Rithm Capital Corp.

Good day, and welcome to the Rhythm Capital second quarter 2023 earnings conference call. All participants will be in a 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, this event is being recorded. I would now like to turn the conference over to Emma Bula, Associate General Counsel. 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 2023 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 this morning to the Rhythm Capital website, www.rhythmcap.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. And with that, I will turn the call over to Michael.

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 are 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 this very same thing we've done for the past 10 years, drive value for shareholders and LPs with teams 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 20 plus years. Capital requirements in the banking system are headed 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 read assets and non-good read assets, such as consumer loans and operating companies. On to the sculptor acquisition. This should be a great one for everyone. Rhythm 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 $7-plus billion in equity. We have a global investment business, and we have a $30-plus billion balance sheet. 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 Rhythm, who Rhythm is, So I'm going to open with page three. We changed our slides a little bit just to talk again about Rhythm and how the company has grown. Over the past 10 years, Rhythm has become a real leader in the real estate and financial services sector. The company, which was launched in 2013 under the Fortress Investment Group, was again set up to capitalize 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, Rhythm has grown into a platform with a diverse and opportunistic portfolio that includes operating companies and a large investment portfolio. The company, which was 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. As we look back in time, in June, while at Fortress, the management contract was internalized, and that goes back to June of 22. In Q4 of 22, Rhythm launched its private capital business. In June of 23, we acquired a billion four 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 Adore from Lenore. 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 Rhythm 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 Rhythm team here has worked together through many economic cycles. That includes the great financial crisis, that includes the period of COVID, and we go back to the late 80s and early 90s, some of us. The scope to $34 billion asset manager complements Rhythm's $7 billion of permanent capital, as well as our $30-plus billion balance sheet. As we look forward, deal flow is significant. The investment opportunities we're seeing are very, very attractive, and we think that's going to continue to help us grow our earnings and add value for, again, shareholders and LPs. Now on to the quarter. Gap net income, $357 million, or 74 cents per diluted share. Earnings available for distribution, $297 million, or 62 cents per diluted share. In that number, there's a 20-cent gain related to the sale of excess MSRs during the quarter. Our dividend, 25 cents, which reflects a 10.7% dividend yield as of June. Our cash and liquidity at quarter end, $1.8 billion. Total equity, $7.1 billion. Page five, the evolution of rhythm. 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 as a result of 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. The companies and assets we've acquired along the way have been all core to our mission, which is in the financial services space. And the addition of Sculptor now is something that really vaults us into hopefully becoming a leader, more of a leader in the alt space and growing not only the AUM, but again, staying very focused on the same things which got us here, which are results for our LPs and shareholders. Rhythm's experience across all asset classes. If you have a look at page six, we just talk on this page, The asset classes that we currently have on balance sheet, the things that we do and the things that we're going to continue to do as we go forward. So those include residential mortgage loans, single-family rental business, which is called Adore, which now has over 4,000 units, our business purpose loan business, which is Genesis Capital, our mortgage servicing right portfolio, which continues to perform extremely well, We're currently in and around $600 billion there, and that's obviously helped us grow book value quarter after quarter as interest rates continue to rise. On the commercial real estate space, we have an investment, co-investment with GreenBarn. Obviously, we're doing some stuff with Genesis Capital. And one thing I want to point out, we have no legacy office in any one of our either operating companies or investment portfolios with others. On the consumer loan side, I announced we bought $1.4 billion of loans from Goldman Sachs, which was under the Marcus brand. If you go back, our experience in that business while at Fortress was in 2013, we acquired $3.8 billion of loans from HSBC, and that was really the growth which helped propel Springcastle to grow into what is now known as one main financial under the Fortress umbrella. In 2017 or 18, I think it was, we acquired Prosper. We acquired 35% of Prosper for penny warrants, and we did that in consortium with Soros, Third Point, and Jefferies. And then around our securitized lending and structured products business, obviously we have a balance sheet and we do a ton of work in the securitization markets. Page seven, I think, is a very important one. There's a lot of talk, obviously, in the industry about bank regulations, higher capital needs. The one thing I would say about this, typically what this does, and again, I'm going to refer back to 2013, so I'm trying to put some history in here. This creates opportunities for asset managers to acquire assets at very, very attractive levels. We think we're in that period of time. You know, with SOFR or Fed funds in the mid fives now, If you think about anything, SOFR plus something, you're going to get, again, to that 8% to 12% on leverage return spectrum. On the Sculptor deal on page 8, again, just repeating a little bit from last week, Alternative Asset Manager, $34 billion of AUM as of July. The transaction was valued at $639 million, $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 1115 share price. Class A unit holders are expected to be offered the opportunity to elect to receive cash or new units in a rhythm 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 Rhythm, 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 Rhythm level. From an earnings perspective, neutral-ish for 24 and accretive in 25 for Rhythm, and we expect to close in early, hopefully early fourth quarter. Page 9, you know, the rationale for doing this is kind of more of the same. We've been pretty vocal about our desire to broaden our reach and our scope, not just as a, you know, away from just being a mortgage REIT, which we don't feel like. We want to differentiate ourselves in many respects in the REIT space. So this acquisition really vaults us and helps us grow in the alt space. We've spent a lot of time over the course of the past year running around the globe meeting with different LPs. We're very, very excited about our prospects to continue to grow. Again, not just AUM, but more to drive higher returns for our LPs and shareholders. Page 10 is this Rhythm 2.0. I think many of you have seen this. Obviously, the difference when you have a look at this slide, The box of operating companies on the lower left side of the page, our investment portfolio, and then as we think about managing private capital, we're really, really excited about the growth prospects of our organization. I'll take you through quickly on 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, $327 million. This includes a 19% pre-tax ROE, and that excludes our MSR mark-to-market in the quarter. From an origination standpoint, obviously higher rates, tough origination markets. Barron and his team have done a great job getting this back to break even to slight profitability in that space. The one thing I want to be really 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 to that a quarter of our business where we're doing something that are going to make money for our LPs and shareholders. So whether we do an extra billion dollars in origination in a channel or a billion dollars less in a channel, we care about one thing, obviously servicing our customers and then driving profitability for our shareholders and LPs. When you look at the mortgage company activity and highlights for the quarter, servicing portfolio again in and around $600 billion dollars. This includes both excess and full MSRs. We continue to move mortgage servicing rights from some of our subservicers back in-house. That goes under the New Res slash Shell Point brand. There's a couple portfolios that will continue to move, and that continues to go on. On gain on sale, a little bit lower, but in general, obviously, with volumes coming off a little bit, you should expect that. And again... Core thesis for us, we are not going to originate something unless it's profitable. As we look at our MSR portfolio, doing terrific, helped us grow book value, a lot of earnings coming into the quarter. I would say there's not a ton to report there. One of the things I would encourage everybody to have a look at when you look at recapture rates or you look at Apple, all the different mortgage companies that report, whether it's us and or others, Look at apples to apples. If you have any questions on that, I'd tell you to refer to Nick Santoro, our CFO, or Barron on some of those questions. MSR portfolio, right now the WAC is 3.8%. That includes all of the new stuff we originate. Average market in and around a five multiple, just to give you for context. On the Genesis business, we expect to do in and around $2 billion, I think, this year. Performance has been great. We love the asset. You know, most of these things are SOFR plus, anywhere from 500 to 700 with points. We've tightened up our credit box when we think about from an underwriting perspective. And Clint Arrowsmith and that team are doing a great job. Consumer portfolio, I mentioned before. I mentioned the Spring Castle stuff. That was under the Fortress umbrella in 2013, Prosper in 2017, and now the Marcus Loans. Really, it's an asset play, term-funded, you know, up until there's a 15% cleanup call. At the end, we expect returns there to be 15% to 20%. On the single-family rental space, continue to grow. If you recall, in prior calls, we had stopped acquiring units for until cap rates increase. We're now starting to acquire units, whether it be in the build-to-rent space and or other areas with higher cap rates. We'll continue to grow that business over time. Obviously, you need to have scale in that business, and we continue to work towards doing that. Our stabilized occupancy in that area is 95%. We still see some new rent growth, and we're excited about the prospects with where rates are to continue to grow that business. Service or advance is really nothing to speak about. The underlying performance of the consumer continues to be extremely strong, and we'll continue to monitor that. Obviously, we have quite a bit of data there, both on the consumer side and on the mortgage side. With that, I'll turn it back to the operator for some questions.

