RITM Q3 2023 Updates And Comparison Article By Scott Kennedy
Introduction section by Colorado Wealth Management Fund.
Article section by Scott Kennedy.
Bringing More of Scott’s Work to Our Website
The REIT Forum is a service produced by Michael Vanloon (better known as Colorado Wealth Management Fund) and Scott Kennedy. After intense consideration, I decided to launch our service through Substack. Since then, we’ve seen great success. Substack enables us to give readers real-time alerts with entire articles delivered directly to their inboxes.
You’re probably used to seeing the “from” field saying: “ColoradoWealthManagementFund from The REIT Forum”.
In some of our future e-mails, it may say:
“Scott Kennedy from The REIT Forum”.
That will simply mean we’ve updated the backend of the website for Scott Kennedy to directly post his articles.
I want to make browsing our work as simple as possible for readers. This will be another step in that direction.
For the moment, I’ll be posting Scott’s work. The following articles are a direct copy and paste from Scott. While we get the back end set up, there is a delay in getting the articles posted. Rest assured that it should be solved soon.
Finding Our Positions
I posted a subscriber-exclusive article with links to our Google Sheets. You can always access our positions there. Scott’s positions are updated each week. CWMF’s positions are usually updated on the same day as the trade.
Related to the stocks in this article:
CWMF is long: RITM-D, GPMT-A, DX-C, EFC-A, RITM-C, EFC-B, PMT-C, PMT-B, CIM-B, AGNCP, CIM-D, RITM-B, RITM, SLRC, GPMT, RC.
Scott Kennedy is long: RITM, RC, SLRC, GPMT, ARCC, TSLX, FSK, RITM-D, MITT-B, MITT-C, GAINL, RCB, ECCC, ECCW.
The rest of this post is from Scott Kennedy.
Part 1 of this article compares RITM’s recent investment composition, leverage, hedging coverage ratio, quarterly BV, economic return (loss), and current valuation to 19 mREIT peers.
Due to what has occurred during the fourth quarter of 2023 (fluctuating rates/yields), understanding the composition of RITM’s MSR/investment and derivatives portfolio is crucial in understanding current/future performance.
My current RITM BV projection and updated price target is in the “Conclusions Drawn” section. RITM is currently deemed undervalued (buy recommendation).
I also provide a list of the mREIT covered stocks I currently believe are undervalued (a buy recommendation), overvalued (a sell recommendation), or appropriately valued (a hold recommendation).
Providing sector-wide metrics allows readers to better understand which mREIT companies will likely outperform (or underperform) peers during specific types of future interest rate environments.
Author’s Note: This is an “early look” for the REIT Forum subscribers regarding my quarterly mortgage real estate investment trust (mREIT) sector comparison article. PART 1 of this article covers mREIT book value (“BV”) fluctuations (and various other metrics), PART 2 covers dividend metrics, and both parts cover projected current valuations and recommendations. While I will be providing this article to the public in the near future, this “version” of the article per se will provide a couple additional metrics/analytics that will not be provided in the public article (including each mREIT’s quarterly hedging coverage ratio change and investment portfolio quarterly change in size). This also includes four separately-ranked tables for more effective sector comparative metrics. In the future, subscribers will get additional early looks regarding mREIT and business development company (“BDC”) articles I provide to the public, along with additional data/metrics and per share price ranges. Furthermore, this includes same day/near future mREIT and BDC earnings articles and weekly recommendation change articles that are only provided to subscribers of the REIT Forum.
Focus of Article:
The focus of PART 1 of this article is to analyze Rithm Capital Corp.’s (RITM) recent results and compare several of the company’s metrics to 19 mREIT peers. This analysis will show past and current data with supporting documentation within four tables. Table 1a will compare RITM’s investment composition, recent leverage, hedging coverage ratio, and change in investment portfolio size to the 19 mREIT peers. Table 1b will compare RITM’s BV, economic return (loss), and premium (discount) to estimated CURRENT BV using stock prices as of 12/1/2023 to the 19 mREIT peers. Table 2a will show an overview of RITM’s investment portfolio while Table 2b will provide some details regarding the company’s largest driver of earnings, its mortgage servicing rights (“MSR”) sub-portfolio. Table 3 will show RITM’s recent hedging coverage ratio over the prior 5 quarters (only contributor/team to provide continuous detailed hedging metrics).
