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PennyMac Mortgage Investment Trust (NYSE:PMT)

Credit Suisse Financial Services Forum

February 13, 2013 13:45 PM ET

Executives

Stan Kurland – Chairman and Chief Executive Officer

David Spector – President and Chief Operating Officer

Stan Kurland

See a lot of faces, I recognize over the last couple of days.

Unidentified Company Representative

As we go to learn more for the future days and as well as talking to…

Stan Kurland

We – how many times you want to do the presentation?

Unidentified Company Representative

Sometimes that’s not clear, that it doesn’t clear up.

Stan Kurland

All right, we’ll try to ask and keep it clear. We are a – PMT is an externally managed REIT. We had our start in – with distressed mortgage loans. Our initial activities was the acquisition of distressed mortgages primarily those offered by banks and we put together activities in the – that are managed by our manager PNMAC, the servicing and the origination activities that were essential to the passing and enhancement of the value of distressed mortgages.

As we built out our capabilities, we moved further into the mortgage market into the area of mortgage aggregation or the – what’s known in the mortgage industry as correspondent lending. So, we offered two correspondents that we had to approve the ability to sell their loans to us and we would capture the origination gain on conventional mortgages, as well as the mortgage servicing rights as a long-term investment and that activity is a very significant part of the company’s activities today in addition to the distressed market. We are also looking forward to the revitalization of the private-label securitization market, which is – results in an asset that is also very attractive to mortgage on real estate investment trust is the subordinate pieces of a jumbo securitization.

And so our correspondent channel, which has relationships with some 140 different mortgage companies also has begun just this last week has rolled out a new program that offers jumbo loan financing as well. Our initial rollout has been very well accepted by our correspondents and we look at that to be a growing part of the businesses that the investment opportunities that we have.

The other opportunity that we hope to participate in the mortgage market is the acquisition of purchased mortgage servicing rights which would be mortgage servicing rights put on to market by large servicers, primarily banks who are looking to reduce their interest in servicing rights as a function of restrictions or capital restrictions under Basel III.

So that is the kind of general direction of the REIT is focusing on the coordination of investing in residential related assets that require certain levels of expertise that our manager and fulfillment provider PLS provide the company. So in that sense, a very unique hybrid REIT that offers access to investments that are not readily available in the market other than you have these activities held within or these investments in banks or sometimes in mortgage-backed securities or REITs, but here we have a multi-faceted view of what are the assets that we have the potential to invest in.

That’s the head of investing side of our activities and we wanted to take time to explain the business and the general activities as opposed to take you through the presentation one more time, but…

Question-and-Answer Session

Unidentified Analyst

And so would you, so here – initially the focusing for business lines, would you be interested in buying the portfolio of mortgage servicing assets of Bank of America?

Stan Kurland

Yes, we would. The Bank of America has sold servicing in the market most recently and it is, what we understand, it looks to continue to sell mortgage servicing rights and we hope to participate in that activity as well.

Unidentified Analyst

So you will be competing with the next several or (inaudible) or whatever?

Stan Kurland

They would be likely participants, whether they – we have – one of the advantages that we have is that we are a Fannie Freddie Ginnie servicer. And so, there is less competition actually around Ginnie Mae servicing than there is around Fannie Freddie. We are unlikely to be a competitive bidder for non-agency type servicing.

Unidentified Analyst

Okay. Thank you. Just on that MSR side, can you talk about the – kind of your relationship with the GSEs and sort of what the approval process would be like for a large or small portfolio of MSRs?

Stan Kurland

Well, we have very good relationship with the GSEs, obviously running a correspondent you have to have licenses with Fannie Mae, Freddie Mac and Ginnie Mae. PMT is licensed as an approved seller servicer with Fannie Mae and Freddie Mac with PLS serving as a sub-servicer within that relationship. Over the last few years, we have worked to establish a similar relationship with Ginnie Mae and I just don’t – I don’t see Ginnie Mae quite getting there. PLS has a Ginnie Mae seller servicer license which allows us to run the full service correspondent that we do run to be able to buy conventional loans and government loans and that’s why PLS is the securitizer for the government loans. Having said that, and we worked and I worked tirelessly with Ginnie Mae on this issue, as I said there are a few stumbling blocks us in the requirement to have dedicated employees and separate dedicated facilities which just doesn’t works very well with the externally managed REIT. But having said that, we work with Ginnie Mae to begin the process to create a synthetic structure where PMT could potentially get the investment in what we call the Excess IO in the form of a strip and we are working right now with Ginnie Mae and it banks to help provide financing for that as well. So, the relationships, Doug are good, they are strong, I think that on a servicing transfer, because of the relationships we’ve built in the correspondent with Fannie Mae and Freddie Mac will position nicely to be able to compete with the other sellers.

