DBRS Morningstar Upgrades New Residential Investment Corp. to BB (low), Trend Stable

DBRS, Inc. (DBRS Morningstar) has upgraded the Long-Term Issuer Rating of New Residential Investment Corp. (NRZ or the Company) and those of its subsidiaries to BB (low) from B (high). The trend on all ratings is Stable. The Company has been assigned a Support Assessment of SA3 resulting in the Company’s final rating being equalized with its Intrinsic Assessment (IA) of BB (low). The Support Assessment for each of the debt issuing subsidiaries is SA1.
Concurrently, the ratings have been removed from Under Review with Positive Implications, where they were placed on April 22, 2021 following the announcement that the Company had entered into a definitive agreement to acquire Caliber Home Loans, Inc (Caliber) for approximately $1.675 billion in cash.

KEY RATING CONSIDERATIONS
The ratings action considers the benefits to NRZ’s growing mortgage operating business from the acquisition of Caliber given the complementary strengths of NRZ and Caliber. Specifically, the acquisition broadens NRZ’s product diversity, strengthening its home purchase mortgage business, expands its mortgage servicing rights (MSRs) portfolio, and strengthens its overall recapture rate across its current servicing portfolio. Importantly, the enhanced scale, broader product set and increased geographic diversification combined with modest cost synergies are expected to benefit earnings generation through interest rate cycles. The ratings action also considers the solid balance sheet fundamentals of NRZ post-acquisition, which are expected to remain consistent and in line with the current ratings per DBRS Morningstar methodology. While improved, NRZ’s funding profile remains reliant on secured forms of funding and is a ratings constraint. As with any sizeable acquisition, we see integration and operation risks associated with the acquisition, but consider NRZ’s history of successfully integrating past acquisitions without material missteps as mitigating this risk.

The Stable trend reflects DBRS Morningstar’s view that the U.S. housing market should remain strong through the remainder of 2021 and into 2022 despite increasing affordability issues and the potential for rates to increase, albeit from historically low levels. Indeed, we expect the U.S. residential mortgage market to shift from a refinance driven market to one that is more oriented to home purchase. We see the acquisition of Caliber, which has a strong retail, purchase mortgage business as positioning NRZ well for the continued shift in market origination volumes.

RATING DRIVERS
A successful integration of Caliber’s business while generating solid results from the mortgage operations business and growing its market share would lead to the ratings being upgraded. Maintenance of the Company’s current balance sheet leverage while reducing its reliance on short-term repo financing would also lead to the ratings being upgraded. Conversely, the ratings would be downgraded if NRZ were to experience sustained losses. A weakening of the Company’s liquidity position or a sustained and notable increase in the Company’s leverage would also lead to the ratings being downgraded.

RATING RATIONALE
DBRS Morningstar considers New York-based NRZ’s franchise as strengthening given its growing presence in the residential mortgage marketplace as it evolves from an investment manager focused on residential mortgage assets to an institution that is more reliant on the operating businesses that it has acquired to drive financial performance. With the addition of Caliber, NRZ is the fourth largest non-bank mortgage originator with combined 2Q21 volumes of $5.1 billion, as well as the fifth largest non-bank mortgage servicer with a servicing portfolio totaling $467 billion in unpaid principal balance (UPB) (excluding MSRs held by NRZ but serviced by third-parties) at June 30, 2021. The Company will continue to also benefit from its ancillary business lines that provide NRZ access to the whole mortgage life cycle, including title, home appraisal, and property management.

Importantly for the ratings, we anticipate that NRZ will benefit from Caliber’s strong retail branch presence in capturing more home purchase mortgage business as refinance activity moderates with the expectation that mortgage rates will move higher in 2022. We expect that NRZ’s existing servicing portfolio will benefit from the strong retention rates experienced at Caliber. Caliber reported a 65% retention rate in 2Q21 compared to 41% at NRZ. Strengthening retention rates would improve NRZ cash flows, net margins on originations and protect the MSR assets on the balance sheet.

We view NRZ’s strengthening market positions as benefiting earnings given the more consistent results generated from the operating businesses, all of which are long-term positives. NRZ has demonstrated an ability to consistently generate profits. Indeed, the Company has only reported three quarterly losses (two of the three quarters occurred in 2020) since the beginning of 2014 (a span of 30 quarters) and has been profitable each year with the exception of 2020. However, the quality of revenues is considered below average as most of the Company’s income (revenue) has been generated through gains on fair value of assets or gains on sale, both of which can be volatile.

