New Residential Investment (NRZ) is technically a mortgage REIT, but the firm doesn't simply buy mortgage loans and collect the interest, asserts Brett Owens, editor of Contrarian Outlook.
That business model prints money when interest rates are declining but runs into trouble as rates rise. NRZ, on the other hand, has uniquely positioned its portfolio to make money during all rate environments. It has steadily increased its book value — the value of the investments it holds — every year since going public in 2013.
The firm's recent secret has been to purchase mortgage service rights (MSRs) instead of mortgages themselves. MSRs rise in value as mortgage refinancing slows down, which they certainly have. Today less than 10% of all outstanding mortgages are "refinanceable".
The current Fed outlook should remain bullish for MSRs. Steady rates would keep these mortgages out of refinance territory. CEO Michael Nierenberg bought $15 to $20 billion more MSRs for NRZ in the fourth quarter (boosting its holdings by another 5%) to help continue to power the stock's $0.50 per quarter payout.
Big picture, that's the near term plan for Nierenberg & Co. He'll continue using MSRs as the cash flow cow while the firm expands other offerings (such as mortgage originations, home loans and mortgage securitizations) for incremental revenue.
The MSR portfolio doubles as the potential Achilles heel for NRZ. While Neirenberg owns hedges on its MSRs, this portion of the portfolio did drop in value in the fourth quarter as the stock market and rates plunged.
The stock's book value is $16.25, yet shares trade barely above this level as I write. This means you and I can buy NRZ for the liquidation value of its investments and get the rest of the business for free.
And oh by the way, the stock pays $2 per share per year, which is good for 12.1% as I write. These generous dividends are covered by the current earnings power of the portfolio itself.
The stock recently dipped on a 40 million share issuance. This is a common practice for REITs, who have little in the way of retained earnings. Their favored tax status requires them to pay most of their profits to their shareholders as dividends. So, they must use their equity as a line of credit.
In my experience these types of issuances are buying opportunities. They temporarily increase the supply of shares on the market and taco the price for a limited period of time. We should take advantage of the sale.