I am writing this 2-part article due to requests that such an analysis be specifically performed on RITM versus its mREIT peers at periodic intervals. This article also discusses the importance of understanding the composition of RITM’s investment and derivatives portfolios regarding projecting the company’s future quarterly results as interest rates/yields fluctuate. Understanding the characteristics of a company’s investment and derivatives portfolios can shed some light on which companies are overvalued or undervalued strictly per a “numbers” analysis. This is not the only data that should be examined to initiate a position within a particular stock/sector. However, I believe this analysis is a good “starting-point” to begin a discussion on the topic.
At the end of this article, there will be a conclusion regarding the following comparisons between RITM and the 19 mREIT peers: 1) trailing 24-month economic return (loss); 2) leverage as of 9/30/2023; 3) hedging coverage ratio as of 9/30/2023; and 4) premium (discount) to my estimated CURRENT BV (BV as of 12/1/2023). My BUY, SELL, or HOLD recommendation and updated price target for RITM will be in the “Conclusions Drawn” section of this article. This includes providing a list of the mREIT stocks I currently believe are undervalued (a buy recommendation), overvalued (a sell recommendation), or appropriately valued (a hold recommendation).
Overview of Several Classifications within the mREIT Sector:
I believe there are several different classifications when it comes to mREIT companies. For purposes of this article, I am focusing on four. It should be noted in light of several prior acquisitions and certain changes in overall investment strategies, some mREIT companies have minor-modest sub-portfolios outside each entity’s main concentration. However, I have continued to group certain mREIT companies in each entity’s main classification for purposes of this article. Some market participants (and even some mREIT companies) have different classifications when compared to Table 1a. Some market participants/companies base classifications on the percentage of capital deployed in each entity’s investment portfolio. However, my preference is to base a company’s classification on the monetary “fair market value” (“FMV”) of each underlying portfolio which, for a fact, is what drives valuation fluctuations. In my professional opinion, there is no “uniform” methodology when it comes to classifying mREIT companies but more of an underlying preference. Readers should understand this as the analysis is presented below.
First, there are mREIT companies who earn a majority of income from investing in fixed-rate agency mortgage-backed securities (“MBS”). These investments consist of commercial/residential MBS, collateralized mortgage obligations (“CMO”), and agency debentures for which the principal and interest payments are guaranteed by government-sponsored enterprises/entities (“GSE”). This is extremely important to understand (especially when markets incorrectly priced in this notion at the onset of COVID-19 in early 2020). Since these investments typically have higher durations versus most other investments within the broader mREIT sector, companies within this classification typically utilize higher hedging coverage ratios in times of rising mortgage interest rates/U.S. Treasury yields (or a projected rise over the foreseeable future). AGNC Investment Corp. (AGNC), ARMOUR Residential REIT Inc. (ARR), Cherry Hill Mortgage Investment Corp. (CHMI), Dynex Capital Inc. (DX), Invesco Mortgage Capital Inc. (IVR), Annaly Capital Management Inc. (NLY), Orchid Island Capital Inc. (ORC), and Two Harbors Investment Corp. (TWO) are currently classified as a fixed-rate agency mREIT. Out of these 8 agency mREITs, CHMI and TWO currently have a large mortgage servicing rights (“MSR”) sub-portfolio as well.
