Rithm Capital - Q3 2023

Transcript

Operator (participant)

Good morning, ladies and gentlemen, and welcome to Rithm Capital Corp conference call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing star then zero on your telephone keypad. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. 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'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. With that, I will turn the call over to Michael.

Michael Nierenberg (Chairman, CEO, and President)

Thanks, Emma. Good morning, everyone. Thanks for joining us. Really exciting times for our company. From an earnings perspective and just overall operations in the quarter, a very, very solid quarter. Core business lines continue to perform extremely well. The positioning we put in place over the course of the past couple of years has continues to pay dividends as they create solid earnings, book value growth, and high levels of liquidity. We expect this to continue into the future with the Fed signaling higher rates for a longer period of time. The global macro backdrop for investing puts our company in a great place to take advantage of where we believe the markets are headed. As you know, we have been very vocal about repositioning the company into more of an alternative asset manager. Before I go there, I want to be clear.

The core business lines, which have gotten us to this point, are crucial to the future of our company. We believe Rithm 1.0, which is our existing core business, plus Rithm Private Capital, will be a huge lift for our investors, shareholders, and our employees. With the Sculptor announcement, we add great investment talent to our already terrific team. This expands our capabilities globally into all areas of credit, real estate, consumer, and other strategies that I'm sure we'll launch at some point here in the near future. We're also working on another transaction that, upon consummation, grows our asset management business to $50 billion of AUM. These transactions are transformational for us and continue our narrative towards being a leading global asset management business.

We are extremely excited by the prospect of growing our business in the private sector, and most importantly, adding partners who want to win with us and grow with us, as growing with our partners will increase revenue, earnings, benefit our shareholders, and our LPs who invest with us. At year-end, we estimate the following, that our business will look like this. Now, these are all projections. Assuming that everything closes and the deals happen, we'll have $50 billion of AUM in the asset management business, $7.2 billion of equity capital, a $35-ish billion balance sheet, and plenty of liquidity, with a bunch of new partners in the private capital business. Back to the core business. During the quarter, we announced the acquisition of SLS.

SLS is a mortgage company with $135 billion of servicing, of which $85 billion or so is true third-party servicing. Consistent with our rate view, this deal will bolster our servicing business, add capacity and clients in our third-party business, grow our special servicing business, and increase earnings. Our total servicing portfolio of investments, from a notional perspective, grows to $840 billion upon the settlement of the SLS deal. This includes mortgages that we service, investment in what we'll call excess MSRs, and legacy MSRs, which are serviced by others. To be clear, this is not a race for us about size. We care about servicing our customers and making money for our shareholders and LPs. Regarding the mortgage company, we continue to be vigilant on expense reduction initiatives, particularly in the origination segments.

We expect the origination business to remain under extreme pressure, with mortgage rates at 8%. So how do we think about this? It's great for our servicing business. As I pointed out, we have $840 billion on a notional basis of mortgage servicing assets. Lower prepayments equals one thing for our servicing business. That's more earnings and more cash flow. On the commercial real estate side, that space remains a very big focus of ours going forward. With no legacy assets and very attractive valuations, you could expect us to allocate more capital to this sector going forward. If you recall, we acquired GreenBarn, which was formerly known as Senlac/Normandy Partners, at the end of last year. Since then, we've made some opportunistic investments, and we'll continue to do so. Right now, we see the debt side extremely attractive.

There's so much more I could talk about, and we're really excited for our company and the prospects ahead. So what I'll now do is I'll flip to page three in our, in our supplement, and I'll take you through the deck, and then we'll take-- then we'll open it up for Q&A. Rithm, from an overall, focus standpoint, $35 billion of assets. After our dividend payment tomorrow, $4.9 billion of dividends paid in 10 years. $7.2 billion of book equity and a 23% total year-to-date shareholder return. When we look at our expertise, I would think of us as an asset management business in all areas of mortgage, real estate, and as we add, expertise around the house and credit, there's, there's no business line that we will-- that we shouldn't be in, number one.

