PennyMac Mortgage Investment Trust Q4 2009 Earnings Call Transcript

| About: PennyMac Mortgage (PMT)

PennyMac Mortgage Investment Trust (NYSE:PMT)

Q4 2009 Earnings Call

February 2, 2010 8:30 am ET


Stanford L. Kurland - Chairman of the Board of Trustees, Chief Executive Officer

David A. Spector - President, Chief Operating Officer, Trustee

Anne D. McCallion - Chief Financial Officer


Presenting to you today will be Stan Kurland, Chairman and CEO of PennyMac. Also joining Mr. Kurland are David Spector, PMT's President and Chief Operating Officer who will present an overview of the markets, and Anne McCallion, PMT's Chief Financial Officer, who will present PMT's financial results.

Stanford L. Kurland

Welcome. Before we begin, please take a moment to review the important disclosure on Slide 1 regarding the forward looking statements. Slide 2 summarizes many of our accomplishments for the quarter. During the quarter we won bids on two portfolios totalling $140 million in unpaid principle balances. We have completed closing one of the portfolios and anticipate closing the second in the coming weeks, although we cannot guarantee that this transaction will close. We also added $24 million in short-term mortgage-backed securities to the balance sheet.

Our manager has also remained very active, reviewing residential whole-loan portfolios totalling over $7.4 billion in unpaid principle balances and submitting bids on $6.2 billion of loans that had been evaluated.

In addition, our manager has worked to expand our ability to source and monetize assets through a variety of channels and has made significant progress on several initiatives that will significantly expand PMT's ability to adapt to the changing dynamics of the mortgage market.

We provided an initial overview of the first initiative in our presentation of the third quarter results. That initiative is the build out of a conduit platform that will allow PMT to purchase newly originated loans from small mortgage lenders and repackage those loans for securitization and sale.

Our manager is also working to establish partnerships that will facilitate participation and securitization activities. Finally, our manager has begun to actively pursue opportunities to acquire troubled mortgage assets that result from distressed condominium development projects.

During the startup phase of our investment activities, operating costs exceeded interest income which resulted in a net loss of $1.15 million or $0.07 per share. Slide 3 is a brief review of PMT's structure and investment thesis. We are a very new enterprise with significant resources devoted to investing prudently. In today's presentation we want to provide our shareholders with a clearer understanding of the markets, our business initiatives, and investment potential.

PennyMac Mortgage Investment Trust commenced operations on August 4th 2009. We are an externally managed REIT, meaning that PMT enjoys the benefit of an established and robust team focused on disciplined and prudent investment in mortgage-related assets.

Our objective is to provide attractive risk-adjusted returns to our investors over the long term, primarily through dividend, and secondarily through capital appreciation. We strive to achieve this objective by investing in mortgage related assets acquired through several channels. A substantial portion of these assets may be distressed and acquired at discounts to their unpaid principle balances.

Our primary focus is on investments in portfolios of troubled residential whole-loan mortgages that may be comprised of performing and of nonperforming loans. We seek to generate returns through collection of interest, enhancement, repackaging, and monetization activities.

With regard to performing loans, value enhancement is primarily achieved through effective high-touch servicing and our ability to implement long-term sustainable loan modification and restructuring programs that keep borrowers in their homes. As for nonperforming assets, we make every effort to implement sustainable loan modification and restructuring programs where financially feasible. However, the core economic value in these cases revolves around our ability to affect property resolution in a timely, orderly, and economically efficient manner.

Slide 4 illustrates how PMT fits into the overall PennyMac structure. As an externally managed REIT, PMT is a primary investment vehicle and benefits from the capabilities of the companies within the PennyMac structure. This relationship gives PMT direct access to the management and operational capabilities of the PennyMac companies.

For the sake of clarification, in this presentation and in general we refer to the REIT exclusively as PMT. We use the PennyMac moniker to refer to the capabilities and activities of our investment manger and mortgage loan servicer. The PennyMac companies together comprise a specialty financial services firm dedicated to addressing the dislocation in the US mortgage market.

