PennyMac Financial Services Inc

NYSE:PFSI

Earnings Call Transcript 2021-Q1

[Isaac Garden, executive]

Good afternoon and welcome to the first quarter 2021 earnings discussion for PennyMac Financial Services, Inc. The slides that accompany this discussion are available on PennyMac Financial's website at ir.pennymacfinancial.com.

Before we begin, let me remind you that our discussion contains forward-looking statements that are subject to risks identified on Slide 2 that could cause our actual results to differ materially, as well as non-GAAP measures that have been reconciled to their GAAP equivalent in our earnings presentation.

Thank you. Now I'd like to begin by introducing David Spector, PennyMac Financial's Chairman and Chief Executive Officer, who will review the company's first quarter 2021 results.

[David Spector, executive]

Thank you, Isaac. PennyMac Financial again delivered exceptional financial performance in the first quarter, driven by continued strong production and core servicing results, partially offset by the performance of our hedged mortgage servicing rights.

Net income was $377 million or diluted earnings per share of $5.15, generating book value growth per share of 8% to $51.78.

Importantly, we repurchased approximately 4.7 million shares of PFSI's common stock during the quarter for an approximate cost of $288 million. And through April, we repurchased an additional 270,000 shares for an approximate cost of $16 million.

This brings the total repurchases year-to-date to over $300 million. And since the beginning of 2020, we have now repurchased approximately 18% of PFSI's common shares.

We also issued $650 million of 8-year senior unsecured notes, taking our total unsecured notes outstanding to $1.3 billion. Additionally, PFSI's Board of Directors declared a first quarter cash dividend of $0.20 per share. Dan Perotti, PFSI's Senior Managing Director and Chief Financial Officer, will discuss our financial performance in more detail later on in this discussion.

Operating results across loan production and servicing remained strong. And we continued to see the strength of our balanced business model reflected in our results. We also continued to see strong market share growth across our direct lending businesses, with another quarter of record lock in funding volumes, despite higher mortgage rates and increased competition.

In total, loan acquisition and origination volumes were $67 billion in the first quarter. These strong production volumes again led to servicing portfolio growth despite continued elevated prepayment activity.

PennyMac Financial's servicing portfolio totaled $449 billion in unpaid principal balance at March 31, up 5% from the end of 2020 and up 17% from March 31, 2020.

Finally, PMT, the investment vehicle that PFSI manages, delivered another strong quarter of investment performance and net assets under management were $2.4 billion, up 3% from year-end 2020.

With that, I will now turn the call over to Andy Chang, Senior Managing Director and Chief Operating Officer, who will review the mortgage origination landscape and the foundation we have in place to drive continued success into the future.

[Andrew Chang, executive]

Thank you, David. The origination market continues to be historically strong, as mortgage rates remain near record lows despite the increase in the 10-year Treasury yield since the start of the year.

Recent economic forecasts for 2021 originations ranged from $3.3 trillion to $4 trillion, while average forecasts for 2022 originations remained strong at $2.6 trillion.

It is worth noting that in each of 2021 and 2022, purchase originations are expected to total $1.7 trillion, almost 40% higher than 2019 levels. So while refinance origination volumes are expected to decline significantly over time as a result of higher interest rates, we believe PennyMac Financial is very well positioned for continued market share growth, especially as we are one of the largest producers of purchase money loans in the U.S.

As Doug will expand upon later, production margins across the industry have decreased as a result of excess capacity in the industry relative to the current origination market. While affected by these pressures, margins for PennyMac Financial's production segment stand to benefit from a continued shift in mix towards our higher-margin consumer direct lending channel, where we have been investing heavily and where there remains much opportunity for continued growth.

Consumer and broker direct have an outsized impact on production segment earnings, as you can see on Slide 7 of the earnings presentation. In fact, only 22% of fallout-adjusted lock volume in the first quarter was from the consumer and broker direct channels, but they contributed approximately 80% to the segment's pretax income.

Servicing becomes an increasingly important component of our earnings as interest rates increase, and we believe that mortgage companies without a balanced business model like PennyMac's will be challenged when origination volumes return to more normalized levels.

Additionally, the investments we have made in technology, such as our cloud-based proprietary servicing system we call SSE, are driving efficiencies across our platform as it continues to grow.

Not only are we seeing scale and workflow benefits from SSE, but it also enables Pennymac to effectively address COVID-19 hardships, and implement loss mitigation programs for borrowers, which has contributed to elevated levels of core profitability in the servicing segment.

Over nearly 8 years as a public company, PennyMac Financial has generated an average annualized return on equity of 26%.

In the first quarter, PennyMac Financial recorded a 43% annualized return on equity, further adding to our long track record of strong financial performance.

For the remainder of 2021, we project PFSI to achieve a return on equity closer to our pre-COVID historical returns.

Now I'll turn it over to Doug Jones, PFSI's President and Chief Mortgage Banking Officer, to discuss our mortgage banking businesses.

[Douglas Jones, executive]

Thanks, Andy. As you can see on Slide 8 of our presentation, PennyMac maintained its leadership position in the correspondent channel, and we estimate that we represent approximately 17% of the channel overall.

