Earnings Call Transcript - RITM Q3 2023

Operator, Operator

Good morning ladies and gentlemen and welcome to Rithm Capital Corp Conference Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would like now to turn the conference over to Emma Bolla, Associate General Counsel. Please go ahead.

Emma Bolla, Associate General Counsel

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 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.

Michael Nierenberg, Chairman, CEO and President

Thank you, Emma, and good morning, everyone. I appreciate you joining us. These are really exciting times for our company. From an earnings perspective, our operations during the quarter were very solid, with our core business lines continuing to perform exceptionally well. The positioning we established over the past couple of years has been rewarding us with strong earnings, book value growth, and ample liquidity. We anticipate this trend to persist, especially with the Federal Reserve indicating that higher rates will remain for an extended period. The global macroeconomic environment for investing places our company in an excellent position to capitalize on anticipated market trends. As you know, we've been vocal about transitioning the company into more of an alternative asset manager. However, I want to emphasize that our core business lines that have brought us here remain vital to our future. We believe that Rithm 1.0, along with Rithm Private Capital, will significantly benefit our investors, shareholders, and employees. With the Sculptor announcement, we’re adding exceptional investment talent to our outstanding team, expanding our global capabilities across various areas, including credit, real estate, consumer, and other strategies that we are likely to introduce soon. We are also pursuing another transaction that would expand our asset management business to $50 billion in assets under management. These developments are transformative for us and support our goal of becoming a leading global asset management firm. We are thrilled about the potential for growth in the private sector and, importantly, for bringing on partners who share our vision for success, as partnering will drive revenue, earnings, and benefits for our shareholders and limited partners. At year-end, we expect our business to look like this: assuming all deals close as anticipated, we will have $50 billion in assets under management, $7.2 billion in equity capital, a $35 billion balance sheet, substantial liquidity, and several new partners in the private capital sector. On the core business front, during the quarter we announced the acquisition of SLS, a mortgage company with $135 billion in servicing, of which approximately $85 billion is true third-party servicing. Consistent with our market outlook, this deal will enhance our servicing business, increase capacity and clients in our third-party operations, expand our special servicing business, and boost earnings. Our total servicing portfolio, in terms of notional value, will rise to $840 billion after the SLS deal closes. This includes mortgages that we service, investments in excess MSRs, and legacy MSRs managed by others. It’s important to note that we prioritize servicing our customers and generating profits for our shareholders and limited partners rather than merely pursuing size. Regarding the mortgage company, we are actively pursuing cost reduction initiatives, especially in the origination segments. We expect the origination business to face ongoing challenges with mortgage rates at 8%. However, this situation is advantageous for our servicing business. As I mentioned, we have $840 billion in mortgage servicing assets on a notional basis. Lower prepayment rates will result in higher earnings and cash flow for our servicing operations. In commercial real estate, the debt market remains a high priority for us going forward, especially since we do not hold any legacy assets and are presented with very appealing valuations. You can expect us to allocate more capital to this sector. Recall that we acquired GreenBarn, previously known as Senlac/Normandy Partners, at the end of last year. Since then, we’ve made several opportunistic investments and plan to continue doing so. The debt market currently appears exceptionally attractive. There's much more to discuss, and we are genuinely enthusiastic about our company’s future. Now, I’ll turn to Page 3 in our supplement to guide you through the presentation before we move into the Q&A session. Rithm's overall focus includes $35 billion in assets following a $4.9 billion dividend payout tomorrow, $7.2 billion in book equity, and a total year-to-date shareholder return of 23%. Our expertise positions us as an asset management firm in all aspects of mortgage and real estate, and as we build our knowledge in housing credit, there are no business