DBRS Morningstar Assigns B (high) LT Issuer Rating to New Residential Investment Corp., Trend Neg

DBRS, Inc. (DBRS Morningstar) has assigned a Long-Term Issuer Rating of B (high) to New Residential Investment Corp. (NRZ or the Company). The trend on the rating is Negative. 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 B (high). Concurrently, DBRS Morningstar has assigned a Long-Term Issuer Rating of B (high) with a Negative trend to each of the Company’s indirect, wholly owned debt issuing subsidiaries HLSS Holdings, LLC, HLSS MSR-EBO Acquisition LLC, New Residential Mortgage LLC and MSR WAC LLC. The Support Assessment for each of the debt issuing subsidiaries is SA1.

KEY RATING CONSIDERATIONS
The ratings considers NRZ’s moderate, but growing franchise in the U.S. residential mortgage market and acceptable capitalization which provides a reasonable cushion to covenants given the risk profile of the balance sheet. The Company’s ability to generate consistent profits demonstrates an ability to produce sufficient earnings to absorb provisioning for credit losses as well as fair value movements in assets held at fair value on the balance sheet. However, the significant loss in 1Q20 illustrates the potential volatility inherent in the Company’s earnings generation ability and is a meaningful constraint on the ratings. While credit and operational risk have been managed appropriately, NRZ has significant market risk with 70% of total assets carried at fair value. Given the adverse operating environment as a result of the Coronavirus Disease (COVID-19) pandemic and the related rapid and material rise in unemployment, DBRS Morningstar expects credit losses in the residential mortgage portfolio to increase in 2020 and 2021. While the Company has made significant progress removing mark-to-market requirements from its financing facilities, the ratings also take into account the Company’s weak funding profile that is reliant on short-term repurchase agreements (repos), which introduces a level of refinancing risk.

The Negative trend reflects the uncertainty as to the future credit performance of the Company’s residential mortgage loans given the coronavirus induced recession. While forbearance levels have declined steadily since May 2020, DBRS Morningstar continues to be concerned that performance could deteriorate should U.S. labor markets remain challenged while government support programs and stimulus expire.

RATING DRIVERS
Given the Negative trend, an upgrade of the ratings is unlikely. The trend on the ratings could be moved to Stable should the Company continue to make progress in strengthening its funding and liquidity position while also stabilizing its financial performance.

Conversely, additional material financial losses as a result of the challenging operating environment would lead to the ratings being downgraded. Weakening of the Company’s liquidity position or an increase in the composition of funding from short-term funding facilities would lead to the ratings being downgraded. A material reduction in the cushion to covenants, including minimum tangible net worth and leverage, would also result in the ratings being downgraded.

RATING RATIONALE
DBRS Morningstar considers New York-based NRZ’s franchise strength as moderate. The Company seeks to leverage its expertise, scale, and infrastructure to capitalize on opportunities in the U.S. residential mortgage market as the marketplace evolves. NRZ’s goal is to own the “whole mortgage asset”, including origination, servicing, securitizing, appraisal, titling, and workout. The Company’s presence in the residential mortgage marketplace continues to grow 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. We view this evolution and strengthening market positions as enhancing the franchise, while also benefiting earnings given the more consistent results generated from these businesses, all of which are long-term positives. While NRZ’s investment in residential mortgage backed securities has diminished over the past several years, the Company will invest in mortgage-backed securities when management perceives opportunities as being attractive. This introduces the risk of investment style drift, and is also a potential constraint on the ratings.

As of June 30, 2020, NRZ had total assets of $23.75 billion, down from $44.9 billion at year-end 2019. With servicing and MSRs portfolios totaling approximately $277.6 billion and $610 billion of UPB, respectively, the Company ranks as a top-10 non-bank mortgage servicer. NRZ is also a leading non-bank residential mortgage originator with $19.7 billion of mortgages originated in 1H20, and is forecasting volumes of $45-to-$50 billion of originations for full year 2020 driven by the record low mortgage rates and corresponding surge in refinancing activity.

