Rithm Capital Corp.

Good day, and welcome to the Rhythm Capital fourth quarter and full year 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 touchtone phone. 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 Simmons. Please go ahead.

Thank you, and good morning, everyone. I'd like to thank you for joining us today for Rhythm Capital's fourth quarter and full year 2022 earnings call. Joining me today are Michael Nirenberg, Chairman, CEO, and President of Rhythm Capital, and Nick Santoro, Chief Financial Officer of Rhythm Capital. 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. 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'll be discussing some non-GAAP financial measures during today's call. 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 Michael.

Thanks, Phil. Good morning, everyone, and thanks for dialing in. 2022 was a transformational year for us in many ways. First on the markets, 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 wider by almost 200 basis points, and investment grade bond spreads wider by at least 25 basis points. Capital markets essentially shut down during different periods. We managed to grow our book value by 5% during 2022, generate a gap 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, Positioning the company in 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 at too large of a discount, in my opinion, to book, and we'll continue to do all we can to see us normalized towards book. During the year, in June, the company rebranded to Rhythm 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 Rhythm 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 23 and beyond. We will also be opening Rhythm Europe. Very excited about this. This will enable us to take advantage of dislocations in the EU and UK. This should happen in Q2, and I'm very excited about the what-if here. In December of 2022, we acquired a 50% stake in the private equity commercial real estate platform, formerly known as Normandy Partners and renamed as Green. This gives us real depth and expertise in conjunction with our rhythm employees to be opportunistic investors in the commercial real estate space, both on the debt and equity side. Regarding our operating business units, We right-sized our mortgage company, our G&A overall in the company, by over 50% year-on-year. We are now in the position to drive higher earnings as a result of the actions taken. Our MSR portfolios, which total $600 billion, have been fantastic, generating tons of cash flows into the higher-rate markets we've seen. We've been very vocal. We will not fight the Fed, and at this point, we will continue not to fight the Fed. Our average gross WAC on 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 our 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 23 and beyond. On the single-family rental space, our Adore business had a good year, as our occupancy rates continue to, or as our lease-up rates continue to increase. A couple things there. One is we've halted our acquisitions very early in the year with the expectation that home prices would decline and cap rates would increase. We are seeing that. However, transactions have been very slow. As we go forward in 2023, and with home prices at this point down approximately 10% from peak, We think that housing supply shortages, home prices being less affordable where mortgage rates are, will be back acquiring units at some point later in the year. As you can tell, a lot to do here. Super excited for our future and super excited for the growth prospects for our business. With opportunities in the market across many asset classes and companies, we look forward to putting up great returns for shareholders and our partners in the private credit business. I'll now refer to the supplement, which we posted online, and I'm going to open up on page three. Just a couple things here. On the Rhythm side, currently 70 full-time employees here in the offices in New York. Balance sheet is approximately $32 billion as of the end of the year, 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 XSMSRs. Today, if you look across the board, we have a number of different operating companies in financial services, whether it be on the residential side, the commercial side, making loans to builders. We have property preservation businesses. We have a single-family rental business, and we have title and appraisal. We're very, 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, page 4, gap net income, $81.8 million, or $0.17 per diluted share. Earnings available for distribution, $0.33 per diluted share, or $156.9 million. Our dividend is $0.25. Cash and liquidity at the end of the year was $1.4 billion. Today is $1.3 billion. That includes all the payments made to Fortress. Total equity, $6.9 billion. That's for Q4. Full year, gap net income, $864.8 million or $1.80 per diluted share. Earnings available for distribution, $633 million or $1.31 per diluted share. Total economic return, 14%. Gap return in equity, 15%. Earnings available for distribution, Return on equity, 11, and book value growth, 5%. End of the year at $12. Book value right now we're probably something between 11 and 3 quarters and 12. Page five, business highlights. Internalized the manager, rebranded to Rhythm Capital, launched our private credit business, bought 50% of the operating entity of Green Barn, and then we successfully right-sized our mortgage company. Very, very good year. A lot of work, a lot of hard work by the team across the board. Page six, the evolution of Rhythm, again, started in 2013 as a manager of or to acquire excess MSR rights. As we progressed through the past 10 years, we drove growth through many different business lines, including becoming operators of different business lines, a lot of what I would call large-scale M&As, where we bought Caliber, for example, in 2021 for book value. That was $1.6 billion. We bought Genesis Capital in 2021. That was $1.4 billion. Everything we do when we think about acquiring assets and or companies is around trying to acquire these assets at book value with a view towards real value in the underlying assets in the event that, for example, in the Caliber business, we see rates go up and the origination side go down. As we go forward, 2023 and beyond, the growth of our private funds business, we've been running around the globe a little bit, meeting with different LPs and look forward to really developing the private credit business as we think it's going to give us the opportunity to deploy capital more opportunistically when those situations arise. Page 7, Rhythm 2.0, operating companies, I pointed out on the left side, Investment portfolio, no surprise what we have going on there, plus our private capital business. I think it puts us in a very, very good place. And again, really excited about what the future looks like for our business. Page eight, the economic landscape. This year is going to be hard. I mean, the rate market is going to be a little bit more challenging than I think what we saw in 2022. 