Number two is there's no business line that we will be in unless we have the expertise in-house. The right side of the slide, powered by partnership. We want to deploy opportunistic capital. We want to create more partners. Now, this is a very different thing from where we grew the company in the public markets. As we go forward, again, we're going to grow more in the private markets 'cause our equity trades at a substantial discount to book, and we think it's a better opportunity for us to deploy capital in the private markets. Page four, just talking about our financial highlights in the quarter. GAAP net income, $193.9 million, or $0.40 per diluted share. Earnings available for distribution, $280.8 million or $0.58 per diluted share.

This includes a realized gain of $0.15 related to the sale of excess MSRs during the quarter. Dividend, $0.25. Cash and liquidity at the end of the quarter, $1.9 billion. Again, total equity of $7.2 billion. I do want to point out to the right side of the page here, the book value growth from the end of Q4 2020, which at that time it was $10.87, to where we are now, which is $12.32, in spite of the ten-year note rising from 91 basis points to the end of the quarter, where it was 460, to where today it's almost 5%. The evolution of Rithm, page five. You can see the company was started while we were all at Fortress in 2013. It began with $1 billion of equity.

Today, we have $7.2 billion of equity, and as you look at the timeline and you look at our acquisition pipeline, we've grown substantially over the years. Everything's been targeted around what I would call mortgage and real estate. The addition of the Sculptor transaction and some of the other things we're working on, will grow not only our real estate presence, but also our credit presence. And we look forward to continued growth as we go forward. Page six just talks about our private capital business. This is a slide you've seen before. The thing I want to point out on the right side of the page, private capital is going to help us generate recurring earnings and performance fees for Rithm shareholders, and also for the folks that we manage capital for on the at the LP level.

We want to create partnerships with investors through specific SMAs, co-investment, as well as the funds that we continue to work on and will continue to roll out. The other thing to point out is the business continues to benefit from all the work that's been done over the years as we've created our own in-house origination and servicing platforms, and those will continue to grow as we go forward. Page seven, the Sculptor transaction update. Obviously, a lot of press around that. We're super excited to bring this deal to a close and bring it in-house. You know, what I would say on this deal, there's very little to no overlap between Sculptor and our business, and we're super excited to get this thing wrapped up.

The expertise that we bring in-house is, in my mind, going to be second to none. If you think about it, our existing investment team, coupled with the Sculptor investment team, is going to create an asset management business that is going to be extremely formidable in the space. Page eight just talks about the SLS deal. Really what it is, is a servicing deal. There's very little on the origination side. The idea here is, again, it's not about so-called scale. This increases our third-party special servicing business to almost $200 billion. So it's a real fee-for-service business. The other thing, what it does for us, is it increases our capacity in the special servicing space.

So as we go forward and you think about the macro, the global macro picture, if the economy in the U.S. does slow down and there is a need for more special servicing, there's going to be nobody better than, you know, then call it Newrez in our business to take to work with homeowners and consumers around that. Commercial real estate, page nine. This really just talks about our expertise in-house. Currently, we have 25-30 investment professionals. As many of you know, we don't have any—we have not traditionally been a large player on the commercial real estate space, as the company was built more around the residential space and consumer side. With it, with...

The opportunity set that we see right now in the marketplace, extremely, what I would call robust, and having no legacy assets, we're extremely excited to grow that business and put up what I would call great returns for our shareholders and LPs. On the loan side, the residential whole loan side, keep in mind, as I pointed out before, our manufacturing capability in our mortgage company, as well as in our Genesis business, which provides loans to builders gives us, I think, a very, very good competitive advantage over just a traditional asset manager, as we're able to manufacture our own assets. When we look at, as we think about deploying opportunistic capital, the rate environment and the macro environment for what we do is probably. It hasn't been this good in probably 25 or 30 years.

I'm gonna take you through a slide in two, in two pages, which talks to where yield levels are. When you look at that and you think about unlevered returns of something between 8% and 12% on senior cash flow, we think it's a great time to deploy capital, and will continue to be a great time to deploy capital in the very assets that we manage money for. Page 12 just talks about a number of different strategies. I'm not gonna spend any time on this, but as we think about mortgage loans, servicing rights, commercial real estate, debt, et cetera, everything, not everything, but most things look very attractive to us.

