RKT Sinks, UWMC Wobbles, RITM Treads Water & Goldman Doubles Down

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March 2, 2023 | Premium Service | This week, Goldman Sachs (GS) CEO David Solomon as much as agreed with our analysis of the past several years and suggested that the loss-leading consumer banking business may be sold. Some observers are suggesting Solomon may likewise head for the door, but with $25 million in compensation for 2022.

Going through the investor materials from GS this week, the amount of actual substance in the documents seems to have declined to a new low, while marketing hype and general statements now predominate. There is little actual objective information for investors in much of the GS marketing materials.

As Solomon and his colleagues admitted at the investor day, GS is a securities dealer first and foremost and has no comparative advantage as a bank. Funding costs are too high. Meanwhile, as discussed below, even as Solomon backs away from the retail strategy and related credit expenses, GS is adding new C&I exposure in residential mortgage and Ginnie Mae.

Rocket Mortgage (RKT) just confirmed that the market for residential mortgage lenders is becoming extremely difficult, reporting a nearly $500 million GAAP loss. The unexpected departure of CEO Jay Farner puts a big question mark over RKT and the entire industry, which uses RKT as an important comp in valuation models. Notice in the table below that in 2022 RKT took a $1.2 billion negative mark on its mortgage servicing rights (MSR), net of the hedge, which was clearly ineffective.

Rocket Companies

Volumes for 2022 were down over 60% for RKT, much like the rest of the industry. GAAP income was likely down sharply, with adjusted net loss of $136 million vs a profit of $4.5 billion in 2021. Earnings before interest, depreciation and amortization (EBITDA) was just $59 million in 2022 vs $6.2 billion in 2021.

Likewise, wholesale market leader United Wholesale Mortgage (UWMC) reported a $62 million loss in Q4 and a sharp decline in EBITDA, as shown the table below. Notice that UWMC does not pick up much ground with its adjusted net income. Despite being in the midst of a price war that has cut margins in half, UWMC predicts expanding gain-on-sale margins next quarter. Is the price war in wholesale lending over?

United Wholesale Mortgage Corp

In our previous note (“The Return of Credit Risk”), we highlighted the warehouse lenders and other liabilities of PennyMac Financial (PFSI), which holds all of the Ginnie Mae exposures in the group. The REIT, PennyMac Mortgage Trust (PMT), holds the conventional assets and is managed externally by PFSI. GS is shown as a relatively small lender to PFSI.

PennyMac Financial Services

Given the low volumes in the industry, it is likely that the group of lenders shown above will be pared back in 2023. Wells Fargo (WFC), for example, is likely to exit the mortgage market this year. But the most important question is what happens to PFSI as the MSR financings that are covered by the variable funding note facility of Credit Suisse (CS) and Citigroup (C) roll off? GS is already involved in the new financing that was completed by PFSI last month with GS involved as administrator and standby lender.

The question comes as to how large is GS willing to take its exposure to PFSI and also Rithm Capital (RITM). The firm completed the acquisition of a residential lender, Genesis, from affiliates of Goldman Sachs in 2021, as well as an associated portfolio of loans originated by Genesis. RITM is a REIT that is also the largest owner of Ginnie Mae MSRs and excess servicing, as well as many other assets.

Subsequently, RITM reportedly moved their MSR financing business from CS to GS, this in apparent anticipation of the exit from the market by CS and the sale of that bank’s structured finance group to Apollo (APO) portfolio company Atlas. APO apparently was willing to manage but not buy the $20 billion or so in Ginnie Mae related loans and other assets. CS also owns a $250 million non-agency MSR managed by servicer Select Portfolio Servicing (SPS).

GS does not mention the words “Ginnie Mae” at all in its latest 10-K nor did they speak about the expansion into lending to Ginnie Mae issuers during investor day. RITM mentions GS only twice in their most recent 10-K and then only in connection with the Genesis transaction. The summary of the outstanding debt of RITM is shown below. Roughly half of RITM’s debt ($4.8 billion) is MSR financing that was structured and facilitated by CS. Will GS pick up the slack?

Rithm Capital

The RITM MSR financing includes $3.0 billion of MSR notes which bear interest equal to the sum of (i) a floating rate index equal to one-month LIBOR or SOFR, and (ii) a margin ranging from 2.5% to 3.3%; and $1.8 billion of capital market notes with fixed interest rates ranging 3.0% to 5.4%. The outstanding face amount of the collateral represents the UPB of the residential mortgage loans underlying the MSRs and MSR Financing Receivables securing these notes.

As you can see, the rate on the RITM floaters has gone up substantially since issuance, but how and at what rate this debt can be refinanced even at current yields is up to question. Also, notice that the notes are not secured by the MSR, which can evaporate as was illustrated by the default of Reverse Mortgage Funding. The entire RITM MSR was valued at 165bp at year-end 2022, roughly 5-5.5x cash flow.

Big picture: For the past decade, CS was the advisor to and facilitator of the market for financing Ginnie Mae MSRs, including providing a bank to back the crucial standby financing facility for these deals that satisfied the concerns of Ginnie Mae. Now the baton is being passed to GS and/or Citi to some degree or another, but it remains unclear just how much of a commitment the $1.5 trillion asset Goldman Sachs can or will provide. At the same time, however, C&I lending grew over 40% at GS in 2022 and we suspect a good chunk of that represents new exposures to Ginnie Mae issuers.

Morgan Stanley (MS), which has historically been involved in financing mortgage assets such as conventionals and jumbos does, not seem at all interested in banking independent mortgage banks in the Ginnie Mae market. Citibank might seem a logical choice, but they have neither the operational team nor the support from the CSUITE to dive back into the world of financing Ginnie Mae assets beyond their current level of involvement.

As we’ve noted before, GS has no comparative advantage as a bank lender because of the high funding costs for the organization. This shortcoming includes lending on government loans and MSRs, a high-risk activity. Yet GS says in their 10-K that the FICC group lending:

“Includes secured lending to our clients through structured credit and asset-backed lending, including warehouse loans backed by mortgages (including residential and commercial mortgage loans), corporate loans and consumer loans (including auto loans and private student loans).”

The strange nature of the government mortgage market means that you cannot create a perfected security interest in either the mortgage notes or the attached MSR, meaning that as a lender you rely solely on the credit of the obligor. Thus the GS loans to RITM, PFSI and other Ginnie Mae issuers are, in fact, unsecured.

Without a substantial lending and servicing operation behind you, like those found at large depositories like the Flagstar unit of New York Community Bank (NYCB), we have significant doubts about whether any bank should be involved in lending against Ginnie Mae assets. Perhaps this is why GS has reportedly found few other banks willing to accept syndications on these new Ginnie Mae exposures. Other lenders can see the mounting delinquency in Ginnie Mae pools and are preparing accordingly. Stay tuned.

Disclosures: L: CS, CVX, NVDA, WMB, JPM.PRK, BAC.PRA, USB.PRM, WFC.PRZ, WFC.PRQ, CPRN, WPL.CF, NOVC, LDI

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