This last week real estate finance REIT Newcastle Investment Corp (NCT) split itself in two with the spin-off of New Residential Investment Corp (NRZ), a REIT specializing in the residential financing sector. Investors received one share of NRZ for each NCT share held. The unique portfolio of New Residential should allow the company to be very profitable if the housing recovery continues to have legs. And investors will earn a very attractive dividend along the way.
When I covered Newcastle Investment in July 2012, the stock was trading for about $6.40 per share and the dividend yield was at 12%. The timing of that article was very good, and investors who picked up shares last summer saw the share price nearly double, producing a 100% plus return including dividends. As the share price increased and the yield dropped, I was starting to view NCT as more than fairly priced and thought seriously about making a recommendation to sell and redeploy the capital elsewhere. Splitting up of the company allows investors to decide which of the company's businesses look more attractive.
The "Old" Newcastle Investment
Newcastle Investment is now a $1.5 billion market cap company focused on two different types of real estate investment. NCT retains the company's legacy CDO investments. Of the $2.35 billion of CDO face value, NCT directly owns $1.15 billion. Newcastle Investment also owns $300 million of leverage agency MBS to round out the real estate debt holdings.
The more recent move by Newcastle has been into senior housing. To date the company has invested $80 million of capital to purchase $200 million of senior housing assets. Currently Newcastle management expects continued growth and investment in this asset class.
The estimated annual dividend for NCT is $0.50 per share, putting the current dividend yield at 8.4%.
The "New" New Residential Investment
New Residential - with an initial market cap of $1.75 billion - is firmly and uniquely entrenched in the residential financing space. About half of the portfolio holdings are non-agency MBS, agency MBS, direct residential mortgage loans and consumer loans. All of these assets are leveraged to a level appropriate for the type.
The remaining half of the New Residential assets are in excess mortgage servicing rights - MSRs. Newcastle started buying MSRs in the summer of 2012 and has done very well with the excess MSRs to date. MSRs are a portion of mortgage interest that goes to the servicing company. The first excess mortgage pool MSR Newcastle purchased paid 31 basis points in service rights, and it cost 8 basis points to actually service the mortgages, leaving 23 bp as free cash flow. The return on excess MSRs depends on prepayment and foreclosure rates in the mortgage pool. If the servicing company can refinance and retain a mortgage, the servicing rights are also retained. Initial assumptions on the mortgage pool results put Newcastle in a position to earn 17% to 18% annually on its invested capital.
NRZ is projected to have an initial annual dividend of $0.61 for a current yield of 8.8% at $6.90 per share.
Choosing NCT or NRZ
Newcastle has put a projected internal rate of return of 14% on the holdings of both NCT and NRZ. As you can see, the cash flow and dividend projections have both stocks paying investors at about the same rate, at least initially. It is understandable if an existing NCT investor would choose to hang onto shares of both companies.
From Newcastle Investment I expect more of a slow but steady growth rate. The cash flow coming off the CDOs will be invested into senior housing assets, allowing for a steady investment into more properties and a resulting growth of cash flow.
I think New Residential is the more exciting of the two companies. The excess MSR business could produce up to 20% IRRs as the housing market continues to improve. In addition, both the excess MSR and non-agency MBS sectors offer ongoing opportunities for the management team to exercise its contacts and expertise to find investments producing those mid-double-digit yields the company shoots for. I think that NRZ could be another double for investors over the next year or two.