SBNY - Rithm Capital: Hammered By Silicon Valley Bank's Collapse

2023-03-23 11:50:03 ET

Summary

• Investors grew increasingly worried about the fallout from Silicon Valley Bank and Signature Bank, leading to Rithm Capital's stock plummeting nearly 20% from its February highs.
• mREITs, such as Rithm Capital, are perceived as "second-order, third-order dangers" that could unravel further, given the ongoing banking crisis.
• The Fed's recent decision to raise its Fed Funds rates by 25 bps may have brought them closer to its terminal rate.
• The interest tailwinds propelling its operating performance may be losing steam as investors focus on the potential fallout of mortgage securities.
• We assessed that an attractive opportunity has likely arrived for investors looking to strike back against the recent selling pressure.

Investors in Rithm Capital Corp. ( RITM ) have had to deal with a series of unexpected events since its FQ4'22 earnings release , as RITM surged to its recent highs.

We believe RITM sellers have nailed the recent pullback correctly, as they denied buyers further upside at a critical resistance level, as buyers joined the bandwagon post-earnings.

Since then, RITM has collapsed more than 20% (in price-performance terms) through last week's lows as investors assess the fallout from Silicon Valley Bank or SVB ( SIVB ) and Signature Bank ( SBNY ).

As a result, we believe the risk premium has gone up as investors synthesize the impact on the valuation of the mortgage securities on the books of Rithm and its mREIT peers. Mortgage spreads have also widened as investors assessed the potential distressed liquidation of mortgage securities by banks facing a liquidity crisis.

Banks hold debt securities (including mortgage securities) in their portfolio, which have racked up significant unrealized losses. According to the FDIC, the unrealized losses have ballooned to about $620B at the end of 2022.

FDIC Chairman Martin Gruenberg also stressed in his early March speech (pre-SVB collapse): " Unrealized losses on securities have meaningfully reduced the reported equity capital of the banking industry."

While Gruenberg expressed confidence that banks "have not been forced to realize losses by selling depreciated securities," he also emphasized that "unrealized losses weaken a bank's future ability to meet unexpected liquidity needs."

Unfortunately, his remarks proved prescient, and SVB's fallout has engulfed its regional banking peers and mREITs like Rithm, given its core business exposure to such securities.

The Financial Times or FT reminded investors to watch out for the " second-order and third-order dangers" from SVB's downfall, pointing to mREITs.

What's at stake here could be the deluge of mortgage securities flooding the market if more regional banks are forced to take losses on their debt securities to raise liquidity. As such, it would affect Rithm's portfolio, damaging its fair value of securities and taking a significant haircut on its book value and equity.

As such, investors must balance the tailwinds from the company's Mortgage Servicing Rights or MSR portfolio, which have benefited from the Fed's rate hikes in 2022.

CEO Michael Nierenberg highlighted at its Q4 earnings call that the company's "MSR portfolios, which totaled $600 billion , have been fantastic, generating tons of cash flows into the higher-rate markets."

Moreover, the FOMC delivered another rate hike yesterday (March 22), raising the Fed Funds rate or FFR by 25 bps to a target of between 4.75% and 5%. However, investors must note that the FOMC's revised summary of economic projections or SEP did not adjust its median FFR projection of 5.1% for 2023.

Given the recent banking crisis, it was a notable shift, which likely led to the FOMC dropping the use of "ongoing hikes" in its statement and replacing it with " some additional policy firming may be appropriate."

Therefore, the interest rate tailwinds could level off and become less meaningful to the company's operating performance as the Fed moves away from aggressively hiking interest rates.

Moreover, the Fed trimmed its GDP growth projections downward to 0.4% from 0.5% for 2023 (still expecting a soft landing), suggesting the economy could weaken further.

Lending growth could also be hampered as financial institutions continue building up excess cash buffers to contain a further liquidity fallout. Investors must therefore consider implications over worsening credit risks as the economy weakens.

Hence, we believe the market has reacted accordingly in pummeling RITM to reflect these intensifying headwinds.

As such, we assessed that the optimism from its post-earnings highs has already been deflated, improving the reward/risk profile for investors waiting for an opportunity to add exposure.

However, Treasury Secretary Yellen's comments that the US government will not initiate a " blanket guarantee " on all deposits spooked the markets yesterday.

Hence, investors considering adding more positions at the current levels need to be prepared for potential downside volatility.

RITM's NTM distributable P/E has also fallen to 5.6x, well under its 10Y average of 7.5x. Moreover, its NTM dividend yield of 12.5% seems attractive, which could attract buyers back into the fray.

Our price action analysis indicates that a bullish reversal has not been validated (repeat: not validated). Therefore, it could be a premature entry for investors who want to assess more constructive buying sentiments before returning.

Hence, more conservative investors could wait on the sidelines first, while more aggressive investors might consider an opportunity to "front-run" the market.

However, note that a decisive breakdown of the current levels could initiate a move down further to potentially re-test RITM's October levels, suggesting that investors expect the banking crisis to worsen.

Rating: Speculative Buy (Revised from Hold).

Important Note: Investors are reminded to do their own due diligence and not rely on the information provided as financial advice. Our cautious/speculative ratings carry a higher risk profile. They are only intended for sophisticated investors/traders. We urge new or inexperienced investors to avoid relying on such ratings. Moreover, investors must exercise prudence and devise appropriate risk management strategies, such as pre-defined stop-loss/profit-taking targets, within a suitable risk exposure.

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