PennyMac Mortgage Investment Trust
Q3 2016 Earnings Call Transcript

Published: 4 Nov 2016

[Operator:]

Good afternoon and welcome to the third quarter 2016 earnings discussion for PennyMac Mortgage Investment Trust. The slides that accompany this discussion are available from the PennyMac Mortgage Investment Trust website at www.pennymac-reit.com. Before we begin, please take a few moments to read the disclaimer on slide two of the presentation. Thank you. Now I’d like to turn the discussion over to Stan Kurland, PMT’s Chairman and Chief Executive Officer.

[Stanford Kurland:]

Thank you, Chris. For the third quarter, PMT reported net income of $35.4 million, or $0.49 per diluted share, representing an annualized return on equity of 10%. PMT paid a dividend of $0.47 per share for the quarter, and book value per share increased to $20.21 at quarter end, from $20.09 at June 30. PMT’s third quarter results represent a significant improvement over recent quarters. Our results were driven by strong contributions from our correspondent production business and GSE credit risk transfer investments. The performance of our distressed loan investments improved, yet these investments underperformed our expectations primarily resulting from lower than expected REO proceeds on loans transitioning from foreclosure to REO, higher defaults on performing loans and fewer loans transitioning from foreclosure to REO. PMT reports results through two segments

[David Spector:]

Thank you, Stan. Let’s turn to slide 11 and discuss the resolution activity on PMT’s distressed whole loan investments. Here we show the five-quarter trend for distressed loan resolutions, which include liquidation and modification activities, and totaled $233 million in UPB during the third quarter. Modifications totaled $121 million in UPB during the quarter and comprised 52% of total resolution activity, compared to 37% in the second quarter and 37% in the third quarter a year ago. Our focus on driving reperformance through loss mitigation programs results in positive outcomes for both the homeowner and PMT, generally allowing homeowners to remain in their home with improved mortgage terms and helping to expedite PMT’s transition out of distressed loan investments. Since the beginning of the year we have placed increased emphasis on using streamlined modification programs offered through the Home Affordable Modification Program, commonly referred to as HAMP, in addition to proprietary modification programs to help more borrowers qualify for a modification. Streamlined modification programs are helpful because they eliminate income documentation requirements and move borrowers into a trial modification once they make their first modified payment. At September 30, streamlined modifications for the third quarter totaled $78 million in UPB, up from $38 million from the prior quarter. Liquidation activities totaled $105 million in UPB, down from $151 million in the second quarter, and comprised 45% of total resolutions. Liquidation activities include payoffs, foreclosure sales to third parties, short sales and sales of REO properties to third parties. Let’s take a closer look at REO activity. In the third quarter, REO property sales were $76 million, down from $110 million in the prior quarter, and comprised 33% of total resolution activity. REO property sales decreased as a percentage of total resolutions due to a reduction in inflow of REO properties and more properties held for rental investment. REO inventory declined from $299 million at June 30 to $288 million at September 30 . In addition, new REO rentals totaled $7 million in the third quarter, down from $12 million in the prior quarter, while the REO rental portfolio was $26 million at September 30, up from $21 million at June 30 . Now let’s turn to slide 12 and discuss the operational results for correspondent production. Slide 12 Correspondent production totaled $18.9 billion in UPB for the third quarter, up 30% from the second quarter, while conventional loan acquisitions were $7.3 billion in UPB, an increase of 40% from the prior quarter. On a year-over-year basis, our correspondent production volumes increased 31%. In addition, total interest rate lock volume was $21.6 billion in UPB, up 35% from the previous quarter. October correspondent acquisitions totaled $7 billion in UPB and interest rate locks totaled $6.7 billion in UPB. Our record volumes were enabled by PennyMac Financial’s highly automated and efficiently scalable mortgage platform. The significant increase in production volume reflects a larger mortgage origination market and a higher share of originations sold to correspondent aggregators. Our market share increases were driven by maintaining high service levels in a market with elevated volumes, increased business from new sellers added in recent periods, and the purchase-money orientation of our correspondent production sellers. Our non-delegated correspondent program drove the majority of growth in correspondent seller relationships during the quarter, which increased to 504, from 457 from the end of the prior quarter. Nondelegated correspondent activities were launched last quarter and primarily relate to underwriting services provided to small lenders and community banks by PMT’s manager and service provider, PennyMac Financial. Additionally, purchase-money loans accounted for 67% of our correspondent production, down slightly from 71% in the second quarter, reflecting our purchase-money oriented franchise and the continued strong demand for home purchases. Now let’s turn to slide 13 and discuss the continued development of our investments in GSE credit risk transfer related to our correspondent production activities. At the end of the third quarter, PMT’s total credit risk transfer investments had grown to $428 million. During the quarter, we completed our third CRT commitment with Fannie Mae for a total of $6.5 billion in UPB, and we entered into a fourth CRT commitment with Fannie Mae for $7.5 billion in UPB. The total income contribution from CRT investments in the third quarter improved significantly delivering an annualized return on equity of 39% driven by fair value gains. Excluding market-driven value changes, the annualized return on equity was 13.7%. Our third quarter CRT investment performance reflects a larger investment position and market-driven value changes due to credit spread tightening. Performance of the underlying collateral in our CRT transactions remains strong. Total 60-day or greater delinquencies as of September 30 were less than 6 basis points of the $12.2 billion in outstanding UPB. The realized credit losses from our CRT transactions totaled $28 thousand in the third quarter, while $14.4 million in cash income has been collected to date. We expect the cumulative losses to increase as these new investments season over the next several years. We have included additional performance and credit metrics in the appendix on slide 31. Now let’s turn to slide 14 and discuss our investments in MSR and ESS. PMT’s current investment in MSRs and ESS is $805 million, up from $766 million at June 30. As of September 30 , the related loans underlying the MSRs totaled $50.9 billion in UPB while the related loans underlying the ESS totaled $34.2 billion. Organic investments in MSRs, which result from PMT’s correspondent production activities, increased to $525 million, up from $471 million at June 30, reflecting strong correspondent production volumes. At the end of the third quarter, our ESS investments resulting from bulk, mini-bulk and flow MSR acquisitions by PennyMac Financial totaled $280 million, down from $295 million at June 30 , as a result of prepayments. Now I’d like to turn the discussion over to Anne McCallion, PMT’s Chief Financial Officer, to review the third quarter’s financial results, Anne?

