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..
Investment Activities and Correspondent Production. The Investment Activities segment reported pretax income of $13.6 million in the third quarter. The Correspondent segment reported pretax income of $31.4 million for the quarter.
Our third quarter results include continued investment in GSE credit risk transfers and mortgage servicing rights resulting from PMT’s correspondent production business. Conventional correspondent loan production totaled $7.3 billion, up 40% from the second quarter.
CRT deliveries for the third quarter totaled $3.6 billion in UPB, resulting in $90 million of new CRT investments. We completed our third CRT commitment with Fannie Mae and entered into a fourth commitment for $7.5 billion in unpaid principal balance. In addition, we added $78 million in new mortgage servicing rights.
We also repurchased approximately 1 million of PMT’s common shares at a cost of $14.4 million. Since the program’s inception last year, PMT has repurchased 8.4 million shares, with $85 million of authorized repurchases remaining under the $200 million program.
Cash proceeds from the liquidation and paydown of distressed mortgage loans and REO were $75 million, reflecting a decrease in REO sales.
After the quarter ended, we entered into an agreement to sell $172 million in UPB of performing loans from our distressed portfolio, bringing sales of distressed performing loans for the year to nearly $600 million. This reflects the continued progress we are making in liquidating and resolving our distressed mortgage investments.
We are particularly pleased with the performance of our newer strategies and correspondent production business, and look for continued improvement from the performance of our distressed investments. Now let’s turn to slide 4 and discuss our perspective on the current mortgage market.
While overall interest rates have been volatile recently, mortgage rates have remained largely stable. The average 30-year fixed rate ended the third quarter at just over 3.4%, relatively unchanged from July and still low on a historic basis.
Mortgage origination volumes remained strong in the third quarter as demand drove significant activity in both the purchasemoney and refinance markets. As home values have improved over time, we have seen more borrowers become eligible for refinance loans.
For the fourth quarter, however, we expect a modest reduction in origination volumes due to the normal seasonal slowdown, which typically affects the purchase-money market in particular. Despite the recent volatility and uncertainty in the global economy, as well as what we see as tepid growth in the overall U.S.
economy, housing remains a source of strength. Relatively low mortgage rates and continued strong demand for homes are expected to drive higher sales of existing and new homes. Currently, total home sales a combination of existing and new home sales now exceed 6 million per year, up significantly versus the last two years.
Economists expect the number to increase to a 6.4 million home sales pace in 2017, and a 6.6 million pace in 2018. Returning to PMT’s results, on slide 5, I would like to highlight the transition in the mix of our investment strategies.
PMT invests in mortgage-related strategies that leverage the unique operational capabilities of its manager and service provider, PennyMac Financial.
PMT’s equity allocation has shifted over the past two years as we have deployed capital into different strategies due to changes in the market opportunities and the risk-adjusted returns available to PMT.
As the chart indicates, our capital deployment has more recently favored MSRs as well as GSE credit risk transfer transactions related to our correspondent production. Today, less than half of PMT’s equity remains allocated to distressed loan investments.
We expect the allocation of equity to continue shifting over time as we redeploy capital into these newer strategies. Now let’s turn to slide 6 and discuss our progress in reducing PMT’s distressed loan investments through liquidations and sales.
The UPB of PMT’s portfolio of nonperforming loans has decreased 38% from the same period a year ago, representing an average reduction of approximately $182 million per quarter. This underscores the progress we have made in the resolution of the nonperforming portfolio.
A primary driver in resolving our distressed loans is reperformance through modifications, the adoption of which has increased significantly in the past year. During the quarter, PMT modified $121 million in UPB of loans.
Reperforming loans may ultimately be sold into a well-established market after at least a six month performance history has been achieved. PMT’s portfolio of performing loans increases as nonperforming mortgages transition to and maintain their performing status, and decreases with loan sales.
The bulk sales we have entered into this year are examples of distressed loans transitioning through to sale.
We remain focused on pursuing strategies to expedite the resolution of the nonperforming portfolio and transition of PMT’s capital into other unique opportunities, including GSE credit risk transfer from our correspondent production activities. Now, let’s turn to slide 7 and discuss PMT’s share repurchase program.
Since last quarter’s release, we repurchased approximately 1 million of PMT’s common shares at a cost of $14.4 million. Since the inception of the program in August 2015, we have repurchased 8.4 million shares at a total cost of approximately $115 million.
An additional $85 million of share repurchases remain authorized under the $200 million repurchase program. The estimated book value of the shares recently repurchased was $19.1 million, for an effective purchase price discount to book value of 25%.
As a result of our share repurchase activity, PMT’s outstanding share count has decreased from approximately 75 million shares at the outset of the program, to just under 67 million shares. We continue to evaluate additional share repurchases using available capital versus the return on alternative investment opportunities.
