Earnings Call Transcript - RITM Q2 2023

Operator, Operator

Good day and welcome to the Rithm Capital’s Second Quarter 2023 Earnings 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 now like to turn the conference over to Emma Bola, 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 second 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. 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.

Michael Nierenberg, CEO

Thanks, Emma. Good morning, everyone and thanks for joining us. As some of you heard last week, we pre-released earnings in conjunction with the announcement we were acquiring Sculptor. These are really exciting times for us, our shareholders, and our LPs. Our strategic measured growth in business lines where we try to create an edge is something we're very proud of. Since inception in 2013, when the company was formed by Fortress to take advantage of price dislocations created by higher capital requirements at the banks, we have executed on that plan and along the way, we grew and acquired a number of operating companies in the financial services space. Our mission is to continue to do the very same thing we've done for the past 10 years, drive value for shareholders and LPs with team-type returns. If you think about where we are in the cycle, interest rates are at some of the highest levels we've seen in over 20 years. Capital requirements in the banking system are heading higher. We are in a period of time where unlevered returns on most of the assets we invest in are between 8% and 12% on an unlevered basis. This period of time from an investment perspective is some of the best environments we have seen in years. The time is now. While we are a mortgage REIT, I like to think of us as an asset manager operating as a REIT. Yes, we do invest in all types of assets, both good REIT assets, and non-good REIT assets such as consumer loans and operating companies. Onto the Sculptor acquisition, this should be a great one for everyone: Rithm shareholders, Sculptor LPs, and all of our employees at both respective firms. It is truly transformational for all of us. The acquisition adds excellent investment expertise and broadens our overall mandate as we continue to produce results, drive higher AUM, and create more value for shareholders and LPs. The combined platform is powerful. We have a very strong capital base of over $7 billion in equity, we have a global investment business, and we have a balance sheet of over $30 billion. I'll now refer to the deck which has been posted online. The theme of this call from my perspective and our perspective is to talk a little bit about Rithm, who Rithm is. So I'm going to open with Page 3. We changed our slides a little bit just to talk again about Rithm and how the company has grown. Over the past 10 years, Rithm has become a real leader in the real estate and financial services sector. The company, which was launched in 2013 under Fortress Investment Group, was again set up to capitalize on investment opportunities in real estate and the financial services space. What was once solely a manager of mortgage servicing rights when the company was formed in 2013, Rithm has grown into a platform with a diverse and opportunistic portfolio that includes operating companies and a large investment portfolio. The company that started in 2013 with $1 billion of equity has grown to over $7 billion of equity. Along the way, we've distributed $4.7 billion of dividends to shareholders, and we currently manage a $34 billion balance sheet. Our recent activity during the quarter and subsequent to quarter-end has really accelerated our mission to become a leading global asset manager. And as we look back in time in June, while at Fortress, the management contract was internalized, and that goes back to June of 2022. In Q4 of 2022, Rithm launched its private capital business. In June of 2023, we acquired $1.4 billion of consumer loans from Goldman Sachs. During the quarter in June as well, we acquired 371 units in our single-family rental space business called Adoor from Lennar. In July, we announced the acquisition of Sculptor Asset Management, which is a $34 billion asset manager. We also agreed to acquire 200 units of newly built townhomes from a company called Dream Finders with equity capital from Rithm and debt provided by Genesis Capital. We continue to execute on our strategic plan, and we're well positioned for new stages of growth. The Rithm team here has worked together through many economic cycles that include the great financial crisis, and the COVID period, and we go back to the late 80s and early 90s, some of us. The Sculptor $34 billion asset manager complements Rithm's $7 billion of permanent capital, as well as our $30 billion-plus balance sheet. As we look forward, deal flow is significant, and the investment opportunities we're seeing are very, very attractive. We think that's going to continue to help us grow earnings and add value for again shareholders and LPs. Now on to the quarter: GAAP net income is $357 million or $0.74 per diluted share. Earnings available for distribution is $297 million or $0.62 per diluted share. In that number, there's a $0.20 gain related to the sale of excess MSRs during the quarter. Our dividend of $0.25 reflects a 10.7% dividend yield as of June, and our cash on liquidity at quarter-end is $1.8 billion, with total equity of $7.1 billion. Page 5 presents the Evolution of Rithm. I'm not going to take you through all of these, but again, the company was started at Fortress to acquire assets that we thought were very attractive due to higher capital rules and Basel III capital rules which were implemented on the banks. As you look from 2013 all the way out to 2023, the growth has been strategic, and the companies and assets we've acquired along the way have been core to our mission in the financial services space. The addition of Sculptor now is something that vaults us into becoming, hopefully, a leader in the space and growing not only the AUM but again staying very focused on the same things that got us here, which are results for our LPs and shareholders. Rithm’s experience across all asset classes, if you have a look at Page 6, just talks about the asset classes that we currently have on our balance sheet, the things that we do, and the things that we're going to continue to do as we move forward. Those include residential mortgage loans, single-family rental business, which is called Adoor, now having over 4000 units, our business purpose loan business, Genesis Capital, as well as our mortgage servicing rights portfolio, which continues to perform extremely well. We're currently near $600 billion there, and that has obviously helped us grow book value quarter after quarter as interest rates