Analyzing Rhythm Capital Corporation (RITM)

Welcome to the second installment of my portfolio series, where I analyze all 31 stocks currently in my personal portfolio. Today, we’ll be taking a detailed look at Rhythm Capital Corporation, ticker RITM. This company was formerly known as New Residential, ticker NRZ, until they decided to rebrand last June. If you’re new to my blog, my primary focus is on income investing and dividend growth investing, with holdings that offer at least a four percent yield.

My Holdings and Dividends

Logging into my Vanguard account, where I manage all my dividend investing, I currently own 603 shares of RITM. Rhythm Capital pays a quarterly dividend, with the most recent payment being 25 cents per share. Unfortunately, Rhythm Capital hasn’t paid a special dividend since 2014, so that’s not something we can expect regularly with this stock. With my current holdings, I receive approximately $150.90 in dividends each quarter. Breaking it down monthly, that’s about $50.30 in dividends from Rhythm Capital. This stock is currently one of my largest holdings for a mortgage Real Estate Investment Trust (REIT), both in terms of capital invested and dividend income.

About Rhythm Capital Corporation

Rhythm Capital operates as an investment manager with a vertically integrated mortgage platform. They invest in real estate and related properties in the U.S. and Europe, providing capital and services to the real estate and financial service sectors. Their investment portfolio comprises mortgage servicing-related assets, residential securities and loans, and single-family rental loans. As a REIT, they are required by law to pay out 90% of their earnings to shareholders in the form of dividends.

Rhythm Capital is currently the fourth largest mortgage REIT (mREIT) with over $32 billion in assets and serves around 3 million U.S. customer members as of December of last year.

Evaluating Rhythm Capital Corporation

I’ve mentioned several times on my channel that out of all the higher-yielding types of investments, mortgage REITs are probably my least favorite. This is because many well-known companies in this sector have a long history of dividend cuts, including Annaly Capital Management, AGNC Investment Corp, and Orchid Island Capital. Given how most mREITs operate in a high-interest-rate environment, these companies tend to perform significantly worse than other higher-yielding investments like BDCs and many closed-end funds.

Naturally, I don’t like to invest a significant amount of money into mREITs because I consider them to be among the riskier types of holdings. However, when I do invest in a mortgage REIT, they must have a competitive advantage that sets them apart. There must be something unique about how they conduct their business that differentiates them from other mREITs like Annaly Capital or Invesco Mortgage Capital.

History and Transformation of Rhythm Capital

Rhythm Capital, in my opinion, is one of those mortgage REITs that stand out. It’s a company that has done exceptionally well in adapting and changing its business to better position itself in a risky industry. If you weren’t aware, Rhythm Capital was originally founded as New Residential Corporation back in 2011. Initially, the company focused on three major areas: investing in excess mortgage servicing rights, non-agency residential mortgage-backed securities, and agency residential mortgage-backed securities. They also invested in some unusual types of debt, including credit card debt, which was atypical for an mREIT.

For years, this was the company’s core business, and they performed well for about six years. However, during the pandemic, the company took a major hit and had to sell many of its assets at a discount, resulting in a significant drop in share price and a drastic reduction in dividend distributions—from 50 cents a quarter down to just 5 cents per quarter. After gradually rebuilding, they now pay 25 cents per share per quarter in dividends.

Strategic Shifts and Acquisitions

During and even before the pandemic, New Residential was in the process of transforming its business and moving in a new direction. The company aimed to ensure better performance across various economic environments, resulting in significant changes over the past few years.

In 2021, the company acquired Genesis Capital, which offers bridge, fix-and-flip, and construction loans to developers. They also acquired Caliber Home Loans, a large national mortgage lender. Additionally, they now own Guardian Asset Management, which provides property management services like inspections and repairs for both government and non-government properties. They also own E Street Appraisal, which offers property appraisal services, and have invested in single-family rental properties through a company called Adoor.

These acquisitions have diversified Rhythm Capital’s revenue streams significantly. They’re no longer just investing in mortgage-backed securities or mortgage servicing rights but have branched out to include a variety of real estate-related income streams.

Internal Management Transition

Last June, Rhythm Capital announced that they were in the process of internalizing their management, a significant move for the company. There are two types of mortgage REITs: internally managed and externally managed. While both can perform well, internally managed REITs generally save money by managing investments in-house rather than paying another financial institution to do so.

According to their second-quarter 2022 investor presentation, Rhythm Capital expects that internalizing their management will save them as much as $65 million a year. Although the transition is costly, the long-term savings make it a worthwhile move for the company.

Financial Performance and Dividend Stability

Despite transforming significantly over the past few years, Rhythm Capital has maintained steady performance. While many mREITs have struggled in the current high-interest-rate environment, Rhythm Capital has been consistent. The company currently pays 25 cents per share in dividends each quarter and earned about 33 cents in distributable income last quarter, giving their stock a current dividend coverage percentage of 132%. Throughout 2022, Rhythm Capital has fully covered their dividend payouts, unlike Annaly Capital and ARMOUR Residential, which recently cut their dividends.

Unique Investment Approach

One of the standout features of Rhythm Capital’s investment portfolio is their focus on mortgage servicing rights (MSRs), a departure from the typical heavy investment in mortgage-backed securities seen with other mREITs. MSRs are agreements where a mortgage lender outsources the management of mortgages to a third party, like Rhythm Capital, which collects payments and performs other administrative tasks.

Given the high-interest-rate environment, one might expect fewer mortgages to be issued, potentially reducing income from MSRs. However, the value of MSRs actually increases as interest rates rise because there’s less prepayment risk. This situation benefits Rhythm Capital, as the value of their servicing rights increases with higher interest rates, balancing out periods when interest rates are low and mortgage origination is high.

Portfolio Composition and Book Value Stability

Currently, 73% of Rhythm Capital’s portfolio is made up of servicing assets, with the remaining percentage spread across various other investments. Their book value has also been more stable than many other mREITs, an important metric for evaluating the performance and stability of these types of investments.

Final Thoughts on Rhythm Capital Corporation

In summary, Rhythm Capital has done an impressive job positioning itself in recent years. They’ve diversified their income streams, internalized management to save costs, and maintained dividend stability in a challenging environment. While I consider mREITs to be inherently risky and thus have a conservative investment in them, Rhythm Capital stands out as a well-managed and strategically positioned company within this sector.

Leave a Comment