Unidentified Analyst

And I guess a final view; try the sensitive paper versus newer production paper, would you be interested in buying MSRs on either?

Stan Kurland

So, with regard to agency MSRs, you have some that are totally clean packages. Obviously those are packages that are highly desirable, competitively sought after and we actually through our correspondent activity create new prime quality mortgage servicing rights for the – that are GSE servicing. We do view that the banks have put servicing on the market for sale or have a combination of good and problem servicing. We think we are a good takeout for that because we are very well regarded for our specialty servicing activities as that was the method that we started out. PennyMac was first as a specialty servicer in distressed mortgages. So we have very sophisticated and well-positioned specialty activities and so we would – we think that positions us well to compete for portfolios. It’s a very – portfolios are somewhat lumpy in terms of how they are presented in the market. It’s not like there is a constant flow of large packages.

Unidentified Analyst

How do you think about the returns that you can generate on an MSR package and how does that compare to the other sources or uses of your capital?

David Spector

So, in mortgage servicing rights, generally a package or servicing on hedged would produce yields of anywhere from 9% to 12%. And leveraged obviously get here moving up to the high teens in terms of the return. Some mortgage servicing packages have refinancable activity embedded and that’s often the target of the portfolio is to be able to engage in HARP refinance or streamline refinances and that generally would push the return levels up into the – we think the mid-20s and if your recapture rates are very high, even further up. So that’s generally how people look at mortgage servicing packages today.

Unidentified Analyst

And just like a shifting to the correspondent business, can you talk about the current competitive dynamics in that business?

Stan Kurland

So the – we are, in our short history the – on the lead table, the fifth largest correspondent lender with a huge gap between us and the major banks that hold the four top spots. There are very few non-bank aggregators of mortgage servicing rights and so the – that’s something there are lots of new competition there maybe banks that as they become comfortable with mortgage lending and the servicing asset that may look to reenter the market. But generally it’s – there has been a lack of or reducing concentration on the aggregation activities or correspondent activities. Today the market I would say from over the last year is probably about 20% smaller as we start 2013 and it was at the beginning of 2012. So the dynamics of the market is that there is less activity. Now that activity is sensitive to interest rates, the level of refinancing as well as the level of purchase activity. So that makes the dynamics of mortgage margins, particularly at the retail level, now we operate at the correspondent level way up the chain, but it does have an impact on overall margins. And I think that we are seeing margin pressures, be it the surface at the retail level, we have operated at very wide margins in correspondent and I think that those margins will normalize over the course of the year that may end up being margins coming in anywhere from 10 to as much as 20 basis points from the way that we see it.

Unidentified Analyst

Just talk about what are pressures on, is it the decline in volumes that is causing those get some pressures or what are those dynamics that are…

Stan Kurland

I think the market itself has been capacity constrained and so, retail originators have operated at very wide margins and warehouse capacity for example for originators was also constrained. The participants mortgage expertise in processing and then underwriting of mortgages was also very limited and you combine those facts with a over alarming desire to refinance and government programs and HARP, the capacity to service consumer needs was constrained and that resulted in very wide margins in the industry and as the industry has added capacity and warehouse capacity for lenders has increased, as well as that the declining volume of loans that can be refinanced has declined because either the loan has been refinanced or we’ve actually had a back up in interest rates, which has reduced some of the loans eligible for refinancing.

Those things have reduced the supply dynamics and I think that’s having at the retail level, the result is greater level of competition for the remaining loans, greater supply of loan origination capacity. When it gets to the correspondent side, obviously the correspondents that exist in the business are competing for a smaller volume of loans and that puts pressure on the margins at the correspondent side. It also however, more from the optimistic perspective is that as pricing for mortgages becomes more competitive, we believe that the volume of sellers that choose a correspondent path to sell their mortgages will actually increase proportionally because the investment in the underlying servicing rights has gone up as they become more competitive and with their price and there are many originators that just don’t have the financial wherewithal or capacity or desire to invest in the servicing asset where their margins have been constrained. And so we think that speaks well for correspondent activity actually gaining in proportion to the market.