continue to rise. On the commercial real estate side, we have a co-investment with GreenBarn. We have no legacy office in any of our operating companies or investment portfolios with others. On the consumer loan side, we announced we bought $1.4 billion of loans from Marcus at Goldman Sachs, which was under the Marcus brand. If you go back, our experience in that business while at Fortress was in 2013, when we acquired $3.8 billion of loans from HSBC, which helped propel SpringCastle to grow into what is now known as One Main Financial under the Fortress umbrella. In 2017 or 2018, I believe we acquired Prosper, taking 35% for penny warrants in consortium with Soros, Third Point, and Jefferies. Around our securitized lending and structured products business, we have a balance sheet, and we do a ton of work in the securitization markets. Page 7 is a very important one. There's a lot of talk about bank regulations and higher capital needs in the industry. The one thing I would say about this is that typically what this creates—again, I'll refer back to 2013—this creates opportunities for asset managers to acquire assets at very attractive levels. We think we're in that period now, with the SFR or Fed funds in the mid-5s. If you think about anything, SFR plus something, you're again going to get to that 8% to 12% unlevered return spectrum. On the Sculptor deal on Page 8, I'm just repeating some of what I mentioned last week. It's an alternative asset manager with $34 billion of AUM as of July. The transaction was valued at $639 million, with $11.15 per share. All cash consideration for Sculptor Class A holders; the Class A unit holders are going to receive consideration in accordance with their operating partnerships, again, based on the $11.15 share price. Class A unit holders are expected to be offered the opportunity to elect to receive cash or new units in a Rithm subsidiary. From a financing perspective, the transaction will be funded with cash and liquidity on our balance sheet. Sculptor will operate as a separate business unit within Rithm, very similar to all of our operating companies. They'll continue to be led by Jimmy Levin and will report to me and our management team here at the Rithm level. From an earnings perspective, it will be neutral in 2024 and accretive in 2025. For Rithm, we expect to close in hopefully early fourth quarter. Page 9 presents the rationale for this acquisition, which is kind of more of the same. We've been vocal about our desire to broaden our reach and our scope, not just moving away from being a mortgage REIT, which we don't feel like. We want to differentiate ourselves in many ways in the REIT space. So this acquisition really vaults us and helps us grow in the alternative space. We've spent a lot of time over the past year running around the globe, meeting with different LPs. We are very excited about our prospects to continue to grow. Again, it’s not just about winning but more about driving higher returns for LPs and shareholders. Page 10 represents Rithm’s 2.0. I think many of you have seen this. Obviously, the difference when you look at this slide, the box of operating companies on the lower left side of the page is our investment portfolio. As we think about managing private capital, we're really excited about the growth prospects of our organization. I'll take you through quickly some of the results from the second quarter, and then we'll open up for some Q&A. On the mortgage company side, total pre-tax income for the quarter is $327 million. This includes a 19% pre-tax ROE and excludes our MSR mark-to-market in the quarter. From an origination standpoint, obviously, higher rates make for a tough origination market. Barron and his team have done a great job getting this back to breakeven to slight profitability in that space. The one thing I want to be clear with everybody, and I've echoed this many, many times, we don't need to originate a unit to originate a unit to do volume. We want to originate units that are core to our business, where we're doing something that is going to be profitable for our LPs and shareholders. So whether we do an extra $1 billion in origination in a channel or $1 billion less in the channel, we care about one thing, obviously, servicing our customers and driving profitability for our shareholders and LPs. When you look at the mortgage company activity and highlights for the quarter, the servicing portfolio is again around $600 billion. This includes both excess and full MSRs. We continue to move mortgage servicing rights from some of our sub-servicers back in-house, transitioning those under the new Shellpoint brand. There are a couple of portfolios that will continue to move, and that process continues. On gain on sale, it's a bit lower, but in general, with volumes coming off a little, you should expect that. Again, our core thesis is, we are not going to originate something unless it's profitable. As we look at our MSR portfolio, it's performing well, helping us grow book value, and there are a lot of earnings coming into this quarter. I would say there's not a ton to report there. One thing I would encourage everyone to do is have a look at recapture rates when comparing various mortgage companies that report, both us and others. For that, reach out to Nick Santoro, our CFO, or Barron on any of those questions. The current WAC for our MSR portfolio is 3.8%, encompassing all of the new items we are originating. On the Genesis business, we expect to do around $2 billion. I think performance has been stellar. We love the asset. Most of these things are SFR plus anywhere from 500 to 700 basis points. We’ve adjusted our credit box regarding underwriting, and members of her team are doing a commendable job. The consumer portfolio—I mentioned before—encompasses the SpringCastle assets under Fortress in 2013, Prosper in 2017, and now the Marcus loans. This really is an asset play, term-funded until a 15% cleanup call at the end. We expect returns there to be 15% to 20%. On the single-family rental space, we continue to grow. If you recall in prior calls, we had paused acquiring units until cap rates increased. We are now starting to acquire units in the build-to-rent space and in other areas with higher cap rates. We will continue to scale that business over time. Our stabilized occupancy is 95%. We still see some new rent growth and we're excited about the prospects, especially with rates, to continue to expand that business. Servicer advance is nothing to speak about. The underlying performance of consumer continues to be extremely strong, and we'll continue to monitor that. We have significant data on both the consumer side and the mortgage side. With that, I'll turn it back to the operator for some questions.

