Most mortgage companies have struggled over the past 18 months as the Federal Reserve has hiked interest rates to defeat inflation. Mortgage originators saw volumes collapse as refinancing incentives disappeared, while mortgage real estate investment trusts (REITs) have struggled with declining asset values.
Most mortgage REITs have been forced to cut their dividends. Rithm Capital (RITM 0.81%) has managed to buck this trend and has a 9.7% dividend yield. How does it do it?
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Rithm Capital has numerous different business lines related to residential real estate
Rithm Capital is a mortgage REIT with a few operating companies included. This means that it doesn't just rely on investment income; it has recurring revenue based on services it provides. This gives the company more stability than the typical mortgage REIT.
Rithm has a mortgage origination arm, which sources agency loans (which are guaranteed by the government) and non-agency loans (which are not). Rithm runs a single-family rental business, and makes business-purpose loans, commercial real estate, and consumer loans. Lastly, Rithm has a large mortgage-servicing business.
Mortgage servicing has been a standout asset over the past 18 months
Mortgage servicing is an unusual asset, and it has been one of the few bright spots in the mortgage space since the Fed began hiking rates. Mortgage servicers administer the mortgage on behalf of the investor. They send out the monthly bills, collect payments, forward the principal and interest payments to the investor, ensure property taxes are paid, and work with the borrower in the event of a default.
The servicer is paid 0.25% of the outstanding principal on the loan as compensation for this service. On a typical $400,000 loan, the servicer will earn $1,000 a year.
Mortgage servicing rights are one of the few assets that increase in value as interest rates rise. This is because as rates rise, the incentive to refinance disappears, which means the servicer will collect that fee for longer. This makes mortgage servicing a natural hedge for mortgage originators.
Rithm filed a confidential S-1 with the Securities and Exchange Commission about a possible transaction with the company's mortgage operations. The REIT has long believed the market undervalues the company when you analyze the value of the individual businesses. If Rithm sells or spins off the mortgage operations, this could help unlock value.
Rithm is diversifying away from mortgage lending
Rithm is also looking to build its asset management business with the purchase of Sculptor Capital Management (SCU), which is an alternative investment manager involved in opportunistic credit, institutional credit, real estate, and multi-strategy. Asset management will be another source of fee income, which will help Rithm diversify its exposure to the highly cyclical mortgage business.
Rithm is one of the two mortgage REITs that have managed to avoid a dividend cut over the past 18 months, with AGNC Investment as the other. Rithm, pays a quarterly dividend of $0.25, which works out to a dividend yield of 9.7%.
In the latest quarter, Rithm had funds available for distribution of $0.62 per share, which more than amply covers the dividend. The company is expected to earn $1.76 this year and $1.61 in 2024, which easily covers the $1 annual dividend.
Rithm Capital's business model should continue to perform well if the U.S. economy manages a soft landing. If the country enters a tough recession, then servicing costs will increase and the company might see credit losses. That said, there is a decent margin for error with the dividend based on earnings estimates.
