PennyMac Financial Services Inc

NYSE:PFSI

Earnings Call Transcript 2021-Q2

[Isaac Garden, executive]

Good afternoon and welcome to the Second 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 second quarter 2021 results.

[David Spector, executive]

Thank you, Isaac. PennyMac Financial again delivered outstanding financial performance in the second quarter, driven by continued strong production and core servicing results partially offset by net MSR fair value declines.

Net income was $204 million or diluted earnings per share of $2.94, representing an annualized return on equity of 23%. Book value per share grew 5% to $54.49 at June 30.

Importantly, we continued to repurchase stock, with 2.6 million shares of PFSI's common stock bought back during the quarter for an approximate cost of $155 million. And for the month of July, we repurchased an additional 2.5 million shares for an approximate cost of $151 million. This brings the total repurchases year-to-date to approximately $600 million. And since the beginning of 2020, we have now repurchased over 18.5 million shares or approximately 24% of PFSI's common shares outstanding.

Additionally, PFSI's Board of Directors approved an increase to its stock repurchase authorization from $1 billion to $2 billion. PFSI's Board of Directors also declared a second 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 his discussion.

In total, loan acquisition and origination volumes were $61 billion in the second quarter. These strong production volumes again led to servicing portfolio growth despite continued elevated prepayment activity. PennyMac Financial's servicing portfolio totaled $473 billion in unpaid principal balance at June 30, up 5% from the end of the prior quarter and 22% from June 30, 2020.

Importantly, and as Doug Jones, Senior Managing Director and Chief Mortgage Banking Officer, will expand on in his section of the presentation, we sold $3.4 billion in UPB of early buyout loans to third-party whole loan investors, thus reducing the risk associated with holding these loans and increasing our capital efficiency.

PFSI's Investment Management segment delivered increased profitability as a result of incentive fees earned based on PMT's profitability over the last 4 quarters. Net assets under management were down slightly quarter-over-quarter to $2.3 billion. We continue to invest in people, systems and processes across our businesses, laying the groundwork that would allow us to achieve the medium-term goals we outlined in our recent Investor Day.

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 drivers of profitability for PFSI going forward.

[Andrew Chang, executive]

Thank you, David. The origination market continues to be strong on a historical basis as mortgage rates have recently returned to near record lows. Additionally, we believe FHFA's elimination of the adverse market refinance fee has resulted in a larger population of loans that would benefit from a refinance at today's lower rates, further supporting the origination market.

Recent economic forecasts for 2021 originations range from $3.6 trillion to $4.2 trillion, while average forecast for 2022 originations remained strong at $2.7 trillion. It is worth noting that purchase originations are expected to grow and are forecasted to be $1.7 trillion and $1.9 trillion in 2021 and 2022, respectively. So while refinance origination volumes are expected to decline significantly over the next several years as a result of higher interest rates, we believe the outlook for PennyMac Financial remained strong, given our large profitable and growing servicing business, our position as one of the largest producers of purchase money loans in the U.S. and the continued expansion of our direct lending businesses.

We believe PennyMac Financial's business model with production from the correspondent, consumer direct and broker direct channels contributes to PennyMac Financial's profitability across different production environments. While industry production margins declined in the second quarter, we saw a smaller decrease in overall production margin given the mix shift towards our consumer direct lending channel.

Our direct lending channels have an outsized impact on production segment earnings, as Dan will discuss later. As we continue to grow our leadership positions in the direct origination channels, this growth will drive the earnings from PennyMac Financial's production segment. Our balanced business with our large and growing servicing portfolio also becomes an increasingly important component of our earnings as interest rates increase, and we believe this provides a competitive advantage relative to others when the industry's origination volumes return to more normalized levels.

The expertise of our deep management team, combined with the technology investments we have made, support PennyMac's growth strategy in a changing mortgage market. And while we believe the mortgage market will continue to change from a competitive and regulatory perspective, the infrastructure and risk management disciplines that distinguish PennyMac from others in the industry position us well.

Now I'll turn it over to Doug, who will discuss our mortgage banking businesses.

[Douglas Jones, executive]

Thanks, Andy. As you can see on Slide 7 of our presentation, PennyMac maintained its leadership position in the correspondent channel, and we estimate that we currently represent approximately 18% of the channel overall.