Page 13, if you just have a look to the right side of the page, over the course of the past couple of years, look at the yield profiles on the different asset classes that we invest capital in. Everything, you know, not everything, again, but most things look extremely attractive to us. And as we raise more and more capital around our funds business, we're hopeful that we're gonna be able to generate what I would call real outsized returns in the asset classes that we have expertise in. And then finally, without. I'm not gonna take you through the, you know, the segment performance. You could have a look at that.

But, you know, I think the net of, of where we are as an organization is, we're a very different company than where we were a couple of years ago. We will remain, you know, true to our core business, the roots that got us here, but overall performance has been very, very good. And with that, I'm gonna turn it back to the operator, and we'll open it up for Q&A.

Operator (participant)

Thank you. We'll now begin the question and answer session. To ask a question, you may press star, then one on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star and two. At this time, we'll pause momentarily to collect questions.

Michael Nierenberg (Chairman, CEO, and President)

Okay, we're ready. Are there any questions?

Operator (participant)

Okay, the first question comes with Tim Chung with BTIG. Please go ahead.

Eric Hagen (Managing Director)

This is Eric Hagen from BTIG. Good morning. Hey, how are we doing, guys? All right, so I don't, I don't mean to be so short-term focused, but how, how have MSR valuations maybe trended in October? Are there any bulk packages, you know, maybe even some opportunities that you feel like could emerge between now and, like, year-end or, 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, here's what I would say on MSRs. We were—I think we were modest in how we thought about our gains in the quarter. As many of you know, we are biased short. You know, MSRs have negative duration. At some point, what you're gonna see is multiples being capped on what I would say is some of the legacy MSRs. So the short answer is modest, modest movement in marks. I think our weighted average MSR multiple is at 5.1 at this point. There's still room to go. We are still biased short, and we're gonna remain that way until we think the, you know, we see things change. You know, the Fed has signaled that higher for longer.

The economic data has been reasonably, you know, what I would say, okay to probably not as soft as the Fed would like to like it to be. So we're gonna, we're gonna stay the course. Regarding other packages, there's always gonna be things that come up. You know, as we all know, the banks, from a capital perspective, there's a lot of, you know, regulation and rules running around right now. The banks are... Nobody's really happy about it, you know, 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, you know, I just want to point out, as we think about capital deployment, we do things strategically where we think we're gonna earn 15%-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 gonna 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 (Managing Director)

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, what's, like, your tolerance level going forward as you look to Sculptor and you look, you know, at closing Computershare? How much headroom do you guys have and all that? Thanks.

Michael Nierenberg (Chairman, CEO, and President)

You know, cash, cash and liquidity at the end of the quarter was give or take, about $2 billion. I think that's increased a little bit as we go into Q4. Candidly, I think the, you know, the capital markets folks, you know, 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 to overlever 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 (Managing Director)

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

Michael Nierenberg (Chairman, CEO, and President)

Thanks, Eric.

Operator (participant)

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

Bose George (Managing Director)

Morning. I just wanted to follow up on the performance quarter to date. Just can you give... In terms of book value, can you just give us an idea where that is now?

Michael Nierenberg (Chairman, CEO, and President)

We reported book 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're biased short on our overall business. So depending upon what happens with rates here, you know, part of this calculus is, as a REIT, we have to hold agency mortgages. So you have a little bit of a basis thing from a whole pool perspective, depending upon what happens with the basis. You know, the basis today is as wide as it's been since the SVB crisis, and, you know, we expect that to remain under a little bit of pressure here with, you know, 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, you know, obviously mortgages are, there's a lot less supply that comes into play. The challenge is the banks are not really able to buy anything just based on where they are from a capital perspective. But, overall, you know, 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 (Managing Director)

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

Michael Nierenberg (Chairman, CEO, and President)

It's typically something around 60-65 kind of advance rates, what I would say. And right now, funding costs in and around, you know, certain things, depending on. You know, we have term funding, and they're likely around SOFR plus 250-ish. SOFR 250-300. The other thing is we have a bunch of term financing that's already existing on our MSR business, that's been outstanding for a few years based on capital markets issuance that we've done, which is lower, obviously.