2022 is very clear. The Fed was going to keep their foot on the pedal and raise rates extremely aggressively. We saw, as I pointed out, Fed funds rise by 400-plus basis points. Bond yields back up, and we positioned the company extremely well going into that. As we look at this year, the yield curve continues to remain inverted. Big employment print on Friday. The consumer seems like they are in very good shape. And I think you're going to see a fair amount more volatility in the rate market this year. And where we are now is we're much closer to home than I think where we were a year ago. And we'll continue to monitor rate moves and at some point likely put on some mortgages and hedge out some of our MSR portfolios. Page nine, the rhythm playbook. Again, some of this is a little repetitive. The investment portfolio. We're going to continue to seek opportunities to deploy capital, not just to deploy capital, but they must be at good risk-adjusted returns. Monitor the credit performance of the existing portfolio. What happens if we go into recession? How do we think about our business to make sure that we're ready for that? Servicing and origination. The hard work that Barron and his team did in 22 is in a very different place, I think, as we enter 23 to be able to grow that business again. From an employee standpoint, we are right-sized right now and look forward to growing our business throughout the course of the year. Private capital business, again, really excited. Going to be a lot of hard work there and look forward to really growing a proper funds business. Genesis Capital on the building side, we're going to grow that business. We love 10% unlevered yielding assets on our balance sheet. Adore, the single-family business, again, we'll enter the market when we deem it appropriate. with higher cap rates and when we think HPA or HPD is kind of leveled off. And then on the commercial real estate side, we're going to be more opportunistic as we think about employing equity and or debt in that business. Page 11, just our experience. I'm not going to spend a lot of time on this across different asset classes. It ranges from residential mortgage loans to commercial real estate to consumer loans. Obviously, we've been involved in what I would call distressed debt situations, even buying the assets from DITEC out of bankruptcy. So a lot of experience and a great team that's in the office every day working their tails off to put up very good results for our shareholders. Mortgage company overview, page 12. You know, for the fourth quarter, $24 million in pre-tax income. What I would caution everybody as you look at these numbers, make sure if you compare us or other organizations to us, make sure you look at everything apples to apples. Nick Santoro, CFO, and Barron are happy to walk you through any of the math in and around that. Year-over-year decline in G&A down 53%. Unfortunately, with rates rising, headcount reductions were very aggressive for us in 22%. Hopefully we're done with that as we go forward. There are some interesting opportunities in the mortgage space around MSRs and other potential entities that we're currently working on as we go forward here. Focus on 23, profitability, customer retention, and that leads into our recapture business. Page 13, our servicing business, very, very strong business. Right now we have $500 billion that we currently service in-house. That doesn't include assets that we service with third parties, either on the rhythm side or in some of the legacy mortgage company stuff that we have on the excess side. As you can see, gain on sale margins, Q4, 1.81%. Big focus is on us. We've right-sized our retail organization. It's going to be driven, real earnings will be driven around, in our view, new home sales, which plays extremely well for the retail side. and then the recapture business around DTC. On the non-QM front, just to point out a couple things there, we continue to try to grow that business. Not the easiest business to grow. Our credit team is taking measures now in light of our expectations that home prices continue to come down a little bit to lower LTVs, which may make us a little bit less competitive in what I would call some of the higher risk products, which we're more than happy to be able to take these actions. Page 14, the MSR portfolio, $600 billion, 3.7 gross WAC. On the excess side, 4.4. On the excess side, those are legacy credit-impaired MSRs. Love where we sit here. A lot of cash flow. As I pointed out before, with our mortgage rates well north of 6%, we expect those portfolios to perform extremely well as we go forward. Thank you. MSR values, we took them down a little bit in the fourth quarter. Weighted average multiple is 4.9. We think that's a little bit on the conservative side. As you can see to the right side of the slide here, amortization is dropped from fourth quarter of 2020 from 30 CPR down to 5 CPR in the fourth quarter of 2022. Service advances, nothing to talk about here. We continue to monitor performance on the underlying homeowner. Effectively, year over year, everything's unchanged. Should we see a material pickup in delinquencies and or the need to fund service advances? Our capital markets team led by Sanjeev Khan has done a great job, not only now, but over the years, having plenty of capacity in that space. Just to frame something, going back, I think it was to like 14 or 15, we had 11 billion of capacity in the service or advance business. And as you look at this, there's really not much going on there. Genesis Capital, I pointed out before, a little under $2.5 billion of origination. Love the business. Love the coupons. Tightened up underwriting guidelines, and we expect some really good growth here as we go forward to 2023 and beyond. And then finally, on the single-family rental space, 3,700 units. We are small in what I would call a sea of big fish to the extent that we see cap rates at attractive levels and we are able to grow that business when we think home prices have leveled off, we will do so. We're not seeing a ton of opportunity there now and our main focus continues to be on getting assets released. Current lease rates are give or take about 96% right now and as we go forward, we're seeing rent growth in and around 4%. So with that, That's my wrap right now. I'll turn it back to the operator for Q&A, and let's open up the lines.