We will now begin the question and answer session. To ask a question, you may press star then 1 on your touchtone phone. If you are 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 then 2. At this time, we will pause momentarily to assemble our roster. The first question today comes from Eric Hagan with BTIG. Please go ahead.

Hey, thanks. Good morning. Got a couple 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 retest from having Sculptor folded in here? Thanks.

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. um, with the scale and, and what, you know, the team has done around the new res brand and obviously the caliber acquisition and all the other stuff we've done there, uh, to bring this company out. Um, I don't, I don't necessarily think that we're going to, you know, turn around and just sell down the entire thing. I think it's more to give us flexibility, have a, have a true, um, operating company that's, that's listed similar in, in ways to what, uh, what Fortress did with, you know, back then, NationStar and Mr. Cooper. So a similar kind of mindset around that. As it relates to your second question, which, you know, from a good read test, you know, Nick's sitting next to me, you know, we have a ton of experience around how to navigate things, whether it be in taxable REIT subsidiaries and other ways, Obviously, we have a fairly large agency mortgage book, which helps 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 in our capital structure. I alluded to that last week. The one thing I would tell from an analyst perspective, we're still going to have a mortgage rate. If you look at some of the some of the best-run and larger alternative asset managers. They have REITs. They have a C-Corp. They have private funds. I think you should think of us in the same light.