For 1H21, NRZ generated net income of $555 million, a significant improvement from the outsized loss to common shareholders of $1.6 billion reported in 1H20. Revenues, net of interest expense, in 1H21 more than tripled compared to the prior year to $1.4 billion from $400 million in 1H20. The improvement was driven by improved marks on the MSR valuation resulting in servicing revenue of $427 million compared to a $379 million loss in 1H20. Gains on sale of mortgages were 44% higher year-on-year (YoY) at $690.3 million. Revenues also benefited from a reduction in funding costs leading to lower interest expense. Results in 1H21 also benefited from a lower loss on the change in fair value of investments at $65 million compared to a $460.0 million charge in 1H20. Further, NRZ’s loss on the sale of investments was $88.3 million in 1H21 compared to $874 million in the comparable period a year ago. We note that the Company’s operating businesses, the servicing and origination business, generated a pre-tax profit of $338.1 million in 1H21, benefiting from a growing servicing book and improved margins on mortgage originations.

NRZ’s risk profile is viewed as elevated with credit and operational risk having been managed appropriately while market risk is above average with 77% of total assets are carried at fair value as of June 30, 2021. At June 30, 2021, New Residential held total receivables and securities of $25.9 billion, up from $15.8 billion a year ago.
Market risk is primarily generated by the Company’s sizeable residential mortgage securities portfolio as well as the MSRs held on its balance sheet. At June 30, 2021, the Company held $15.0 billion of residential mortgage securities at fair value, up from $6.1 billion in the comparable period a year ago. Of the total securities portfolio, 93% is comprised of Agency RMBS that are a hedge for the Company’s MSR portfolio. The Company also holds Non-Agency RMBS securities totaling approximately $1.0 billion at fair value, representing approximately 6% of the face amount of the securities. The residential mortgage securities portfolio was in a net unrealized loss position of approximately $140 million at June 30, 2021. Meanwhile, at 2Q21,NRZ held $4.8 billion of MSRs on its balance sheet with an underlying UPB of mortgages totaling $398.6 billion. Of the underlying mortgages, 67.6% were Agency mortgages with an additional 14.7% Ginnie Mae mortgages.

Overall, the credit performance of NRZ’s servicing portfolio has been solid throughout the pandemic. Through July 20, 2021, a total of approximately 200,000 borrowers had requested and were granted coronavirus-related forbearance from NRZ. Forbearance trends were positive through the end of July with loans in forbearance declining to 2.3% of the portfolio, down from a peak of 8.4% in May 2020, and from 7.8% a year ago. While the housing and mortgage markets continue to be robust, DBRS Morningstar believes there is still a level of uncertainty in the operating environment which could lead to weaker asset performance as government stimulus and support programs expire, as well as the potential for additional restrictions in economic activity to combat the spread of the coronavirus.

Funding has improved with NRZ completing its inaugural issuance of unsecured senior debt as well as reducing the potential for liquidity calls from facilities. Nevertheless, the Company continues to be reliant on secured forms of wholesale funding. At June 30, 2021, NRZ had $29.1 billion of debt outstanding, of which $21.3 billion was repo financing. NRZ has focused on improving its funding profile by removing mark-to-market exposure from its facilities. As of June 30, 2021, 99% of the Company’s investment portfolio (MSRs, residential loans, non-agency MBS and servicer advances) are funded with facilities without mark-to-market exposure compared to 100% call exposure at year-end 2019. However, NRZ continues to be reliant on short-term repo financing for longer-dated but liquid assets in its investment portfolio. NRZ has maintained access to the securitization markets, completing seven transactions in 2021 through July. Importantly, the Company expects to maintain its sound liquidity position post-closing, forecasting approximately $1.1 billion of available cash liquidity post-closing.

NRZ’s equity position is acceptable with a reasonable cushion to covenants. NRZ’s total shareholder’s equity was $6.2 billion at June 30, 2021, 15% higher than in the comparable period a year ago, reflecting the $522 million of common equity raised as part of the financing of the Caliber acquisition. Leverage (debt-to-equity) has increased with the higher business volumes. At June 30, 2021, the Company’s leverage was 4.7x, up from 3.3x a year ago.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

Notes:
All figures are in U.S. dollar unless otherwise noted.

The principal methodology is the Global Methodology for Rating Non-Bank Financial Institutions (September 2, 2021): https://www.dbrsmorningstar.com/research/383936/global-methodology-for-rating-non-bank-financial-institutions. Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021): https://www.dbrsmorningstar.com/research/373262/dbrs-morningstar-criteria-approach-to-environmental-social-and-governance-risk-factors-in-credit-ratings.

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.

The primary sources of information used for this rating include Company Documents and S&P Global Market Intelligence. DBRS Morningstar considers the information available to it for the purposes of providing this rating was of satisfactory quality.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar’s outlooks and ratings are under regular surveillance.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com.

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