PennyMac Financial Services Inc

NYSE:PFSI

Earnings Call Transcript 2022-Q4

[Isaac Garden, Vice President, Investor Relations]

Good afternoon, and welcome to the Fourth Quarter and Full Year 2022 Earnings Discussion for PennyMac Financial Services, Inc. The slides that accompany this discussion are available on PennyMac Financial's website at pfsi.pennymac.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.

Now I'd like to begin by introducing David Spector, PennyMac Financial's Chairman and Chief Executive Officer who will review the Company's fourth quarter and full-year 2022 results.

[David Spector, Chairman & Chief Executive Officer]

Thank you, Isaac. In the fourth quarter, PennyMac Financial delivered net income of $38 million, or $0.71 in earnings per share. These results include a non-recurring tax rate change which negatively impacted earnings per share by $0.22. Dan Perotti, PFSI's Senior Managing Director and Chief Financial Officer will provide greater detail later on in this discussion. For the full year, PFSI achieved a return on equity of 14%, driving continued growth in book value per share, which ended 2022 at $69.44.

Our servicing portfolio ended the year at $552 billion in unpaid principal balance as additions from loan production continued to exceed prepayment activity. The growth of our servicing portfolio continues to differentiate PFSI from its competition, serving as an increasingly important asset, which I will discuss later on.

We remained active in stock buybacks and in the fourth quarter we repurchased 1.1 million shares of PFSI common stock at an average price of $46.99 for an approximate cost of $51 million. Repurchase levels were down meaningfully from the third quarter as we prefer to maintain flexibility to address potential risks and opportunities in the evolving market environment.

In PFSI's Investment Management segment, net assets under management were $2 billion at quarter end, down slightly from the prior quarter due to PMT's financial performance.

PFSI's Board of Directors also declared a fourth quarter cash dividend of $0.20 per share. While 2022 was a challenging year for the mortgage industry due to the rapid and significant increase in interest rates, our operating discipline combined with the meaningful actions we took throughout the year to right-size our business for a smaller origination market, led to strong financial performance.

In fact, for the full year PFSI produced net income of $476 million, which drove book value per share up 16% from year end 2021. Though profitability was down from last year, our strong financial performance enabled us to continue returning capital to shareholders while simultaneously positioning the company for success in the future. To that end, for the full year 2022, we returned over $460 million to stockholders through stock repurchases and dividends, and opportunistically raised $500 million in five-year term notes secured by Ginnie Mae MSRs at attractive rates.

Total production, including acquisitions made by PMT, was $109 billion in UPB. This led to servicing portfolio growth of 8% for the year to more than $550 billion in UPB with nearly 2.3 million customers. With mortgage interest rates currently still above 6%, the most recent third-party forecasts for 2023 originations range from $1.6 trillion to $1.9 trillion, down meaningfully from 2022. While many industry participants have taken the appropriate steps to reduce capacity, it has been happening slowly and we believe overcapacity still remains. As we have demonstrated with our 2022 performance, we believe mortgage banking companies with large servicing portfolios and diversified business models like PennyMac Financial are better positioned to offset the decline in origination profitability that has resulted from lower volumes.

As a key part of our balanced business model, our large and growing servicing portfolio provides significant value to the company. Servicing and sub-servicing revenues, the majority of which are cash, totaled more than $1.2 billion in 2022. Additionally, higher short-term rates have driven strong earnings on custodial balances.

Our proprietary servicing technology provides us with significant operational scale and workflow efficiencies that enable us to adapt quickly to forthcoming market conditions and regulations while also providing quality service to our customers. Finally, given the scale we have achieved, we have begun offering our customers, homeowners and title insurance through joint ventures, which we expect will provide recurring fee income over time as the businesses grow.

As I briefly mentioned earlier, our servicing portfolio growth can be attributed to the large volume of loans we produce every quarter, as we retain the MSRs on nearly all of our mortgage loan production. On Slide 7 of our earnings presentation, you can see PennyMac’s total production over the most recent three quarters against average mortgage rates. Even as interest rates increased, the UPB of our production volume on a quarterly basis consistently represented 4% to 5% of the total servicing portfolio balance.

As we continue to add significant volumes of servicing to our portfolio at current market rates, we will continue to build significant refinance opportunities in the future for our consumer direct division if mortgage rates decline.

Again, we implemented meaningful expense savings and capacity reductions early and throughout 2022 given the anticipated significant decline in the overall market, and we took additional actions in the fourth quarter. Quarterly operating expenses in the fourth quarter were down 44% from average 2021 levels. While we believe the majority of expense management activities have been completed, we remain disciplined, continuing to rapidly adjust capacity levels relative to the size of the origination market, whether growing or contracting.

While PennyMac Financial is not insulated from the challenges presented by today’s mortgage market, I believe we are the best-positioned in the industry to continue executing with our balanced business model in 2023. Our multi-channel approach to mortgage production provides the flexibility to adapt to different market conditions and drives organic growth of our servicing portfolio. Our servicing business provides ongoing cash flow to support business operations and produces low cost leads to our consumer direct business in the future.

