Having had one of the best years in over a decade, mortgage bankers are being treated as suspects by the market. Investors are worried about rising mortgage rates choking the refinancing market and heightened competition among bankers which is squeezing margins. In this environment, a mortgage banker with several complementary professions such as New residential investment (NYSE: NRZ) can be a good way to navigate the current environment.
New Residential is officially a Mortgage Real Estate Investment Trust (REIT) and owns a $ 15.9 billion portfolio of mortgage-backed securities and entire residential loans. The company also owns $ 5.4 billion in mortgage management rights (MSR) and is the largest non-bank owner of mortgage management rights.
Mortgage management rights are an unusual asset
Mortgage management rights are attractive in that they increase in value as interest rates rise; just about every other financial asset (stocks, bonds) goes down when this happens. Since mortgage originators are likely to see refinancing activity decline when rates rise, asset servicing mortgages can help offset this drop in volumes.
Here’s how a mortgage management right works: Mortgage managers take care of the administrative tasks of a mortgage loan. They collect the monthly payment, make sure the loan owner receives the principal and interest owed, and make sure property taxes are paid and home insurance is up to date. If the borrower is behind on payments, the service agent works with the borrower to secure the current or amended loan. If the borrower defaults, the service agent handles the foreclosure process. To perform these tasks, the service agent gets 0.25% of the loan value per year.
Mortgage service can compensate for lower origination volume
From an investor’s perspective, the server is going to earn 0.25% per annum, but the question is for how long. If the borrower refinances the loan within a short period of time, the asset is not worth much. On the other hand, if the borrower keeps the loan for a decade, then the asset is worth a little.
Much of this value depends on changes in interest rates. If rates go up, the borrower will have no incentive to refinance, and the mortgage service charge is worth a lot. This increase in services will help offset the drop in revenues from the origination business.
On the first quarter earnings conference call last week, CEO Michael Nierenberg explained it this way:
With significantly lower refinancing volumes and a home buying market expected to remain strong, no one will be better positioned to take advantage of this scenario than us. Going forward, our investing activities are well positioned to benefit from higher rates, led by MSRs. It will increase as rates rise resulting in more cash flow and higher profits. Adding Caliber [Home Loans] and the great strides we have made around recovery at NewRez will offset the lower expected profits we will see in the origination business as the gains on selling margins continue to narrow.
Maintenance revenues represented 44% of revenues in the first quarter, which was a function of maintenance revenues and an increase in maintenance values. As a percentage of the loan amount, they went from 1.06% to 1.19%. Management said during the earnings call that they saw a lot more upside in assets as rates rose.
New Residential said book value increased 4.4% in the quarter to $ 11.35 per share. At current levels, the stock is trading at a 13% discount to book value, which is pretty big for the mortgage REIT industry these days. The stock also pays a quarterly dividend per share of $ 0.20, giving the company a dividend yield of 7.8%. For income investors, New Residential offers a decent dividend yield, in addition to having an operating activity that makes it less susceptible to the vagaries of the mortgage-backed securities market.
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