lines we will shy away from. We believe it's crucial to operate in business lines where we possess in-house expertise. We aim to deploy opportunistic capital and develop more partnerships. Our growth strategy will differ from the public markets approach we used in the past as we shift focus towards private markets, where our equity trades at a substantial discount to book value, representing a more advantageous opportunity for deploying capital. On Page 4, we highlight our financial performance for the quarter, including GAAP net income of $193.9 million or $0.40 per diluted share. Earnings available for distribution were $280.8 million or $0.58 per diluted share, which includes a realized gain of $0.15 tied to the sale of excess MSRs this quarter. The dividend stands at $0.25, with cash and liquidity at the quarter's end being $1.9 billion, and total equity at $7.2 billion. I want to point out the growth in book value from the end of Q4 2020, increasing from $10.87 to $12.32, even as the 10-year note rose from 91 basis points to 4.60% by the end of the quarter, and is approaching 5% today. On Page 5, the company was founded while we were all at Fortress in 2013, starting with $1 billion in equity; today we possess $7.2 billion in equity, and our acquisition pipeline has shown significant growth over the years. Most of our efforts have centered around mortgage and real estate, with the Sculptor transaction and other deals contributing to our growth in both the real estate and credit sectors as we look to expand further. Page 6 emphasizes how our private capital initiatives will create recurring earnings and performance fees for Rithm shareholders and our capital partners at the limited partner level. We strive to build partnerships with investors through bespoke SMAs, co-investments, and the ongoing funds we are developing. Additionally, our business continues to thrive from the foundational work done to create our own in-house origination and servicing platforms, and we anticipate ongoing growth in these areas. On Page 7, we update on the Sculptor transaction, which has garnered considerable media attention. We are eager to finalize this deal and integrate it into our operations. There is minimal overlap between Sculptor and our existing business, and we are excited about the unparalleled expertise we will bring in-house. When we combine our current investment team with the Sculptor team, we will form a formidable asset management operation. Page 8 refers to the SLS deal, which is primarily a servicing arrangement with little focus on origination. This strategy not only expands our third-party special servicing business to nearly $200 billion but also enhances our capacity in that area. As we look ahead and monitor the global macroeconomic landscape, should the U.S. economy slow down and necessitate increased special servicing, our business will be well-positioned to assist homeowners and consumers effectively. Page 9 discusses our in-house expertise in commercial real estate. Currently, we have 25 to 30 investment professionals, and although we haven't historically been a major player in this space, the current market offers robust opportunities for growth, and the lack of legacy assets makes us particularly excited about our prospects for delivering excellent returns for our shareholders and limited partners. Furthermore, in residential home loans, our manufacturing capabilities within our mortgage company and Genesis business, which provides loans to builders, provide us with a competitive edge over traditional asset managers by enabling us to create our own assets. The current macro and rate environments are highly favorable for deploying opportunistic capital, presenting a unique opportunity not seen in the past 25 to 30 years. In the following slides, I’ll present where yield levels are currently at. We are enthusiastic about unlevered returns expected to be between 8% to 12% on senior cash flow, believing this is a prime time for capital deployment in the assets we manage. Page 12 includes various strategies we are considering, and while I won’t go into detail here, many areas, including mortgage loans, servicing rights, and commercial real estate debt, appear very attractive to us. Page 13 provides an overview of the yield profiles and asset classes we've invested in over the past few years, with most opportunities looking promising to us. As we continue to raise capital for our funds business, we are hopeful for the potential of achieving outsized returns in our areas of expertise. Lastly, while I won't go through segment performance in detail, it is clear that we are a very different company than we were a few years ago. We remain committed to our core business, which has brought us success, and overall performance has been outstanding. I will now turn it back to the operator to begin the Q&A session.