Total correspondent loan acquisition volume was $51.2 billion, down 10% from the prior quarter and up 72% from the first quarter of 2020.

Our correspondent mix percentage was largely unchanged from the previous quarter, as 34% of the correspondent acquisitions were government loans and 66% were conventional loans.

Government loan acquisitions in the quarter totaled $17.4 billion, down 8% from the prior quarter and up 28% from the first quarter of 2020.

Conventional correspondent acquisitions, for which PFSI earns a fulfillment fee from PMT, totaled $33.8 million, down 11% from the prior quarter and up 109% from the first quarter of 2020.

Government correspondent locks were $17.1 billion, down 14% from the prior quarter and up 15% from the first quarter of 2020.

Revenue per fallout-adjusted government lock in the first quarter was 41 (sic) [ 37 ] basis points, down from 51 basis points in the prior quarter as margins in the channel continued to trend towards more normalized levels.

In April, our correspondent volumes remained strong, with $18.5 billion of acquisitions and $15.6 billion of locks. Looking ahead further, we expect the role of the correspondent aggregators to become increasingly important in the mortgage ecosystem, as the government-sponsored enterprises implement changes to their preferred stock purchase agreements.

Additionally, the implementation of the $1.5 billion annual limit per client on cash window deliveries is expected to drive more volume to leading aggregators like PennyMac.

As we turn to consumer direct, we estimate that we gained significant market share during the quarter with approximately 1.3% of total originations in the channel.

We originated a record $10.7 billion of loans in the channel, up 33% from the prior quarter and 165% from the first quarter of 2020, driven by growth in sales and fulfillment capacity as our new hires in fulfillment and direct lending begin to season.

Interest rate lock commitments for the first quarter were also a record, totaling $13.4 billion, up 4% from the prior quarter and up 87% from the first quarter of 2020.

Importantly, new customer acquisition or non-portfolio interest rate lock commitments, in the first quarter were $1.5 billion, up from $1.3 billion in the fourth quarter and $267 million in the first quarter of 2020 as we begin to see the results of the commitment we have made to growing this channel.

Similarly, the purchase lock volume was a record $514 million, up from $503 million in the fourth quarter and $353 million in the first quarter of last year.

The technology-based digital marketing platform, coupled with dedicated loan officers and efficient operating processes, give PennyMac a strong foundation for continued growth.

Though mortgage rates increased and the industry remains competitive, we saw revenue per fallout-adjusted lock of 477 basis points in the first quarter, which is very strong by historical standards.

In April, originations for our Consumer Direct channel totaled $3.5 billion and locks totaled $4.7 billion. The committed pipeline at April 30 was $7 billion.

Lastly, our broker direct channel continued its impressive growth with a record $5.1 billion in origination volume, up 14% from the prior quarter and 227% from the first quarter of 2020.

We now estimate that we represent approximately 3% of the market share in the channel with almost 1,900 brokers approved to offer our products, up 18% from the end of 2020.

Volumes and pricing margins in the channel trended as we expected in January and February, but decreased in March and April, reflecting high levels of competition between channel leaders.

Lock volume in the first quarter totaled $5.7 billion, essentially unchanged from the prior quarter, while April locks totaled $1.5 billion.

Margins in the broker channel decreased more sharply than other channels, and revenue per fallout-adjusted lock was 145 (sic) [ 140 ] basis points, down from 205 basis points in the prior quarter.

While we have seen them recently stabilize, margins in April were down meaningful (sic) [ meaningfully ] from their average levels in the first quarter, with broker direct margins impacted the most.

In total, these strong acquisition and origination volumes continue to drive the organic growth of our servicing portfolio, despite elevated prepayment activity.

As you can see on Slide 12, $45 billion of portfolio runoff in the first quarter was more than offset by $67 billion of total production added, and we ended the quarter with a servicing portfolio of $449 billion in unpaid principal balance or approximately 3.8% of all residential mortgage debt outstanding in the U.S.

PennyMac Financial's own portfolio reported a prepayment speed of 32.6% in the first quarter, essentially unchanged from the prior quarter. The prepayment speeds of PennyMac Financial's subserviced portfolio, which includes mostly Fannie Mae and Freddie Mac mortgage servicing rights owned by PMT, decreased to 35.1% from 38.9%.

PFSI's own servicing portfolio, which consists primarily of Ginnie Mae MSRs, had a 60-plus day delinquency rate of 8.6%, down from 10.2% in the prior quarter, while our subserviced portfolio, primarily consisting of conventional loans, reported a 60-plus day delinquency rate of 2.1%, down from 2.7% at December 31 as borrowers continue to emerge from forbearance plans.

The UPB of completed modifications was $5.5 billion, down from $6.3 billion last quarter and the UPB of EBO volume totaled $4.2 billion, also down from last quarter as a result of the smaller population of loans eligible for modification, as delinquency rates continue to decline.

I would now like to turn it over to Dan Perotti, Senior Managing Director and Chief Financial Officer, who will speak to the financial results for the quarter.

