Rithm Capital Corp.

Good day, and welcome to the Rhythm Capital Third Quarter 2022 Earnings Conference Call. All participants will be in listen-only mode. Should you need 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 a touch-tone phone. To withdraw your question, please press star then two. Please note today's event is being recorded. I would now like to turn the conference over to Sil Sivan, Chief Legal Officer. Please go ahead.

Thank you, Operator, and good morning, everyone. I'd like to thank you all for joining us today for Rhythm Capital's third quarter 2022 earnings call. Joining me today are Michael Nirenberg, Chairman, CEO, and President of Rhythm, and Nick Santoro, Chief Financial Officer of Rhythm. Throughout the call, we are going to reference the earnings supplement that was posted to the Rhythm Capital website, www.rhythmcap.com, 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. Please 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 GAAP measures can be found in our earnings supplement. And with that, I will turn the call over to Michael.

Thanks, Phil. Good morning, everyone. Thanks for joining us today. As we are all aware, the investing environment remains challenging. Our messaging and approach in prior quarters has been to not fight the Fed. We remain biased to a higher rate environment with wider credit spreads. We will continue with this view until we feel like the Fed signals they will stop raising rates and or we see the economic data softening. Our goal is to protect our balance sheet, maintain book value, maintain higher levels of liquidity, and reduce expenses in our operating business lines while we drive consistent earnings and dividends for our shareholders. I'm proud to say today that with all the volatility that we've seen in the markets, our team and our company have done that. As we look at our company, we've been clear that we'll be looking to expand our investment strategies into other areas, and we're happy to announce the acquisition of 50 percent of CENLAC Rich Partners. CENLAC is led by David Welsh, who is one of the founders of Normandy Partners, a vertically integrated commercial real estate investment company. David and his team of 20 investment professionals have a great track record, and we will be focusing on all areas of commercial real estate, including debt, equity, as well as transitional lending opportunities. Working together with the Rhythm team, we will now have all the expertise and manpower we need to compete against anyone. We're also happy to announce the formation of a third-party fund business. This will enable us to raise callable capital in the private markets, investing capital opportunistically, creating value for both our shareholders and the LPs that we manage money for. As we look back at our quarter, our servicing book and our other lending business lines created consistent, sustainable earnings. Our origination segment was mixed as we took one-time charges related to severance, right-sizing the organization, leases, and some other items. As we look forward, we will continue to focus on efficiency in the mortgage company, marketing to our 3 million customers through our retail and DTC channels. We must be ready when the time comes that the future rate and spread environment create an opportunity to offer our customers savings and innovative solutions. Our Genesis business originated 600 million of loans in the quarter, mostly floating rate, high coupon loans. Genesis makes business purpose loans. The portfolio is 90% floating rate, and the average coupon is approximately 8.5% heading towards 10%. The loan portfolio today is 99 point something current. Any fixed rate exposure we have in that organization is hedged with interest rate swaps. As we think about the housing market, with home prices likely to continue a slight decline, we have lowered our LTVs and tightened our underwriting guidelines. On the single family rental business, ADORE, we stopped acquiring units with the belief that we will be able to deploy capital at higher cap rates as we go forward. There will be an opportunity for us to increase and acquire units as home prices decline and cap rates increase. There are more conversations that we're having today with builders and others than we've seen in quite some time. In summary, we're very excited for our future. While the environment remains difficult and will continue to be difficult, our experienced team has the tools and resources to continue driving shareholder value. Our entry into the third-party managed fund business is something that we're very excited about as we believe we'll be able to create additional value for our shareholders through fee streams and the partners that we manage capital for. I'll now refer to the supplements that we posted online. So I'm going to open on page three. And just a couple of highlights here. Book value quarter over quarter, essentially unchanged after taking into account the dilution on the warrants that we issued during COVID. Cash and liquidity, $1.8 billion. Again, we will maintain higher levels of cash and liquidity as we