Operator, Operator

The first question today comes from Eric Hagen with BTIG. Please go ahead.

Eric Hagen, Analyst

Hey, thanks, good morning. Got a couple of questions here. I mean how do you think the valuations for other mortgage originators and servicers right now is sort of driving your thinking around the value you could pick up in a spin-off of the originator and servicer? And then just from a timing standpoint, at what point do you maybe run into issues with the REIT test from having Sculptor folded in here? Thanks.

Michael Nierenberg, CEO

So on the timing of the mortgage company, we announced that we filed a confidential S-1 on that. We continue to work hard with where mortgage companies are trading. I don't know that anybody trades at a significant premium at this point, and quite frankly, they don't. We just think the timing is right now with the scale and what the team has done around the new Res brand and the Caliber acquisition as well as all the other activities we've undertaken to bring this company out. I don't necessarily think we are going to turn around and just sell down the entire thing. I think it's more to give us flexibility, allowing for the emergence of a true operating company that’s listed, similar in some ways to what Fortress did with Nationstar and Mr. Cooper. So there's a similar kind of mindset around that. As it relates to your second question about the REIT test, Nick, sitting next to me, has a wealth of experience determining how to navigate things, whether it be in taxable REIT subsidiaries or other methods. Obviously, we have a fairly large agency mortgage book, which aids with the whole pool test. So we don't anticipate any issues. I do think over time you'll see an evolution of the company regarding our capital structure. I hinted at that last week. We’re still going to maintain a mortgage REIT. If you look at some of the well-run and larger alternative asset managers, they have REITs, a C Corp, and private funds. Think of us in the same light.

Eric Hagen, Analyst

Yes, that's helpful. Thank you very much. Diving into the portfolio a little bit—what do you feel like would take servicing valuations higher from here? How sensitive do you feel like valuations for MSRs are to an inverted yield curve? Do you feel like there's any upside for servicing fields curve were to steepen from here? Thank you guys very much.

Michael Nierenberg, CEO

I think on the MSR values, they're stable where they are. You have unlevered yields that I would say are anywhere from 8% to 10%. If you hold the belief that at some point down the road, although we don't foresee it this year, the Fed will cut rates. When short rates start coming down and better financing terms arise, I think the levered asset yield will enter the teens. That said, I don’t see a ton of upside in yield pricing in regards to the MSR asset right now. However, it is very stable cash flow. I was watching an interview this morning where someone was discussing the current landscape of fixed income assets decrease in value as rates rise, which is completely true. This is the one asset that does appreciate in value when rates rise. We are getting towards the upper end from a value standpoint. Keep in mind, new issue MSRs tend to have a 4-handle, so there’s room for growth there. Some of the legacy MSRs—those with the 3% gross WAC that originated during the COVID zero-rate days—will only prepay if we see housing turnover. Therefore, I think there's limited upside for us, but we are monitoring rates closely, and you're going to see us place more rate hedges against that asset moving forward.

