PennyMac Mortgage Investment Trust
Q3 2015 Earnings Call Transcript

Published: 5 Nov 2015

[Operator:]

Good afternoon and welcome to the third quarter 2015 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. PMT’s third quarter earnings were consistent with our expectations from the present investment portfolio. This quarter’s results benefited from improved performance in our distressed loan investments, correspondent production and our interest rate sensitive strategies as well. For the third quarter, PMT earned a total of $38.8 million in net income, 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 $20.52 at quarter-end. PMT reports results through two segments

[David Spector:]

Thank you, Stan. Let’s turn to slide 11 and discuss PMT’s distressed whole loan portfolio. The slide shows where PMT’s distressed loan portfolio was valued as of September 30th, split between nonperforming and performing loans in the distressed portfolio. The bars on the right, in blue, are the outstanding principal balance, or face value, of the loans. The green bars in the middle show the estimate of the current collateral value, or the current value of the properties underlying the loans. We use several methods to estimate the current value of the properties, but they are primarily based on broker price opinions. The bars on the left, in gray, are our fair value marks for the assets as recorded on PMT’s balance sheet. What you will note is that the fair value of the loans held by PMT is significantly lower than the value of the underlying properties. The mark on the nonperforming loans is held on average at a 30% discount to current property value while the mark on the performing loans is held on average at a 31% discount to current property value. This embedded value is generally realized over time through a variety of loan resolution strategies we pursue, which are executed by the servicing operations of PFSI. In the case of nonperforming loans, valuation gains are recorded as each loan progresses closer to liquidation or is rehabilitated to a reperforming loan. Performing loans also have a significant embedded value, but their resolution options differ and include restructure through modifications and refinance strategies. Many of PMT’s performing loans were acquired as nonperforming loans and were brought back to performing status through successful servicing activities which may have included a loan modification. Reperforming loans can continue to be held in our portfolio and earn interest income as the underlying borrowers make their scheduled monthly payments or gains can be realized through portfolio sales after a repayment history is established. The interest income earned by PMT from these loans has increased significantly in recent periods and over the last twelve months in particular. These loans become more valuable as their reperformance history improves. We continue to analyze the best execution for these portfolios and our manager, PennyMac Financial, is experienced in the opportunistic acquisition, sale and active management of these assets. PMT remains a leading investor in distressed whole loans with a track record of realizing value through these strategies. During the third quarter, we did not purchase any new pools of distressed mortgages; however, we remained active in reviewing pools available for sale in the market. Distressed whole loans comprise more than half of PMT’s mortgage assets and it is important to understand that our distressed portfolio, with a weighted average life of over 4 years, is well positioned to continue making significant contributions to PMT’s earnings for the foreseeable future. Now, let’s turn to slide 12 and discuss the resolution activity that occurred in PMT’s distressed loan portfolio during the third quarter. Here we show the various resolution activities which include liquidation activities, modifications, and loans transitions from foreclosure to REO. Liquidation activities include payoffs, foreclosure sales to third parties, short sales and sales of REO properties to third parties. The UPB of total liquidation activities decreased 25% from the second quarter, primarily as a result of our increased focus on loan modification activities versus home forfeiture outcomes such as foreclosure sales and short sales. Modification activity increased 23% quarter over quarter, driven by the implementation of our proprietary streamline modification program and simplification of the document collection process. Our strong modification and collection efforts have helped to increase the UPB of completed modifications to $79 million in UPB in the third quarter versus $64 million in UPB in the second quarter. The pipeline of modifications in process at the end of the quarter was $355 million. Foreclosure to REO activity increased 15% quarter over quarter. This activity relates to completed foreclosures where PMT retains ownership of the property, with the ultimate resolution coming through sale or rental. PMT’s portfolio of REO rentals totaled $4.4 million at September 30th. Now let’s turn to slide 13 and discuss the operational results for correspondent production. Correspondent production totaled $14.4 billion in UPB for the third