Yep, that's helpful. Thank you very much. Thank you. Diving into the portfolio a little bit, I mean, what do you feel like would take servicing valuations higher from here? Like, 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 if the yield curve were to steepen from here? Thank you guys very much.

I think on the MSR values, they're fine where they are. You know, you have unlevered yields, I would say, anywhere from 8% to 10%. If you do have a view that at some point down the road, and we don't have this view that in, you know, this year that the Fed's going to cut rates, when short rates start coming down and you see better financing terms, I think the levered asset yield will be, you know, in the teens. While saying that, I don't doing this for a long, long time. I don't see a ton of upside in yield in pricing in the MSR asset right now, but it is a very, very stable cash flow. I was watching an interview this morning about somebody talking about where we are and fixed income assets going down in value as rates rise, which is absolutely true. This is the one asset that does go up in value when rates rise. I do think we're getting towards the upper end of a value standpoint. Keep in mind, you know, new issue MSRs or whatever, a four-handle, I think, from a value standpoint. So there's room for those to go. Some of the legacy stuff that, you know, with the 3% gross WAC that were originated during the, you know, the days of COVID when rates essentially went to zero will only prepay if you see housing turnover. So I think there's limited upside for us, you know, we're monitoring where rates are and, you know, you're going to start to see us put more rate hedges on against that asset as we go forward.

Thanks, Michael. Appreciate it.

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

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

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

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?

Yeah. You know, I think at this time, you know, both organizations are going to be running separate organizations. Obviously, the Sculptor deal is not closed. So Jimmy and that team will continue to lead their business, no different than what we do at the Genesis level or the mortgage company level. Again, it's a wholly owned operating sub is the way that I view that. Yeah, I mean, the possibilities are endless. I mean, the one thing I would say is you look at our balance sheet, you look at most alternative asset managers don't have larger balance sheets. I think KKR does. But there's a lot of work. you know, to be done here. If you look at our balance sheet today, you know, on our loan side, we look at our loan book and I think where that's carried is probably a 15 plus percent return. You know, why should we not take that, work with our, you know, our new partners at Sculptor and drop that into a fund? It would reduce our balance sheet. We'd create more, we'd create some capital and we'd create, you know, more AUM And then we drive more earnings through our, you know, asset management business, which theoretically those earnings are going to get valued significantly higher than the way our earnings get valued at the REIT level.

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.

I would assume it's, you know, in and around, what, the same at this point? You know, 12, 15 to 12 and a quarter, something in that range. I don't think there's any material move for us right now.

Okay, great. Thanks.

Thank you.

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

Thanks. What is the timeframe that you expect to see, you know, 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?

I think the answer is it's, you know, we're seeing it now. Obviously, the Marcus Loans, Goldman made a decision to get out of, you know, that line of business. And clearly, with a number of our relationships, we took advantage of that. I would tell you our pipeline of investments, whether it be company investments and or asset investments, that we're working on is pretty significant right now. So it's here. It's now. You know, you look at, I'm just looking at some news feeds as we're chatting here. You know, the ADP number from an employment standpoint is well above expectations this morning. You got an employment report tomorrow. So that will likely move rates higher, and we're seeing that. As we go forward and think about capital from a third-party standpoint, Not only on the – and listen, the Sculptor folks have a pretty significant capital formation team, and hopefully with this transaction we will be able to – or the Sculptor team will be able to leverage that and grow AUM. I look at what we've done on the Rhythm side and kind of my travels through this year with some of my other colleagues here. I think there's plenty of capital to be partnered with us to take advantage of this stuff now.

Great. And then just on the Marcus deal, I was wondering if you could give us a little more detail about kind of the price paid for those loans.

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

We did not.

Yeah. What I would say is it's a discount to par term financing, essentially, with a 15% to 20% return and roughly a 10% coupon. you know, with higher FICO borrowers.

Okay. Appreciate it.

Thanks, Doug.

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

Good morning. Congratulations on a great quarter. Maybe similar to some of the other questions. I'd be curious over time, you know, now that you'll potentially have Sculptor, you know, in a number of months here under the Rhythm umbrella, Is there a focus on shifting more of the AUM to externally managed? Obviously, you're talking about potentially doing an IPO as part of the mortgage company and pushing more assets potentially into different fund vehicles. Is there a general sense of kind of what your capital allocation should look like going forward or if you want the rhythm side of the equation to be smaller from an AUM perspective and then continue to expand the asset management side at a much higher rate?