[Anne McCallion:]

Thank you, David. On slide 16 we show the pretax income contributions from each of PMT’s segments over the last five quarters. As Stan mentioned earlier, PMT’s third quarter pretax income totaled $45 million, comprised of $13.6 million in pretax income from Investment Activities and $31.4 million of pretax income from Correspondent Production. Now let’s turn to slide 17 and look at the results of the Investment Activities segment. The Investment Activities segment income is derived from the performance of PMT’s investment portfolio. In the third quarter, investment segment revenues totaled $41.3 million, an increase of $31.9 million from the second quarter. The quarter-over-quarter increase in revenues was driven by a $29.8 million increase in net gain on investments and a $2.6 million increase in net interest income related to higher modification activity. Our investments generated a net gain of $14.3 million in the third quarter, compared with a net loss of $15.5 million in the second quarter. Net gains on investments for this quarter were driven primarily by an $18.5 million gain on CRT transactions resulting from credit spread tightening and a larger investment position. These results were partially offset by a $3.4 million loss on the distressed loan portfolio, which I will discuss in further detail on slide 19, and a $2.8 million loss related to excess servicing spread, net of recapture income. Net loan servicing fees derived from PMT’s investments in MSRs were $15.8 million in the third quarter, up slightly from $15.7 million in the second quarter. Net loan servicing fees included $34.3 million in servicing fees and $409 thousand of MSR recapture income, reduced by amortization of $17.9 million. Net loan servicing fees also included $3.5 million of provisioning for impairment and $3.2 million of fair value losses related to MSRs, partially offset by $5.6 million of related hedging gains. PMT’s hedging activities are intended to manage its net exposure across all interest rate-sensitive strategies, which also include ESS and MBS. Net interest income increased 49% quarter-over-quarter, which I will discuss in greater detail on the following slide. Other investment losses were $1.1 million, compared with losses of $520 thousand in the second quarter, driven by an increase in valuation losses on PMT’s REO properties. Segment expenses were $27.6 million in the third quarter, down $6.3 million from the prior quarter, primarily due to a $5.1 million servicing activity fee paid to PFSI in the second quarter related to a prior sale of performing loans from the distressed portfolio. On slide 18, we show the components of interest income for the Investment Activities segment which increased 13% quarterover-quarter. Interest income earned on PMT’s interest rate-sensitive strategies of ESS, MBS and mortgage loans held by a variable interest entity totaled $12.3 million, a 9% decrease from the second quarter. This decrease primarily resulted from reduced interest income from ESS, due to a smaller investment position resulting from prepayment activity and the sale of PMT’s jumbo MBS, which are represented by mortgage loans held by a VIE on the balance sheet. Interest income from PMT’s distressed mortgage loans totaled $29 million, up from $23 million in the second quarter, a 26% quarter-over-quarter increase, driven by a 41% quarter-over-quarter increase in capitalized interest from modifications. Capitalized interest from modifications increases interest income and reduces valuation gains on reperforming loans in the period of modification. Total interest expense for the Investment Activities segment totaled $31 million, an increase of 8% from the prior quarter. Now let’s turn to slide 19 and discuss the gains and cash flows related to PMT’s distressed loan portfolio. PMT’s distressed mortgage loan portfolio generated realized and unrealized losses on mortgage loans totaling $3.4 million in the third quarter, versus losses of $13.5 million in the second quarter. Valuation losses on distressed loans totaled $4.8 million in the third quarter, compared to losses of $14.3 million in the second quarter. While significantly improved from last quarter, this quarter’s income contribution from the distressed loan portfolio underperformed PMT’s expectations, primarily resulting from lower than expected REO values on loans transitioning from foreclosure to REO, higher redefaults of performing loans and fewer loans transitioning from foreclosure to REO. Positively impacting valuation gains for the distressed loan portfolio were home prices, which trended in line with our prior forecast. A significant portion of the valuation losses this quarter reflect loans modified to performing status that result in capitalized interest, which increases interest income and reduces loan valuation gains. Combining valuation changes with net interest income, revenue from the distressed portfolio was $14.1 million for the quarter, compared with a loss of $2.5 million in the second quarter. Gains from the payoff of distressed loans totaled $1.3 million, compared