New Residential’s 13% Dividend Yield Makes It A Buy

31 October, 2019

LIT COMMENT; New Residential purchased substantial interest in MSRs from OCWEN who have been fined in excess of $3 BILLION Dollars since the financial crisis in 2008 and their founder now lives in St Croix and makes it his goal to avoid paying US Taxes. Yes, a great BUY if you are an unethical investor seeking financial gain from a company that makes it’s living illegally foreclosing on homeowners that live in the USA and pay US Taxes.

Summary

New Residential offers a very high dividend yield to its owners.

The company managed to protect its book value despite headwinds from declining mortgage rates.

Investors can expect attractive total returns over the coming years.

Article Thesis

Buying purely based on dividend yields is oftentimes not a great idea, but as long as the dividend is well covered and supported by profits, high-yielding stocks can be attractive for income investors as well as for those interested in total returns. New Residential (NRZ) is one such company with a high dividend yield that is well supported by its profits. On top of that, New Residential also trades below book value right now, which is why there is ample potential for share price appreciation.

New Residential is not an investment without risks, but for the right type of investor, and in the right amount, New Residential provides ample potential to boost a portfolio’s current yield and total return potential.

Dollar jar full of money, dividends income stream, cash generation, high-yieldNew Residential: Unique Focus On MSRs

New Residential is a mortgage REIT, but unlike most other mREITs, it invests a large amount of its cash into a special type of mortgage-related assets, so-called (excess) mortgage servicing rights, or MSRs.

New Residential presentation slide, MSRs, business model Source: New Residential presentation

The company’s asset portfolio also includes other types of investments, including residential securities and consumer loans (unsecured and homeowner loans). New Residential also provides a range of services to customers through operating businesses.

45% of New Residential’s assets are held in MSRs and servicer advances, with 32% of the company’s assets being held in residential securities and call rights. MSRs have provided the biggest part of New Residential’s asset base since the company went public, but its share of total assets has declined in the recent past, from ~2/3rds of assets 1.5 years ago to less than half of assets at the end of the most recent quarter.

New Residential asset holdings yields returns Source: New Residential presentation

MSRs make up more than $3 billion of New Residential’s asset base right now. The company targets high returns with MSRs, with lifetime yields of 12%-18%, but this is in line with the yields that New Residential seeks to generate with other types of investments, which usually come with yields of 15% or even more.

With targeted yields being this high, investors have to wonder what the risk characteristics are for New Residential, as loaning out money at double-digit yields usually comes with a significant degree of risk. New Residential points out that both the consumer as well as the housing market are strong in the US, which is why management believes that risks of defaults are low.

It should be noted that New Residential was not a standalone company during the last financial crisis, we thus don’t know what the performance of New Residential’s portfolio would look like during a downturn. There is good reason to believe that an increase in defaults could hurt the company in such a scenario.

Interest Rate Headwinds For MSRs: Mostly Dealt With Already

Mortgage servicing rights are more valuable with interest rates rising, whereas MSRs decline in value with rates shrinking. The current interest rate environment, therefore, is not beneficial for New Residential’s MSR business.

The company has written down the value of its MSR portfolio during the last couple of quarters to some extent already, though, which is why current book value does already account for the fact that lower interest rates are somewhat of a headwind for this part of the business. On top of that, there are benefits to lower interest rates as well:

Increased refinancing of mortgages results in higher mortgage originations, which allows New Residential to buy new assets

New Residential’s portfolio includes an above-average amount of seasoned loans, and a below-average amount of its portfolio is refinancable (23% versus 44% for the industry, according to New Residential). This means that its competitors will face a much larger amount of refinancing than New Residential itself, which could allow New Residential to capture market share.

New Residential’s assets do not all suffer from lower interest rates. Instead, assets such as call rights increase in value with interest rates being on the decline.

All in all, New Residential looks like it is better positioned versus its peers, interest rate declines will likely not be much of a headwind for New Residential. The downward move in mortgage rates has been quite pronounced over the last year:

ChartData by YCharts

Most of the rate decline happened before the end of June, though. Mortgage rates stood at 3.7% at June 30, whereas they stand at 3.65% right now, and it looks like they have stabilized around the current level. New Residential has written down the value of its MSRs substantially during Q2. Since the end of the second quarter, mortgage rates have declined only very slightly, by just 5 base points, which pales in comparison to the 120+ base point move over the last year. Write-downs on New Residential’s MSRs will thus likely be much lower during Q3 and Q4.

It Is Rare To Find New Residential Trading Below Book Value

Most of the interest rate headwind due to lower mortgage rates has thus already been realized, and New Residential should get back to book value growth over the coming quarters.

