Good afternoon, and welcome to the First 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 moment to read the disclaimer on Slide 2 of the presentation. Thank you. .
Now I'd like to turn the discussion over to Stan Kurland, PMT's Chairman and Chief Executive Officer. .
Thank you, Chris. I would like to begin with PMT's first quarter results on Slide 3. For the first quarter, PMT earned $7.5 million in net income or $0.09 per diluted share, which represents an annualized return on equity of 2%. PMT paid a dividend of $0.61 per share for the quarter and book value was $20.68 per share at quarter end. .
Investment Activities and Correspondent Production. The Investment Activities segment reported an $8.2 million pretax loss, and the Correspondent Production segment earned $4.4 million in pretax income. In addition, there was an income tax benefit of $11.3 million for the quarter.
The results of Investment Activities were adversely impacted by a combination of factors, including lower than forecasted performance in the distressed loan portfolio, higher prepayment speeds that negatively affected MSR and ESS valuations, and hedge losses related to mortgage spread widening in our MBS portfolio. .
Cash flows from PMT's existing investment portfolio remains strong, including $111.9 million in proceeds generated from the liquidation of distressed mortgage loans and REO. New Investment Activities during the first quarter included additional capital deployment into mortgage servicing rights and excess servicing spread. .
PMT created $27 million of new MSRs from our conventional Correspondent Production activities, which represents $2.9 billion in unpaid principal balance. Investments in ESS totaled $46 million, which relates to $6.4 billion in UPB of Agency MSRs from mini-bulk and flow acquisitions by PennyMac Financial.
The value of MSRs and ESS totaled $581 million at the end of the quarter, which relates to $68 billion of UPB. .
Turning to Slide 4. Today, we are also announcing progress on several important initiatives that have taken place in the second quarter. First, we have obtained financing for our ESS and MSR investments through 2 separate facilities. These new facilities add leverage for PMT and are expected to enhance our investment returns.
As of today, we have a combined $108 million utilized from these financing lines. We recently completed an ESS investment of $136 million relating to $15 billion of UPB of Agency MSRs acquired by PennyMac Financial. This was the largest and last portion of the ESS investments that were announced last quarter. .
Today, we are announcing a new planned ESS investment of $74 million, relating to $9.3 billion of Ginnie Mae MSRs to be acquired by PennyMac Financial. We expect to complete this newly announced investment in July.
Another major initiative we are announcing is that PMT has entered into a credit risk transfer structure with Fannie Mae to invest in what we believe is the high credit quality of our Correspondent Production. .
Finally, another great milestone is that PMT, through its captive insurance subsidiary, has been granted membership in the Federal Home Loan Bank of Des Moines. The credit risk transfer structure and the FHLB membership are both significant initiatives that facilitate the participation of private capital in mortgage lending.
And I will discuss each of them in greater detail later in the presentation. All of these new initiatives we are announcing today are significant events that help position long-term investment strategies for PMT. .
Now, let's turn to Slide 5 and discuss our current perspectives on the mortgage market. During the first quarter, 30-year fixed mortgage rates declined to their lowest quarterly average level since mid-2013.
In addition to declining interest rates, the FHA 50 basis point reduction in its annual insurance premiums paid by borrowers on new FHA loans increased the incentive for many FHA borrowers to refinance and lower their mortgage payments.
As a result of these factors, the industry experienced a significant increase in refinance activity during the first quarter. The average of industry forecasts from Fannie Mae, Freddie Mac, and the Mortgage Bankers Association now predicts a $1.3 trillion mortgage origination market for 2015. .
As you can see from the chart, in the lower right-hand portion of the slide, home prices have been stagnant on a not seasonally adjusted basis since last summer. This year, home prices are forecast to rise at a pace that is closer to the average home price appreciation rate over the last 30 years of 4.1%.
We continue to believe that home price gains, going forward, will be driven by macroeconomic improvements and tight housing inventory in certain regions. Lastly, recent regulatory actions against large nonbank mortgage companies reinforced the importance of effective governance, compliance and operating systems.
