Part 1: Active Asset Management
This article is the first in a multiple-part series exploring specialized investment strategies utilized by New Residential Investment Corp. This real estate investment trust (REIT) is based in New York and focuses on opportunistic residential real estate investments such as excess mortgage servicing rights (MSRs) and non-Agency residential mortgage-backed securities (RMBS).
Active asset management and passive asset management are two extremes when describing portfolio management styles. New Residential is a stellar illustration of a company that actively manages investments — especially as applied to residential mortgage assets. Because active management styles and strategies are often misunderstood by investors, this article provides an overview of the primary challenges and effective resolutions for active asset management as applied by New Residential.
Active Asset Management: Problems and Solutions
Here are three of the most serious challenges often faced by active asset managers:
- Requirements for Constant Portfolio Monitoring — Active asset management is not an easy lifestyle for the portfolio manager. While passive investment styles involving assets like index funds entail virtually no portfolio management whatsoever after investments are purchased, actively managed assets require an ongoing commitment on a daily and hourly basis. In a rapidly changing political and financial environment, both small and large fluctuations in market conditions are commonplace. The built-in intensity of active management might explain the preference of some portfolio managers to avoid this challenge by simply choosing to pursue a more passive asset management strategy.
- Misunderstandings by Investors — An active investment manager must maintain a delicate balance among a series of complex transactions. However, these complexities can be difficult for even experienced institutional investors to understand at times. For example, with residential real estate financing vehicles such as excess MSRs and under-performing portfolios of RMBS, detailed analysis and execution of transactions need to be deftly coordinated. An active portfolio manager is simultaneously engaged in multiple time-consuming tasks such as analyzing, selling, buying, managing and refinancing. But regardless of success, it is not unusual for investors to be confused by an active asset management process.
- Maintaining Larger Cash Positions — Large cash balances can reduce earnings from cash holdings and lower overall investment returns. On the one hand, active portfolio managers must be prepared to take advantage of unexpected buying opportunities. On the other hand, a “fully invested” portfolio would inhibit the ability to do this, so most actively managed portfolios maintain ample cash positions that facilitate the capability to make purchases with a quick turnaround time. For example, when institutional investors are forced to suddenly sell because they must quickly increase capital reserves, an active asset management style will enable a portfolio manager to buy if the selling price is temporarily depressed due to the forced sale circumstances.
Multiple Active Management Solutions — New Residential Investment Corp. has successfully overcome active asset management challenges like those noted above by implementing multiple strategic solutions. The company has assembled a specialized and seasoned team that is adept at handling the demanding day-to-day responsibilities of actively managing a diversified portfolio of residential real estate investments. New Residential portfolio managers have focused on unique and hard-to-replicate assets such as mortgage servicing rights — excess MSRs additionally provide the advantage of increasing in value when interest rates go up. The company is well-positioned to benefit from mortgage servicing rights opportunities by successfully meeting qualifications for MSR acquisitions throughout the United States. To facilitate investment opportunities in the mortgage origination and servicing areas, the company’s subsidiaries now include ownership in both businesses. New Residential has also emphasized undervalued RMBS assets such as specific non-Agency portfolios and associated call rights.
One strategy employed by New Residential to reduce the need for large cash positions is twofold: (1) to finance some asset purchases with the participation of co-investors; and (2) to issue new asset-backed notes. It should be emphasized that these solutions would not realistically be available to all investors as they require strong existing business relationships and a solid capital structure to facilitate issuing new securities.
The Bottom Line: Active asset management is time-consuming and requires a specialized mindset — portfolio managers who are comfortable with constant change and the need to overcome difficult challenges. It is increasingly common to encounter new asset choices and unexpected circumstances in today’s dynamic investment environment. For example, during the past 10 years the mortgage servicing business has changed in ways that has surprised many experienced investors.
A reminder — This series will continue with “Part 2: Recent Acquisitions.”
New Residential Investment Corp. operates as a qualified REIT and is publicly traded on the New York Stock Exchange. Subsidiaries include Shellpoint Mortgage Servicing (integrated mortgage platform) and NewRez (mortgage origination).
Part 2: Recent Acquisitions
This is the second in a series focusing on investment strategies used by New Residential Investment Corp. Part one featured an overview of active asset management.
Portfolio managers typically buy and sell stocks as part of their normal investment routine. However, successful active investors have found that acquisitions of entire companies are frequently prudent under the right circumstances. As observed by Warren Buffett, “Buy a business; don’t rent stocks.” This article will highlight two of the recent acquisitions completed by New Residential.
Shellpoint Mortgage Servicing — Integrated Mortgage Platform
Because mortgage servicing rights (MSRs) play such an instrumental role in the investment activities of New Residential, the company began a lengthy and exhaustive search for alternative assets that would support and complement MSR investment opportunities. A major step in this direction was finalized during 2018 — by acquiring Shellpoint Mortgage Servicing (SMS).