Eric Hagen, Analyst

Thanks Michael, appreciate it.

Operator, Operator

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

Bose George, Analyst

Hey guys, good morning. Had a couple on Sculptor. First, is there any tangible equity coming with the transaction or is there goodwill equivalent to the purchase price?

Nick Santoro, CFO

We expect the tangible equity to be about $300 million to $350 million. There's approximately $200 million to $250 million in goodwill, Bose.

Bose George, Analyst

Okay, great, thank you. And then to the extent the Marcus deal was done after Sculptor closed, is that the kind of asset that could end up there going forward?

Michael Nierenberg, CEO

Yes, I think at this time both organizations are going to be run as separate entities. Obviously, the Sculptor deal is not closed yet. So Jimmy and that team will continue to lead their business, much like what we do at the Genesis level or within the mortgage company. Again, it’s a wholly owned and operated subsidiary, as I see it. Yes, the possibilities are endless. If you look at our balance sheet, you'll find that most alternative asset managers do not possess larger balance sheets. KKR does, but it’s a significant undertaking. Reviewing our balance sheet today, on the loan side, we notice a probable return of over 15%. Why shouldn’t we take that, work with our new partners at Sculptor, and place that into a fund? This would reduce our balance sheet, create capital, and more AUM—which theoretically would enhance earnings through our asset management business, which, in turn, will likely be valued significantly higher than the normal valuation of our earnings at the REIT level.

Bose George, Analyst

Okay, that makes sense, thanks. And then just rates are up a bit since you guys preannounced, just wondering if we could get just an update on book value?

Michael Nierenberg, CEO

I would assume it's in and around about the same at this point, around $12 to $12.25, something in that range. I don't think there's any material movement for us right now.

Bose George, Analyst

Okay, great, thanks.

Michael Nierenberg, CEO

Thank you.

Operator, Operator

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

Douglas Harter, Analyst

Thanks. What is the timeframe that you expect to see additional assets kind of come available from the banks, from regulatory changes, and do you think you'll be kind of up and running with third-party capital to take advantage of that?

Michael Nierenberg, CEO

I think the answer is we're seeing it now. Obviously, the Marcus loans; Goldman made a decision to exit that line of business, and clearly, with several of our relationships we took advantage of that. I would tell you our pipeline of investments—whether they are company investments or asset investments that we're engaged with—is quite significant right now. It’s imminent. News updates as we chat show that the ADP number from an employment standpoint is well above expectations this morning. With the employment report tomorrow, we might see rates increase, and we are observing that. As we move forward and think about capital from a third-party standpoint, not only do the Sculptor folks have a significant capital formation team, we anticipate that they will be able to leverage that to grow AUM. Observing what we've achieved on the Rithm side—with my colleagues, there appears to be plenty of capital that can be partnered with us to benefit from these opportunities now.

Douglas Harter, Analyst

Great. And then just on the Marcus deals, I was wondering if you could provide more detail regarding the price paid for those loans?

Michael Nierenberg, CEO

I don't think we disclosed it. Did we disclose it? Did Goldman disclose it?

Nick Santoro, CFO

We did not.

Michael Nierenberg, CEO

Yes. I would say it's a discount to par term financing essentially with a 15% to 20% return and roughly a 10% coupon with higher FICO borrowers.

Douglas Harter, Analyst

Okay, appreciate it.

Michael Nierenberg, CEO

Thanks Doug.

Operator, Operator

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

Giuliano Bologna, Analyst

Good morning and congratulations on a great quarter. Maybe going along these similar lines to some of the other questions, I'd be curious over time now that you'll potentially have Sculptor in a number of months under the Rithm umbrella, is there a focus on shifting more of the AUM to externally managed? Obviously, you’re discussing possibly doing an IPO as part of the mortgage company and pushing more assets potentially into different fund vehicles. Is there a general sense of what your capital allocation should look like going forward? Do you want the Rithm side of the equation to be smaller from an AUM perspective and then continue to grow the asset management side at a much higher rate?