These have all been areas of emphasis for PennyMac since our inception, and we remain committed to investing in these areas as we grow. .
On Slide 6, I'd like to discuss the cash flows from PMT's investments and how they relate to our quarterly dividend. PMT's investment portfolio continues to generate strong cash flow in excess of our dividend payments for each of the last several quarters.
The chart shows the cash flows generated by PMT's existing investments, such as liquidation of individual distressed loans and REO, excess servicing spread and servicing fees generated from mortgage servicing rights. Cash flows are net of PMT's operating expenses and the repayment of debt associated with the liquidated assets.
For purposes of this analysis, we have excluded onetime proceeds from the sale of investments, such as bulk sales of distressed loans and sales of MBS, and capital raised from increased use of financing or securities issuance. The chart excludes cash deployed in making new investments, including our ongoing activities in Correspondent Production.
There are a variety of factors we assess in establishing the appropriate dividend level, which include cash flows, taxable income for the year and our long-term view of investment returns. .
Now let's turn to Slide 7, and begin a discussion and analysis of how our investment strategies contribute to PMT's return on equity. PMT manages an investment portfolio consisting of multiple residential mortgage-related strategies that we expect to produce attractive long-term returns across changing market environments.
Our strategies include investing in distressed whole loans as well as several interest-rate-sensitive strategies comprised of correspondent loan production, the resulting MSRs, excess servicing spread, agency and non-agency MBS and retained interests from the securitization of prime jumbo loans. .
Our multiple asset classes produce offsetting exposures to changes in interest rates. For example, when interest rates decline, while our MSR and ESS investments will tend to decline in value, our agency and non-agency MBS investments should increase in value.
Our investments combined to produce a 12.6% return on equity, or ROE, in 2014 and a 15.1% ROE in 2013. We are also pursuing newer investment strategies including commercial real estate loans and GSE risk transfers on our Correspondent Production, which we expect to contribute to attractive returns on equity in the future. .
Let's now turn to Slide 8 and analyze how these investment strategies performed in 2014. Beginning on Slide 8, we detail our performance, as measured by return on equity contribution for each of PMT's investment strategies.
We have added these disclosures to provide investors additional information on what we believe are the drivers of PMT's performance.
For each investment, we show the equity we have allocated and the estimated return contribution, which is net of direct expenses associated with the investments, but does not include management fees and other corporate expenses. These are deducted at the bottom. .
Looking at the full year 2014, despite volatility across the quarters, the distressed loan investments contributed a 19% return on equity.
As I mentioned previously, we managed to the net performance across all interest rate strategies, so while the ESS, for example, contributed lower performance than targeted primarily driven by declining interest rates, the agency and MBS strategies contributed greater performance than targeted.
Combined, the 5 interest-rate-sensitive strategies produced a 12% ROE. And after all expenses and income taxes, PMT produced an ROE of 12.5% for the year. .
Let's turn to page 9 and review this analysis for the first quarter of 2015. In the first quarter, a number of factors contributed to produce an ROE that was significantly lower than our target. The ROE contribution from distressed loan investments was 5.5%.
Stagnant home prices in recent months were one factor that reduced returns on distressed loan investments. As yields on distressed loans have tightened, variability in home prices has an increasing effect on the performance of our distressed loan investments.
The net return from interest-rate-sensitive strategies for the first quarter was negative 0.9%. Higher prepayment activity due to lower mortgage rates and an unanticipated reduction in FHA mortgage insurance premium drove a loss in the value of MSRs and ESS.
And while we would expect MBS values to increase with the decline in interest rates, hedge losses related to mortgage-spread widening contributed to a loss on our non-agency MBS investments. .
The bottom line ROE for the first quarter was 1.9%. While we are disappointed by these results, we don't believe that this quarter reflects the long-term ROE we expect from PMT. .
Now let's turn to Slide 10, and review the growth in PMT's balance sheet and leverage. PMT's mortgage assets increased significantly during the first quarter. Distressed mortgage loans grew with the addition of 2 recently acquired distressed loan pools and continue to comprise more than half of PMT's mortgage assets.