Shellpoint is the 15th-largest non-bank mortgage servicing company in the United States. The SMS acquisition enabled New Residential to add in-house servicing as well as new revenue streams and capabilities to recapture assets. Shellpoint provides servicing to third-party clients that include hedge funds, government-sponsored enterprises (GSEs) such as federal agencies and banks. The third-party servicing activities by SMS increased by 33 percent during 2018. Shellpoint has offices in Houston, Texas and Greenville, South Carolina.
NewRez — Mortgage Origination
The desire to add mortgage origination capabilities contributed to the acquisition of NewRez as part of the Shellpoint Partners transaction. This company was formerly known as NewPenn Financial and was rebranded to reflect the acquisition by New Residential. To further enhance NewRez capabilities, the size of this team was increased by 300 percent during 2018. NewRez is headquartered in Plymouth Meeting, Pennsylvania (near Philadelphia) and is licensed to lend in 49 states plus the District of Columbia. Among the specialized capabilities offered by NewRez are non-QM (qualified mortgage) origination services.
It should be noted that Shellpoint Partners added much more than mortgage origination and servicing to New Residential’s operations. Among ancillary businesses that provide new revenue sources are real estate owned (REO) management, appraisal services and title insurance.
Vertical Integration and Scaled Platforms — A Key Goal of New Residential Acquisitions
With acquisitions like those noted above, New Residential is now focusing on capturing the entire mortgage pipeline — a “whole pie” strategy. This enables the company to incorporate competitive advantages such as scaled platforms and vertical integration.
Vertically Integrating the Mortgage Business — Vertical integration is the process of performing multiple production stages within one company rather than within separate enterprises. For example, mortgage origination, title insurance and mortgage servicing are often performed by three separately owned companies. By integrating the ownership role within New Residential, the company obtains more control over activities that directly relate to the investment portfolio — assets such as excess MSRs and non-Agency residential mortgage-backed securities (RMBS).
Benefits of vertical integration often include lowering costs, creating economies of scale and reducing reliance on third-party providers. In addition to these major advantages, vertical integration aids New Residential in coping with the multiple and complex challenges due to the rapidly changing nature of the mortgage servicing business. For example, bank-owned servicing companies frequently emphasize sale of assets and foreclosures rather than workout strategies and collections. For mortgage investors like New Residential, foreclosure avoidance is a key component in a winning mortgage investment strategy.
Scaling the Mortgage Platform — A business platform is a model creating value by facilitation of communication between groups such as consumers and service providers. With the mortgage business, the key groups usually include mortgage borrowers, lenders and servicers. Scaling refers to changing the size of the team responsible for business functions such as originating and servicing loans — “scaling up” is a business effort to increase activities (and revenues) rapidly and efficiently.
However, scaling up is much more difficult when a company like New Residential is forced to deal with external and independent companies rather than internal and wholly owned businesses such as Shellpoint Mortgage Servicing and NewRez. Equally important, owning the “whole pie” enables New Residential to expand the businesses at a comfortable pace that is practical and cost-effective.
A reminder — This series will continue with “Part 3: Finding Undervalued Residential Assets.”
New Residential Investment Corp. is a residential real estate investment trust (REIT) that is well-positioned to invest in mortgages and servicing-related assets that include mortgage servicing rights and excess MSRs. The company’s recent stock market valuation was $6.7 billion ($16.60 per share February 28, 2019).
Part 3: Finding Undervalued Residential Assets
This is the third in a series discussing specialized investment strategies employed by New Residential Investment Corp. In part one, the focus was on active asset management. Part two featured an overview of how recent acquisitions have reinforced portfolio management and operating decisions by the company.
New Residential has established a specialized real estate investment trust (REIT). One of the core investment strategies employed by portfolio managers at New Residential is to find undervalued opportunities among real estate assets that include mortgage-related vehicles. This article will examine four examples of assets and special circumstances targeted by New Residential in their quest for undervalued investments:
- Non-Agency Residential Mortgage-Backed Securities (RMBS)
- Re-Performing Residential Real Estate Loans
- Forced Sales by Institutional Investors
- Lack of Understanding About Mortgage Servicing Rights (MSRs)
These specialized residential asset situations are discussed in the following sections.
Non-Agency RMBS Assets
For many years the prevailing RMBS investment scenario primarily involved agency-backed mortgages. With an increasing number of non-Agency mortgage loans, suitable RMBS asset choices now include both alternatives. However, valuations for non-Agency portfolios are often inaccurate and inconsistent. This results in periodic undervalued opportunities.
Re-Performing Mortgage Portfolios
A mortgage servicing strategy that emphasizes collections and loan workouts instead of foreclosures can transform under-performing and non-performing mortgages to a re-performing status — a borrower resumes payments after being delinquent for at least 90 days.
