PennyMac Mortgage Investment Trust
Q1 2020 Earnings Call Transcript

Published: 9 May 2020

[Operator:]

Good afternoon, and welcome to the First Quarter Earnings Discussion for PennyMac Mortgage Investment Trust. The slides that accompany this discussion are available from PennyMac Mortgage Investment Trust’s website at www.PennyMac-REIT.com.Before we begin, please take a few moments to read the disclaimer on Slide 2 of thepresentation. Thank you. Now I’d like to introduce David Spector, PMT’s President and Chief Executive Officer who will discuss the Company’s first quarter results.

[David Spector:]

Thank you, Isaac. For the first quarter 2020, PMT reported net loss attributable tocommon shareholders of $600.9 million, or $5.99 per common share.PMT reports results through four segments

[Vandy Fartaj:]

Thank you, David. Let’s begin with Slide 14 for a look at our correspondent production highlights. Correspondent acquisitions by PMT from non-affiliated sellers in the first quarter totaled $29.8 billion in UPB, down 20% from the prior quarter and up 100% year-over-year.54% of our acquisitions were conventional loans, and 46% were government loans. Conventional correspondent acquisitions totaled $16.2 billion in UPB, down 21% from the prior quarter and up 99% from the first quarter of 2019. Government loan acquisitions in the quarter, for which PMT earns a sourcing fee from PennyMac Financial, totaled $13.6 billion in UPB, down 18% from the prior quarter and up 102% from the first quarter of 2019.As part of its correspondent loan acquisitions, PMT also acquired conventional loans originated by PFSI totaling $1.9 billion in UPB. These loans were originated through PFSI’s consumer and broker direct lending channels. PMT does not expect to purchase conventional loans originated by PFSI in upcoming quarters. Combined, conventional lock volume totaled $19.1 billion in UPB, down 3% from the prior quarter and up 113% from the first quarter of 2019.According to Inside Mortgage Finance, our acquisition volumes made PennyMac the largest correspondent aggregator in the United States for the third consecutive quarter. As David noted earlier, margins in the correspondent channel have improved significantly since February as certain lenders have reduced or limited their participation.The weighted average fulfillment fee paid to PFSI to facilitate correspondent loan production was 26 basis points, down from 28 basis points in the previous quarter. Purchase-money loans accounted for 58% of total acquisition volume. The number of approved correspondent sellers in our network continued to rise and we reported nearly 700 at quarter end, up from 676 at the end of the prior quarter.Looking at April, volumes and margins remain elevated. Total correspondent loan acquisitions for the month were $11.1 billion in UPB and interest rate lock commitments were $11.2 billion in UPB. Now let’s turn to Slide 15 and discuss PMT’s investments and GSE credit risk transfer. As David noted, PMT is curtailing new investments in GSE CRT.The Federal Housing Finance Agency has directed Fannie Mae and Freddie Mac to gradually wind down front-end lender risk share transactions such as PMT’s by the end of this year. This quarter we continued to deliver loans to Fannie Mae pursuant to our sixth CRT transaction.The UPB of eligible loans delivered totaled $14.7 billion, which resulted in a firm commitment to purchase $555 million in CRT securities. For the full year 2020, we expect total CRT loan deliveries to be approximately $18 billion in UPB. On a pro forma basis at March 31, 2020, PMT’s outstanding CRT investments totaled $3.1 billion, down from $3.7 billion at December 31, 2019, driven by fair value declines which exceeded the fair value of new investments.The UPB of the loans underlying PMT’s CRT agreements was $89.6 billion. Credit performance and characteristics of the loans underlying these investments remained strong through the end of the first quarter. Realized losses in the first quarter were $1.5 million dollars, bringing cumulative losses to $10.3 million. The 60 plus day delinquency rate was 0.33%, down from 0.35% in the prior, reflecting seasonal trends. However, as discussed, delinquency rates and realized losses are expected to increase in future periods as a result of the impact of COVID-19.Now let’s turn to Slide 16 and talk about trends in MSR and ESS investments. PMT’s organic MSR investments resulting from its correspondent conventional production activity totaled $1.2 billion dollars at quarter-end, down from $1.5 billion at December 31 driven by fair value losses. These losses resulted from expectations for increased prepayment activity related to lower interest rates, and higher servicing costs related to expected increases in delinquencies as a result of hardships related to COVID-19. PMT’s MSR portfolio totalled $141.8 billion in UPB at March 31, up from $131 billion at December 31.PMT’s ESS investments resulting from bulk, mini-bulk and flow MSR acquisitions by PennyMac Financial from 2013 to 2015 decreased to $157 million at March 31 driven by repayments of the underlying loans. The UPB associated with ESS investments totalled $19.2 billion at March 31, down from $19.9 billion at December 31st.Now let’s turn to Slide 17 to for a broader discussion on how we hedge PMT’s MSR and ESS. The charts on this page illustrate the percentage change in PMT’s equity from an instantaneous parallel shock in interest rates based on the hedge profiles that were in place on December 31, 2019 and March 31st, 2020. PMT’s exposure to long assets, or loans acquired for sale and interest rate lock commitments net of associated hedges and MBS is shown on the green dotted line. PMT’s exposure to MSR, ESS, CRT and hedges is shown on the blue dotted line. The solid yellow line represents the net exposure.As you can see, PMT’s net exposure to changes in interest rates changed meaningfully throughout the first quarter to address the significant interest rate volatility. PMT’s hedge profile seeks to protect against the risk of significant fair value changes as well as timing-driven liquidity impacts, which led to a profile positioned for gains in the event of large interest rate changes.In addition, higher revenues from improved correspondent production margins provided the ability for PMT to purchase additional option-based coverage, and in part, the additional option-based coverage was established to hedge the interest rate sensitive component of PMT’s CRT investments.Now let’s turn to Slide 18 to discuss the outstanding performance from the Interest Rate Sensitive Strategies segment in the first quarter. PMT seeks to manage interest rate risk exposure on a global basis, recognizing interest rate sensitivities across its investment strategies. In a period of decreasing interest rates, PMT’s MSR and ESS investments typically decrease in fair value while Agency MBS and interest rate hedges increase in fair value.In the first quarter, MSR fair value decreased significantly due to lower interest rates as well as higher costs to service related to expected increases in delinquencies as a result of COVID-19. This decrease represented approximately 37% of the MSR fair value at December 31. However, gains from interest rate hedges