- Jonathan Poyer
Mortgage Servicers - Servicing Returns in 2023?
While hindsight is 20/20, entering 2022 we identified many investment themes related to residential real estate correctly but still posted negative performance for the year. For example, we accurately predicted that book values for certain mortgage equities would increase even as interest rates increased in 2022. However, despite these increases, the prices of these securities fell in varying degrees as panic overwhelmed most corners of the market. Given the heightened disconnect between market prices and fundamentals for many securities, we ended the year witnessing, what we believe to be, significant buying opportunities.
Mortgage servicers generally performed better in 2022 as evidenced by Mr. Cooper (COOP) only posting a marginal decline for the year.
However, Rithm Capital (RITM, formerly NRZ) was down ~15% for the year, despite increasing its book value after paying out a double-digit dividend yield and paying a fee to terminate its external management agreement. RITM is one of the largest holders of mortgage servicing rights (MSRs), which skyrocketed in value throughout the year as mortgage prepayment projections fell sharply.
The largest underperformers in mortgage equities for 2022 were pure-play mortgage originators and smaller Non-Agency mortgage REITs like Redwood Trust (RWT). While RWT did not do a stellar job of protecting book value for the year (down 14%), its stock fell more than 42% and ended the year trading at a ~35% discount to book value. RWT is a stock that historically trades at or above book value.
We believe it’s a good time to be invested in residential mortgage credit – not due to potential short-term home price appreciation – but because mortgage defaults are likely to remain low and recoveries high given the current state of consumer credit. While Agency and Non-Agency MBS should likely perform well in 2023, we believe the best risk/reward exists at the bottom of the capital structure (common shares, preferred shares, corporate bonds) in certain mortgage equities.