Bose George (Managing Director)

Okay, great. Thank you.

Michael Nierenberg (Chairman, CEO, and President)

Thanks, Bose.

Operator (participant)

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

Kevin Barker (Senior Equity Analyst)

Great, thanks for taking my questions. I just wanted to follow up on, you know, the plans for Sculptor and the mortgage spin-off. You know, obviously, there's a lot of moving parts there, and, you know, there's different things that need to come into place. But ideally, how do you see this playing out as far as a timing perspective? And then how much capital you think will, will remain in the mortgage company? I know you addressed it previously, but just love to refresh there,

Michael Nierenberg (Chairman, CEO, and President)

Sure.

Kevin Barker (Senior Equity Analyst)

as all the, all that plays out. Thanks.

Michael Nierenberg (Chairman, CEO, and President)

So we have the S-1 on file. We continue to evaluate alternatives. As we all know, you 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 to try to figure out a way to recycle capital. I think one of the things we're going to do, you know, when you think about MSRs, for example, we're working on different funds, not necessarily just specific to 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 know, you have the origination business and the MSR side, you know, as rates—if rates do rally at some point in our careers going forward, you know, you want the folks that are deploying capital in these funds to be able to realize the, you know, 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, you know, I've been pretty vocal. We are going to, and I alluded to this in my opening comments, you know, 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 sleeve. So we're working on all of these things. The capital formation around our business is gonna 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, you know, how poorly I think REIT stocks trade.

But, you know, it's safe to say, based on our ambitions and where we're headed, and I think the progress that we've made, that we will be a real global alternative asset manager by the end of the year.

Kevin Barker (Senior Equity Analyst)

Okay, and so are there any specific points that we should look for to see that this is, you know, really has legs and we start to see, like, it really playing out? Is it, is it the S-1 on the, on the mortgage company or the closing of Sculptor, or is there certain particular points that you're looking for to really say this is gonna play out as expected?

Michael Nierenberg (Chairman, CEO, and President)

Sure. So I think Sculptor obviously is an important piece as we go into the asset, you know, grow our asset management business. I'd also say that, you know, we are an asset manager. We just operate under the wrapper of a REIT. Sculptor is very important in the asset management side. We're working on another, what I would call sizable, transformational transaction that we expect to get done by the end of the year as well, and that gets you on the asset management business to where we want. On the mortgage company side, it's you know, the cash flow that we get from that as a corporation or at the Rithm level is, you know, awesome.

So if you think about it, you look at our earnings for the quarter where, you know, $0.42 or whatever it is, plus $0.43, plus $0.15 for the excess. When I look at the mortgage company overall, and I look at our ROE, you know, and I look at where we were at minus, you know, the one-timers, I think actual return on equity for the quarter is something around net net 15%. Is that right? You know, on an annual basis, I think we're trending towards annual ROE about 30%.

So we're not looking to give up any of these assets because on a go-forward basis, in this rate environment, you know, the mortgage company will help, as well as all the other things that we have going, probably contribute to something between $0.35-$0.45, you know, run rate on our core business. We don't want to give that up. We just want to figure out a way to manufacture more capital at the cheapest basis, and then figure out how we can deploy that capital in what I would call today's great investing environment. But overall, you know, it's. We're not giving up on the mortgage company. Things that we're looking at are expenses.

We're looking at retail, clearly, you know, because that business really doesn't make any money right now when you think about true volumes and cost to run that business. But overall, you know, we're really happy with the asset that we have. We just have to figure out a way to generate more capital because we think the investing environment's that good. That's why we're running around the globe, quite frankly, on our private capital business.

Kevin Barker (Senior Equity Analyst)

Great. Thanks for all the color, Michael.

Michael Nierenberg (Chairman, CEO, and President)

Thanks, Kevin.

Operator (participant)

Thank you all very much. And with that, 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, in our company. Have a great day. Thank you.

Operator (participant)

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