Rising interest rates have caused what many call a housing recession. Mortgage origination has collapsed from 2021's rates, and housing starts and home sales are well below last year's levels. How does this affect Rithm Capital (RITM -0.36%)?
Image source: Getty Images.
Mortgage origination volume is a shadow of what it was last year
Rithm Capital is the new name for New Residential, which went through a reorganization recently. The company is a mortgage REIT that also originates mortgages. It is also a major servicer of mortgage loans. In 2021, mortgage origination volume hit $4.4 trillion as originators feasted on easy refinance volume, which was powered by the Federal Reserve cutting rates to about zero while buying oodles of mortgage-backed securities to support the economy in the aftermath of COVID. This is now all reversing. The Mortgage Bankers Association sees origination volume falling to $2.4 trillion as refinance activity evaporates as rates rise.
Mortgage servicing income offsets declining origination income
Rithm Capital has relied on servicing income to offset declines in mortgage origination. As a mortgage servicer, Rithm collects the payments from the borrower, ensures that any taxes and insurance are paid, and deals with the borrower if he or she falls behind in the payments. The servicer is then paid a fee (typically 0.25% of the mortgage outstanding balance each year) for performing these services. The right to perform this service is worth something, and it is carried on the company's balance sheet as a mortgage servicing right.
Mortgage servicing rights are one of the few assets out there that increase in value as rates rise. Almost every financial asset is negatively affected by rising rates. Mortgage servicing rights gain value because rising rates reduce the incentive for the borrower to pay off the mortgage early, which means the servicer can expect that income stream to last longer.
The gains from servicing are getting played out, and costs are rising
So far this year, servicing income has risen, which is helping to cushion declining origination income. That said, servicing income is a function of rising mortgage rates, not rising federal funds rates, and the yield curve (in other words, the difference between short-term rates and long-term rates) is in an unusual situation called an inversion. This means that the Fed is raising the federal funds rate, but long-term rates are rising more slowly. This is a signal that mortgage rates may be topping out, which means that servicing income will start topping out as well.
If the U.S. does hit a recession, servicing costs should increase, especially since we should see an uptick in delinquencies. For a servicer, handling a loan that is paying is easy money, but that gets harder as delinquencies increase. Mortgage delinquencies are at historically low levels, which means that servicing costs will rise as the economy contracts. This will get even worse if we real estate prices decline.
The dividend is well covered, for now
That said, Rithm Capital currently pays a quarterly dividend of $0.25, which gives the company a dividend yield of 11.9%. Analysts expect the company to earn $1.30 this year, so the dividend is well covered, at least for now. The takeaway for investors is that rising servicing income might not be enough to offset the massive slowdown we are seeing in mortgage origination.