ChartData by YCharts

Since it went public, New Residential has grown its book value by more than 60%, or by close to 8% annually. The recent MSR write-downs due to the headwinds from declining mortgage rates are already factored into the book value and book value growth rate, without that, New Residential’s performance had been even more compelling.

With shares trading for slightly above $15, shares are valued at a couple of percentage points below book value right here:

New Residential valuation, undervalued, price to book, below book value

New Residential’s shares are trading at one of the lowest valuations they have traded at ever, only for very short periods of time its shares were valued at even lower levels, such as during the market sell-off in early 2016. Most of the time New Residential has been trading well above book value, which makes shares look historically inexpensive right here. This is especially surprising as the MSR write-downs are already dealt with, which is why further hits to book value are not overly likely in the foreseeable future.

When shares traded above book value, New Residential has regularly issued new equity in order to grow the asset base further. Selling new shares above book value to grow the company is mostly accretive to book value per share, and therefore an opportune move. Since shares are trading below book value now, issuing new shares would be dilutive, and therefore a bad idea. Management has thus decided that issuing new shares right here is not the right move. Instead, management chose to issue preferred stock instead.

Issuing preferred stock at a yield of 7.1%, which does not hurt book value of the common, is much more shareholder-friendly than issuing common stock with a yield of 13.0% that does hurt book value per share on top of that.

Even better, management has decided to capitalize on the fact that New Residential is trading below book value right now, through a $200 million stock buyback program.

Management’s ease at shifting between issuing and buying back shares, depending on what is more advisable at the time, shows its shareholder-friendly approach that is centered around growing the value per share in the long term.

New Residential’s Dividend: Boosting Portfolio Yield, And The Basis For Attractive Total Returns

New Residential’s dividend of $0.50 per quarter results in a dividend yield of 13.0% at the time of writing. This is not only a massive dividend yield relative to what investors can get from the broad market, but it also compared favorably to the dividend yields of other mortgage REITs.

ChartData by YCharts

The VanEck Vectors Mortgage REIT Income ETF yields 6.9% right here, or a little bit more than half of New Residential’s dividend yield. The yield spread has widened substantially over the last year, which could mean that it is an especially opportune time to buy shares of New Residential.

New Residential core earnings per share EPSSource: New Residential investor relations

During the last couple of quarters New Residential has consistently earned more than $0.50 per share, the dividend has thus been covered. In total, the company has generated earnings per share of $2.27 over the last four quarters, while paying out $2.00 in dividends, for a coverage ratio of 114%.

New Residential’s dividend alone would allow for quite compelling total returns in the double-digit range, but there is some potential for share price gains as well. This is, on one hand, based on the fact that shares trade at an abnormally low valuation of just 0.95 times book value, which results in some multiple expansion potential.

On the other hand, New Residential also has the potential to grow its book value over the coming years, as they have done for years. This book value growth, on a per-share basis, can be the result of the ongoing expansion of New Residential’s business and asset base. Book value per share growth could also come from share repurchases, as long as New Residential does not pay more than book value when buying back shares.

Through a combination of its dividend and some low single-digit share price growth, New Residential could generate mid-teens total returns annually, which looks quite attractive.

Takeaway

New Residential has a different focus compared to most mREITs, as it invests a large amount of its money into MSRs and other high-yielding investments. Declining mortgage rates are a headwind for its MSR business, but other business units benefit from lower rates.

On top of that, the majority of the rate declines happened during Q2 of 2019 and earlier, which is why there will likely not be any large asset write-downs in the future.

New Residential offers a dividend yield of 13.0%, and trades below book value right now, which is a rare opportunity. Due to the nature of the higher-yielding investments the company makes, it would likely be vulnerable versus steep economic downturns, but for those that are not afraid of the risks, New Residential looks like an attractive investment right here. Shares could generate mid-teens total returns over the coming years, I believe.

The Power of Multiple Cash Flow Streams

Jonathan Weber is covering the large-cap dividend sector for Cash Flow Kingdom: “The Place where Cash Flow is King”.

From inception (1/1/2016) through January 2019, the CFK Income Portfolio has had a total return of 50.2% (verse 46.8% for the S&P 500, and 32.3% for the Russell 2000). This was accomplished while offering a very attractive average portfolio yield (currently 9.6%), an income stream that looks like this:

Cash Flow Kingdom, “The Place where Cash Flow is King”

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Screenshot of New Residential and their relationship with OCWEN, HLSS and latest acquisiton in bankruptcy DITECH