PennyMac's current focus is on investing in and managing troubled mortgage assets. The firm's long-term objective is to play an active role in the revitalization of the mortgage market by supporting improved liquidity for smaller lenders, creating opportunities for public investment, and raising the standards for underwriting and analytic discipline. PennyMac's core guiding principle is to create value for investors and consumers while preserving home ownership wherever financially feasible. PennyMac is committed to employing a disciplined analytic approach and the highest ethical standards in all of our activities.

PMT is externally by managed by PNMAC Capital Management or PCM, the blue section. PCM provides investment advisory services that are unique and essential to the residential mortgage asset arena. Specifically for PMT, PCM provides a capital markets function related to the acquisition and disposition of mortgage related assets including best in class analytics to support valuation and modeling activities, essential portfolio management capabilities, due diligence services for all PMT acquisitions, as well as secondary marketing and conduit operations.

PennyMac Loan Services or PLS, the grey section, is PMT's loan servicer. PLS provides primary and special servicing for PMT's portfolio of residential mortgage loans. In addition to basic servicing activities and loss mitigation, PLS offers origination capabilities that may be leveraged by PMT to conduct refinancing and to offer financing to facilitate short sales and sales of REO properties.

Slide 5 offers a brief overview of PMT's investment advisor. Our investment advisor's asset acquisitions and asset management capabilities enable PMT to fully engage in a broad spectrum of mortgage business activities. With regard to asset acquisition, PCM supplies PMT with staff solely responsible for sourcing investments and building institutional relationships with banks, investment banks, and government entities, a fully operational capital markets function that utilizes best in class valuation methodology and analytics, and due diligence expertise to provide thorough loan file review on all transactions.

These teams combined possess a proven track record in structuring and closing transactions and executing appropriate financing arrangements. PCM also provides unparalleled portfolio management capability. These capabilities are critical functions and are based in PCM's proprietary strategy platform called LENE. LENE stands for Loan Enhancement Normalization Engine. PCM uses LENE to analyze each loan and borrower situation and to match each borrower with the highest value loan modification restructuring program or property resolution alternative.

The PCM solution set includes a broad range of proprietary and government sponsored loan modification and restructuring programs that can be tailored to each borrower's circumstance and implemented to create long-term sustainable solutions for borrowers. This critical and detailed analysis is undertaken prior to loans being transferred. When a loan comes onto our servicing platform, our servicer can immediately initiate contact and begin offering solutions not only to delinquent borrowers, but also to borrowers who may be at risk of becoming delinquent in the future.

Finally of most importance to PMT investors, PCM is the cornerstone of PMT's asset monetization capability. PMT will benefit from PCM’s secondary marketing of restructured and reperforming loans to fully realize the value created through our loan enhancement activities. Also, PMT anticipates participating in earnings generated by PCM’s conduit activities, primarily focused on purchasing newly originated loans from small mortgage lenders and repackaging them for securitization and sale. The PCM conduit is in its final stages of implementation, and it is expected to execute its first acquisitions during this year.

Slide six offers an overview of PMT’s servicer. Our servicer, PLS, provides PMT with a comprehensive high-touch lending and servicing platform that allows us to fully implement portfolio strategies by PCM. PLS delivers primary and special servicing operations, as well as loan origination and fulfillment capabilities. PLS’s primary servicing operations include all activities of loan administration, call center and web-based customer service, and payment processing, as well as sophisticated investor accounting and loan-level reporting for whole loans and securitizations.

PLS’s special servicing operations include workout and loan resolutions support for troubled borrowers, implementation of HAMP and PennyMac modification programs as directed by our proprietary Portfolio Strategy function, and resources dedicated to property resolution employing a broad range of liquidation alternatives when necessary. PLS also offers a origination and fulfillment capability providing underwriting and closing of loan modifications, a centralized origination platform to facilitate refinancing of existing customers, buyer financing on Short Sales and REO properties, and consumer direct lending.