Operator, Operator

Thank you.

Michael Nierenberg, Chairman, CEO and President

Okay, we are ready. Are there any questions.

Eric Hagen, Analyst

This is Eric Hagen from BTIG. Good morning. Hey, how you doing guys? Alright, So I don't mean to be so short term focus 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? Thank you.

Michael Nierenberg, Chairman, CEO and President

Yeah, here's what I would say on MSR. I think we were modest in how we thought about our gains in the quarter. As many of you know, we are a buyer short. MSRs have negative duration, at some point where you're going to see as multiples being kept on what I would say some of the legacy MSRs. So the short answer is modest, modest movement in March. I think our weighted average MSR multiples of 5.1 at this point. There's still room to go. We are still a buyer short, and we're going to remain that way until we think 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's 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 think 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 and we can manufacture our own.

Eric Hagen, Analyst

Yeah, that's great color. Hey, so from a financing standpoint, like how much headroom did you have to borrow more on the secured MSR funding and what was like your tolerance level going forward as you look to Sculptor and you look at closing Computershare, how much headroom do you guys have and all that? Thanks.

Michael Nierenberg, Chairman, CEO and President

Cash and liquidity at the end of the quarter was 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 Sanjeev 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 over our balance sheet though, right here. I think you'll see other sources of capital come in, including private capital from third parties.

Eric Hagen, Analyst

Yep. Really helpful. Thank you guys. Appreciate it.

Michael Nierenberg, Chairman, CEO and President

Thanks Eric.

Operator, Operator

Thank you. The next question comes with Bose George with KBW. Please go ahead.

Bose George, Analyst

Good morning. I would like to follow up on the performance for the current quarter. Can you provide an update on the current book value?

Nick Santoro, CFO

We've booked 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. You know, like I said, we are a buyer short on our overall business. So depending upon what happens with rates here, part of this calculus as a REIT, we have to have 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 SBB 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 challenges that 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.

Bose George, Analyst

Okay, great. Thanks. And then actually on this sheet that we show the yields, so on the conventional MSR you showed 9% to 10%. What's the leverage that you use on that and what are the funding costs, what's kind of the levered ROEs on the investment?

Nick Santoro, CFO

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 term funding, and they're likely around SOFR Plus 250ish. SOFR 250 to 300. The other thing is we have a bunch of term financing that's already existing on our MSR that's been outstanding for a few years based on capital markets issuance that we've done, which is lower obviously.

Bose George, Analyst

Okay, great. Thank you.

Operator, Operator

The next question comes with Kevin Barker with Piper Sandler. Please go ahead.

Kevin Barker, Analyst

Great. Thanks for taking my questions. I just wanted to follow up on the plans for Sculptor and the more you spin off. 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 timeline perspective, and then how much capital you think will remain in the mortgage company? I know you addressed it previously but just love to refresh there, as all that plays out? Thanks.

Michael Nierenberg, Chairman, CEO and President

So we have the S1 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 as a way is 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 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 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 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 leads. So we're working on all of these things. The capital formation around our businesses 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 have made, that we will be a real global alternative asset manager by the end of the year.

Kevin Barker, Analyst

Okay, and so, are there any specific points that we should look for to see that this really has legs, and we start to see like it really playing out? Is it S1 on the mortgage company or the closing of Sculptors or certain particular points that you’re looking for to really say this is going to play out as expected?

Michael Nierenberg, Chairman, CEO and President

Sculptor is a crucial component as we expand our asset management business. It's important to note that while we are an asset manager, we operate under the structure of a REIT. Sculptor plays a vital role in our asset management efforts, and we are currently pursuing another significant transformational transaction that we anticipate completing by the end of the year, which will enhance our asset management capabilities. On the mortgage company side, the cash flow generated at the corporate level is impressive. If we break down the earnings for the quarter, they total around $0.42, $0.43, and $0.15, and when I analyze the mortgage company and consider our return on equity, excluding one-time items, our actual return on equity for the quarter is approximately 15%. On an annual basis, we are aiming for about 30% return on equity. We intend to retain these assets, as in the current rate environment, the mortgage company, along with our other initiatives, is expected to contribute between $0.35 and $0.40 to $0.45 as a run rate on our core business. Our goal is to find ways to create additional capital at the lowest cost and strategically deploy that capital in today's favorable investment landscape. We are committed to the mortgage company and are assessing our expenses and the retail sector, as it hasn't been profitable given the current volume and operational costs. Overall, we are pleased with our assets but recognize the need to generate more capital because we believe the investment environment presents great opportunities, which is why we are actively pursuing our private capital business globally.

Kevin Barker, Analyst

Right. Thanks for all the color, Michael.

Michael Nierenberg, Chairman, CEO and President

Thanks, Kevin.

Operator, Operator

Thank you all very much. 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.

Michael Nierenberg, Chairman, CEO and President

Great. So thanks for dialing in everybody. Stay well and we look forward to updating you on more developments and as things change in our company. Have a great day. Thank you.

Operator, Operator

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