Michael Nierenberg, CEO

Yes. I think asset management businesses tend to receive value. One of our strategic goals is to raise third-party AUM, and we have been very clear about that. The Sculptor acquisition assists us in that endeavor under that umbrella. Last week in our announcement, we were clear that we're not going to issue equity here—we don't intend to—when we're trading at book values of $12.25, and our stock is around $10; we aren't going to issue equity here. Thus, based on that and the opportunities for investment that we see today and going forward, we aim to engage with third-party LPs and develop our business away from our existing balance sheet from a capital perspective and in third-party markets. That is our trajectory. If we succeed in this effort, which I believe we will, and considering the successful capital-raising strategies of larger asset managers, we will likely succeed, leading to a significant increase in equity valuation, which is our goal: to enhance equity valuation for shareholders, while driving real results for both LPs and shareholders.

Giuliano Bologna, Analyst

That sounds great. And then thinking about the—you obviously mentioned there's a strong pipeline of opportunities. When you're examining opportunities at this point, are you more focused on assets, or are there other operating platforms you could add that would be accretive or related to the other assets that you're involved in at the moment?

Michael Nierenberg, CEO

I would say both. We want to pursue endeavors where we believe we have a reasonable edge or where we could create value. If we can identify assets with 15% to 20% returns in today’s interest rate environment, we’ll aim to act quickly. Right now, that's where we are. So whether it’s an operating company we're assessing or a cheap pool of assets, we will consider both.

Giuliano Bologna, Analyst

That’s great, thanks for answering my questions, and I will jump back in the queue.

Michael Nierenberg, CEO

Thank you.

Operator, Operator

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

Trevor Cranston, Analyst

Hey, thanks, good morning. One more on the Sculptor deal. When you guys talk about it being neutral to earnings in 2024 and accretive in 2025, can you sort of take us through what makes it accretive in 2025, and if there are any assumptions that are built into that in terms of AUM growth or anything like that? Thanks.

Michael Nierenberg, CEO

Yes. I think we're not assuming a lot of AUM growth. I think it comes down to some of the existing results in the portfolio investments today and when they're realized. The expectation is that 2024 and 2025 should be good years for realizing several of the results from earlier investments made. The Sculptor team has some fantastic business lines, and as we begin to witness results from previous investments, I believe we will see a significant uptick. When you take a step back and consider the valuation of the company and the relationship we have assessed, knowing Jimmy for probably over a decade, that platform and the capability of driving results for LPs is quite substantial, and that honestly excites us about this acquisition. We can’t look at everything as a day-one aspect; we need to maintain a long-term vision while building business lines, and I think that’s something we have excelled at.

Trevor Cranston, Analyst

Sure, okay, appreciate that. Thank you.

Operator, Operator

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

Kevin Barker, Analyst

Thank you. Just in relation to the S-1 that you filed, within the mortgage company, are you including all of the origination and servicing segments, including the servicing segment and the MSR related investments, or would that be broken up as well whether it's in the mortgage REIT or in the mortgage company?

Michael Nierenberg, CEO

It's likely going to entail most but not all assets or MSRs that will be incorporated because some are held at what I would call the Rithm level, while some may remain within NRM. But I get it — it's one of those TBD matters as we proceed.

Kevin Barker, Analyst

And then you discussed having a mortgage REIT as well and possibly the asset manager, right, and obviously with the Sculptor deal. Would the mortgage REIT basically have all the real estate securities and the property and residential mortgage segments you have existing now, or would there be other segments embedded within the mortgage REIT?

Michael Nierenberg, CEO

I think it's to be determined. You could draw comparisons to what Blackstone has done with BXMT, which is a commercial REIT. The way we're envisioning it likely mirrors that path. However, there’s much work ahead from a capital structure standpoint. What I want to emphasize on this call is we will still maintain a substantial mortgage REIT. The asset management business will evolve. We'll probably have a C Corp, and from a structural standpoint, we just want to determine a way to enhance; one is our share price, and two, enabling AUM growth, which will hopefully drive it significantly higher.

Kevin Barker, Analyst

Okay. And then this quarter, you were pretty—you were selling MSRs, you obviously deemphasized those.

Michael Nierenberg, CEO

We didn't sell any MSRs. We just did an excess trade.

Kevin Barker, Analyst

It was an excess trade, okay. Do you anticipate doing several more of those in order to?

Michael Nierenberg, CEO

Likely—yes, there will be more coming up, whether it's this quarter or next, I just don't know, but there will be more excess MSR deals executed.

Kevin Barker, Analyst

Okay, thank you.

Michael Nierenberg, CEO

Thank you.

Operator, Operator

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

Michael Nierenberg, CEO

Thanks for joining us this morning. Have a great rest of the summer. Appreciate the support. Super excited about where we are as an organization, and let’s go.

Operator, Operator

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