Earnings Call Transcript - RITM Q4 2022

Operator, 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, Director

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 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. The 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, CEO

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 widening by almost 200 basis points and investment grade bond spreads wider by at least 25 basis points, capital markets essentially shut down at 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, and 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 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, which I am very excited about. This will enable us to take advantage of dislocations in the EU and U.K. This should happen in Q2, and I am very excited about the potential here. In December of 2022, we acquired a 50% stake in a private equity commercial real estate platform, formerly known as Normandy Partners and now renamed as GreenBarn. This gives us real depth and expertise along with our Rithm employees to be opportunistic investors in the commercial real estate space, both on the debt and equity sides. Regarding our operating business units, we right-sized our mortgage company and our G&A overall in the company by over 50% year-on-year. We are now positioned to drive higher earnings as a result of the actions taken. Our MSR portfolios, which totaled $600 billion, have been fantastic, generating significant cash flows in the higher rate markets we've seen. We've been very vocal that we will not fight the Fed. At this point, we will continue not to fight the Fed. Our average gross WAC 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 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 and lease-up rates continue to increase. We've halted our acquisitions very early in the year with the expectation that home prices would decline, and cap rates would rise. We are seeing that; however, transactions have been very slow. As we go forward in 2023, with home prices at this point down approximately 10% from peak, we think that housing supply shortages and home prices being less affordable where mortgage rates are, will allow us to begin acquiring units later in the year. As you can tell, there is a lot to do here and I am super excited for our future and for the growth prospects of our business. With opportunities in the market across many asset classes and companies, we look forward to delivering great returns for our shareholders and our partners in the private credit business. I'll now refer to the supplement, which we posted online, and I'll open up on page 3. Just a couple of highlights here. On the Rithm side, we currently have 70 full-time employees in the New York offices. The balance sheet is approximately $32 billion as of the end of the year, with a little under $7 billion of total equity. When you look at the portfolio of operating companies, keep in mind that this business was started in 2013 to be an asset manager of excess MSRs. Today, if you look across the board, we have multiple operating companies in financial services, whether it be on the residential side, the commercial side, making loans to builders, we have property preservation businesses, a single-family rental business, and we offer title and appraisal services. We are very proud 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: GAAP net income was $81.8 million or $0.17 per diluted share. Earnings available for distribution totaled $0.33 per diluted share or $156.9 million. Our dividend is $0.25. Cash and liquidity at the end of the year were $1.4 billion and today it is $1.3 billion, which includes all payments made to Fortress. Total equity for Q4 was $6.9 billion. For the full year, GAAP net income was $864.8 million or $1.80 per diluted share. Earnings available for distribution totaled $633 million or $1.31 per diluted share. Total economic return was 14%, GAAP return on equity was 15%, earnings available for distribution return on equity was 11%, and book value growth was 5%, ending the year at $12. Our current book value is probably somewhere between $11.75 and $12. Page 5 highlights business achievements, including our internalization of management, rebranding to Rithm Capital, launching our private credit business, buying 50% of the operating entity of GreenBarn, and successfully rightsizing our mortgage company. It was a very good year, with a lot of hard work by the team across the board. Page 6 illustrates the evolution of Rithm. Again, this started in 2013 as a manager of excess MSR rights. Over the past 10 years, we have driven growth through various business lines, including becoming operators of several business lines, which involves a lot of what I would call large-scale M&A, like when we acquired Caliber for book value at $1.6 billion in 2021 and Genesis Capital for $1.4 billion in 2021. Everything we do with regards to acquiring assets or companies is to acquire these assets at book value, ensuring we can see real value in the underlying assets. As we move forward, 2023 and beyond, the growth of our private funds business is being actively pursued as we meet with different LPs and look forward to developing the private credit business, as we believe it will give us the opportunity to deploy capital more opportunistically when those situations arise. On Page 7, we cover Rithm 2.0 and our operating companies. I think it places us in a very favorable position for the future. Page 8 discusses the economic landscape, which I expect will be hard. The rate market is going to be more challenging than what we saw in 2022. In 2022, it was clear that the Fed would keep raising rates aggressively. We saw, as I pointed out, Fed funds rise by over 400 basis points. As we look at this year, the yield curve continues to be inverted, and the consumer seems to be in very good shape. So I think you're going to see more volatility in the rate market this year. We are now much closer to home than a year ago, and we're closely monitoring rate movements. Our playbook remains to seek opportunities to deploy capital with sound risk-adjusted returns, and we constantly monitor credit performance in our existing portfolio. Our focus also includes preparing for a potential recession, ensuring we are ready for that. The hard work that Baron and his team did in 2022 put us in a different place entering 2023 for growth. In terms of private capital business, there will be significant work required and we look forward to establishing a strong funds business. We are optimistic about Genesis Capital on the building side as we plan to grow that business. And on the single-family rental side, we will enter the market when cap rates are attractive and home prices have stabilized. That business is currently focused on re-leasing assets, with current lease rates around 96% and we've observed rent growth around 4%. That's my wrap for now, and I'll turn it back to the operator for Q&A.