Unidentified Analyst

Is that one of the reasons behind kind of your expectations that you can grow your monthly volumes from $3 billion to $4 billion over the course of the next – over the course of this year?

David Spector

We have a couple of activities that we are working on for expanding our market share. One we talked about is the jumbo mortgage activity which is the brand new subset of mortgage activity to pursue. We also recently rolled out DA mortgages to our correspondents as another incremental volume in the market as well as LP, AUS mortgages prior to just a few weeks ago we would only do DU which is the Fannie Mae’s underwriting engine would only do DU, so that excluded a portion of the business that actually went through Freddie Mac’s automated underwriting system which is called the LP. And so those things are examples of product changes that will lead to higher levels of activity for us. The other is that we are still fairly new operation and we have a sales force that pursues mortgage lenders across the country. We have about 140 approved correspondents and our general objective is to increase that to 200 correspondents by the middle of this year. So, those activities should result in our gaining position in share and continuing to increase our volume.

Unidentified Analyst

What’s the impact with the big banks getting out of that?

Stan Kurland

So, what – the question is, what’s the impact the big banks getting out of the correspondent business? For us, initially it was very dramatic if you see the kind of growth charts of our correspondent activity as the banks were backing away and primarily the BOA announcing they had announced their reduction along with several others even Wells Fargo had certain reductions in their correspondent activity and we quickly gained share by presenting an alternative. We are a very attractive correspondent for community banks, because we are not a bank and that’s another area that we’ve just hired account executives that specialize in dealing with community banks. And the reason that community banks are so interesting is that they would like to resist selling their loans or their customers to other banks because they pursue their bank products and present competition whereas we present really no threat to them from that perspective. So that’s another avenue of business and customers that were just starting to go after to produce added volume.

Unidentified Analyst

Just on the jumbo correspondent, is that’s something where you are looking to execute a sale of those loans or would you look to aggregate that for securitization?

Stan Kurland

So we look aggregate for securitization, it would be – within their REIT, a qualified REIT asset and the economics of that would really show up as a spread income, net interest income on the securitization.

Unidentified Analyst

Transitioning to the investment activities, can you talk about the dynamic, sort of the pipeline of activity out there for whole loan either re-performing or non-performing loans today?

Stan Kurland

So, our base or initial start was in the area of distressed mortgage loans and that’s been over the course of our history very lumpy business where there are sellers that enter in with big packages and then they are out to the market for several months or quarters and we would – I think as we originally went into distressed we would have thought we would have reached the end of distress by this point. But I think this is going to be one of the largest years of where distress is being offered out of the banking system that looks to cleanse its balance sheet of distress mortgages and we are seeing – we’ve seen a high volume of packages come to market late January or early February. I think it’s – at least as it’s starting out this year, it seems like it’s going to be multiples of what the volumes that were offered in the prior year.

Unidentified Analyst

There has also been some recent speculation that the GSEs could begin selling NPLs, I guess, do you have any thoughts on that, whether that offers a real another opportunity set?

Stan Kurland

Sure, any additional sale of non-performing loans is a good opportunity for PMT. We’ve seen sales at – we saw good sales last year. There is another two groups of loans that are going to be sold. They are typically lower balance and the absolute contingencies around them that we will be looking at. We are on top of the GSEs in terms of this non-performing loan sale. I think there – if there is going to be a sale we will definitely be looking at it, I think given our position in the distressed loan market and given our position with our relationships with the GSEs, we will be actively involved if there is such a sale.

Unidentified Analyst

And could you talk about, I guess maybe obviously non-agency securities markets that moved quite substantially during 2012 and even into 2013? Can you talk about how the whole loan markets, what types of yields those markets have seen? Whatever compression you’ve seen over the past year and what type of yields you have available to you today?

Stan Kurland

So, is – you are talking about non-performing loans?

Unidentified Analyst

Yeah, non-performing, either non-performing and re-performing.