As part of PennyMac’s overall objective to play a meaningful role in the revitalization of the mortgage markets, PLS strives to be a trusted partner in the servicing arena and has obtained Freddie Mac and Fannie Mae approval as a Seller/Servicer, HUD approval as a lender, and is a registered HAMP participant.

We believe that PennyMac operating structure, which combines operational capabilities of PCM and PLS, along with access to capital provided by PMT, uniquely positions us to invest carefully and to participate in residential mortgage opportunities in a manner that benefits from well planned organizational activities and a dedicated and experienced management team. These are unique times for the economy and the housing market. We actively monitor and continuously evaluate environmental shifts and have designed our organization to remain flexible enough to react accordingly.

I have asked David Spector, our President and Chief Operating Officer, to share our perspective on the current state of the economy, housing, and mortgage market.

David A. Spector

Thank you, Stan. Looking at the charts on slide eight, we can see the following: Unemployment continues to weigh on the overall economy. In December, the unemployment remained at double digits at 10%, while 85,000 jobs were lost. The average worker remained unemployment for 29.1 weeks last month, which was the longest average length of unemployment since record keeping began in 1948. In addition, we are witnessing a developing trend of workers opting out of the labor force. Approximately 1.7 million Americans have opted out since July of 2009, representing a 1.1% decline. According to the Labor department, this is the largest six month decrease since 1961. Participation rate for the share of the population in the labor force has fallen below 65%, its lowest level since 1985. These figures support the rise in the volume of distress mortgages we have seen as borrowers struggle to keep pace with their financial obligations.

On a more positive note, disposable personal income in the U.S. savings rate is at 4.7%, remaining steady in November. Likewise, household financial obligations declined in the third quarter to the lowest rate since the first quarter of 2001, while consumption as a percentage of income remained at historically low levels. This data suggests that consumers may be managing their personal finances more effectively, which may support an optimistic outlook for the likely sustainability of mortgage modification and restructuring programs.

On slide nine we have a review of the current housing environment. For most of the second half of 2009, the housing market appeared to be on the path toward recovery, supported by government intervention. However, after three months of increases, sales of existing homes fell 16.7% in December, but remained above December 2008 levels. Much of the increase from 2008 to 2009 could be attributed to first time home buyers rushing to close sales before the original November 30 deadline for the first time home buyers tax credit. This credit has since been extended to April 30, 2010.

The median existing home sales price was also up slightly in December. This past week the S&P and Case-Shiller Home Price indices each posted slight monthly declines of 0.21% and 0.22% respectively for November — the first monthly decline after six consecutive periods of increases. Likewise in September, according to the S&P U.S. National Index, quarterly home prices posted a year-over-year decline of 8.8%, which represented the smallest year-over-year decline since the first quarter of 2008. Finally, the affordability index remained relatively steady November, compared to October — it declined approximately 0.1%, about 6.2% off of its record high in April 2009.

Turning to slide ten, we can see a snapshot of the current interest rate environment. Mortgage rates in the U.S. increased slightly in December, as 30-year fixed rates rose from 4.78% at the end of November to 5.14% at the end of December. Similarly, five-year ARM rates rose from 4.18% to 4.44%. Nonetheless, mortgage rates remained near record lows as the Federal Reserve continued its purchase program of MBS securities.

Looking forward, mortgage rates are expected to remain low. However, upward pressure may occur as the Federal Reserve looks to eliminate its program of purchasing residential MBSs at the end of the first quarter. End-year treasury notes rose in December, averaging 3.60% compared to an average of 3.34% in November.

Slide eleven is a review of recent FDIC activities. In December, the FDIC seized 16 banks with approximately $28.9 billion in total assets. These seizures brought the total number of failed banks in 2009 to 140, with combined total assets seized to $158.5 billion. This was the most since 1992. (Inaudible) September 30, the FDIC had placed 552 banks with $345.9 billion in assets on its problem list, a 33% (inaudible) from the previous quarter, as you can see from the number of announcements and other activities listed on this slide, obviously a time of change and considerable action for the FDIC. Our managers, business development team, and I have, and will, continue to work to maintain this important relationship as we pursue and develop investment opportunities.

