Rithm Capital Corp.

Good morning, and welcome to the Rhythm Capital second quarter 2022 earnings call. All participants will be in a listen-only mode. Should you need any assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, 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 now like to turn the conference over to Phil Sivan. Please go ahead.

Thank you, and good morning, everyone. I would like to thank you for joining us today for Rhythm Capital's second quarter 2022 earnings call. Joining me today are Michael Nirenberg, Chairman, CEO, and President of Rhythm Capital, Nick Santoro, Chief Financial Officer of Rhythm Capital, and Barron Silverstein, President of New Res. Throughout the call, we are going to reference the earnings supplement that was posted to the Rhythm Capital website this morning. 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 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 review the risk factors contained in our annual and quarterly reports filed with the SEC. In addition, we'll be discussing some non-GAAP financial measures during today's call. Reconciliations of these measures to the most directly comparable gap measures can be found in our earnings supplement. And with that, I will turn the call over to Michael.

Thanks, Phil. Good morning, everyone, and thanks for joining us. The second quarter was a period of extreme volatility. I'm very proud of our team as we navigated some of the most difficult markets we've seen in many years. We saw interest rates rise dramatically, credit spreads widen, and liquidity in the markets become challenged. We positioned our company for higher rates and our portfolios rose in value. As a result, book value increased to $12.98 from $12.56 before the internalization payment to Fortress. Our company, formerly known as New Residential, rebranded to Rhythm Capital and internalized its management contract. The result of that transaction will add approximately $0.12 to $0.15 in core earnings as we create synergies not only within the investment manager, but also in our operating business lines. In addition to our synergies, we've been very focused on our expense reduction and happy to announce that our expenses in our mortgage company have been reduced by half. Our approach to investing is that we don't need to be the biggest, we just want to be the best, deploying capital at times where we see real returns. If a division or sector will not yield great returns for our shareholders, we'll pivot and deploy capital elsewhere. A good example of this is how we reduced the capital in our origination business from approximately $2 billion at the time we closed the Caliber transaction to $650 million today. As we look at the financial services sector, we believe the next six to 12 months will provide us with the opportunity to deploy capital with teams-type returns, driving earnings higher and creating more value for shareholders. We'll be adding some great talent in business lines where we have not been as active in the past. As we think about capital, we've been very patient, as I pointed out earlier. We ended the quarter with $1.8 billion of cash and liquidity, and that number stands at roughly $1.65 billion today, and that's after a $200 million payment made to Fortress during the quarter. As we go forward, you'll continue to see the same discipline around investing, a terrific investment team, more diversification in our income streams, and hopefully higher earnings. I'll now refer to the supplement, which has been posted online. I'm going to start on page three. I'm going to get through this pretty quick, and then what we'll do is we'll open up for Q&A, because I think the important part of our presentation this morning is not what was, but where we're going on a forward basis. So when we look at our company, obviously we rebranded to Rhythm Capital, and I think that reflects our where we are today at the company, and also the desire to diversify away from more on the single-family residential side. Our portfolio of operating companies and assets put us in a very unique position that I think differentiates us from some of our peers in the marketplace. When we think about capital, we maintain higher levels of cash and liquidity on our balance sheet. That's done purposely as we look at the volatility in the markets, we think about funding, and with the Fed obviously in play in the uncertainty, we think we'll have the opportunity to deploy capital at higher ROEs. When we look at the single-family rental business, that's something that we've spoken about on prior earnings calls. We're currently up to 3,700 properties. And when we look at the housing market, with mortgage rates higher and housing starting to really slow down, we think we're going to be able to deploy capital at much higher cap rates. When we look at the landscape, We do think we're going to start seeing more pockets of opportunity, not only again in some of the traditional business lines that we've been in, but in other areas such as commercial real estate. Our track record is very, very strong. Since inception in 2013, our total economic return is 162% or 18% on an annual basis. Page four, our business overview. Just a little bit of the highlight reel. Since inception, $4.1 billion in dividends. At the time of 630, our dividend yield was 10.7%, $7 billion in net equity, $35 billion balance sheet, $600 plus billion of MSRs, a top