Yeah, I think asset management businesses get value. One of the strategic things for us is we want to raise third-party AUM, and we've been very, very clear about that. The Sculptor acquisition helps us do that under that umbrella. Last week in our announcement, we were pretty clear we're not going to go out and issue equity here, or we don't intend to anyway, when we're trading at you know, book values, you know, 12 and a quarter, whatever that number is in our stock trades in and around 10 bucks, we're not going to issue equity here. So based on that and the opportunities for investment that we see today and going forward, it's our desire, uh, to, to work with third party LPs and grow our business away from, um, our existing balance sheet, you know, from a capital perspective and in third party markets. And that's, you know, that, I mean, that's, that's where we're headed. If we're successful in doing that, which I believe we will, and you look at some of the larger asset managers and how they've raised capital, we're going to be very successful and our valuation on our equity should go significantly higher. And that's really what the goal is. It's to improve our equity valuation for shareholders and continue to drive real results for LPs and shareholders.

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

I would say both. We want to do things where we think we have a reasonable edge or where we could create value If we could do things that are 15% to 20% returns in today's interest rate environment, I think we're going to try to pounce on that and seize that. And right now, that's kind of where we are. So if it's an operating company and we're working on some of those now, or it's a cheap pool of assets, we'll look at both.

That's great. Thanks for answering my questions, and I'll jump back in with you. Thank you.

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

Hey, thanks. Good morning. One more on the Sculptor deal. When you guys talk about it being neutral to earnings in 24 and accretive in 25, can you sort of take us through – you know, what it is that makes it a creative in 25 and if there's any sort of assumptions baked into that in terms of AUM growth or anything like that. Thanks.

Yeah, I think we're, we're not assuming a lot of AUM growth. I think it's, it's comes down to, uh, some of the results that are already existing in there, um, in the portfolio of investments today and when they're realized. So, um, the expectation is that 2024 and 2025 should be good years for realizing a number of the results as a result of prior investments made. The Sculpture team has some great, great business lines. And as we start to see results come through from earlier investments, you're going to start to see, I think, a good pop. And I think when you take a step back and look at the valuation of of the company and kind of how we valued it and think about the relationship there. And I know Jimmy for probably 10 to 12 years now, or actually more. You know, that platform and the ability to drive results for LPs is pretty significant. And that's what gets us really excited about this acquisition. We can't look at everything like a day one thing. You know, we do have to have a vision ahead. as we build business lines, and that's one of the things that I think we've been very successful at and on doing. You know, you take a step back and you look at, you know, and one of the reasons I wanted to give a little bit of revisionist history on the Fortress side, you know, you go back to 13 when Wes Edens and Randy Nardone came up with, you know, we could make excess MSRs a good REIT asset. That propelled, that started the growth of New Residential, which was spun out of Newcastle. So financial engineering and being able to create value for shareholders, you may not see it all day one, but it's something that as we look forward, we have a vision that goes out not just quarter to quarter, but something that's a little bit longer than that. Sure. Okay.

I appreciate that. Thank you.

As a reminder, if you would like to ask a question, please press star then 1 to be joined into the question queue. The next question comes from Kevin Barker with Piper Sandler. Please go ahead.

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

It's likely going to be most but not all assets or not all MSRs that will go in there because some are held at the, what I would call the rhythm level, and the sub there is NRM. But mostly it's all the origination. It's most of the servicing stuff. Some MSRs may stay back. But, again, it's one of these TBD things, you know, as we continue to work through it.

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 that you have existing now, or would there be other segments embedded within the mortgage REIT?

You know, I think it's TBD. You know, you look at what, you know, Blackstone, I used this analogy last week. They have BXMT, which is a commercial REIT. I think the way that we're thinking about it is likely in a similar vein, but there's a lot of, I mean, clearly we just announced a deal last week, so we have a lot of work to do from a capital structure standpoint. But, you know, the one thing I wanted to emphasize on this call is we are still going to have a mortgage REIT and a large mortgage REIT in that. the asset management business will grow. We'll likely have a C-Corp. And, you know, from a structure standpoint, we just want to figure out a way that we're going to increase, one, is our shareholder price, and then, two, be able to grow AUM, which will feed into that and hopefully drive that significantly higher.

And then this quarter, you're pretty, you know, you were selling MSRs. You obviously de-emphasized those. I believe there was

We didn't sell any MSRs.

We just did an excess trade. Do you anticipate doing several more of those?

There will be more coming up, whether it's this quarter or next quarter. I just don't know, but there will be more excess MSR deals done. Thank you. Thank you.

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

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

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