The past year has been absolutely terrible for companies in the mortgage market. Mortgage real estate investment trusts (REITs), which invest in mortgage-backed securities, saw the values of their portfolios fall as interest rates rose. Mortgage originators saw volumes collapse as rising interest rates made homes less affordable and the incentive to refinance disappeared. Shares of such companies lost ground, which left some of them with high dividend yields. Case in point: Rithm Capital (RITM 1.51%), a combination mortgage originator and mortgage REIT with a double-digit dividend yield.
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Mortgage servicing provided the majority of Rithm's 2022 revenue
Rithm Capital's portfolio contains mortgage-backed securities, mortgage servicing rights, single-family rentals, and other investments. Its structure is designed to perform in all interest rate environments with a combination of investment gains and revenue from operating businesses. Last year the entire mortgage industry struggled, and Rithm was no exception: Its shares have fallen 20% in the past year. But hyper-aggressive tightening regimes like the Federal Reserve adopted last year don't come around often.
Mortgage servicing rights are an integral part of Rithm's business. They're an unusual asset in that they give the owner the right to perform a service -- in this case, handling the administrative tasks of managing the mortgage on behalf of the debt's owner. Servicers send out monthly bills, collect payments, ensure that principal and interest go to the ultimate investor, pay property taxes, and work with borrowers in the event of default. For this, a servicer is compensated 0.25% of the annual mortgage balance outstanding.
Mortgage servicing rights are one of the few financial assets that respond positively to interest rate increases, which made that business a bright spot for Rithm last year as the Fed rapidly hiked the federal funds rate to combat high inflation. Rithm also provides services on behalf of other mortgage servicers. In 2022, servicing income accounted for over half of its revenues.
Rithm is also a mortgage originator. It owns Caliber Home Loans, a large correspondent lender, and also originates mortgage loans that are not guaranteed by government-sponsored enterprises such as Fannie Mae. Mortgage banking revenue accounted for 23% of Rithm's revenue last year. Mortgage banking has been in a deep freeze since the Fed began hiking rates last year. However, we are moving into the segment of the year that is seasonally strongest for home sales, and we should see some improvement in the mortgage banking numbers.
Finally, Rithm earns interest income from the portfolio of newly originated loans and reperforming loans it holds on its balance sheet. That accounted for another 23% of its 2022 revenue. Going forward, mortgage servicing should still throw off plenty of cash and the mortgage origination business will probably recover.
Rithm's dividend appears to be well covered
Rithm pays an annual dividend of $1, which gives it a dividend yield of 12.7% at the current share price. Analysts expect Rithm to earn $1.39 per share this year, so the dividend is well covered. Note that while Rithm is a REIT, it doesn't report earnings as funds from operations the way most REITs do. The funds from operations metric isn't really applicable for a REIT without big real estate holdings.
Both mortgage REITs and mortgage originators have been under pressure over the past year as the Fed has raised interest rates. Investor sentiment is terrible toward the sector. The adage "Don't fight the Fed" is especially relevant to mortgage REITs and mortgage originators. Once the Fed pauses its rate hikes, the mortgage market should start attracting investor attention again, but until then, negative sentiment will dominate.