with $1.2 million in the prior quarter. Liquidation and pay down activity on distressed loans continued to generate significant positive cash flows. For the third quarter, gross cash proceeds from the liquidation of mortgage loans and REO before debt repayment and payment of related expenses totaled $75 million, down from $114 million in the second quarter, primarily resulting from the reduction in REO sales that David mentioned earlier in his presentation. With respect to the distressed loans and REO liquidated during the quarter, $274 thousand in net valuation losses were recognized over the holding period of the assets and $3.3 million of gains were realized at liquidation. Now let’s turn to slide 20 and discuss the value of PMT’s mortgage servicing rights and excess servicing spread assets. PMT’s mortgage servicing rights portfolio, which is subserviced by PennyMac Financial, grew to $50.9 billion in UPB, up from $47.1 billion at the end of the second quarter. PMT also owns investments in ESS with a UPB on the underlying loans of $34.2 billion. MSRs and ESS comprise a significant portion of PMT’s long-term investments and their fair value generally increases in a rising interest rate environment and decreases when rates fall. In the third quarter, these investments incurred fair value losses as a result of higher expected future prepayment activity and elevated prepayments during the period, which were partially offset by hedge gains. ESS valuation losses were also partially offset by recapture income from PennyMac Financial totaling $1.3 million. The chart on slide 20 shows some of the key metrics for PMT’s MSR and ESS portfolio, and highlights the difference between the carrying value of PMT’s MSRs and their estimated fair value. At the end of the quarter, the fair value of PMT’s MSR asset was $4.1 million greater than its carrying value. For the excess servicing spread column, the UPB, weighted average coupon, and expected prepayment speed represent the characteristics of the underlying MSR portfolio owned by PennyMac Financial, while the weighted average servicing spread, fair value and valuation multiple relate to the ESS asset owned by PMT. Let’s now turn to slide 21 and discuss the income statement and balance sheet treatment for the Credit Risk Transfer transactions. Our investments in Credit Risk Transfer, or CRT, are evidenced by M-1 bonds, which we own and pledge as collateral in financing transactions. However, for accounting purposes, our investments in CRT are depicted as the components of the M-1 bonds, restricted cash and a net derivative consisting of the expected future cash inflows related to our assumption of the credit risk and expected future losses of the credit guarantee. This slide illustrates how the CRT transactions are carried on the balance sheet and flow through the income statement. From inception of the CRT investment program last year through September 30, 2016, a total of $13.3 billion in UPB of residential mortgage loans has been delivered to the CRT Special Purpose Vehicles and in turn sold to Fannie Mae. We have deposited cash into the SPVs and it is recorded as a separate line item on our balance sheet. The restricted cash balance, combined with the net value of expected future cash inflows related to our assumption of credit risk and expected future losses, represent PMT’s investment in credit risk on the delivered loans and largely comprise the M-1 bonds. Realized gains and losses recognized on the CRT investment represent cash income or loss to PMT from the SPVs. Gains and losses are represented by fair value changes, which in the third quarter were gains resulting from credit spread tightening. Payments made to Fannie Mae to settle our contractual losses are made from cash delivered to the SPVs. To date, PMT’s CRT investments have paid $28 thousand in credit losses. The bottom table provides information related to the outstanding balance of our CRT investments. The current UPB of the underlying loans totaled $12.2 billion at September 30. The delinquency summary is divided into two categories

[Stanford Kurland:]

Thank you, Anne. PMT remains uniquely positioned to access investment opportunities that result from our correspondent production activities, including GSE credit risk transfers and excess servicing spread, which are made possible through PennyMac Financial’s specialized capabilities as our manager and service provider. We continue to transition capital over time into these opportunities and away from distressed loan investments, which represent a decreasing allocation of PMT’s equity. We also continue to evaluate repurchasing our common shares, where we believe the return is superior to other investment opportunities. We believe that these strategies have the potential to produce earnings over time in line with our current dividend level. Lastly, we encourage investors with any questions to reach out to our Investor Relations team by email or phone. Thank you.

[Operator:]

This concludes the PennyMac Mortgage Investment Trust third 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. Q -