and Agency MBS more than offset those losses primarily due to significant gains from option-based hedge coverage that was in place to address the significant interest rate [Technical Difficulty] turn the discussion over to Andy Chang, PMT’s Chief Financial Officer, to review the first quarter’s financial results.Let’s turn to Slide 20 and discuss the first quarter results and return contributions by strategy. PMT’s activities in the first quarter reflected a net loss attributable to common shareholders of $600.9 million, or an annualized return on common equity of negative 119%, net of all expenses. In total, Credit Sensitive Strategies contributed $960.5 million of pretax loss, or a negative 462% annualized return on equity for the quarter. Within the segment, CRT investments contributed pretax loss of $954.2 million, which I will expand upon later. Interest Rate Sensitive Strategies, which include the performance of our MSRs, ESS and Agency and non-Agency senior MBS positions, and related interest rate hedges, together contributed a pretax income of $324.8 million, or a 185% annualized return on equity for the quarter.As Vandy discussed earlier, the outsized segment results were primarily driven by fair value gains on interest rate hedges and Agency MBS which more than offset fair value losses on MSR and ESS assets. While we show the income contribution for each of these interest rate sensitive strategies separately, they are managed together as the interest rate sensitivity of the MSRs and ESS is inversely correlated to that of the MBS and our other interest rate hedges.Correspondent Production contributed a record $65.3 million to pretax income, or a 56% annualized return on equity for the quarter, driven by significantly higher margins. The Corporate segment contributed a pretax loss of $14 million. And finally, we recorded $10.2 million in income tax expense as a result of recording a valuation allowance against PMT’s net operating loss carry forwards.Now let’s turn to Slide 21 to discuss the performance of PMT’s CRT investments in the first quarter. Our CRT investments contributed $954.2 million of pretax loss in the first quarter, consisting of just over $1 billion in losses from market-driven value changes, and $47.4 million of income excluding market-driven value changes.Market-driven value changes on our existing CRT investments included fair value losses of $969.2 million, reflecting changes in the market’s discount rate and expectation for credit losses resulting from the COVID-19 crisis. Net losses on mortgage loans acquired for sale contributed an additional $32.3 million.These fair value losses were recognized upon loan delivery under firm commitments to purchase CRT securities pursuant to our current transaction with Fannie Mae. In the first quarter, $5.7 million dollars of related fair value gains upon loan delivery were attributed to the Correspondent Production segment.Income excluding market-driven value changes consists of net realized gains and net interest expense related to our CRT investments. For the quarter, realized gains and carry on CRT investments totaled $55.9 million, while losses recognized were $1.5 million dollars. Interest income earned on cash deposits securing CRT investments was $6.1 million, while interest expense relating to the financing of these investments was $13.1 million.Now let’s turn to Slide 22 and discuss the delinquency and forbearance trends we see in PMT’s MSR portfolio. The 30 plus day delinquency rates on PMT’s MSR portfolio have historically been around 1%. As of April 30th, the 30-day plus delinquency rate was 5%, driven by borrower hardships related to COVID-19 and forbearance requests.As of April 30th, PFSI, our subservicer, had placed approximately 7% of PMT’s loans into forbearance plans. We believe this reflects the ability of our subservicer, PFSI, to rapidly and efficiently provide access to forbearance. It is also important to note that of the 7% in forbearance, approximately 3% are current and 4% are delinquent.PMT is in a strong position to successfully manage hardships related to COVID-19 given the technology platform and specialty servicing expertise of its subservicer, PFSI. PFSI began offering forbearance plans on March 19 following the GSEs’ initial guidance, allowing customers to request, be evaluated for, and receive forbearance through its automated systems.In fact, 93% of PFSI’s customers in a forbearance plan have been enrolled through one of its automated channels, reflecting the flexibility of PFSI’s technology and its ability to respond to a rapidly changing market environment. For delinquent borrowers including those in forbearance plans, PMT has the responsibility to fund servicing advances for its owned MSRs.Now let’s turn to Slide 23 and discuss PMT’s projected needs for servicing advances. This slide details PMT’s expectations for servicing advances as a result of the COVID-19 crisis. As of March 31, PMT’s MSR portfolio was approximately 86% Fannie Mae loans, 11% Freddie Mac loans, with the remaining balance allocated to non-agency loans.Fannie Mae requires a servicer to continue advancing scheduled principal and interest payments for delinquent loans for 120 days. Similarly, Freddie Mac requires a servicer to continue advancing scheduled interest for 120 days. These principal and interest advances are typically covered by prepayment activity, except in adverse scenarios where high delinquency rates combine with extended average periods of delinquency. We expect the vast majority of PMT’s servicing advances to relate to property taxes, insurance premiums, and other expenses.Historically, PMT has funded any required servicing advances with corporate cash. Outstanding servicing advances were $34 million as of April 30, 2020. As of the same date, PMT had $1.6 billion in available liquidity less $100 million in minimum liquidity covenants. PMT’s expected servicing advances assume that 15% of borrowers are in forbearance plans and that the delinquency rates peak at 10% in both cases.In the moderate scenario, we assume that the average months delinquent for the delinquent loans reaches four months before the start of recovery. We also consider a more severe scenario where the average months delinquent for the delinquent loans reaches 8 months before the start of recovery.In the moderate case, peak advances reach a total of $82 million in the third quarter of 2020, and primarily consist of other advances, as prepayments of principal and interest during the periods may be used to offset the principal and interest advance obligations.In the stress case, peak advances reach a quarterly total of $141 million in the first quarter of 2021, still primarily consisting of other advances for the same reasons I mentioned before. In both cases, the majority of advances for PMT’s Agency MSR portfolio are expected to be related to property taxes and insurance to protect investors’ interest in the property collateralizing the mortgages. Advance balance projections could increase if recoveries of advances from borrowers or insuring agencies are prolonged or delayed significantly after borrower reinstatement or loan modification.And with that, I’ll turn the discussion back over to David Spector for some closing remarks.