Forced Institutional Sales of Assets
Institutional investors are frequently forced to sell assets at inopportune times for getting full value. It is common for such investors to liquidate securities like RMBS investments in order to raise capital reserves on short notice. Regardless of the reason for selling, this can result in a buying opportunity due to the temporary pricing discrepancy.
Misunderstood Assets Like MSRs
MSRs are complex investment vehicles that require careful analysis of underlying terms and portfolios in order to ascertain a prudent and accurate valuation. This is a challenging process even for experienced institutional investors, and it is not unusual for these assets to be sold at undervalued prices. In a similar fashion, RMBS portfolios can be misunderstood and undervalued if all elements are not properly analyzed.
Unusual Market Conditions That Create Undervalued Investment Opportunities
In addition to assessing circumstances that are unique to each specialized mortgage asset category (as just discussed above for four examples), New Residential portfolio managers periodically find undervalued assets due to external financial circumstances that can negatively impact a wide variety of securities and investments. When this occurs, it is common for mortgage-related assets to also exhibit short-term pricing discrepancies and become temporarily undervalued. Here are three examples:
Changes in Banking and Financial Regulations — The financial crisis that began around 2007 ultimately resulted in a wide array of new financial guidelines. Some of these imposed additional capital standards that required banking institutions to increase liquidity. The exact timing varied but the bottom line was similar — substantial asset sales to bolster financial statements and balance sheets. For example, while banks own more than 70 percent of mortgage servicing rights, banking institutions have sold MSRs worth more than $3 trillion since 2010. Depending on the specific timing and volume of sales, this can present opportunities for locating undervalued assets.
Stock Market Fluctuations — The daily changes in overall stock market performance can spill over to individual securities and assets even when nothing has changed materially with many asset situations. For example, during the fourth quarter of 2018, many market indices declined by 10 to 20 percent — defining a “bear market” in some cases. However, several factors that had the biggest impact on the market decline had little or nothing to do with day-to-day fundamentals involving residential mortgages and related assets — for example, declining economic activity in China and deteriorating economic conditions in emerging countries such as Argentina.
Industry Changes — It is common for most industries to have “peaks and valleys” in growth due to economic events such as a recession and inflation. Additional factors such as changing consumer preferences and new industry practices can force sudden changes in industries that are independent of the economy. The mortgage servicing industry is a case in point. This industry faced a long list of challenges during the past decade, and New Residential periodically identified undervalued asset situations as a result.
More Information: New Residential Investment and Michael Nierenberg
New Residential’s stock market valuation was $6.7 billion ($16.62 per share) as of February 28, 2019. New Residential Investment Corp. trades on the New York Stock Exchange (ticker symbol “NRZ”). To enhance opportunities involving the mortgage servicing and mortgage origination industries, New Residential subsidiaries now include companies in both areas.
More Information: Mike Nierenberg and New Residential Investment (NYSE: NRZ)
Michael Nierenberg is President, Chief Executive Officer and Board Chairman of New Residential Investment Corp. and has been a leader in the residential mortgage market for more than two decades. He has been described as “among the most highly skilled and knowledgeable people in the mortgage business” (while at Bank of America Merrill Lynch) and has repeatedly developed innovative solutions for residential financing investment opportunities.
New Residential Investment Corp is a specialized real estate investment trust that operates out of New York City. A real estate investment trust (REIT) is an entity that is responsible for financing, operating or owning real property or mortgages across numerous sectors. REITs are often categorized into different types based on the primary category of the assets that they manage. Five of the most popular examples of this are mortgages, office buildings, healthcare facilities, retail properties, and residential real estate. Some real estate investors may choose to buy these properties themselves but this is ill-advised because many REITs have a history of outperforming individual investors as well as the market.
New Residential Investment Corp is one such REIT that is publicly traded on the New York Stock Exchange. You can find this company by looking for the ticker “NRZ”. Michael Nierenberg is the President, CEO, and board chairman of this company. As a whole, New Residential focuses on real estate investments that are good opportunities for excellent returns. The four key asset classes that New Residential Investment Corp frequently includes in their portfolio are Excess MSRs, RMBS, Call Rights, and Servicer Advances. MSR stands for mortgage servicing rights and it is the right to service a mortgaging loan pool. RMB is short for Residential Mortgage-Backed Security. This is something that is created when residential real estate loan pools are converted into marketable securities.
As of February 19th, New Residential Investment Corp announced that they are offering 40,297,096 shares of its common stock. This is done with the intent of fundraising for the company. New Residential seeks to use these funds on new investments and for general corporate expenses. This offering is being made in accordance with the company’s effective shelf registration statement that was filed with the Securities and Exchange Commission. For those who seek more complete information about the company and about the offering, it is a good idea to read the documents that the company has filed with the SEC. These documents can be found for free by visiting EDGAR which can be found on the SEC’s website. Alternatively, the documents can be obtained by Morgan Stanley & Co. LLC who is working with Credit Suisse Securities (USA) LLC and J.P. Morgan Securities LLC as joint book-running managers.