Slide twelve is a review of how we see the mortgage market and our activities for the quarter. We continue to see attractive opportunities in the market. Recently, we have seen an increase in the volume of non-performing residential mortgage loans available for sale. In just the past three weeks, we have reviewed more than $1 billion in non-performing portfolios. We have, and will, continue to bid on these types of portfolios, recognizing that the value will be derived primarily from the speed and efficiency of liquidation.

We see, however, few performing mortgage transactions, which would offer greater opportunity for value enhancement. There has not been any significant volume, and the pools that have been marketed have traded levels that would deliver less than attractive ROEs.

We do expect the FDIC to market approximately $2 billion in residential mortgage whole loans during the first half of this year. During the fourth quarter, our investment advisor evaluated over $7.4 billion in UPB of whole loans, bid on $6.2 billion, and won two pools of whole loans with an unpaid principal balance of $140 million for PMT.

We also added approximately $24 million in short-term mortgage-backed Securities to the PMT balance sheet (inaudible) FDIC, banks, and GSEs continuing to own many trouble and non-performing loans. We are spending a lot of time dialoguing with many leaders in the industry. We are in Washington, D.C. and New York regularly, as well as visiting other potential strategic partners. Transactions take longer than they used to, but we continue to evaluate many unique opportunities.

With that, I will turn the presentation back over to Stan for a discussion of our investments and opportunities.

Stanford L. Kurland

Thank you, David. As you might perceive from David’s comments, the mortgage arena has undergone, and continues to undergo, very dramatic changes. One of the most significant shifts we have had to deal with is how and where we source attractive investment opportunities. Over the past several months, we have worked to evolve our investment pieces to include a broader array of investment opportunities.

Slide fourteen is a review of our initial asset focus. Our primary focus has always been on investing in troubled residential whole loans. Our definition of troubled mortgages includes performing and non-performing loans. The operations of our investment advisor and our servicer should generate returns for PMT through value enhancement and monetization of those assets. The investment objectives for performing loans is value enhancement through effective, high-touch servicing, and the ability to implement long-term sustainable loan modification and restructuring programs that keep borrowers in their homes. Alternatively for non-performing assets, the ability to affect property resolution in a timely, orderly, and economically efficient manner is essential to generating attractive returns.

We have also used investments in short-term mortgage-backed securities as vehicles to put capital to work, pending the anticipated reinvestment in suitable pools of mortgage loans. The FDIC has always figured prominently in our asset acquisition strategy. In December 2008, prior to the PMT initial public offering, our investment advisor successfully acquired a pool of performing and non-performing residential mortgage loans with unpaid principal balances of approximately $558 million in the FDIC’s first structured transaction of residential mortgages. We bid and lost on the FDIC auction of Franklin Bank’s residential mortgage loan portfolio in the third quarter of 2009, and the FDIC did not bring any mortgage related assets to market during the fourth quarter. We do expect, however, that they will auction three of more pools of performing and non-performing residential mortgage loans with unpaid principal balances in the neighborhood of $2 billion during the coming months.

Despite the challenges the market presents, we remained firm in our commitment to investing wisely on behalf of PMT shareholders. I have always said that this business requires patient, long-term investors. On the other hand, our commitment to approaching the market with sound analytic discipline does not mean that we will not aggressively pursue all potential opportunities.

Slide fifteen lays out some of the initiatives our investment advisor has undertaken to forge opportunities through atypical channels and transaction types. PennyMac has distinguished itself in the area of structured transaction and securitization activities. In situations where a direct sale does not suit the interests of loan portfolio holders, our team has the ability to design a structured transaction that would provide immediate proceeds to the holder, while delivering upside potential for all participants. In these transactions, we anticipate that PMT would purchase a portion of the securitizations and PLS would be the designated servicer for the entire portfolio.

As I mentioned previously, our investment advisor played a prominent role in the first FDIC structured residential transaction. PCM also played a big part in the first unrated securitization in nearly two years, that was offered back in July of 2009. We are in ongoing discussions with potential securitization partners.

