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.