New investments during the quarter included the MSRs and ESS that I mentioned previously. And PMT's correspondent loan inventory was significantly higher at quarter end due to increased production volumes. We also continue to prudently increase the use of leverage to finance investments.
PMT's overall leverage ratio increased to 2.6x equity at quarter end versus 2x equity a quarter earlier. The higher level of correspondent inventory, which are financed at advance rates exceeding 90%, was the largest driver of higher weighted average leverage at quarter end. .
Let's turn to Slide 11 and discuss the financing initiatives in greater detail. As I mentioned earlier, we are pleased to announce that PMT Insurance, LLC, a wholly owned subsidiary of PMT has been granted membership in the Federal Home Loan Bank of Des Moines.
FHLB advances are an important source of financing, which we believe will help facilitate the expansion of non-agency mortgage lending. FHLB advances will further diversify PMT's funding sources and expand its use of term financing.
We have recently entered into a bank facility that provides financing against Freddie Mac, MSRs, from which we have drawn $56 million to date. This facility provides cost-effective secured financing, which is expected to significantly enhance returns on equity from these MSRs, which are generated from PMT's Correspondent Production. .
Lastly, PFSI recently amended its Ginnie Mae MSR financing facility to allow the financing of ESS by PMT. The restructured facility provides $150 million of new financing to PMT that is expected to enhance the returns on ESS and help facilitate continued co-investment by PMT in Ginnie Mae MSR acquisitions.
In this structure, PFSI is passing through its financing terms with Crédit Suisse to PMT. .
Now I'd like to turn to Slide 12 and discuss in greater detail our new Fannie Mae credit risk transfer transaction. Today, we announced that we have entered into a credit risk transfer structure on PMT's correspondent loan production.
This structure is the culmination of considerable effort by PMT's manager working closely with Fannie Mae and JPMorgan as the underwriter, and we believe that it is an important addition to PMT's investment strategies going forward. .
The structure provides PMT the ability to invest in the credit risk on its own Correspondent Production. Doing so creates a significant alignment of interests with PMT as a producer of the loans and also as the investor in the bonds.
Additionally, the structure aligns with Fannie Mae's interest in bringing more participation by private capital through new risk transfer transactions. Under this structure, PMT will continue to produce conventional conforming loans and securitize them with Fannie Mae on a flow basis, but delivered through a new special purpose vehicle.
PMT will deposit cash into the SPV in exchange for a Class M1 bond. This bond will cover first losses on the pool of loans and represents our investment in the credit risk. This bond can be financed, and based on our modeled performance is expected to produce attractive returns on equity for PMT.
Additionally, this structure is designed to be repeatable and grow as a portion of PMT investments over time. .
On Slide 13, we lay out the long-term returns on equity we are targeting for PMT. The ROE associated with each asset in the far-right column of the table is the return we target for the investment that PMT holds today and for new investments we would make, using our base assumptions for variables such as prepayment speeds and credit performance.
The ROE shown is the targeted contribution for each strategy on a pretax basis and net of direct expenses associated with the strategy.
For example, for distressed loans, which include PMT's investment in nonperforming and reperforming loans, we expect 6% to 8% unlevered deals on a go-forward basis and levered returns on equity of between 12% and 16%. In estimating the return on equity for each strategy, we have incorporated the current financing terms we expect.
So for example, we are targeting higher expected returns for ESS and MSRs as a result of the new financing facilities I discussed. While our periodic results can vary, this slide represents our current target returns for each of PMT's investment strategies. .
Now I'd like to turn it over to David Spector, PMT's President and Chief Operating Officer. .
Thank you, Stan. Let's turn to Slide 15 and discuss the resolution activity that occurred in PMT's distressed loan portfolio, and discuss how it impacted interest income and valuation gains. .
During the first quarter, we did not purchase any new pools of distressed mortgages. However, we remained active in reviewing pools available for sale in the market. .
On Slide 15, we show the resolution activity in the distressed portfolio for each of the various resolution activities, which includes liquidation activities, modifications and foreclose to REO. Liquidation activities are payoffs, foreclosure sales to third parties, short sales and sales of REO properties to third parties.
