New Residential Investment Corp. (RITM -0.36%) reported core earnings per share of $0.61 for the fourth quarter of 2019, easily surpassing analyst expectations of $0.52 a share.

For the year, New Residential earned $2.17 per share, compared to $2.38 a year ago. Book value for the year fell slightly from $16.25 to $16.21 and the company paid $2.00 in dividends, which works out to be a 11.6% dividend yield based on a closing price of $17.24 a share. 

Mortgage Origination drives the increase

Mortgage origination rose to $10.6 billion in unpaid principal balance in the fourth quarter, which is up 85% from the third quarter and 412% on a year-over-year basis.

The volume increase was largely from New Residential's strategy of buying completed loans from smaller lenders. The last year was strong for mortgage originators in general, as falling interest rates generated a lot of refinance business.

New Residential is a leader in the non-qualified mortgage space, which refers to loans that aren't eligible for government insurance. The government is likely to restrict government insurance even further next year, when it limits debt-to-income ratios to 43% from their current 50%. This will push a lot more volume to lenders who specialize in securitization and non-traditional lending, like New Residential. Management estimated that origination volume will grow to $50 billion in 2020, and that non-qualified lending will double. 

Picture of a mortgage agreement

Image source: Getty Images.

The mortgage servicing rights portfolio swelled in size

New Residential's mortgage servicing rights (MSR) portfolio grew to $630 billion, which is up 6% sequentially and about one-third on an annual basis. The biggest highlight was the acquisition of $62 billion of MSRs from the Ditech bankruptcy.

Mortgage servicers generally receive a fee of 0.25% for collecting the monthly payment from the borrower and passing it on to the ultimate holder of the mortgage. The right to perform this duty is considered an asset, and it can be bought and sold.

Many mortgage real estate investment trusts (REITs) and mortgage originators like one key characteristic of MSRs, and that is they increase in value as interest rates rise. This is due to the fact that rising rates make it less likely the underlying loan will refinance, so the valuation model will predict a longer life for the asset.

Unlike an interest rate hedge, which costs money, MSRs generate cash flow. New Residential's servicing valuations took a hit overall in 2019 as interest rates fell throughout the year. However, management expects the asset to generate 8% to 9% unlevered returns going forward, and mid-teens returns with the use of leverage ("leverage" means borrowed money, and acts the way margin does on a stock). 

Servicing and reperforming loans

New Residential also has a servicing activity that's separate from its MSR strategy. The company buys loans with uneven pay histories (in other words, a borrower with a history of missing or making late payments) at a discount to par, and then works with the borrower to find a way to improve performance.

New Residential was able to increase the performance of a sampled pool from 69% current to 80% current, meaning it brought about 11 of the borrowers up to date on their mortgages. New Residential then securitizes these loans as reperforming loans. During the year, New Residential completed three securitizations representing $2.6 billion in principal amount. 

Mortgage REITs are an excellent asset in an income portfolio

Investors who are looking for income should take a look at mortgage REITs like New Residential or AGNC Investment Corp. These stocks often pay double-digit dividend yields, which can be tough to find in the current market environment.

New Residential's annual dividend of $2.00 a share was supported by $2.17 in core earnings per share, and with portfolio growth, New Residential could also increase book value per share, which would translate into higher stock prices.