Stan Kurland

I think we’ve seen – we definitely have seen some real compression over the last year. I think you can be talking about mid-teen returns to lower than that. But I think in the case of PMT, we are quite fortunate as we’ve also because, and when you look at the non-performing loan facilities that we have, we’ve seen an increase in the advance rates that come along with those facilities. So while unlevered deals have come down, the levered deals have remained relatively in the same range. I think that – we are seeing – what we are seeing as Stan pointed out, more packages that are going to be coming out. I think that there is a differentiation among sellers when you are looking at these packages, then there is differentiation amongst the products that go into these and where we are today originating from. And so I think there is – it’s just – as we move now into our fifth year. we have a good understanding of who the sellers are and what the product is and as I said, while deals have come down having the facilities, the financing facilities helps us to return the same levered returns.

Unidentified Analyst

Could you just talk about that financing, is that sort of term committed financing or is it more sort of warehouse line?

David Spector

So the facilities we have are very much into warehouse – to warehouse lines, the 364 day facilities. We have – they are offered by more than a few banks. We have two such facilities and we’ve had them now for almost three years and they are – we use them often. We know we – understand how they operate and we just – they are good given, and we feel comfortable with the facilities given the short average life of the investment itself and when you look at it versus securitization and we’ve seen a good number of non-performing loan securitizations. It’s just was non-performing loan securitizations just look a lot more expensive and appear lot more expensive and the trade-off doesn’t just appear worth that trust and so we use the facilities to get the leverage.

Unidentified Analyst

And then just sort of big picture, can you just talk about, sort of where you sit? How you kind of view housing? What kind of assumptions you are now making when you are buying these pools versus what you were making a year ago?

Stan Kurland

So the – it’s a good question and I think one of the significant changes that has taken place in the bidding of distressed mortgage pools were initially we would – where housing values were projected to continue to decline, we bid consistently to what we call the trough of the market where we thought the decline would trough out and that was usually within the period of time that we would be working and liquidating the portfolio.

Over the course of the last year and as housing prices has stabilized, we saw the kind of modelers or competitors move to a more stable market they bid housing prices to be flat. And most recently, we see it more aggressive where there is a build in HPA over the horizon of holding the portfolio which has generally been around 3% per annum increase and the value of home price is on national basis. And so that’s one kind of way that we look at a pool and as David mentioned, we see the returns declining to our model which really troughs out value.

So we don’t – so for looking at consistent models, we were projecting declines in bidding in the sort of towards the mid-teens and now as we trough the – as our models – at the trough and we bid the same packages our returns come out to be several percent lower. And however if you are building in HPA that are actually haven’t changed that much and we are at a little bit of discomfort of how much of home price appreciation is really worthy of building into the model. But that is the most significant change that has taken place in distressed pool modeling.

Unidentified Analyst

And just one sort of bigger picture for PMT, I guess as correspondent continues to grow, kind of what are the challenges for you to continue to be a REIT, is that your plan to continue to – for PMT to continue to be a REIT?

Stan Kurland

So we very much like the structure that we’ve created because in the – to be involved in mortgage finance as a non-bank, you need to have a pool of investible assets and the products that are produced through the mortgage process and the REIT is a very efficient mechanism for that because it passes through income without double taxation and has desired in – and that’s desirable for investors that are seeking dividend returns. Our activities, those activities that don’t really qualify for REIT are housed in our taxable REITs and we can manage the size of those activities to maintain REIT status and that is our desire to do that and we’ve seen over the course of our REIT the actual expansion of capability for example to hold mortgage servicing rights, it’s fairly new for a REIT and that’s been a great expansion of capability.

Unidentified Analyst

Great. If anyone, open it up to the audience to see if anyone has any questions.

Unidentified Analyst

Yeah, increases in your monthly borrowings, because of the level for this activity to be LTEs, is there any difference in your margins?

Stan Kurland

We are basically looking at our kind of return targets and we are evaluating what’s taking place in the competitive landscape and that the competitive landscape more or less dictates what are the levels of margins that we can achieve, sort of over our margin force. And it certainly helps to have product that is scarce in the market place and so, it is helpful for us to have, for example, jumbo mortgage activity and that relationship that we have with the correspondents and that they can look to us as an enterprise that they can deliver all of their products is one that enhances not only the relationship, but the levels that which they all sell and look to make sure that they are retaining their relationship with us. So, sort of an all in kind of package of activities that we are providing which I believe enhances our opportunity to produce margin on the origination of – or acquisition of the loan.

Unidentified Analyst

Any other questions? All right, please join in thanking the PMT management team.

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