We have a long history of successfully developing and deploying innovative mortgage technology, which has resulted in an extremely flexible and scalable platform as evidenced by our ability to rapidly right-size our cost structure.

Finally, I believe this management team is the best in the industry and I’d like to thank them all for their various contributions to PFSI’s strong performance in 2022. More than 15 years ago we founded PennyMac with an unwavering focus on enterprise risk management and doing the right thing for our customers. Since then, we have become one of the largest mortgage producers and servicers in the country, while also providing strong returns to our stakeholders. So while PFSI’s ROE is projected to trend towards its pre-COVID range during 2023, I remain confident in our ability to continue delivering strong financial performance as the market returns to more normalized conditions over time.

Now I’ll turn it over to Doug Jones, PennyMac’s President and Chief Mortgage Banking Officer, who will review our market share trends and fourth quarter mortgage banking results.

[Doug Jones, President]

Thanks, David. Overall production was solid in the fourth quarter with total production volumes down only 12% from the prior quarter, while industry volumes were down 34%, according to Inside Mortgage Finance. PennyMac widened its leadership position in correspondent lending as our strong capital position and consistent commitment to the channel provides our partners with the stability and support they need to successfully navigate the challenging mortgage market. We estimate that over the past 12 months we represented approximately 15% of the channel overall.

Total correspondent loan acquisition volume in the fourth quarter was $20.8 billion. 51% were conventional loans and 49% were government-insured or guaranteed loans. Purchase loans accounted for 93% of total correspondent acquisitions during the quarter. Acquisitions for PFSI’s own account totaled $14 billion, up 15% from the prior quarter due to the acquisition of certain conventional loans from PMT in addition to government loans during the quarter.

Conventional acquisitions for PMT’s account totaled $6.8 billion, down from $10.2 billion in the prior quarter, as a result of the previously mentioned sales to PFSI. Similarly, correspondent lock volume for PFSI’s account was up 25% from the prior quarter. Revenue per fallout-adjusted lock in the fourth quarter was 21 basis points, down from 24 basis points in the prior quarter, driven primarily by PFSI’s purchase of lower margin conventional loans from PMT.

While we respected Wells Fargo as a competitor in the correspondent channel, we believe their exit from the channel creates additional opportunities for PennyMac, particularly in the community bank and credit union sector of the market where they previously had a strong presence. 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 efficiently through the volatile market environment, even as other participants have exited or retreated from the channel.

We stand ready and able to absorb the volumes left by Wells Fargo’s exit and remain committed to being a strong capital partner for independent mortgage companies throughout the country. In January, we estimate that correspondent acquisitions totaled $6.8 billion and locks totaled $6.1 billion.

Turning to consumer direct, we estimate we accounted for approximately 1.2% of total originations in the channel over the last 12 months. Origination volumes for the fourth quarter were $1.1 billion and interest rate lock commitments were $1.7 billion, down meaningfully from last quarter due to seasonal impacts and declining refinance volumes. Purchase lock volume for the quarter of $681 million was 40% of total locks, compared to $1.37 billion, or 36% in the prior quarter.

Margins in this channel were down slightly with revenue per fallout adjusted lock of 358 basis points versus 366 basis points in the third quarter. We estimate originations in our consumer direct channel in January totaled $300 million, and locks totaled $700 million. We estimate the committed pipeline at January 31st was $700 million. Originations in our broker direct channel totaled $1.1 billion and locks totaled $2 billion, also down meaningfully from the prior quarter, reflecting a smaller market, seasonal impacts and the continuation of intense competition from channel leaders. Purchase loans were 85% of total originations. Revenue per fallout-adjusted lock was 56 basis points, down from 70 basis points in the prior quarter, although we have seen margins in this channel improve thus far in the first quarter. We estimate that in 2022 we represented approximately 2% of the origination volume in the channel.

Despite elevated levels of competition currently, we believe PennyMac is well-positioned for market share growth in the channel over time given our strong capital position, operational excellence and the exit of channel participants. Last quarter, we completed the roll out of POWER+, our next generation technology platform providing brokers with the tools they need to successfully grow their businesses and convert leads into loans. Thus far, we have received very positive feedback on the new portal, garnering the attention of top brokers in the channel who are looking to expand their relationship with PennyMac.

We estimate broker originations in January totaled $500 million and locks totaled $800 million. We estimate the committed pipeline at January 31st was $800 million.

As David discussed earlier, these acquisition and origination volumes continue to drive the organic growth of our servicing portfolio. I am pleased to report that we ended the quarter with a servicing portfolio of $552 billion, or approximately 4.1% of all residential mortgage debt in the U.S.

Prepayment speeds have slowed meaningfully given higher mortgage rates. PennyMac Financial’s owned servicing portfolio reported a prepayment speed of 5.4% in the fourth quarter, down from 9% in the prior quarter. Similarly, prepayment speeds in PennyMac Financial’s sub‐serviced portfolio, which includes mostly Fannie Mae and Freddie Mac mortgage servicing rights owned by PMT were 4.4%, down from 6.9% in the prior quarter.