Modification activity slowed by 40% quarter-over-quarter due to a smaller portfolio of distressed loans, uncertainty regarding the extension of the FHA's negative equity trial modification program and a lower response rate to modification initiatives.
The decline in modification was a significant driver of the 35% quarter-over-quarter decline in net interest income. .
The negative equity trial modification program was ultimately renewed and our manager, PennyMac Financial, is implementing a new proprietary modification program. We expect both of these programs to be impactful to modification activity in future quarters. Foreclosure-to-REO activity remained consistent 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. I will discuss our newly announced rental program in detail on the following slide. .
Additionally, reduced estimates of home prices drove a reduction in the expected realization value of certain properties, transitioning from foreclosure-to-REO status during the first quarter, adversely impacting valuation gains from the distressed loan portfolio. .
Now let's turn to Slide 16 and discuss our newly announced REO rental program. In previous earnings discussions, I've emphasized our continual assessment of best execution strategies for the distressed loan portfolio, and we adjust our resolution strategies accordingly.
Today, we are announcing the launch of PMT's REO rental program, which leverages our sizable portfolio of REO properties in order to achieve best execution outcomes for select REO where renting results in a higher long-term return than an immediate sale.
We have targeted several geographies around the country with strong rental markets, and we will proceed in a thoughtful manner to prudently grow the rental portfolio over time. .
We have initiated the program in select geographies in Florida and plan to implement the program in several other states during 2015. We expect that this strategy will deliver attractive returns on equity with the potential for securitization in the future. .
An additional aspect to the rental program is the PennyMac Equity Advantage Lease, which helps transition renters to homeowners by allowing them to apply a portion of their monthly rent towards a future home purchase.
We believe that this unique program addresses the needs of first-time homebuyers, who want the benefits of home ownership, but do not currently have the down payment. It also provides a path to homeownership for qualified borrowers with a steady income history who may have had a short sale or foreclosure in the past. .
Now let's turn to Slide 17 and discuss the operational results for Correspondent Lending. PMT's correspondent acquisitions totaled $8 billion in UPB for the first quarter, up 10% from the fourth quarter. Conventional conforming and jumbo loan acquisitions were $2.9 billion in UPB, unchanged from the prior quarter. .
Correspondent lock volume for the quarter was $9.5 billion in UPB, a 27% increase from the fourth quarter. Conventional conforming and jumbo locks were $3.5 billion in UPB, a 16% increase from the prior quarter. In April, total correspondent loan acquisitions were $3.6 billion in UPB, and interest rate lock commitments were $4.6 billion in UPB. .
During the quarter, we continued to execute on a number of strategic initiatives to grow market share and optimize the business relationships with existing sellers. We have made significant gains in growing our presence in New England, which now accounts for approximately 7% of our total lock volume. .
To support our geographic expansion and grow our book of correspondent seller relationships, our manager hired additional correspondent sales managers in the first quarter. Their goal is to help the business achieve its target of 480 seller relationships by year-end and to also maximize the business we do with each relationship.
An important aspect of this initiative is to continue building what we call our development book, which typically consists of small originators.
These sellers tend to deliver their loans on what's known as a best-efforts basis, and we believe that this type of seller can benefit from the operational expertise and risk management capabilities offered through PMT. .
This quarter, the development book accounted for $1.5 billion or roughly 15% of lock volume in the first quarter, up from less than 2% of lock volume in the first quarter of 2014. And its further development remains a key strategic focus for the correspondent sales team. .
Finally, we are making use of proprietary technology to optimize our margin opportunities by product and geography, allowing us to more effectively manage the economics of each transaction we execute. .
Now let's turn to Slide 18 and review the economics of the Correspondent Production business in the first quarter. Pretax income in the Correspondent Production segment increased to $4.4 million in the first quarter, up from $900,000 in the fourth quarter, driven by margin improvement, which affected both revenues and expenses.