Total correspondent loan acquisition volume was $46.7 billion, down 9% from the prior quarter and up 56% from the second quarter of 2020. Our correspondent mix percentage was essentially unchanged from the previous quarter, as 35% of the acquisitions were government loans and 65% were conventional loans.

Government loan acquisitions in the quarter totaled $16.2 billion, down 7% from the prior quarter and up 47% from the second quarter of 2020. Conventional correspondent acquisitions, for which PFSI earns a fulfillment fee from PMT, totaled $30.5 billion, down 10% from the prior quarter and up 61% from the second quarter of 2020.

Government correspondent locks were $15.7 billion, down 8% from the prior quarter and up 21% from the second quarter of 2020. Revenue per fallout-adjusted government lock in the second quarter was 30 basis points, down from 37 basis points in the prior quarter. The scale we have achieved in our correspondent business, combined with our low-cost structure and operational excellence in the channel, allow us to operate profitably through volatile market environments.

As we outlined in our Investor Day, we see additional opportunities resulting from changes to the GSE's preferred stock purchase agreement. And we believe the role of a well-capitalized correspondent aggregator like PennyMac will be increasingly important over time. Ultimately, we believe for these reasons, PennyMac will continue its market share growth as a channel leader.

In July, our correspondent acquisitions were $15 billion in UPB and locks were $12.8 billion. Our consumer direct lending division produced record origination and lock volumes again despite a smaller origination market in the second quarter. Origination volumes totaled $10.7 billion in UPB, while interest rate lock commitments totaled $14.1 billion. We estimate that our market share in the channel has increased meaningfully since last year, and we now account for approximately 1.3% of total originations in the channel.

The ongoing success can be attributed to the increased application of data analytics, our growing servicing portfolio and the investments we have made in the loan fulfillment and sales process.

Purchase lock volume for the quarter was also a record $744 million, up from $514 million in the prior quarter and $505 million in the second quarter of 2020. Similarly, new customer acquisition or non-portfolio interest rate lock commitments were $1.5 billion, essentially unchanged from the prior quarter and up from $274 million in the second quarter of 2020. The technology-based digital marketing platform, coupled with dedicated loan officers and an efficient operating processes, gives PennyMac a strong foundation for continued growth.

Revenue per fallout-adjusted lock was 343 basis points in the quarter, a decrease from the first quarter. However, margins in this channel remain attractive.

In July, originations for our consumer direct channel totaled $3.5 billion and locks totaled $5.5 billion. The committed pipeline at July 31 was $7.2 billion.

Lastly, originations in our broker direct channel totaled $4 billion in UPB, down 22% from the prior quarter. Similarly, lock volume totaled $4.5 billion, down 21%. Pricing margins in the channel decreased sharply, reflecting intense levels of competition between channel leaders.

Revenue per fallout-adjusted lock was 71 basis points, down from 140 basis points in the prior quarter. We estimate we are now represent approximately 2.5% market share in the channel with over 2,000 brokers approved to offer our products, an increase of 11% from March 31, 2021.

Despite these currently elevated levels of competition, we continue to see opportunity in the channel over the long term and remain committed to providing our broker partners and the customers they serve a superior mortgage experience. Broker originations in July totaled $1.2 billion and locks totaled $1.7 billion. And the committed pipeline at July 31 was $1.9 billion. 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 11, approximately $37 billion of portfolio runoff in the second quarter was more than offset by the addition of $61 billion in total production. And we ended the quarter with a servicing portfolio of $473 billion in unpaid principal balance, approximately 4% of all residential mortgage debt in the United States.

PennyMac Financial's owned portfolio reported a prepayment speed of 28.3% in the second quarter, down from 32.6% in the prior quarter. The prepayment speeds of PennyMac Financial's subservice portfolio, which includes mostly Fannie Mae and Freddie Mac mortgage servicing rights owned by PMT, decreased to 24.7% from 35.1%.

The PFSI's owned servicing portfolio, which consists primarily of Ginnie Mae MSRs, had a 60-day delinquency rate of 6.7%, down from 8.6% at the end of the prior quarter. While our subservice portfolio, consisting primarily of conventional loans, reported a 60-plus delinquency rate of 1.6%, down from 2.1% at March 31 as borrowers continue to emerge from forbearance plans.

The UPB of completed modifications was $5.5 billion, essentially unchanged from the prior quarter, and the UPB of EBO loan volume totaled $6.8 billion, up from $4.2 billion in the prior quarter. As David mentioned earlier, we sold $3.4 billion in UPB of EBO loans to third-party whole loan investors, up significantly from last quarter.