[Daniel Perotti, executive]

Thanks, Doug. As David mentioned earlier, PFSI's net income was $376.9 million or diluted earnings per share of $5.15. I will cover each segment's results and then briefly review our forbearance and servicing advance trends.

Production segment pretax income was $362.9 million, down 37% from the prior quarter and up 51% from the first quarter of 2020.

As you will see on Slide 11, we provide a breakdown of the revenue contribution from each of PFSI's loan production channels, net of loan origination expenses including the fulfillment fees received from PMT for conventional correspondent loans. The direct lending channels have an outsized impact on PFSI's production earnings.

As Andy mentioned, consumer and broker direct represented 22% of the fallout-adjusted lock volume in the first quarter, but accounted for approximately 80% of segment pretax income.

Production revenue margins declined from the prior quarter, and revenue per fallout-adjusted lock for PFSI's own account was 176 basis points in the first quarter, down from 217 basis points in the fourth quarter of 2020.

Our costs varied by channel, ranging from approximately 15 basis points in correspondent to 150 basis points in consumer direct. As our production mix continues to shift toward direct lending, production expenses as a percentage of fallout adjusted locks are expected to trend higher.

The servicing segment recorded pretax income of $141.7 million, up from pretax income of $42 million in the prior quarter, and down from $170.8 million in the first quarter of 2020.

Pretax income, excluding valuation related items for the servicing segment, was $258.4 million, up 10% from the prior quarter and 511% from the first quarter of 2020.

These increases were primarily driven by continued loss mitigation activities related to COVID-19. As you can see in greater detail on Slide 13, EBO loan-related revenue increased significantly to $283.7 million as a result of continued loss mitigation activity, with borrowers emerging from forbearance while related expenses were modest.

Operating revenue decreased $5.6 million from the prior quarter, driven by lower net servicing fees as a result of seasonal payment trends and lower earnings rates on custodial deposits.

Operating expenses were up $18.4 million from the prior quarter, driven primarily by seasonal accruals of compensation-related expenses and a greater allocation of corporate expenses.

Payoff-related expenses, which includes interest shortfall and recording and release fees related to prepayments, remain elevated and increased by $4.2 million quarter-over-quarter.

In order to protect the value of our MSR asset, we utilize a comprehensive hedging strategy. This hedging strategy is designed to moderate the impact of interest rate changes on the fair value of our MSR asset and also considers production-related income.

On Slide 14, you can see the fair value of our MSR increased by $461 million in the first quarter, driven primarily by lower expectations for prepayment activity in the future as a result of higher mortgage rates.

This fair value increase was partially offset by $155 million in other valuation declines, primarily driven by significant levels of prepayment activity and early buyouts.

Hedging and related declines totaled $443 million and included hedge costs of $52 million. Market volatility during the quarter impacted both hedge costs and hedge effectiveness.

Overall, combined with pretax income from our production segment, our hedging strategies have been successful over time, mitigating the volatility of interest rate changes on our income.

Our Investment Management segment delivered pretax income of $1.4 million, down from $2.6 million in the prior quarter.

Net assets under management totaled $2.4 billion as of March 31, up 3% from December 31 as PMT recorded another strong quarter of investment performance.

Segment revenue was $9.6 million, essentially unchanged from the prior quarter. Lastly, I would like to touch on the trends we are seeing related to forbearance and loss mitigation. The percentage of loans in forbearance decreased to 6.3% at March 31 from 7.8% at December 31, as borrowers in forbearance plans at December 31 who have since exited, more than offset new forbearance plans.

Servicing advances outstanding decreased to approximately $437 million at March 31 from $454 million at December 31, consistent with seasonal trends in the first quarter.

Advances are expected to continue increasing over the next 6 to 12 months. No P&I advances have been made to date as prepayment activity continued to sufficiently cover remittance obligations.

And with that, I would like to turn it back to David for some closing remarks.

[David Spector, executive]

Thank you, Dan. Our balanced business model once again delivered outstanding results in an increasingly challenging market. We continue to grow our direct lending businesses as well as organically grow our servicing asset, building an extremely valuable mortgage banking enterprise well positioned for future growth.

We believe deeply in that value, which is why we continue to repurchase shares. Since the beginning of 2020, we have now repurchased approximately 18% of PFSI's common shares. We also continue to make substantial investments in our technology and operations. I remain confident in our ability to profitably and responsibly grow our direct lending channels, while maintaining our leadership position in correspondent production.

Combined with our large and growing residential loan servicing portfolio, we expect to continue producing strong returns for our stockholders as we look ahead.

Finally, we look forward to further discussing our outlook for the business at our upcoming Investor Day for PennyMac Financial and PennyMac Mortgage Investment Trust.

We encourage investors with any questions to reach out to our Investor Relations team by e-mail or phone. Thank you.

[Isaac Garden, executive]

This concludes PennyMac Financial Services, Inc.'s first quarter earnings discussion. For any questions, please visit our website at ir.pennymacfinancial.com, or call our Investor Relations department at [phone]. Thank you.