2022 was incredibly difficult for companies in the mortgage space. Mortgage originators struggled as the Federal Reserve raised interest rates in order to combat outsized inflation. Those rising rates helped drive origination volumes down to about half of 2021 levels.
Mortgage real estate investment trusts (REITs) also struggled as their portfolios underperformed their interest rate hedges, causing declines in book value per share. Mortgage companies that had servicing assets performed best. Rithm Capital (RITM 1.39%) is a mortgage REIT that operates a number of businesses, and it is branching out beyond traditional mortgage lending.
Image source: Getty Images.
Rithm Capital is a mortgage REIT that was formerly known as New Residential. It operates several different businesses, including mortgage origination, mortgage servicing, and mortgage-backed securities investing, and it's branching out into single-family rental and commercial real estate. In 2022, the mortgage origination business took a back seat to mortgage servicing, which accounted for 38% of its revenue in the fourth quarter of last year.
Mortgage servicing was the star of the show
Mortgage servicing is an unusual asset. A mortgage servicer performs the administrative duties of managing a mortgage on behalf of the investor. The servicer sends out monthly bills, collects payments, forwards the principal and interest to the investor, ensures property taxes are paid, and deals with the borrower in the event of default.
The servicer is typically compensated 0.25% of the outstanding balance of the mortgage per year to perform these services. In other words, if the borrower has a $400,000 mortgage, the servicer would get about $1,000 per year.
The right to perform this service is worth something, and the asset is capitalized on the balance sheet. Valuing servicing is a complicated business, and no two portfolios are the same. Things like the rate on the mortgage, the state, credit scores, and interest rate forecasts all factor in.
For the past year, servicing values were increasing because interest rates rose. Investors tend to like mortgage servicing because it increases in value when rates go up. This is because the incentive to refinance goes away, and the holder of the servicing contract expects to get that 0.25% of the mortgage balance for a longer period. Over the past year, Rithm's servicing portfolio has increased from 1.25% of its loans outstanding to 1.65%.
Of course, valuations can fall too, and that could happen if delinquencies rise or rates fall enough to bring back the incentive to refinance.
Origination has declined a lot
The origination business suffered last year, probably more than average for the typical originator. Q4 2022 origination volume came in at $7.9 billion, which was a 43% decline from the third quarter of 2022 and 79% lower than a year ago. Rithm has historically been big in loans that are not guaranteed by the U.S. Government, which can suffer from spotty liquidity. When it was still New Residential, it bought Caliber in 2021, which was the peak of mortgage origination volume.
Rithm is working to diversify into other ancillary businesses, including commercial real estate, title insurance, single-family rentals, and personal loans. Many of these businesses are still too small to compete meaningfully with origination and servicing, but they will help the company better manage the highly cyclical mortgage origination business.
The dividend is well-covered, but servicing valuations are high
Rithm announced that Q4 earnings available for distribution came in at $0.33 per share, which covers the $0.25 per share quarterly dividend. At current levels, Rithm is trading with a dividend yield of 10.8%, which is pretty attractive. Book value per share came in at $12, and the stock is trading at a sizable discount to book. This could be at least partially driven by the perception that servicing valuations are at peak levels and have nowhere else to go but down. Regardless, other mortgage REITs are trading at a premium to book while Rithm is trading at a 21% discount.
The dividend is well-covered at least for the moment, and as long as delinquencies remain low, the dividend is probably sustainable. The mortgage origination space is still out of favor, and that will be a headwind for the stock.