We have long-standing partnerships with several EBO loan investors, with a program in place to buy delinquent Ginnie Mae loans out of securitizations and sell them to these third-party investors. These transactions provide PennyMac the additional capacity and liquidity to efficiently execute loss mitigation strategies as sales of these loans to third parties also eliminate the potential for associated margin calls.

Importantly, PennyMac retains the servicing rights and carries an option to repurchase these government-insured loans in the event they become eligible for redelivery into Ginnie Mae securities. This quarter, we increased meaningful the number of partnerships we have with these third parties and also expanded the volumes of sales to our existing partners, driving the quarterly increase in the EBO loan volume I mentioned earlier.

Finally, transactions like these provide meaningful savings to PennyMac Financial over the life of the loan while providing the opportunity for redelivery in the future.

I'll now turn it over to Dan, who will speak to the financial results for the quarter.

[Daniel Perotti, executive]

Thanks, Doug. As David mentioned earlier, PFSI's net income was $204.2 million or diluted earnings per share of $2.94. I will cover each segment's results and then briefly review our forbearance and servicing advance trends.

Production segment pretax income was $244.4 million, down 33% from the prior quarter and 55% from the second quarter of 2020. As you will see on Slide 10, 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 earlier.

As you can see on Slide 10 of the presentation, consumer and broker direct represented 23% of fallout-adjusted lock volume in the second quarter but accounted for approximately 70% of segment pretax income.

Production revenue margins declined from the prior quarter and revenue per fallout-adjusted lock for PFSI's own account was 154 basis points in the second quarter, down from 176 basis points in the first quarter of 2021.

Our costs vary by channel, ranging from approximately 15 basis points in correspondent to 150 basis points in consumer direct. And 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 $30.9 million, down from pretax income of $141.7 million in the prior quarter and up from a pretax loss of $62.4 million in the second quarter of 2020. Pretax income, excluding valuation-related items for the servicing segment, was $174.4 million, down 33% from the prior quarter and up 101% from the second quarter of 2020. The decrease from the prior quarter was primarily driven by a $76 million decrease in EBO loan-related revenue.

Operating revenue decreased $2 million from the prior quarter driven by declines in earnings on custodial balances. Operating expenses were also down quarter-over-quarter as the prior quarter included seasonal accruals of compensation-related expenses. Payoff-related expenses, which include interest shortfall and recording and release fees related to prepayments, remained elevated but decreased slightly 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 decreased by $251 million in the second quarter and included $196 million in fair value losses as a result of higher expectations for prepayment activity in the future driven by lower mortgage rates and a flatter yield curve, as well as an additional $55 million in other valuation declines. These valuation declines were primarily driven by significant levels of prepayment activity and early buyouts. Hedging and related gains totaled $91 million.

Our investment management segment delivered pretax income of $4.1 million, up from $1.4 million in the prior quarter as a result of incentive fees earned and down from $4.7 million in the second quarter of 2020.

Net assets under management totaled $2.3 billion as of June 30, down slightly from March 31 and up 5% from June 30, 2020. Segment revenue was $13.5 million, up 41% from the first quarter and 28% from June 30, 2020.

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 4.9% at June 30 from 6.3% at March 31, as borrowers in forbearance plans at March 31 who have since exited more than offset new forbearance plans. Servicing advances outstanding decreased to approximately $424 million at June 30 from $437 million at March 31. Advances are expected to increase over the next few quarters as many property tax payments become due toward the end of the calendar year. No P&I advances are outstanding 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. PennyMac Financial delivered another outstanding quarter of operational and financial performance, despite the increased volatility in the mortgage market. Our higher-margin consumer direct lending channel continued to expand, producing record locked and funded volumes during the quarter, which we estimate has resulted in a significant increase in market share.

Strong production volumes across all 3 channels continue to drive the growth of our servicing portfolio despite the elevated level of prepayments. Our balanced business model is a key strategic advantage for PFSI, which has consistently delivered outstanding returns across different environments, producing a 33% return on equity for the first half of 2021.

We also remain very active repurchasing shares driven by our medium-term expectations for PFSI's return on equity. 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 second quarter earnings discussion. For any questions, please visit our website at ir.pennymacfinancial.com or call our Investor Relations department at [phone]. Thank you.