focusing on dividend and earnings, it seems the combination of the mortgage company and the REIT provides an optimal structure. What are your thoughts on the separation model and cash allocation between different parts of the business?

It boils down to the portfolio composition. The mortgage company needs to achieve a robust valuation for us to capture value for shareholders. Our main focus remains on driving earnings and providing dividends for our investors. We're well-positioned for this.

Could you discuss the capital allocation to the agency and what ROE was in the fourth quarter?

The total capital allocated to the agency book is approximately $600 million. We ended the quarter with $13 billion of market value in agencies.

Can you approximate what the ROE or contribution to earnings was in Q4?

The contribution to core earnings was approximately $50 million or $0.12 for the quarter.

Regarding MSR and amortization, given the 10-year rates, how do you view the current dynamics and any increase in the MSR multiple?

There was a slight increase in the multiple on the MSR; we're still in the low 3s overall. We expect a slowdown in amortization from the competitive government buying in the market.

Can you clarify the strategy for increasing brand awareness in the DTC channel? Will it also include pursuing non-portfolio originations?

Yes, our brand awareness initiative will be comprehensive, targeting internal levels for our employees and externally towards our customers to enhance how NewRez is viewed. We're refining our marketing strategies to reach existing and prospective customers.

Regarding the rate impacts displayed on Page 6, do you factor in similar increases for mortgage rates? What's realistic for a 50 bps increase in treasury rates?

As rates rise, we anticipate mortgage rates to increase accordingly. However, multiple factors will play a role in this dynamic, and we’re usually cautious about predicting exact movements.

This concludes our question-and-answer session. I would now like to turn the conference back over to Michael Nierenberg for any closing remarks.

Thank you for joining us today and for all your questions. We look forward to updating you throughout the quarter. Stay well, everyone. Thanks.

This conference has now concluded. Thank you for attending today's presentation. You may now disconnect.