Now, let’s turn to slide 8 and discuss the third quarter results by strategy. PMT’s investments in the third quarter generated an annualized return on equity of 10.4% net of expenses and overhead. Distressed loan investments produced a loss of $2 million in the quarter versus a $22.4 million loss in the prior quarter.
This represented a negative 1.3% annualized return on equity for the third quarter compared with a negative 12.3% annualized return on equity in the previous quarter. The income contribution from the credit risk transfer investment was $17.3 million, due to marketdriven changes and ongoing income related to the investment.
Other credit sensitive strategies contributed $1.4 million, and include non-Agency subordinate bonds and commercial real estate loans.
In total, credit sensitive strategies contributed $16.6 million in pretax income during the third quarter compared to $13.8 million pretax loss in the prior quarter, representing an 8.4% pretax annualized return on equity in the third quarter of compared with a negative 6.3% pretax annualized return on equity in the second quarter.
Interest rate sensitive strategies, which include the performance of our MSRs, excess servicing spread and Agency and non-Agency MBS positions and related hedges, together generated $5.8 million of pretax income in the third quarter, which represented a 6.4% annualized return on equity, versus pretax income of $0.5 million in the prior quarter, representing a 0.6% pretax annualized return on equity in the second quarter of 2016.
While we show the income contribution for each of these interest ratesensitive strategies separately, they are managed in aggregate as the interest rate sensitivity of MSRs and ESS are inversely correlated to the MBS positions. Valuation losses on the MSR and ESS assets resulted from higher actual and expected future prepayment activity.
The contribution from correspondent production was significant, at $32 million. This was driven by increased interest rate locks and production volumes, reflecting a larger origination market driven by continued low mortgage rates and market share gains during the third quarter.
Now let’s turn to slide 9 and discuss the run-rate income potential for PMT’s strategies. This slide illustrates PMT’s income potential based on its current allocation of equity. The income potential shown represents our base expectations. The actual contribution from each strategy can vary based on market movements and other factors.
The income potential does not reflect the impact of any share repurchases or gains or losses related to fair value changes or from bulk asset sales, such as distressed loans. We expect significant contributions from correspondent production to continue in the near term.
These contributions should be driven by strong purchase and refinance markets, which we also expect to support healthy margins.
A potential modest increase in interest rates is expected to result in a smaller origination market in 2017, which should be counterbalanced by our expected market share growth in conventional correspondent production and PMT’s historic overweight toward purchase originations.
Returns on net credit sensitive strategies are expected to improve over time, with increasing capital allocated to CRT investments and away from distressed loans. In addition, returns on net interest rate-sensitive strategies are expected to improve as MSR and ESS amortization normalizes.
In our evaluation of earnings potential for PMT and determining the appropriate dividend for PMT, we also consider the income required to be distributed for the year in order to maintain our tax-advantaged status as a REIT. PMT’s objective is to distribute a dividend consistent with earnings per share.
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 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?.
the UPB of loans that, as of September 30, are current to 89 days delinquent, and the UPB of loans that are 90 days or more delinquent. More detail on the performance of the loans underlying the CRT investment is presented on slide 31 of our third quarter earnings presentation.
Restricted cash included in “Deposits securing credit risk transfer agreements” on the balance sheet was $427.7 million at September 30 and the net derivative position was an asset of $16.7 million at quarter end. During the third quarter, PMT entered into a fourth CRT commitment with Fannie Mae.
The latest CRT agreement contained a structural change which adjusts the timing of cash flows due to the cash collateral account, allowing for more efficient deployment of capital during the aggregation period.
As a result, the schedule now includes a new line item entitled “Commitments to fund Deposits securing CRT agreements” which represents the amount, as of September 30, that is due to the cash collateral account upon completion of the loan aggregation period.
Moving to slide 22, correspondent Production segment revenues totaled $62.1 million in the third quarter compared with $38.2 million in the prior quarter.
Net gains on mortgage loans acquired for sale totaled $43.9 million, an 81% increase from the second quarter, driven by higher volumes and margins on the acquisition and sale of conventional loans, in addition to specified loan sales made possible by the large volume of conventional loans that PMT produces.
Net interest income for the segment was $5.5 million, unchanged from the second quarter, as a result of higher funding costs which reduced the net interest spread. Other income, which is primarily comprised of loan origination fees, was $12.7 million, a 49% improvement from the prior quarter resulting from increased production volume.
These strong financial results reflect a larger mortgage origination market and strong demand for mortgage financing, but also PMT’s success in profitably growing market share and the ability of PFSI’s highly efficient fulfillment capabilities to maintain high service levels in a market with elevated volume.
Expenses in the Correspondent Production segment increased 41% due to a volume-driven increase in fulfillment fee expense and a slight increase in the weighted average loan fulfillment fee rate, which was 38 basis points in the third quarter and 37 basis points in the prior quarter.
And with that, I’ll turn the discussion back over to Stan for some closing remarks..
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..
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 -.