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.
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.