Segment revenues as a percentage of interest rate lock commitments totaled 54 basis points during the quarter, an increase of 6 basis points from last quarter, primarily driven by higher margins resulting from industry capacity constraints. .
Expenses were 41 basis points as a percentage of locks. A 3 basis point improvement from the fourth quarter. The average fulfillment fee paid by PMT during the quarter was 45 basis points of loans funded compared to 41 basis points in the fourth quarter. .
During the quarter, our manager's scalable platform was able to accommodate record lock volume without an appreciable impact on inventory turn times, while many other correspondent producers struggled to keep up as demand increased.
We believe that PMT's correspondent platform's ability to maintain service levels resulted in a notable competitive advantage, which gave sellers confidence that their loans can be processed efficiently, facilitating more production volume and resulting in higher revenues for PMT. .
Now let's turn to Slide 19 and discuss the growth in PMT's investments in MSRs and ESS. PMT's investment in MSR and ESS reached $581 million, up from $549 million at December 31, with the related loans underlying the investment totaling $68 billion in UPB at March 31.
Investments in MSRs totaled $359 million, up from $358 million at December 31, a $1 million quarter-over-quarter increase despite new investments in MSRs, which totaled $27 million. A modest net increase reflects the high prepayment activity experienced this quarter.
Investment in ESS totaled $222 million, up from $191 million at December 31, a $31 million increase attributable to $46 million of new ESS investments that settled during the quarter, and reflects the impact of prepayment-related valuation adjustments. .
Now let's move to Slide 20 and discuss the recently closed and pending bulk MSR acquisitions with PennyMac Financial. After the end of the first quarter, PMT completed an investment in $136 million of ESS associated with PennyMac Financial's acquisition of $15 billion in UPB of Agency MSRs.
This investment was the largest of 3 ESS investments announced last quarter. .
We are also pleased to announce a new ESS acquisition, where PMT is expected to invest $74 million in the ESS associated with PennyMac Financial's pending acquisition of $9 billion in UPB of Ginnie Mae MSRs. The MSR acquisition and PMT's purchase of the ESS are expected to be completed early in the third quarter.
The loans underlying this pending acquisition are seasoned Ginnie Mae loans with relatively low delinquency rates and the potential to recapture opportunities. .
Now I'd like to turn the discussion over to Anne McCallion, PMT's Chief Financial Officer, to review the first quarter's financial results.
Anne?.
An $8.2 million pretax loss from investment activities and $4.4 million of pretax income from Correspondent Production. Additionally, first quarter net income included a tax benefit of $11.3 million. This benefit was related to a loss in PMT's taxable REIT subsidiary. .
Now let's turn to Slide 23 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 first quarter, segment revenues totaled $18.9 million, down 51% from the fourth quarter.
The quarter-over-quarter decline in revenues was driven primarily by a 78% decline in net gains on investments, which includes realized and unrealized gains and losses on our distressed loan investments, agency and non-agency MBS and excess servicing spread. .
Net gain on investments this quarter included valuation gains on distressed loans of $17.2 million, a 17% decrease from the fourth quarter, which I will discuss in greater detail on the next slide.
Our investments in retained interest from the jumbo securitization, mortgage-backed securities and ESS experienced valuation losses totaling $13.8 million during the quarter. .
Valuation losses in our MBS portfolios resulted in part from widening in mortgage spreads to the interest rate swap curve.
Valuation losses on ESS primarily resulted from higher actual and projected prepayments for the underlying mortgage loans, due to lower interest rates and the unanticipated reduction in FHA annual mortgage insurance premiums announced in January.
Recapture income paid to PMT by PennyMac Financial from prepayments on loans underlying the ESS totaled $1.3 million for the first quarter and are included in the ESS valuation loss. .
Net interest income declined 35% quarter-over-quarter, driven by a $6.3 million decline in capitalized interest from loan modifications, which totaled $10.2 million for the first quarter.
Capitalized interest on loan modifications is recorded as interest income and is generally offset by a negative adjustment to the fair value gains or losses of the loan. .