five non-bank originator and servicer. With Genesis, we are an industry-leading business purpose lender. Our growth in the single-family rental business, we have complementary operating businesses, which are all listed on the bottom side of the right page. And again, our desire to enter other parts of the financial services business, which we'll talk about shortly. Page five, our highlights from a financial perspective. During the quarter, our gap net loss was $3.3 million. That reflects a one-time fee to the external manager to Fortress of $325 million. Earnings. $145.8 million in core earnings, or $0.31 per diluted share. Dividend, $0.25. Cash and liquidity, as I pointed out earlier, $1.8 billion. Net equity, $7 billion. Our book value, $12.28, but that reflects a $0.70 hit from the termination fee paid to Fortress. Page six, business highlights. June 17th, Rhythm announced the internalization of its management function. We're all part of what we'll call NUCO, Rhythm Capital. We do think, as I pointed out earlier, should add about 12 to 15 cents per diluted share in earnings for our shareholders. We'll see more synergies as we leverage the infrastructure across our entire ecosystem. The rebranding, I believe it's today, we trade as RITM on the New York Stock Exchange. We'll actually be ringing the bell on August 10th. We're very excited about that. And again, the rebrand to Rhythm, we think, just distinguishes our company from one, our mortgage company and New Res, but also it will reflect the diversified nature of our company as we go forward. Our focus on profitability is always there. I pointed out earlier, our run rate expenses are down by about 50% in the mortgage company. We'll continue to focus there. When you look at the mortgage company, for the most part, all the integration has already happened. And we continue to focus on ways to drive additional cost savings as well as increased revenue as we go forward. On the financial side, again, $1.8 billion, 99% of our portfolio is a non-daily mark-to-market. And then when we look at our business, we're totally focused on ROE and IRR and risk-adjusted returns. We reduced our equity in our mortgage and the origination side because, quite frankly, gain on sale is just not there. There's no reason to produce a unit that we don't think is going to make money for shareholders. Page 7 is really our strategic evolution. As you can see from 13, we started as an XSMSR owner to where we are today. We think we've made great progress, great job by the team, as we've gone from just being what I would call an asset owner into more operating business lines. Page 8. really just defines our ability or talks about our ability to manufacture assets. As I pointed out a minute ago, we're not just going to manufacture assets to do that because we're in the operating business. We're going to manufacture assets because we think the return on equity for shareholders is the reason why we want to manufacture assets. So, again, pointing out that the capital in the origination business has shrunk. We can take excess capital there and deploy it to other areas where we think the return in equity is going to be greater than that as it relates to just originating a mortgage loan. The macro environment, there's nothing surprising here. Inflation continues to be a multi-year high. We're starting to see a little bit of softening in some of the economic numbers that are coming out. The Fed, you know, 75 basis point back-to-back. We're expecting 50 in September and probably at least another 50 going forward. Obviously, the economic data is something that we continue to monitor. So how do we think about that? I pointed out earlier that we've been positioned for higher rates. To the extent that we believe the market will rally, we will start adding hedges to some of our portfolios. As it relates to our MSR portfolio, just to give you a sense, our gross WAC is 3.6%. So you're probably about 175 basis points out of the money at this point. And I'll talk a little bit about that in a bit. As we look at the housing market, you know, mortgage rates anywhere from five and a quarter to give or take five and three quarters right now. We do think we're going to continue to see the slowdown in the housing market. I think I am, and I'll talk personally, I'm a little bit more embarrassed than I think some of the analysts out there. I think when you look at housing, everybody's banking on supply, the lack of supply to keep housing at kind of what I would call these elevated levels or pricing at these elevated levels. Could be wrong, but I do think higher interest rates will lead to lower home prices. From a financing standpoint, Great shape on our financing side. What I would say there from a macro standpoint, all financing costs in the marketplace have increased. And when you look at the securitization markets, overall cost of funds have increased. When you look at some of our bank counterparties, some of the cost of funds have increased there as well. And again, we'll talk to that in a little bit. Second here, preview, patient approach to investment strategy. We started to deploy some capital at what I would call wider spreads here. We'll continue to do so. If you take a step back and think about our capital, $1.65 billion of cash today, let's assume that we deployed $1 billion even at a 12% kind of return. That's $120 million of net income on the year. So