[David Spector:]

Thank you, Andy. PMT’s financial results in the first quarter reflected the extreme market dislocations resulting from the COVID-19 crisis and were driven by non- cash fair value losses on CRT investments partially offset by outstanding performance from the interest rate sensitive strategies and correspondent production.We believe that the fair value losses recognized on our CRT investments in the first quarter are outsized compared to the additional losses from borrower defaults that we expect to incur over the life of these investments. Furthermore, PFSI, PMT’s manager and subservicer is well-positioned to refinance qualifying borrowers and successfully manage forbearance and other assistance programs to reduce the likelihood of borrower default and ultimate credit losses.We believe that PMT’s performance during this crisis and the strength of PMT’s liquidity and capital position are the direct result of our manager’s steadfast focus on risk management, including interest rate, credit and operational risk disciplines, throughout our more than 10-year history.Unlike other market participants, PMT has not sold any assets to raise liquidity; and as a result of the innovative term financing structure we put in place, PMT has not been subject to margin calls for its CRT investments. While we have curtailed new investments in CRT, recent market dislocations have expanded the opportunity for PMT as certain competitors have limited or reduced their participation in what was already a capacity constrained industry.Looking ahead, we expect improved financial performance and are confident in the return potential of PMT’s investment strategies.

[Operator:]

This concludes PennyMac Mortgage Investment Trust’s first quarter earnings discussion. For any questions, please visit our website at www.pennymac-reit.com, or call our Investor Relations department at 818-224-7028. Thank you.