Rithm Capital: Recent Acquisitions Support Its High-Dividend Yield (NYSE:RITM)

Rithm Capital (NYSE:RITM) offers a high-dividend yield that seems to be sustainable in the medium term, plus its recent acquisitions should lead to more recurring revenue and improved earnings profile, being positive for its business model and valuation over the long term.

As I’ve covered in a previous article, Rithm Capital offers a high-dividend yield, but the trust was in the middle of an acquisition dispute to buy Sculptor Capital Management, and there was some risk it could eventually pay too much for this target, a scenario that could be negative for its shares. While Rithm did increase its offering, this acquisition was completed at a reasonable price, and its share price has performed quite well in recent months.

In this article, I do an update on Rithm’s recent earnings and update its investment case, to see if it has now a better income appeal or not.

Recent Events

Rithm Capital’s strategy has been to diversify its business beyond mortgage servicing rights (MSRs) into a diversified investment platform, including other areas of the credit segment. Despite that, its business model is still quite exposed to MSRs, which account for some 55% of its revenue.

Due to this business profile, Rithm benefits from a rising interest rate environment, while other mortgage REITs (mREITs), such as Annaly Capital Management (NLY) or AGNC Investment Corp. (AGNC), suffer from this trend because they invest heavily in agency mortgage-backed securities.

While agency MBSs decline in value when interest rates increase, putting pressure on the book values of mREITs, MSRs increase in value because higher rates lead to lower prepayments and higher average life of servicing rights. As shown in the next graph, Rithm’s book value has increased by more than 13% since the end of 2020, to $12.32 per share at the end of Q3 2023.

While long-term interest rates have declined considerably since peaking last October (at close to 5% for the 10-year Treasury yield), most of Rithm’s MSRs portfolio has lower rates than current new mortgage production, which means loan amortizations and pre-payments are expected to remain quite low, boding well for its MSR valuations and cash flow profile in the coming quarters.

In Q3 2023, revenue related to MSRs amounted to $463 million, a slight decrease from the previous quarter due to some sales of excess MSRs. On the other hand, interest income increased by close to 20% on a quarterly basis, due to its acquisition of a part of Goldman Sachs (GS) Marcus loans, in which Rithm invested some $145 million to purchase a $1.45 billion unsecured consumer loan portfolio. These loans have a relatively short duration and high yield, boosting Rithm’s interest income, and aren’t expected to lead to much in the way of loan losses in the short term.

This consumer loan portfolio acquisition was the main reason why its revenues increased in Q3 to $1.09 billion, up by 4.8% compared to the previous quarter. Expenses also increased in the quarter and the trust booked some unrealized losses from investments, leading to a net income of $193 million in the quarter, while its non-GAAP measure of Earnings Available for Distribution amounted to $280 million, or $0.58 per share.

This is much higher than its current quarterly dividend of $0.25 per share, thus Rithm seems to have a dividend that is well covered by its earnings stream, which is quite positive for a sustainable dividend over the long term.

Beyond its positive operating momentum in recent quarters, the company continues to take some important steps to grow its business and also regarding its strategic pivot to become a global asset management company, shifting gradually its business focus from real estate into a diversified investment platform across real estate and private credit.

Regarding business growth, Rithm announced at the beginning of last October the acquisition of Computershare Mortgage Services, including its affiliated company Specialized Loans Servicing, for around $720 million, increasing its Newrez subservicing and special servicing businesses in a significant way. This acquisition is expected to close in Q1 2024 and is expected to increase its servicing revenue, especially from third-party servicing.

In relation to its goal to shift its business into a global asset management company, Rithm completed the acquisition of Sculptor Asset Management in November, for a total amount of $720 million. This was higher than its initial offer of $639 million, as Rithm had to raise its offer price due to competing offers on the table.

While this acquisition was more expensive than initially expected, it makes a good strategic fit into Rithm’s strategic pivot into becoming a diversified investment platform, accelerating its business growth in the private credit segment.

Sculptor is an alternative asset management specified in opportunistic credit, real estate, and multi-strategy, having some $34 billion of assets under management. This increases Rithm’s assets under management to more than $50 billion in the asset management business at the end of 2023 and increases Rithm’s long-term growth prospects as the overlap to its current business is rather low. From a financial standpoint, Rithm funded this acquisition through its cash position and expects to be neutral to 2024 earnings and be accretive for its bottom line thereafter.

Going forward, Rithm is expected to maintain a positive operating momentum, as the interest rate environment is supportive for the company’s MSRs business. While inflation has moderated in recent months and there is some speculation about potential interest rate cuts during 2024, I think it’s likely that the Fed will cut rates gradually rather than aggressively shift its monetary policy, thus mortgage pre-payments are likely to remain at historically low levels during the next few quarters.

Regarding other growth sources, the trust has good potential in private credit where it’s growing its business organically and now also through the acquisition of Sculptor, plus it also sees opportunities in the commercial real estate market, where it can use its strong pool of liquidity to buy interesting assets from struggling owners.

This means the company seems to be in a good position to grow its business in the near future from several initiatives, which should lead to a more diversified business model and being less exposed to interest rates compared to its past.

Regarding its dividend, its current quarterly dividend has been maintained at $0.25 per share, unchanged since October 2021, which at its current share price leads to a dividend yield of about 9.5%. This high-dividend yield is quite attractive to income investors and is covered by the trust’s earnings, plus Rithm has a good liquidity position, thus the dividend seems to be sustainable in the short to medium term.

Conclusion

Rithm Capital is still considered a mortgage REIT due to its sizable exposure to MSRs, but its recent acquisitions led to a more diversified business profile over the long term, making it increasingly comparable to other financial services companies rather than REITs.

I think its strategy of gradually shifting its business model from an mREIT to a diversified investment platform makes sense to create more value for shareholders over the long term, creating a more recurring earnings profile which is supportive of its dividend and a higher valuation going forward.

While a business overhaul takes some time to achieve, Rithm is taking the right steps to become an asset management company, which would lead to higher valuation multiples in the future. This means its current valuation of 6.5x forward earnings and 0.9x book value can be considered cheap, plus its high-dividend yield is also quite attractive for income investors.

While I was worried some months ago that Rithm could overpay for Sculptor, now that the acquisition is completed and the price paid seems reasonable, I now see Rithm as a good income play due to its combination of high-dividend yield and attractive valuation.