Operator, 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, Analyst

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 happening in that area?

Michael Nierenberg, CEO

So – good morning, Bose. Yeah, on the private capital business, when you look at where our equity trades, we are trading roughly at 80% of book. When you think about where we are in the marketplace now with investment opportunities, typically, these opportunities present themselves when your equity is trading at a discount, and that's essentially our current situation. Coupled with our pivot from Fortress into being internally managed, we believe the private credit business is positioned for success. Regarding MSR opportunities, yes, to the extent that Wells or others come out with large pools of MSRs that we consider have attractive risk-adjusted returns, we will seize those opportunities. However, keep in mind, we also generate our own MSRs at $600 billion. We have production every day and are in a good place in that business. If opportunities arise at a favorable price and terms, we will definitely pursue them, and we are starting to see some opportunities.

Bose George, Analyst

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, CEO

Currently, our servicing plan is in motion, including moving a portion of the servicing over to Service Director, which is our own software. We are exploring ways to create added shareholder value through third-party software or servicing systems as well. At the moment, we are proceeding steadily.

Bose George, Analyst

Okay. Great. Thanks.

Michael Nierenberg, CEO

Thanks, Bose.

Operator, Operator

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

Doug Harter, Analyst

Good morning. You mentioned potential opportunities in Europe. Do you envision that being on balance sheet, or would that be through private capital?

Michael Nierenberg, CEO

Most likely through private capital, although it could be slightly on balance sheet as well. We'll be selective in our approach. My experience here and working with partners in Europe has pointed out that most situations around distressed debt will require capital raised in private funds initially, potentially starting from our public company.

Operator, Operator

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

Michael Nierenberg, CEO

Hey, Eric.

Eric Hagen, Analyst

Hey, good morning, guys. How are you doing? The MSR portfolio looks really stable here, maybe two questions. The first, just asking about your expectations for recapture and the piece that isn't subserviced directly by you; how do you think about that?

Michael Nierenberg, CEO

I would say everything is pretty much out of the money at this point. We have some servicing with Cooper due to our longstanding relationship and history with Jay and his team from our time at Fortress. We are also partnering with LoanCare. Our goal is to ensure that the economics are aligned in the best interest of our shareholders. However, as I pointed out earlier, with the weighted average coupon in the US housing market being around 3.5%, the recapture rates are not likely to be substantial right now. Customer retention is vital for us, and we are working hard on our marketing strategy to acquire and retain our customer base of 3 million.

Eric Hagen, Analyst

Yeah. That's helpful detail. Thanks. And then another question on the MSR. Do you have a rough idea for how big of a margin call you could withstand in that portfolio? And anything that could bring about a margin call other than a change in interest rates? And how do you cushion for that risk in the portfolio more generally? Thanks.

