New residential investment company (NYSE: NRZ) reported earnings per share of $ 0.61 for the fourth quarter of 2019, significantly exceeding analysts’ expectations of $ 0.52 per share.
For the year, New Residential earned $ 2.17 per share, up from $ 2.38 a year ago. The book value for the year decreased slightly from $ 16.25 to $ 16.21 and the company paid out $ 2.00 in dividends, which works out to a dividend yield of 11.6% on the basis of a closing price of $ 17.24 per share.
Mortgage origination drives growth
The outstanding principal balance reached $ 10.6 billion in the fourth quarter, up 85% from the third quarter and up 412% year-over-year.
The increase in volume was largely attributable to New Residential’s strategy of purchasing completed loans from smaller lenders. The past year has been a good one for mortgage originators in general, as falling interest rates have generated a lot of refinancing activity.
New Residential is a leader in ineligible mortgages, which refers to loans that do not qualify for government insurance. The government is likely to further restrict public insurance next year, when it limits debt-to-income ratios to 43% from the current 50%. This will push much more volume to lenders specializing in securitization and non-traditional loans, like New Residential. Management has estimated that the origination volume will reach $ 50 billion in 2020 and that unqualified loans will double.
The portfolio of mortgage management rights has grown
New Residential’s Mortgage Management Rights (MSR) portfolio reached $ 630 billion, an increase of 6% sequentially and about a third on an annual basis. The highlight was the $ 62 billion acquisition of MSR following the bankruptcy of Ditech.
Mortgage agents typically charge a 0.25% commission to collect the monthly payment from the borrower and pass it on to the ultimate mortgage holder. The right to perform this duty is considered an asset, and it can be bought and sold.
Many mortgage real estate investment trusts (REITs) and mortgage originators appreciate one of the key characteristics of MSRs – that they increase in value as interest rates rise. This is because rising rates make refinancing of the underlying loan less likely, so the valuation model predicts a longer life for the asset.
Unlike an interest rate hedge, which costs money, MSRs generate cash flow. New Residential’s service valuations were hit broadly in 2019, with interest rates falling throughout the year. However, management expects the asset to generate 8-9% non-leveraged returns in the future, and mid-teens returns with the use of leverage ( “leverage” means borrowed money and acts like the margin on a stock).
Loan management and repayment
New Residential also has a service activity separate from its MSR strategy. The business buys loans with an uneven payment history (in other words, a borrower with a past or missing payment history) at a price equal to par, then works with the borrower to find a way to improve performances.
New Residential was able to increase the performance of a sampled pool from 69% to 80%, meaning that 11 of the borrowers updated their mortgages. New Residential then securitizes these loans into reproductive loans. During the year, New Residential completed three securitizations representing a capital amount of $ 2.6 billion.
Mortgage REITs are a great asset in an income portfolio
Investors looking for income should take a look at mortgage REITs like New Residential or AGNC Investment Corp. These stocks often pay double-digit dividends, which can be difficult to find in today’s market environment.
New Residential’s annual dividend of $ 2.00 per share was supported by basic earnings per share of $ 2.17, and as the portfolio grows, New Residential may also increase book value per share, which would result in a rise in stock prices.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are heterogeneous! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.