quarter, a 21% increase from the second quarter. Conventional conforming and jumbo loan acquisitions were $4.1 billion in UPB, an increase of 14% from the prior quarter. Correspondent lock volume was $13.6 billion in UPB, a %5 decrease from the second quarter. Conventional conforming and jumbo locks were $4.1 billion in UPB, a 7% decrease from the second quarter. In October, total correspondent loan acquisitions were $3.8 billion in UPB, and interest rate lock commitments were $3.9 billion in UPB. Our increase in production volumes was a result of our ability to grow market share and capture the available market opportunity. PennyMac Financial’s technology-enabled platform allowed us to significantly increase transaction volumes while maintaining high production quality. Our ability to scale reflects the investments our manager has made in the systems and processes for correspondent fulfillment. During the quarter, we grew the number of approved sellers while continuing to maximize the business we do with each relationship. We have had success adding new correspondent seller relationships, which increased to 400 from 377 last quarter. A key strategic focus is to grow seller relationships with small to medium-sized originators which benefit the most from our operational expertise and risk management capabilities. These sellers accounted for $2.5 billion of lock volume in the third quarter, up 14% from the second quarter and we expect these relationships to generate increased volume and become a more meaningful portion of our correspondent business over time. We also executed on our strategic initiatives to grow market share and optimize our business relationships with existing sellers. We have made significant gains in under-represented geographies such as the Midwest where acquisition volumes rose by 23% from the second quarter. Now let’s turn to slide 14 and discuss MSR and ESS investment activity. PMT’s investment in MSRs and ESS reached $842 million, up from $754 million at June 30th, with the related loans underlying the investments totaling $94 billion in UPB at September 30th. Investments in MSRs, which resulted from PMT’s correspondent production, totaled $423 million, up from $395 million at June 30th. During the quarter, we invested $84 million in ESS on bulk, minibulk and flow acquisitions of Agency MSRs by PennyMac Financial relating to $10 billion in UPB. As of September 30th, our investment in ESS totaled $419 million, up from $359 million at June 30th. 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 pre-tax earnings contribution from each of PMT’s segments over the last five quarters. In the third quarter of 2015, PMT’s pre-tax earnings totaled $45.1 million, comprised of $34.9 million of pre-tax income from Investment Activities and $10.2 million of pre-tax 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, segment revenues totaled $60.4 million, up 28% from the second quarter. The quarter-over-quarter increase in revenues was driven primarily by an increase in interest income and higher net loan servicing fees. Net gain on investments in the third quarter included valuation gains on distressed loans of $31.9 million, a 6% increase from the second quarter. We strategically manage our overall interest rate exposure through a variety of strategies which include offsetting interest rate sensitivities. These strategies include mortgage servicing rights, excess servicing spread and Agency and non-Agency mortgage backed securities. The net impact of valuation changes on ESS, Agency MBS and non-Agency MBS was a $7 million loss during the quarter. ESS and non-Agency MBS had valuation losses totaling $10.2 million, while Agency MBS had a valuation gain of $3.2 million during the quarter. Valuation losses on ESS resulted from higher projected prepayment activity on the loans underlying the investment, driven by lower interest rates during the quarter, partially offset by increased recapture income. Recapture income paid to PMT by PennyMac Financial from recapture on loans underlying the ESS totaled $2.4 million for the third quarter, up from $1.5 million last quarter. Net interest income increased 43% quarter over quarter, which I will discuss in greater detail later in my presentation. Net loan servicing fees resulting from PMT’s investment in MSRs were $20.8 million in the third quarter, up from $13 million in the second quarter. Fair value losses and impairment provisioning that resulted from lower interest rates and higher expected prepayments were offset by strong performance in our financial hedges. Other investment losses were $1.7 million, compared to a $13,000 gain in the second quarter, driven by higher property preservation expenses and servicing advances related to PMT’s growing inventory of REO properties. Segment expenses were $25.4 million in the third quarter, down from $27.1 million in the second quarter due to declines in activity-based special servicing fees and management fees. On slide 18, we show the components of gain on investments and interest income for each of the Investment Activities and Correspondent Production segments. PMT’s interest income has grown 36% quarter-over-quarter, and is an increasingly important component