Net loan servicing fees were $8 million, a $3.2 million decrease from the fourth quarter, also as a result of higher prepayments and prepayment projections. Other losses totaled $4.2 million, which declined from a $6 million loss in the fourth quarter.
Other losses generally relate to reductions in the value of REO properties as well as valuation adjustments for property preservation, taxes and maintenance costs, partially offset by gains from the sale of REO properties.
Because our REO properties are recorded at the lower of cost or fair value, downward adjustments in value are recognized as a current period item, but increases in value generally are not recognized until the properties are sold. .
Segment expenses decreased 3% quarter-over-quarter, to $27.1 million, primarily due to reduced servicing expenses resulting from a reduction in loan resolution activity as well as a 17% decline in management fee expense related to PMT's reduced financial performance in the first quarter. .
Now I would like to turn to Slide 24 and discuss the performance of the distressed loan portfolio in the first quarter in greater detail. PMT's distressed mortgage loan portfolio generated realized and unrealized gains on mortgage loans totaling $17.2 million in the first quarter compared to $20.7 million in the fourth quarter. .
Valuation gains on distressed loans totaled $15.4 million in the first quarter compared to $17.5 million in the fourth quarter. Valuation gains on performing loans were $15.2 million and on nonperforming loans were $200,000.
The higher gains on performing loans resulted from an increase in observed market prices for similar assets as well as improved performance characteristics in the performing loan portfolio.
Valuation gains were adversely impacted by a decrease in current home prices, versus prior forecasts and lowered expectations for future home prices appreciation in addition to slower transition, or roll, rates than expected, with fewer loans transitioning from severely delinquent status to foreclosure, and fewer loans transitioning into rate performance.
Payoff and sales gains on distressed loans totaled $1.8 million, compared to $3.2 million in the prior quarter. .
Liquidation activity on distressed loans continue to generate significant cash flows. For the first quarter, gross cash proceeds totaled $111.9 million, up from $103.8 million in the fourth quarter.
With respect to the distressed loans and REO liquidated during the quarter, $6.6 million in valuation gains had been recognized over the holding period of the assets and another $7.3 million of gains were realized at liquidation. .
Now let's turn to Slide 25 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 $35.2 billion in UPB, up from $34.3 billion at the end of the fourth quarter.
PMT also owns investments in ESS, totaling $222.3 million, with a UPB related to the underlying loans totaling $33.1 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. When those prepayments result in a financing by PFSI, however, PMT should earn contractual recapture income. .
The chart on Slide 25, 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. .
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.
At the end of the quarter, the fair value of PMT's MSR asset was $18 million greater than its carrying value. .
Let's now turn to Slide 26 and discuss the correspondent segment's first quarter performance. Correspondent Production segment revenues totaled $18.8 million compared to $14.2 million in the fourth quarter.
Net gains on mortgage loans acquired for sale increased 71% from the prior quarter, driven by higher margins due to an increase in refinanced demand resulting from lower mortgage rates. Net interest income for the segment was $3.3 million, compared to $3.4 million in the fourth quarter.
Other income, which is primarily comprised of loan origination fees, increased 9% from the prior quarter to $5.4 million. Expenses in the Correspondent Production segment increased 8% quarter-over-quarter as a result of an increase in the average fulfillment fee to 45 basis points versus 41 basis points in the fourth quarter. .
And with that, I'll turn the discussion back over to Stan for some closing remarks. .
Thank you, Anne. We remain focused on strategic initiatives that we expect to drive attractive, long-term returns on equity for PMT. We have obtained financing for ESS and MSRs on attractive terms, which enhance the expected returns for these strategies.
Membership in the FHLB and the resulting access to term financing helps facilitate our strategies such as investment in non-agency mortgage loans. And we are excited about our progress on the GSE credit risk-sharing structure that allows us to invest in the credit risk of PMT's own Correspondent Production.
We are making progress in diversifying PMT's mortgage-related strategies, which we believe will enable the company to achieve our performance target across different market environments. .
In closing, we encourage investors with any questions to reach out to our Investor Relations team by e-mail or phone. Thank you. .
This concludes the PennyMac Mortgage Investment Trust 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..