PFSI’s owned servicing portfolio, which consists primarily of Ginnie Mae MSRs, had a 60-day plus delinquency rate of 3.8%, up from 3.5% at the end of the prior quarter, while our subserviced portfolio, consisting primarily of conventional loans, reported a 60-day plus delinquency rate of 0.6%, up from 0.5% at September 30th.

The UPB of completed modifications was $2.3 billion, down slightly from the prior quarter while EBO loan volumes remained low. We expect EBO revenues to remain low in the coming quarters as lower overall volumes and redelivery gains are expected to be limited due to the higher interest rate environment.

I’ll now turn it over to Dan who will review PFSI’s financial results for the quarter.

[Dan Perotti]

Thanks, Doug. As David mentioned earlier PFSI’s net income was $38 million or diluted earnings per share of $0.71. The fourth quarter included non-recurring tax items, which resulted in an effective tax rate of 44.4% versus 27.1% in the prior quarter. The increase in the effective tax rate was primarily driven by an increase in the provision tax rate, which increased from 26.5% to 26.85% for 2022. The increase in tax rate resulted in the repricing of PFSI’s net deferred tax liability, which was the primary driver of a non-recurring tax expense of approximately $11.9 million in the quarter. The impact of this tax rate change was negative $0.22 in earnings per share.

Production segment pretax income was negative $9 million. As you will see on Slide 12, 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 the conventional correspondent loans it retains.

Production revenue margins were lower across all three channels. Revenue per fallout-adjusted lock for PFSI’s own account was 55 basis points in the fourth quarter, down from 99 basis points in the prior quarter driven by lower volumes in Consumer Direct and lower overall margins. This includes $24 million in gains realized related to the timing of revenue and loan origination expense recognition, hedging, pricing & execution changes, and other items.

As David mentioned earlier, we remain focused on managing expenses in the current market environment, and although fallout adjusted locks were up 11% from the prior quarter, production expenses net of loan origination expense were down 13%. The Servicing segment recorded pretax income of $76 million, down from pretax income of $145 million in the prior quarter and $126 million in the fourth quarter of 2021.

Pretax income excluding valuation-related items for the servicing segment was $79 million, up from the prior quarter as higher realization of MSR cash flows, interest expense, and lower EBO-related income was more than offset by higher loan servicing revenue, higher earnings on custodial balances and deposits, and lower operating expenses.

Operating revenues increased from the prior quarter as loan servicing fees grew by $9 million primarily due to growth in our servicing portfolio. Earnings on custodial balances and deposits and other income increased $17 million. With rates at current levels, we expect a continued meaningful contribution to overall servicing profitability. Operating expenses as a percentage of average servicing portfolio UPB decreased.

Payoff-related expenses, which include interest shortfall and recording and release fees related to prepayments, decreased by $1 million. Realization of MSR cash flows increased by $7 million driven by higher average MSR values during the quarter. In order to protect the value of our MSR asset we utilize a comprehensive hedging strategy. This 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 16, you can see the fair value of our MSR increased by $83 million in the fourth quarter, driven by lower than expected realized prepayment speeds as well as expectations for lower prepayment activity in the future. Hedging losses totaled $73 million, primarily driven by hedge costs and higher interest rates.

While overall delinquency rates increased from the prior quarter, they remain consistent with our expectations for a primarily government-insured or guaranteed portfolio. Servicing advances outstanding for PFSI’s MSR portfolio increased to $520 million at year end from $397 million at September 30th due to seasonal property tax payments. No principal and interest advances are currently outstanding, as prepayment activity continues to sufficiently cover remittance obligations.

Regarding the $650 million of Ginnie Mae MSR term notes originally due February 2023, we exercised our option to extend the maturity for 2 years. Importantly, the $650 million of Ginnie Mae MSR term notes due in August 2023 also contain an optional extension at PFSI’s discretion.

Finally, our Investment Management segment delivered pretax income of $1.2 million, down from $1.6 million in the prior quarter. Net assets under management totaled $2 billion as of December 31st, down 3% from September 30th. Segment revenue was $9.9 million, down 4% from the prior quarter.

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

[David Spector, Chairman & Chief Executive Officer]

Thank you, Dan. More than 15 years ago, we founded PennyMac with a vision to help revitalize the mortgage market and become a trusted partner in home ownership. Since then, we have grown responsibly and profitably into one of the largest residential mortgage producers and servicers in the country with an industry-leading correspondent production business, and a growing presence in the direct lending channels.

Though 2023 is expected to be another challenging year for the mortgage industry, I remain confident in PennyMac Financial’s ability to continue executing given its balanced business model and long history of generating stockholder value through different mortgage market cycles and environments.

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

[Operator]

This concludes PennyMac Financial Services, Inc.’s fourth quarter earnings discussion. For any questions, please visit our website at pfsi.pennymac.com, or call our Investor Relations department at 818‐264‐4907. Thank you.