The past year has been exceedingly difficult for companies in the mortgage industry. Rising interest rates choked off mortgage origination volume and ate away at the value of companies that held mortgage-backed securities as investments.
Rithm Capital (RITM 1.27%) is a combination mortgage originator and mortgage real estate investment trust (REIT). While most mortgage REITs have cut their dividends, Rithm has been able to maintain its dividend. What is it doing differently?
The Federal Reserve building. Image Source: Getty Images.
Mortgage REITs differ from the typical REIT
Most REITs follow a landlord/tenant model. The REIT develops and invests in properties like shopping malls, apartments, or office buildings and then rents out space to tenants.
But mortgage REITs don't invest in real estate, they invest in real estate debt, usually in the form of mortgages that have been bundled into bond-like securities. Instead of collecting rent, they collect interest. In many ways, mortgage REITs look more like banks or hedge funds than real estate landlords or developers.
Rithm is unusual among mortgage REITs in that it does much more than just hold mortgage assets. Its portfolio includes a lot of operating businesses in the real estate sector. So on one hand, the company holds a portfolio of mortgage-backed securities and loans, and on the other hand, it runs a number of businesses. Its portfolio includes mortgage originators (Caliber and New Rez), mortgage servicing rights, single-family rentals, business-purpose loans, and consumer loans.
Mortgage servicing has supported the stock
Over the past 18 months, mortgage servicing rights have stolen the show. Mortgage servicing is an unusual business: The mortgage servicer handles the administrative tasks of a mortgage on behalf of the ultimate investor. The servicer sends out the monthly bills, collects the payments, sends the principal and interest to the investor, and works with the borrower in the event of a default.
The servicer receives 0.25% (or one quarter of 1 percent) of the balance outstanding of the loan as compensation. On a typical $400,000 loan, the servicer is paid $1,000.
The right to perform this service has value, and it is capitalized on the balance sheet as an asset. The past 18 months have been the perfect situation for mortgage servicing because rising interest rates make the servicing asset worth more, and low mortgage delinquencies have limited servicing costs.
Mortgage-backed securities have struggled over the past year as the Federal Reserve has been hiking interest rates. Mortgage-backed securities have underperformed Treasuries as interest rate volatility spiked, making them less rewarding investments.
The increase in volatility was driven by uncertainty over the Fed, and as the Fed approaches the end of its rate-hiking cycle, this volatility should revert to the mean. The underperformance translated into declining book value per share in the near term, but it also implies higher returns in the future. On the company's second-quarter earnings conference call, Rithm Chief Executive Officer Michael Nierenberg said that he thinks the portfolio will deliver 8% to 12% returns.
The dividend is well covered
During the quarter, Rithm Capital's book value per share increased from $11.67 to $12.16. The company earned $0.74 per share in the second quarter, but part of the gain was due to a sale of servicing rights. Earnings available for distribution were $0.62 per share, which more than covers the $0.25 quarterly dividend.
Rithm filed a confidential S-1 with the Securities and Exchange Commission that contemplates a spinoff or sale of its mortgage origination unit. The company can't say too much about the potential sale, but the idea is to help unlock hidden value in the REIT's stock price.
Rithm is one of the few mortgage REITs that has not cut its dividend during the past 18 months. At current levels, the stock yields almost 10% and is trading at a significant discount to book value per share. The worst is probably over for the mortgage sector, and Rithm looks attractive at current levels.
