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We regularly cover the mortgage REIT sector. We also focus on preferred shares and baby bonds for the mortgage REITs that we cover. Preferred shares behave very differently from the common stock and are generally a much safer option.
Rithm Capital Corp.’s (RITM) Preferred Share RITM-D (RITM.PR.D)
RITM-D is one of my largest holdings. I have been investing in RITM-D for many years. You can see the performance of those positions below.
The REIT Forum
RITM-D offers investors a respectable dividend yield (about 7.07%) and a much more attractive yield to call (about 8.3%, but it was around 9.5% in early February). If the shares are not called immediately when call protection ends, the dividend rate would reset to yield around 10% on the current price if 5-year Treasury rates in November are similar to the 5-year Treasury rates today.
I believe there is a significant chance that these shares will be called when that date arrives. The spread over the five-year Treasury rate is quite attractive and would lead to a significant increase in the dividend rate unless the five-year Treasury rate plunges before then. The calculated rate after the shares become callable will be fixed for another five years based on the five-year treasury rate at that time plus the spread of 6.223%.
The REIT Forum
Given that spread and the resulting projected dividend increase, I believe it is very likely that we will either see the shares called or that they will trade at least moderately above the $25 call value plus the dividend accrual. The logic there is that investors would be willing to risk a small loss on a call to get such an attractive yield if the shares are not called.
Is The Risk Worth It?
Investors may be willing to accept that risk so long as the amount of the potential loss was relatively small. So, for instance, if they were paying 1% above the amount they would expect to get back in the case of a call, then they could justify that it might be a reasonable premium to risk in exchange for a dividend rate that would be fairly high relative to the risk level for those shares.
In practice, the market has frequently awarded such shares a larger premium than I would be comfortable paying for shares.
My Plan
Given my typical strategy with preferred shares, I would probably look to exit my position if the worst cash-to-call fell to around negative $0.15, or if I got really aggressive, I might sit in it until it hits something around negative $0.35 cents. However, I still see the odds of a call as being high enough that I would certainly want to be out (harvesting gains) without waiting to see if shares could trade high enough to have a worst-cash-to-call breaking negative $.50. It just doesn’t make sense for me to accept that much call risk.
Regardless, the shares have performed very well for me over the time I’ve been invested in them. As I look at the shares today, I think that they are moderately close to the level where they make sense for new investors.
Shortly after shares went ex-dividend, they were trading around $24.45 to $24.50. In the last 8 to 10 days, they rallied by about 1% to $24.76. That rally cut into the yield-to-call materially since the callable date is 11/15/2026. When we’re annualizing based on 9 months, a 1% shift in the price has a material impact on yield to call (around 1.3%). A call is still far from certain, but the combined probability that shares are either called or traded above call value is very high, in my opinion. Absent a recession starting later this year, I think it is very likely that we either see a call or the shares trade above $25.00. Given those expectations, the impact of entry prices is quite important.
To be fair, my chart shows them at 102.4% of the target price. That target price will probably continue to see several modest increases as the callable date approaches. It will also fall on each ex-dividend date since the future cash flows would be reduced by one dividend.
Currently I rank the shares as slightly attractive, but definitely not significantly attractive. If the share price were to decline by, say, 1.5%, I would be quite excited about the opportunity. That is only about $0.38, so it’s not like it’s a substantial move. At that point, the yield to call would be increased quite a bit (around 2% hypothetically) because the shares become callable in about 9 months. Even if the shares are not called, the dividend rate should be reset to be very attractive (unless 5-year Treasury rates plunge).
The $100k Chart
This chart demonstrates the amount that needed to be invested (with dividend reinvestment) on any prior day at the closing price to reach a value of $100k today (or the day before depending on how long the article takes):
The REIT Forum
As you can see in the chart above, the preferred share delivered fairly steady returns. The valuation took a hit when Treasury rates soared because investors were much more concerned about the duration exposure. Also, the whole market had a rough time in 2022. However, shares have been climbing back up as we get closer to the date that the rate resets. The only dip larger than about 3% or 4% (adjusted for dividends) since the start of 2024 was the day massive tariffs were announced. Even then the shares recovered quite quickly.
When a share offers a relatively steady price and pays out around 7% or more in dividends, this is what the chart looks like.
Rithm Capital Common Stock
The mortgage REIT has done dramatically better than most peers across nearly any time period. They have done better at protecting their dividends (not perfect, but better than most peers) and protecting book value. That combination led to superior total returns for shareholders compared to the vast majority of their peers. I also have a small position in the common shares, and I might decide to increase that position. Rithm Capital is a bit unique because it is more complex than most mortgage REITs. They have more to do with managing assets and dealing with mortgage servicing rights. There are simply more moving parts. The result is a REIT that is simply much more complex to analyze. Since this article is focused on the preferred shares, I’m not going to go in depth on the underlying company, but Scott Kennedy provides regular coverage for members of The REIT Forum. For more detail on Rithm, please see the most recent report we published on Rithm Capital for Seeking Alpha Premium.
Investors who have read our work for a long time may be familiar with the purchases we had during the pandemic.
The REIT Forum
We bought shares of RITM while the price was collapsing, and we were able to buy the shares for around $5. And then about a week later, the shares were trading at $3.50. So we bought more shares. Then they bounced back to around $5, and we bought some more shares. At the time, the company traded under the ticker NRZ.
This chart shows all the shares we closed and emphasizes the first 3 purchases:
The REIT Forum
We did pretty well with it. When it came to the purchase on 4/6/2020, I had purchased 1,481 shares. I ended up selling 744 of those for a quick profit and holding on to the other 737.
The moral of the story is that during a pandemic, there’s definitely some dramatic risk to the share price. Who knows what the next issue will be to crash the stock market? It’s probably going to be AI, but who knows for sure? If it’s not AI, it could be the magnitude of people who are looking to retire and the huge problems Social Security is going to have as there is less money paid in and more money going out.
Conclusion
One of the ways that I deal with the risks in the market is to keep a significant allocation to preferred shares and baby bonds. They tend to have dramatically less volatility than common equity, though I will admit that they have not delivered the same price increases we’ve seen in the major tech stocks as the market rejoices about a future where companies make enormous amounts of money selling services to customers who don’t have jobs because they were replaced by AI. That’s going to be quite the business model!