Second, there are mREIT companies who earn varying portions of income from investing in agency MBS holdings, non-agency MBS holdings, other securitizations, and non-securitized mortgage-related debt and equity investments (including residential/commercial loans). This type of company is known as a “hybrid” mREIT. In regards to non-agency MBS, this includes (but is not limited to) Alt-A, prime, subprime, and re/non-performing loans where the principal and interest are not guaranteed by a GSE. Since there is no “government guarantee” on the principle or interest payments of non-agency MBS and residential/commercial loans (or rental income on properties), coupons are generally higher when compared to agency MBS of a similar maturity. However, borrowing costs (including repurchase agreements) for these specific investments are also higher (no government guarantee; credit risk). Due to the subtle yet identifiable differences between agency MBS, non-agency MBS, and residential/commercial loans, I like to differentiate between an agency and a hybrid mREIT company. Since there is credit risk when it comes to non-agency MBS and residential/commercial loans, leverage ratios are typically lower when investing in these securitizations/investments when compared to agency MBS (even when credit risk remains low). Arlington Asset Investment Corp. (AAIC), Chimera Investment Corp. (CIM), Ellington Financial Inc. (EFC) (converted to a REIT in 2019), MFA Financial Inc. (MFA), AG Mortgage Investment Trust Inc. (MITT), New York Mortgage Trust Inc. (NYMT), and Ready Capital Corp. (RC) are currently classified as a hybrid mREIT. It should be noted, during July 2022, AAIC was moved from a fixed-rate agency mREIT to a hybrid mREIT due to the company’s gradual shift away from fixed-rate agency MBS into a greater proportion of non-agency MBS, non-securitized mortgage-related investments, and mortgage servicing rights financing receivables. AAIC exited the company’s single-family residential (“SFR”) sub-portfolio late last year. It should also be noted RC was moved from an originator and servicer mREIT to a hybrid mREIT during the fourth quarter of 2023 due to the company’s rapidly declining proportion of paycheck protection program (“PPP”) loans (which the company also services) directly due to the COVID-19 pandemic.
Third, there are mREIT companies that invest in, but are not limited to, a combination of agency MBS, non-agency MBS, credit risk transfers (“CRT”), other mortgage-related investments, non-securitized debt investments (including residential, multifamily, and commercial loans), and MSRs. There are also mREIT companies that have underlying subsidiaries who directly originate mortgages (including via correspondent production) and/or mortgage-related debt products. I currently believe RITM and PennyMac Mortgage Investment Trust (PMT) should be classified as an “originator and servicer” mREIT. Since RITM and PMT currently have at least a modest portion of the company’s investment portfolio in MSR and MSR-related investments, which act as an “indirect” hedge (the same can be said regarding interest only [IO] securities), these companies do not need to utilize as high of a hedging coverage ratio when compared to the agency mREIT sub-sector (some could even argue to not have derivative instruments in place; if anything, “contra” hedges to counter a drop in rates/yields). Indirect hedges are not calculated within each company’s hedging coverage ratio within this analysis (not the main purpose of these investments). As I have pointed out in the past, these investments actually benefit, from a valuation standpoint, in a rising interest rate environment as prepayment risk (and in a majority of scenarios credit risk) decreases while there is an increase in projected future discounted cash flows (and vice versa).
Finally, there are mREIT companies that basically solely invest in non-securitized, commercial whole loans with underlying collateral (real estate) tied to offices, multifamily units, hotels, retail stores, industrial complexes, and other miscellaneous types of properties. Regarding the three commercial whole loan mREIT peers I currently cover, Ares Commercial Real Estate Corp. (ACRE), Blackstone Mortgage Trust, Inc. (BXMT), and Granite Point Mortgage Trust Inc. (GPMT), these companies typically originate/invest in variable-rate, interest-only senior secured (typically first lien) debt. Since ACRE, BXMT, and GPMT all had 98%+ of its investment portfolio in variable-rate debt as of 9/30/2023, these companies currently do not need to utilize a high hedging coverage ratio (some could even argue to not have derivative instruments in place; LIBOR/SOFR floors are a good substitute as well).
Now let us start the comparative analysis between RITM and the 19 mREIT peers.