while we've been very patient on capital, we're going to start to look to opportunities to deploy capital. at what we think are some wider spreads here. Continued focus on profitability, MSR valuations. Just to talk to that for a second, we have slowed down our origination in our mortgage company pretty dramatically. Again, because I think we don't see the merit of what I would call real gain on sale there unless we increase our MSR multiples. So when you think about it, we have 600 plus billion of MSRs on our balance sheet. with a weighted average gross rack of 3.6 or 3.7, five-year season speeds about 11 CPR. When we take a step back, we say, okay, should we produce 6% coupon mortgage rates at kind of a five multiple, or should we just stay the course? And I think the general view is keep some extra capital. We could deploy capital at wider levels, slow down origination, until we get to a place where we think that the risk returns are warranted and we see gain on sale come back. So we've been very, very cautious there on the origination side. And I think as we go forward and we expand into other product areas, you're going to see the diversification of earnings from our company really hit its stride. Page 12, summary of our business segments, origination, servicing, MSR-related investments, We do have some real estate-related investments. The single-family business will grow. Again, we're very patient there. We've increased cap rates. Quite frankly, as a result of our increase in cap rates, our ability to source at higher cap rates has really slowed down. So we'll continue to monitor that because the market hasn't adjusted. Our loans, you know, remember we still have $76 billion of call rates. on the legacy mortgage market. They're currently out of the money. Any market rally should kind of bring that back in, and then other when we look at consumer loans and corporate. Page 13, our MSR portfolio. I'm not going to spend a ton of time on the next number of pages, but I hit the highlights. Roughly 60-month season, 3637 gross WAC. As you look at page 14, 11 CPR. Recapture rates are fine. Keep in mind, in a lower refi market, You're going to see less recapture because there's just less refinancing activity going on, and we still believe we're going to be in a purchase market, which lends credence to the caliber purchase franchise that we have there on the retail side. Page 15, single-family rental business. I pointed out 3,700 units. We're very thoughtful when we think about geographies, where we're going with this, Obviously, we'd like to see this grow, but we're going to be patient and we're going to deploy capital at higher cap rates unless the markets tell us otherwise. Page 16, Genesis, $1.3 billion of production in the first half. The business is performing extremely well. Robert Wassman and his team have done a great job there. We'll continue to spend a lot of time on that business, think about other areas where we can invest capital to grow the business. The way the company's performing isn't on track for the way we've underwritten, you know, the initial investment. Service Advance is not allowed to talk about their advance capabilities. They're extremely high, and advance balances are down and continue to remain lower as the consumer continues to perform. PGT, a mortgage company, pre-tax income $552 million. G&A expenses, I told you, you know, we continue to bring those down dramatically. A couple things to point out here. On the origination side, I think the way that we're trying to forecast this going forward is a flat pre-tax income number. As we go forward, you look in the quarter, we have a pre-tax loss of $26 million. $23 million of that is due to the legacy cleanup around some scratch and dent stuff on the caliber side. And then we're exiting some leases, and there's a little bit of severance there. But in general, if you take out these kind of one-time charges, and we hope they're one-time charges, the origination business is going to be run break-even as we go forward. As we look at the overall company itself, just to give you some metrics, when we did the caliber acquisition, the combined company had roughly 13,500 people. Currently, I think we sit, give or take, around 7,800 people today. So dramatic reduction in costs, trying to right-size for the existing environment. Origination business will run flat, and the servicing portfolio will continue to generate what we think are very good earnings. And then finally, on page 19 and 20, the origination and servicing business, I think, you know, Barron will talk to this, but when we look at gain on sale, we're starting to see a little bit of what I would call openings for higher gain on sale margins. We continue to work on there. We're very, very disciplined that we're not going to originate a mortgage loan that doesn't make money just to kind of substantiate revenue. So with that, I'll turn it back over to the operator. We'll open up for Q&A. And again, I think the big thing for us is where we are today. We have a great business. We're sitting on a lot of cash. Earnings have been very, very good. But I think where we go as Rhythm Capital is something that the team is extremely thrilled about and we're thrilled about as we strive to drive higher earnings for shareholders and continue to diversify around just the residential side of the mortgage market. So with that, I'll turn it back to the operator.