of the company’s earnings. In particular, interest income earned by the distressed loans is a significant component of PMT’s investment returns. Capitalized interest on loan modifications increased 50% in the third quarter to $14.8 million, increasing interest income but generally offset by lower gains from loan valuations. Interest income from reperforming loans in the distressed portfolio has more than doubled since the third quarter of 2014, and this trend is expected to continue as the portfolio continues to transition toward reperforming loans. Interest income is an important component of the returns on our excess servicing spread investments, and was up $2.2 million from the prior quarter. In the correspondent production segment, interest income totaled $13.7 million, up from $9 million in the second quarter, driven by higher acquisition volumes. The investment activities segment also earned $7 million of interest income related to loans acquired for sale. Now let’s turn to slide 19 and discuss the cash flows related to PMT’s distressed loan portfolio. PMT’s distressed mortgage loan portfolio generated realized and unrealized gains on mortgage loans totaling $31.9 million in the third quarter, compared to $30.1 million in the second quarter. Valuation gains on distressed loans totaled $29.1 million in the third quarter, compared to $27.2 million in the second quarter. Valuation gains on performing loans were $6 million and on nonperforming loans were $23.1 million. Valuation gains benefited from higher actual home prices versus prior forecasts, partially offset by a reduction in the outlook for future home price appreciation. Home price data used in our valuation model indicate home prices in various regions of the country have improved in recent months. Additionally, improving home prices increased the expected realization value of certain properties transitioning from foreclosure to REO status during the third quarter. Payoff gains on distressed loans totaled $2.9 million, compared to $2.6 million in the prior quarter. Liquidation activity on distressed loans continued to generate significant cash flows. For the third quarter, gross cash proceeds totaled $103.7 million, down from $128.7 million in the second quarter, due to a decline in liquidation activity. With respect to the distressed loans and REO liquidated during the quarter, $6.9 million in valuation gains had been recognized over the holding period of the assets and another $7.4 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 $39.9 billion in UPB, up from $37.1 billion at the end of the second quarter. PMT also owns investments in ESS totaling $418.6 million, with a UPB related to the underlying loans totaling $54.2 billion. MSRs and ESS are a growing portion of PMT’s long-term investments and their economic value generally increases in a rising interest rate environment and decreases when rates fall. This quarter, the value of the ESS investment was adversely impacted by the projection of higher future prepayment speeds resulting from the lower interest rate environment. However, when those prepayments result in refinancing by PFSI, PMT earns recapture income. Recapture income paid by PennyMac Financial from recapture on loans underlying the ESS totaled $2.4 million for the quarter, in addition to $670,000 from recapture underlying the MSRs. The chart on slide 20 shows some of the key metrics of 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 $21.2 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 correspondent segment’s third quarter performance. Correspondent Production segment revenues totaled $30.4 million compared to $22.8 million in the second quarter. Net gains on mortgage loans acquired for sale totaled $13.9 million, a 24% increase, primarily resulting from the optimization of GSE deliveries and the sale of specialized loans. Net interest income for the segment was $7.4 million, compared to $4.2 million in the second quarter. Other income, which is primarily comprised of loan origination fees, increased 25% from the prior quarter to $9.2 million. As a percentage of IRLCs, segment revenues totaled 74 basis points in the third quarter, compared to 51 basis points in the second quarter. The increase resulted from higher net interest income and loan origination fees from a 14% increase in acquisition volumes during the quarter. Expenses in the Correspondent Production segment increased 15% quarter-over-quarter, as a result of higher funding volumes. And with that, I’ll turn the discussion back over to Stan for some closing remarks.

[Stanford Kurland:]

Thank you, Anne. PMT’s improved financial performance in the third quarter reflects our focus on maximizing returns from existing investments and deploying capital in unique mortgage-related strategies. We are allocating capital to investments in mortgage servicing rights, GSE credit risk transfer transactions and other mortgage-related securities as opportunities for investing in distressed mortgage loans are diminished. We believe that these strategies will also improve the predictability of PMT’s earnings and drive increased shareholder value over time. In closing, 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.