go forward until the markets settle down. On the operating company and the investment portfolio, we have $615 billion UPB of MSRs. The gross WAC is 3.7%. Most of these folks have seen the low in rates, you know, the weighted average maturity. These are about five-year seasons on average in our portfolio. Our MSR portfolio remains unhedged, and our positive duration assets across the company have been hedged for rate risk. We have $12 billion today. of custodial deposits, and as the Fed continues to increase rates in the short end, we will continue to see more interest income as it relates to those deposits. As we look at the credit of the environment or where we are with home prices, again, lowering LTVs at origination to protect from declining home prices and housing uncertainty. From a financing perspective, 100% of our portfolio away from the agency business has non-daily mark-to-market funding or financing. During the quarter, we priced two securitizations. And when you look at the experience that we have on the capital market side, we feel very good of where we are as it relates to our financing and where we're going to go on a forward basis. Page four, financial highlights. Gap net income $125 million, or 26 cents per diluted share. Again, book value unchanged quarter over quarter, despite the huge sell-off we've seen in rates and the big widening we saw in credit spreads. Earnings available for distribution, $153 million, or 32 cents per diluted share. Third quarter common dividend, 25 cents per common share. Cash and liquidity, as I pointed out, $1.8 billion. Total equity in the business, $7 billion. Page five, I'm not going to spend time on this. It's really just our evolution. Started in 2013 as an owner of MSRs, grew into different operating businesses. And as we go forward, you're going to see a shift as we morph more into what I would call an alt asset manager. Page six, Rhythm 2.0, the very same theme that we want to continue to highlight. Great operating companies on the left side of the page. Great investment portfolio. and now our entry into third-party managed capital. This is not new to us. During the Fortress days, we managed MSR funds, and as we think about the volatility in the markets, having callable capital at times that you think you have opportunistic investments is something that's very important to us as we drive more earnings for our shareholders. The housing market, page seven, just a graph or some charts to show about how we think about the housing market. We are bearish, just to be clear. We do think home prices will continue to come down. We do think there's going to be a floor due to supply and the good underwriting that's occurred over the course of the past number of years. And then finally, when you look at homeowners today that have locked in at lower mortgage rates, whether that be 2%, 2.5%, there won't be a need for folks to turn around and sell their homes. Page 8, how we're positioned in the current market. Inflation continues to rear its head. So what we're going to do, remain defensive. $1.8 billion of cash and liquidity, make sure all of our fixed-rate assets are hedged, and then at some point we'll pivot when the Fed signals that they're going to either slow down their rate increases and or we think that the mortgage basis will tighten. And right now we don't have that view, even though asset prices and yields we think are pretty attractive here. As we look at rates, our mortgage servicing rate portfolio will continue to benefit from rising rates. During the quarter, we took a modest mark, as you think about it in the context of the size of our servicing book, of $143 million. Housing market, I just spoke about the way we're going to be positioned there. We're going to look for a good entry point into the single-family rental space at higher cap rates. We expect rental demand to be strong. And we think the homeowner today continues to be strong and will remain strong. As we look at our financing costs and we think about where we are, we are seeing higher financing costs across all asset classes. We've de-risked our non-daily mark-to-market, as I pointed out before, with 100% of our portfolio non-daily mark-to-market away from the agency business. And from an investment team, we love our team. A lot of experience. We've seen the highs and lows, the good and the bad, and we feel like we're positioned and ready to go on any front. As I look at the different business segments, I'll rip through these pretty quick. One, I'm on page 10. When you look at our business, servicing, top mortgage servicer, We include $400 billion in-house of MSRs, and we have $91 billion serviced on behalf of other third parties. Clearly, we have some third-party relationships. Those include Cooper, LoanCare, and a couple others. Mortgage origination platform. You've heard Barron talk about all the different channels we have. We're very, very focused on efficiency in each and every channel, as the origination market is challenging and will continue to be challenging today. Our big focus is how do we become more efficient while growing our business. On