Michael Nierenberg, CEO

The key is to ensure that our financing is structured properly in the capital markets, which we do. We also ensure we have non mark-to-market facilities, which we currently have. In terms of shocks, I don't foresee anything worse than the shock we experienced in 2020, which we managed quite well. Our financing facilities are predominantly non mark-to-market, and we are confident in our capital markets structure. Our focus is maintaining discipline within the business as we navigate market fluctuations.

Eric Hagen, Analyst

Yeah. Great. Thank you guys very much.

Operator, Operator

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

Kevin Barker, Analyst

Good morning. Thanks for taking my questions. I just wanted to follow up on the origination side. Do you see any particular opportunities emerging within certain channels that may make it more advantageous to invest in that space? I appreciate the comments around limited refi opportunities with mortgages at 3.5%. But are there certain channels that may be opening up, whether it's correspondent, broker, or even parts of the shelter business? Is there anything here that you see that could be a potential for reinvestment?

Michael Nierenberg, CEO

Baron, do you want to take it?

Baron Silverstein, CRO

Certainly. Wells exiting the correspondent market has certainly opened things up in that sector. Also, we feel that the wholesale channel, where we utilize brokers to expand, shows promise. Activity continues on the retail side, and we're seeing opportunities from an M&A perspective as well, which Michael touched on during the third quarter earnings call. There seems to be more possibilities arising within origination. However, we won't grow just for the sake of growth and will be strategic in how we approach these opportunities.

Michael Nierenberg, CEO

Furthermore, we've done considerable work on the retail side, consolidating operations with the shelter business to reduce expenses. You can think of that as an internal merger. Pricing remains competitive despite Wells exiting correspondent, but many mortgage companies might require solutions, which may present M&A opportunities. For now, we feel we're well-positioned in all necessary channels, and we won't pursue anything unless it presents an accretive benefit.

Kevin Barker, Analyst

And then could you provide an operational update regarding all the various integrations that have taken place? You've accomplished a lot in the past couple of years; are there any larger integrations still to be finalized within the origination channel or servicing channel?

Michael Nierenberg, CEO

As far as servicing assets from legacy Caliber MSP, they are transitioning smoothly to Service Director, with a completion expected by Q2. On the origination side, we are well-established and fully integrated. Our savings for shareholders will come as we integrate technology across more operating businesses. A tech hub is being established to improve efficiencies and save costs. Our value will stem from the synergistic integration of our operating businesses, rather than merely focusing on the mortgage company.

Kevin Barker, Analyst

Thank you, Michael. Thank you, Baron.

Michael Nierenberg, CEO

Thanks, Kevin.

Operator, Operator

The next question comes from Stephen Laws with Raymond James. Please go ahead.

Stephen Laws, Analyst

Hi, good morning. Michael, looking at the new segments, you've really pieced together a broad investment platform. From a medium-term outlook, say, two to four years, which of these segments do you think have the ability for outsized growth or an outsized capital allocation?

Michael Nierenberg, CEO

Our approach has always favored opportunistic investments rather than solely seeking deployments of capital. As I mentioned, our earlier acquisitions include GreenBarn, which specializes in office redevelopment in the Northeast, led by a strong operator, David Welsh. This company is poised for strategic growth, and we will likely allocate additional capital towards its development. MSRs remain robust, with potential for our acquisition and expansion in that space. We believe the Genesis business will excel, and we also anticipate emerging opportunities for growth in consumer companies later in the year. Overall, our strategy is grounded in being opportunistic and leveraging our expertise across all our operations to generate competitive returns, ideally in the teens. Our core competency in financial services will be pivotal in our approach.

Stephen Laws, Analyst

Great. Thanks, Michael.

Michael Nierenberg, CEO

Thank you.

Operator, Operator

The next question comes from Trevor Cranston with JMP Securities. Please go ahead.

Trevor Cranston, Analyst

Thanks. Good morning.

