We are Long the REIT. This is not a mREIT in the traditional sense of an Annaly $NLY
New Residential Investment Corp. (NYSE: NRZ) is a real estate investment trust (REIT) that invests in and manages residential real estate. The company invests in Excess Mortgage Servicing Rights (MSR – a $10 trillion industry), Servicer Advances and non-Agency residential mortgage backed securities. With a business model focused on MSRs – where the company collects mortgage payments, sets aside insurance payments and taxes, and forwards monthly mortgage payments to primary lenders without taking on payment default risk – New Residential does not face the same risks associated with owning mortgages and related securities. New Residential is not responsible for actual servicing duties, advance obligations or potential liabilities and risks that come with owning or servicing actual mortgages.
The MSR industry faced a lot of scrutiny after the 2008 financial crisis, and new regulations pushed banks into selling off MSRs – and this was a boon to New Residential which saw its business surge, with significant growth opportunities. Over the years, management has used its investment expertise and industry experience to develop a $415 billion MSR portfolio that contains residential assets offering long-term and stable cash flows. New Residential has a conservative capital structure that it uses to grow returns and dividends to shareholders.
New Residential Investment Corp. $NRZ
$1.84-Annual Dividend Offers a 14.15% Yield
New Residential’s Board declared a 3Q15 dividend of $0.46 per share, to be paid on October 30, 2015, for shareholders of record October 5, 2015. This marks the second dividend increase in 2015. The third quarter dividend was 2% higher than in the second quarter and 163% higher than in the first quarter, and will be the highest quarterly dividend paid in the company’s history. The company paid out $0.49 per share in dividends for 2013 and in $1.225 per share in dividends for 2014, representing annual growth of 150%. With an annualized dividend of $1.84, up 50% from 2014, shares offer a dividend yield of 14.15% with shares at $13 as of October 9, 2015.
The company’s dividend yield is now up 21% year-over-year. Management plans to distribute 95% to 100% of the company’s core earnings to shareholders in the form of dividends, and the company’s high yield and commitment to growing dividends is a boon to income-oriented investors.
Sound Balance Sheet
In parallel, management is focused on being fiscally conservative with a strong balance sheet. On October 2, 2015, New Residential completed its repayment of $2.5 billion of term notes from HLSS Servicer Advance Receivables Trust. The company used the excess portion of its $4 billion surplus servicer advance financial commitments to pay off the debt as part of management’s focus on maintaining liquidity. New Residential has $200 million of additional liquidity available. Shares climbed about 3% on news of New Residential repaying debt.
New Residential reported second quarter financial results for the three months ended June 30, 2015, with net interest income of $96.3 million, up approximately 72% from $56.1 million in the year ago quarter. With a profit margin of about 83%, New Residential grew earnings from $0.44 per share in 1Q15 to $0.45 per share in 2Q15. Earnings are up about 12% year-over-year (from $0.40 per share in 2Q14). Wall Street analysts are bullish on the company’s third quarter performance and expect 3Q15 earnings to rise to $0.50 per share, a quarter-over-quarter increase of 11%, which is conservative considering the company’s historic earnings growth.
With management’s philosophy of paying almost all earnings as dividends to shareholders, higher third quarter EPS could bode well for another dividend increase in 4Q15 or 1Q16. Additionally, future earnings growth will likely be catalyzed by the company’s clean-up call rights portfolio with a total unpaid principal balance (UPB) of $235 billion, which is approximately 30% of the Non-Agency mortgage market.
Herein, the company purchases underlying bonds at a discount but receives full par value payment if the bonds are called in. Call rights become exercisable when the current balance of a loan is equal to or lower than 10% of the original balance. Once a call is exercised, New Residential purchases the loan at par plus expenses. The company can then decide to sell or re-securitize performing loans at a premium and keep non-performing or distressed loans, which can be liquidated over time for mid-teens’ returns. New Residential had a callable balance of $31 billion as of June 30, 2015, and another $70 billion over the next 4 years. The company averages a margin of 2% to 3% on its calls and management anticipates being able to call $90 to $120 billion over the next 10 years, which represents potential future earnings of $1.8 billion to $2.4 billion on the low end and $2.7 billion to $3.6 billion on the high end. This is a significant additional revenue stream currently not factored into the company’s stock price.
New Residential Shares were at $13 as of market close on October 9, 2015, up about 2% year-to-date after a massive sell off. With a book value of $12.43 per share, shares are very attractively priced with just a 5% premium over book value. Moreover, New Residential shares have a consensus 12-month analyst price target of $18.85, which represents upside potential of about 45%. The company has a low price target of $17, with potential upside of 31%, and a high price target of $21, with higher potential upside of 65%. So New Residential shares offer both income and capital appreciation upside, with potential 12-month total returns north of 50% with minimal downside as shares are virtually at book value now.
The REIT has taken a big hit on the downside. We have locked into this position with a protective put. The company is operating with the wind at its back. Rates are lower and have reduced, partially, the fear of rising rates. The stock offers a tremendous 14.15% interest rate. I believe a hedged 14.15% yield is simply a great purchase.
If you have owned mortgage REIT’s in the past, then you know the dynamics of the key terms and the key business entities.