A common refrain that “yield hunters” find themselves advocating is “what good is a 10% return if the price drops 15% every year?” or something to that effect. Everyone’s situation and investment goals are unique; take for example the “reverse mortgage“whereby homeowners can stay in their home but lose equity each year (not entirely different from the yield hunter refrain described above). Plus, this situation is actually preferred by some investors, and it may prove to be an accurate recoil description of an investment in Rithm Capital (NYSE: RTM) five years later. In this report, we explain why the Rithm Capital Mortgage REIT is an unattractive and systemically unimportant investment, then we offer two larger high-dividend REIT alternatives that we believe are worth considering. We conclude with our firm opinion on the investment.
Rhythm CapitalYield: 10.0%
Formerly known as New Residential Investment Corp (NRZ), Rithm Capital is a high-dividend mortgage REIT that should be avoided by most investors. Its balance sheet consists of a hodgepodge of legacy mortgage assets that are difficult to manage and of little importance to the financial system, its CEO has a history of questionable behavior, the company has just lost its credible external management team and its opportunities are limited in the future. It is essentially money that dies, as we will explain below.
History of Rhythm
To give a bit of history, Rithm was initially founded around the time of the financial crisis of 2008-2009. It was a shrewdly opportunistic venture that took advantage of the mortgage woes of the crisis. Specifically, it first owned mortgage servicing entitlements (which became surprisingly large when the housing bubble burst) and then excess mortgage servicing entitlements. In fact, it still holds many of these assets on its balance sheet, but the tremendous growth and very high yield opportunities in this asset class (that emerged during/after the financial crisis) are now long gone. And since the opportunities had already passed, Rithm seized new opportunities (none of which are as attractive as those that existed shortly after the start of the financial crisis of 2008-2009). And as a result, Rithm’s balance sheet now consists of a hodgepodge of mortgage-related assets that are risky and difficult to manage, like those in the chart below.
The Fortress just got rid of Rithm
A testament to the challenges and lack of attractiveness of Rithm’s business and balance sheet, the company has just been dumped by its external management company, Fortress Investment Group (FIG). And while Rithm tries to pass this off as a great opportunity to become internally managed (thereby reducing expenses and eliminating conflicts of interest), it’s really just an indication that the future of the business is not not particularly promising. CEO Michael Nierenberg tries to put a positive spin on it as follows:
“We have changed dramatically since our inception, moving from an owner of MSR assets to a company with complementary operating companies and a unique portfolio of investments. The new name and brand help distinguish us from our operating companies, including Newrez, and reflect our culture, team and ambitions for growth beyond residential mortgages.”
In plain English, the company is giving up the white flag and is now trying to use shareholder capital to come up with other options. And for perspective, here’s how the company’s stock price has fared (remember it recently changed its name from New Residential to Rithm Capital) since its risky assets were destroyed (and the decimated dividend) when the cash crisis of early 2020 hit (as we warned in late 2019).
Rithm CEO Contributed to Bear Stearns Demise
If you remember the distress of the 2009-2008 financial crisis, it was largely triggered when Wall Street bank Bear Stearns (followed by Lehman Brothers) collapsed. And a look under the hood reveals that the current CEO of Rithm (Michael Nierenberg) worked at Bear Stearns and his risky behavior contributed very significantly to the collapse. And for reference, here’s more color on what Nierenberg has been up to lately.
Rithm assets: NOT systemically important
When the COVID pandemic hit, Rithm was badly hit due to its risky balance sheet assets. It is extremely important to note that the Fed was working overtime to bail out the financial markets at this time (buying all sorts of assets to inject liquidity into the system), but it was NOT bailing out the miscellaneous and exotic MSRs. from Rhythm. The Fed was buying agency mortgage-backed securities (Agency MBS) in spades (to the benefit of other mortgage REITs, but not so much Rithm). Rithm was actually trying to buy Agency MBS at that time to offset some of the MSR risk (as the quote from CEO Michael Nierenberg explains below), but it was too little too late as the lack of cash and the damage to the book value had already been done.
As we think about the investment portfolio going forward, one of the areas we have been focusing on, we have added agency stocks to offset part of our MSR portfolio.
For reference, here’s a look at what happened to book value and dividend.
2 Best Big Dividend Opportunities
In our view, Rithm is simply dying of money, it’s only a matter of time before localized market turmoil and risk throws it into distress and book value declines further. . Sure, he could pull a rabbit out of his hat and put himself on the path to recovery and miraculous gains, but that seems unlikely. Investing in Rithm is not an attractive risk in our view (regardless of the high dividend yield). Instead, we offer two better (and more systemically important) big dividend opportunities below.
Annaly Capital (NLY) preferred, yield: 7.2%
Like Rithm, Annaly is also a mortgage REIT. However, unlike Rithm, Annaly’s balance sheet assets are more systemically important, as increasingly demonstrated by the Federal Reserve’s clear commitment to backing them. Specifically, the overwhelming majority of assets on Annaly’s balance sheet (~71%) are agency MBS, which are essentially government-backed. For example, the Fed quickly bought massive amounts of agency MBS when the pandemic hit in order to inject liquidity into the system.
However, in Annaly’s case, it is actually preferred stocks (eg (NLY.PF) that we prefer (not common stocks). Preferred stocks are higher in capital structure and have less volatility In addition, they trade at a small discount to their $25 redemption price (unlike common stocks which currently trade at a large premium to their book value). large dividends).
Medical Properties Trust (MPW), yield: 7.3%
Although a real estate REIT (not a mortgage REIT), Medical Properties Trust is another high-dividend REIT that we like more than Rithm. And one of the reasons we like MPW is that its assets (hospital real estate) are systemically important (unlike most assets on Rithm’s balance sheet).
Specifically, MPW owns the real estate currently occupied and operated by hospitals that is extremely important to the communities in which they operate. The basic business model is that MPW provides essential capital to hospitals by purchasing their real estate, and it is a win-win as it gives MPW ownership of significant hospital properties and gives hospital operators access to capital so that they can improve their operations. . We recently wrote about MPW in detail in our report: “Medical Properties Trust: 50 Big-Dividend REITs Down Big.”
Each investor has their own goals and their own risk tolerance. For example, some investors place such value on large dividends that they don’t mind the stock price deteriorating over time. In our view, this is likely to happen with Rithm Capital over time. It will continue to pay big dividends as its stock price drops (yes, there will be ups and downs, but we expect the long-term trend to be a steady decline in stock price).
Unlike Rithm, Annaly Capital and Medical Properties Trust own assets that are important to the operation of society (MPW owns major hospitals and NLY primarily owns Agency MBS which helps support the residential mortgage market so people can have houses to live).
Ultimately, you have to decide which investments and which investment strategy are right for you. Disciplined, goal-oriented, long-term investing is a winning strategy.