NRZ has demonstrated an ability to consistently generate profits. Indeed, the Company has only reported three quarterly losses (two of the three quarters have occurred in 2020) since the beginning of 2014 (a span of 26 quarters) and has been profitable each year since 2015. 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 1H20, NRZ generated a significant loss to common shareholders of $1.6 billion compared to net income of $113.6 million in 1H19. With 2Q20 results reflecting a small net loss, the six month results primarily reflect the outsized loss in 1Q20, which was driven by an $800 million loss on the sale of securities, a $265 million loss on the fair value of mortgage loans, and an 14% reduction in net interest income due to the sale of residential mortgage loans. Earnings were also pressured by a $289 million negative move in the fair value of MSRs and an impairment of $144.6 million for REO property. DBRS Morningstar notes that the Company’s operating businesses, which are comprised of the servicing and origination business, generated a pre-tax profit of $296.0 million in 1H20, 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 70% of total assets are carried at fair value. However, we expect credit losses in the residential mortgage portfolio to increase in 2020 and 2021 given the abrupt downturn in the U.S. economy and record levels of unemployment. At June 30, 2020, New Residential held total receivables and securities of $15.8 billion, down from $36.4 billion at year-end 2019.

Through July 20, 2020, a total of approximately 185,000 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 7.8% of the portfolio, down from a peak of 8.4% in May 2020. Moreover, new forbearance requests are down significantly. With extra unemployment benefits having expired at the end of July and coronavirus cases still elevated in certain areas across the U.S., there is uncertainty as to whether forbearance requests will increase again in the fall of 2020. To address this liquidity pressure, NRZ had total committed servicing advance financing capacity of $5.12 billion, at June 30, 2020. The Company ended 2Q20 with $2.2 billion of unused servicing advance capacity under its facilities.

We see NRZ’s meaningful reduction in its residential mortgage securities portfolio as on overall positive as it reduces the Company’s market risk exposure. At June 30, 2020, the Company held $6.1 billion of residential mortgage securities at fair value, down from $19.5 billion at year-end 2019. Of the total securities portfolio, 68% is comprised of Agency RMBS that is carried at a slight premium to par. The Company also holds Non-Agency RMBS securities totalling $1.9 billion at fair value, which is 8% of the face amount of the securities. The residential mortgage securities portfolio is in a net unrealized gain position of approximately $18 million at June 30, 2020.

DBRS Morningstar considers the Company’s funding profile as weak. NRZ continues to be reliant on short-term repo financing for longer-dated but liquid assets in its investment portfolio. This was demonstrated to be significant weakness during the substantial market turmoil at the end of March 2020 as the coronavirus pandemic intensified in the U.S. Furthermore, the Company’s financial flexibility is limited as the balance sheet is highly encumbered.

In response to these developments, NRZ has focused on improving its funding profile by removing mark-to-market exposure from its facilities and introducing more term financing for its assets. As of June 30, 2020, 95% 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. NRZ has maintained access to the securitization markets completing three transactions in 2Q20 and a subsequent transaction in July 2020. At June 30, 2020, NRZ had $16.6 billion of debt outstanding, down dramatically from $35.6 billion at year-end 2019. Repurchase agreements comprised $9.2 billion of debt, or 52% of total debt at June 30, 2020, down from $10.8 billion, or 61% at March 31, 2020, and materially reduced from $27.9 billion, or 78% of total debt at year-end 2019.

Liquidity has improved reflecting management’s intention to hold higher levels of cash until the operating environment becomes more clear. At June 30, 2020, the Company held $1.0 billion of cash on its balance sheet (4% of total assets), and had $9.3 billion of borrowing capacity across various facilities, subject to eligible collateral.

NRZ’s equity position is acceptable with a reasonable cushion to covenants. NRZ’s total shareholder’s equity was $5.4 billion at June 30, 2020, 20% lower than in the comparable period a year ago, reflecting the impact of the sizeable loss in 1Q20. The Company has been successful in raising additional capital over the last 18 months. However, these raises have been via preferred equity , to prevent dilution of common shareholders. Despite the sizeable loss generated in 1Q20, the Company’s leverage declined to 3.1x at June 30, 2020, from 5.0x at YE19, reflecting the liquidation of the agency securities portfolio and rapid pay down of debt in late March 2020, as the Company faced margin calls on certain facilities.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.

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

The principal methodology is the Global Methodology for Rating Non-Bank Financial Institutions (September 24, 2019): https://www.dbrsmorningstar.com/research/350802/global-methodology-for-rating-non-bank-financial-institutions.

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 did not have 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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