Michael Nierenberg, CEO

Good morning.

Trevor Cranston, Analyst

Just one more question on the origination segment. You guys have, obviously, done a lot to reduce the expense level over the course of the year. Would you say that the run rate numbers shown on slide 12 for expenses are fully reflective of everything you've done, or are there any actions taken that are still material to Q4 expense numbers for originations?

Nick Santoro, CFO

I would say that the current numbers fully reflect what we've accomplished, and any go-forward actions won't be significant.

Michael Nierenberg, CEO

It's important to note that our positioning last year to prepare for higher rates led to aggressive headcount reductions. We are now in a solid position but must continue to manage expenses across all our operations.

Trevor Cranston, Analyst

Got it. You mentioned potentially looking to add mortgages and hedge out the fair value of the MSR at some point. Could you expand on what you would be looking for in the market to implement that strategy?

Michael Nierenberg, CEO

If we perceive that the Fed is done raising rates, and we believe that mortgages will improve over time, we will start adding hedges. Our broader portfolios are already hedged with either interest rate swaps or mortgages. For now, in the MSR business, our strategy remains steady. It's also essential to note that the 3.5% coupon won't be attractive to refinance other than through housing turnover, thus impacting our need for hedging.

Trevor Cranston, Analyst

Great. Thanks, guys.

Michael Nierenberg, CEO

Thank you.

Operator, Operator

The next question comes from Giuliano Bologna with Compass Point. Please go ahead.

Giuliano Bologna, Analyst

Good morning and congrats on continued execution in a challenging environment. One thing I was curious about is the potential to leverage the mortgage company and sub-servicing capabilities to acquire MSRs from a fund perspective since there's a lot of capital chasing that asset class? If Wells is looking at $200 to $250 billion of MSRs, there could be significant supply. Can the Rithm platform seize this opportunity with external capital and fees while leveraging sub-servicing?

Michael Nierenberg, CEO

The answer is yes, yes, and yes. To address your three questions, we have a robust sub-servicing business ready to expand. There are large sub-services that may enter the market, and we are well-prepared to grow our sub-servicing capabilities to gain a competitive edge. Regarding MSR acquisition, we find them attractive and believe there will be supply available, including the opportunity presented by Wells. We will act on any investment we deem to have suitable risk-adjusted returns.

Giuliano Bologna, Analyst

That's insightful. Can you share how long you anticipate the CPR will stay at historic lows? Also, when do you expect the origination platform to become profitable and stop being a drain on servicing performance?

Michael Nierenberg, CEO

Regarding profitability for origination, we expect that to occur either in Q1 or early Q2. We've taken significant action on the retail side, leading to much better positioning now. Regarding MSRs, the trend will largely depend on housing turnover. We do not expect people to refinance current low rates unless affordability improves, leaving a gap in the housing transaction market.

Giuliano Bologna, Analyst

I appreciate the answers.

Michael Nierenberg, CEO

Thank you.

Operator, Operator

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

Bose George, Analyst

Thanks. I just had a follow-up on the gain on sale margin trend. In the last quarter, it looked like the margin was up for each of the channels. I was curious if we have seen a bottom in the markets or if reduced volume is prompting us to be more selective in engagement?

Nick Santoro, CFO

Bose, we did see margin improvement this quarter. Adjustments to prior quarter pull-through rates also impacted the margin observed during this period.

Bose George, Analyst

Could you explain the prior quarter adjustments?

Nick Santoro, CFO

Essentially, we estimate our pull-through adjusted margin when determining rate for a given quarter. If we perform better than our expectations, that influences margins positively.

Bose George, Analyst

Okay, great. Thanks very much.

Michael Nierenberg, CEO

Thanks, Bose.

Operator, Operator

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

Michael Nierenberg, CEO

Thanks, everybody, for dialing in. I look forward to updating you throughout the course of the quarter and on our next call. I appreciate the support for Rithm.

Operator, Operator

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