Rithm Capital: Wells Fargo’s Exit An Opportunity (NYSE:RITM)

Albert Pego

The mortgage origination market is one of the areas most affected by high interest rates. Light games like Rocket Companies (RKT) is down about 40% while those like Wells Fargo (WFC) and Rithm Capital (NYSE:fast) is only partially shown to decrease slightly.

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Most of the price drops in the space are very justified, but I think Rithm Capital has found the right balance in the debate. The RITM ratio is very protective of the mortgage event which puts the company in a position to eat the market share left by competitors.

On January 10thWells Fargo launch plan mostly out of the mortgage business except for WFC’s clients. Therefore, with the decrease in other mortgage originators, the supply has decreased to balance the demand which is much lower. As the mortgage market recovers, RITM will be one of the best recovery positions due to its strong financial position and non-banking position.

Let me start with an overview of the industry in terms of what has happened and the future. Then we follow RITM’s special status and its respective perspective.

The mortgage industry

For many years, the mortgage industry has benefited from new mortgage applications added through refinancing operations. As prices fell below current mortgage rates, homeowners were encouraged to refinance resulting in larger amounts and income.

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Business

As interest rates have risen in recent quarters the opposite has occurred. Currently most mortgages are priced below market value. Not only is refinancing no longer encouraged, but it is also highly avoided because doing so would significantly increase the purchase price. Those with existing low-cost mortgages are also less mobile so the number of new mortgages is also lower.

As you can see in the chart below, refinancing volume (shadow) is closely related to mortgage rates and is now at its lowest level in many years.

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mortgage news daily

Mortgage origination is a very competitive business to operate. Each investment generates income for the founder, but it is a very lucrative business.

With the majority of the voice being closed almost the entire industry had to lay off a large part of its workers. This discount is ongoing and helps in providing mortgages based on the demand for mortgages. It also helps in preserving the edges.

Wells Fargo is a big player and its entire exit represents a big step down in a supply chain that has been in slow motion.

Outlook

Ultimately, most startups will recover to their normal levels regardless of what happens to interest rates. Simply put, people need homes and they need a lot of mortgages to buy a home. Lower interest rates will speed up the recovery, but I see volume moderation as inevitable.

Time of return

Volumes have been subdued for about a year. I suspect they will remain low for another 1 to 3 years depending on the course of interest rates.

Equity in industry

Pure-play mortgages must last for a long period of time which will significantly reduce income. Lowering prices will make many of them move, but it won’t save them lower incomes. While the reduction in public demand is temporary, the destruction of income is very real.

For this reason, I think hybrids are better and Rithm Capital takes the cake in the best position. There are 4 distinct advantages that I think will lead to the value of this market share.

  1. The initial mortgage loan amount is low
  2. MSR income fully hedged against rising interest rates
  3. Strong business sectors will continue to generate income while waiting for the mortgage market to recover.
  4. Non-banking status makes recovery easier

Rithm’s largest weighting is in mortgage-backed rights (MSRs) and income from this segment is greater than income from mortgages.

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Plus

In many ways to make a big bang because of the same growth in interest that hurt the origination that caused the value of their MSR. The way this works is that RITM buys the right to service mortgages and then collects the service fee for the remaining term of the loan.

As refinancing rates decreased, the cost of paying these loans dropped from about 28% to 8%.

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fast

This greatly extends the life of service revenue and causes each MSR to initially purchase a greater amount of revenue than originally anticipated. Reflecting this long life cycle of income, the market value of MSRs rose higher, instead of reducing the impact on RITM’s other businesses from higher interest rates.

As a result, RITM’s book value is growing well in the inflation environment.

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That’s a big difference between RITM and most of the mortgage industry that used to experience falling book prices.

This puts RITM in a good financial position relative to the generation. The condition is also good to wait for the recovery of the mortgage market because it is still receiving good income from other sectors. RITM’s interest income increased, partly from its real estate and mortgage-backed securities.

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I also know that its single family rental segment will benefit because RITM properties are well located in areas where jobs are growing.

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fast

Since RITM does not rely on startups for its revenue, it was in a position to rapidly reduce its volume in this sector. Beginning G&A fell by $900 million from Q4 21 to 3Q22.

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fast

Continued income from other businesses with reduced costs to maintain the health of RITM through the recession, but the real opportunity is what happens when the mortgage market comes back.

The non-banking situation makes it easy to scale up

Banks are over-regulated. Since the financial crisis SIFI has had rules and oversight in everything they do. Perhaps one could argue that this is good for the economy as a whole, but from a competitive point of view it is a huge disadvantage.

As a non-bank mortgage REIT, the regulatory burden on RITM is relatively small allowing it to operate quickly and at low costs. I believe this will lead to market share for non-banks.

The stock market that Wells Fargo abandoned will be valued and RITM is well positioned to proceed.

Appraisal

While RITM’s MSRs are fully meeting the challenges of rising interest rates, there is a general weakness in home mortgages that I think is the wrong draw. the RITM down through the association with his group.

Due to the decline in price and book value, RITM is now trading at 74% of book value. Since its earnings have largely remained the same due to strength in other areas of the business, RITM is currently trading at 6.7X forward earnings.

It’s an affordable purchase and I find the front end to be much stronger than that price would suggest. I think RITM will be better than the market.

It’s a better way to invest in it

While competitive on the regular, the specialists seem to offer a higher return due to the large discount to par.

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Income Solutions – Certification required – data as of 1/12/23

The interests of RITM are slightly different because the convertor is a floating rate and the terms of these were written when interest rates were very low. As a result, the floating rate coupons on conversion are anywhere from 496 to 622 basis points above LIBOR (soon but become SOFR). As the height of the short end of the curve increases it gives more measurements.

Looking at the best C as an example, it has a coupon of 6.38% against $25 par value but since it is trading Priced at $18.80 it yields 8.48% currently. In 2025 it will be converted into a floating rate of SOFR + 496 basis points which is the daily interest rate of a coupon of 9.78% which returns because the discount will carry a rate of 13.00% .

At the top of the big dividend, one can capture 33% of the investment in return to par. I find this to be a very attractive return profile for the desired segment of a large mREIT in financial terms.

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