the MSR front, there's nothing new there. On real estate securities, as we think about it, we have some very high coupon loans on our balance sheet. Our bond portfolio is modest as we think back to the way that we used to run the business and buying bonds for our call strategy. Right now our bond business is limited mostly to retained interest that we have from securitizations that we've done over the course of the past number of years, and those are all term funded with either our banks or in the capital markets. Single family rental business, again, we will grow that business. We currently have about 3,700 homes. It's north of 90% occupied, so it's up and running, but we are going to be extremely prudent on how we approach that business. We have been prudent, and we're looking for better entry points to deploy capital at higher cap rates. And then as we think about our business purpose loan business, which is the Genesis business, again, tightening LTVs, tightening credit standards, you're probably going to see less growth as we go forward until the housing market settles out. All of those loans have what I would call corporate guarantees from the sponsors. So it's not like we're making loans to every single mom and pop. Right now, that portfolio, for the most part, is all current. And as I pointed out earlier, coupons are going to migrate towards 10%. Mortgage company overview, $209.8 million of pre-tax income. That includes $131 million in the MSR mark. It also includes some severance, some lease termination fees, and some write-offs. That's the stickiness, or I shouldn't say the stickiness, that relates to some of the one-time charges we saw in the origination business. Servicing, $267 million of pre-tax income. The origination business, $57 million of a pre-tax loss. And in that pre-tax loss, there's probably about $20 to $25 million of one-time charges. As we go forward, continued focus on efficiency. Here's an important point to note. When you look at the time that we acquired Caliber, which was in It closed in August of 2021. We had approximately $2 billion of capital in the origination business. One of the things we're proud of is the ability to be portable with our capital. Today, that number is down to $493 million. And I bring that up because if the opportunity is there, we'll grow it. If the opportunity is not there, we'll allocate capital to what we'll call other higher-yielding strategies. Just on the caliber transaction, to give everybody a sense, closed August of 2021. The return on equity to date, including all the origination gains, losses, and MSRs where we booked at is a 29% IRR, just to give you a metric to point out. Gap pre-tax income, when you look to the bottom left part of the page, nine months of 2021, $587 million. with Caliber, $1.5 billion through 2022. And I've hit a bunch of the metrics on the right side of the page. Clearly, G&A on the bottom right is something that we continue to be focused on. To give you another sense from a headcount perspective, at the time of the closing of Caliber in 2021, there were 13,500 employees in the system. Today, unfortunately, due to the current market environment, that number is down to about 6,000 people. And as I pointed out earlier, we will be growing certain origination segments, including our retail divisions. We're going to look for opportunities to acquire platforms that we think could be accretive to our company. Page 12, our mortgage company activity. Again, there's no real secret in anything. Higher rates, declining origination volumes, servicing portfolio continues to perform extremely well focused on gain on sale margins. The one thing I would say is if you look at our MSR mark for the quarter, Q2, our MSR mark was 4.8 in aggregate. Today it's 4.88. So just a nominal increase. And I know when we get into Q&A, we're going to talk a little bit about that, but I just wanted to point that out. I'm going to skip the MSR portfolio. And then as we look at values, one of the questions that we always talk about is can MSR values go up? And the answer is they can. Our approach to this quarter with wider credit spread seen everywhere in the fixed income markets, including agency mortgages, we made a conscious decision to be prudent about our increase in our MSR multiple to widen our unlevered yield towards 9%. When we look at our MSR portfolio, again, five-year season, 3-7 gross WAC. We will be ready for recapture to the extent that mortgage spreads tighten and or rates stop going up. Amortization will continue to come down. Page 15, service or advances, not a lot to discuss there. The consumer performs extremely well. Advances are down 3% from June. Plenty of financing available. It's all term. And then finally, I'll just hit the last two pages, and then we'll open up for Q&A. Genesis. I pointed out $600 million of origination in the quarter. That business will likely slow down as we tighten up credit. 99.9% performing coupons gravitating towards 10%. And then finally, the single-family rental space, which I mentioned before. With that, we'll turn it back to the operator for questions. Operator?