We are also pursuing several opportunities to acquire troubled mortgage assets that result from distressed, condo development projects. In these deals PMT would acquire the construction loan, while PCM and PLS would work together to design and deliver complete condo financing solutions, creating the opportunity to effectively repackage troubled developer loans into high quality residential loans on behalf of PMT.

Also, PCM continues to build out of its conduit platform that will allow the purchase of newly originated loans from small mortgage lenders and the repackaging of those loans for securitization on behalf of PMT. We anticipate the first acquisition to take place in the next several months, and our initial focus will be on agency conforming and jumbo conventional loans.

We believe that the space offers attractive, near-term opportunities. We also believe that as this space returns to a normalized state, our early participation will position us to continue to extract long-term sustainable value from these activities.

Lastly, PCM has determined that investment in mortgage servicing rights from liquidating entities and others may represent an attractive opportunity for PMT. These assets reflect that value of the future stream of expected cash flow to service a given pool of mortgages. MSR investment would allow PMT to capture attractive current returns and to leverage the capabilities and efficiencies of our servicer to improve the asset value. PCM has reviewed several opportunities to invest in MSRs and expects to participate in bidding over the coming weeks.

During the quarter, our manager's persistent pursuit of investment opportunities resulted in winning bids on two portfolios of residential mortgage whole loans, one performing and one non-performing. The performing pool contains approximately $40 million in unpaid principal balances with loans secured by homes located throughout the United States. The weighted average coupon is 8.153%, 83% of the homes are owner occupied, over 90% of the loans of fixed rate mortgages, and the current weighted average FICO of the borrowers is 634.

PLS has begun its borrower outreach campaigns, placing particular emphasis on modification and restructuring programs. Our manager has initiated its portfolio management capabilities analyzing each loan individually to determine the appropriate action for maximizing value. The range of actions to be taken may include refinancing, loan modification, and other activities. Our analysis indicates that refinancing may represent the highest value alternative for slightly more than 60% of the portfolio, while modification may be the preferred alternative for slightly more than 20% of the portfolio. Without any enhancement, one might expect the portfolio to generate a return on investment in the neighborhood of 9% to 11%. However, taking into consideration the potential impact of aggressive value enhancement activities and accelerated monetization, return levels in the high teens would be our high end target.

We are in the process of closing on a non-performing pool that contains approximately $100 million in unpaid principal balances. The weighted average coupon is 6.35% over 90% of the homes are owner occupied, and the current weighted average FICO score of the borrowers is 677. When these loans are transferred to PLS’s servicing platform, the special servicing team’s focus will be on implementing property resolution strategies as quickly and efficiently as possible. Our preliminary (inaudible) suggests that we may able to cure approximately 3% of the portfolio while moving forward to liquidate the remainder. We expect to be successful in implementing various alternatives to foreclosure, such as Short Sales and acquiring deeds in lieu of foreclosure, with approximately one half of the portfolio. In addition, PLS will leverage its origination capability to facilitate financing of Short Sales and REO purchases. Please be aware that the variables of this pool are subject to change since the transaction is not yet closed. At this time we anticipate our high end target may be a return on investment at levels in the mid to high teens, but of course we cannot guarantee any of the return levels discussed on this slide.

A summary of our portfolio and mortgage-backed securities as of December 31, 2009 is shown on slide eighteen. During the quarter we purchased approximately $24 million in short-term MBS. As of December 31, 2009 the securities in our short-term MBS portfolio totaling $83.8 million are backed by non-agency Alt-A, subprime, and prime jumbo loans in our currently cash flowing senior priority securities with an average remaining life of less than one and one quarter years, averaging coupon of 2.52%, and having a yield of approximately 8.11%.

In the five and a half months since PMT commenced operations, our manager and servicer have made significant progress in establishing best-in-class capabilities to support long-term and sustainable value generation for PMT shareholders. We believe that we have created an organization that is well prepared to respond to the continuing market changes. We remain fully committed to evaluating and closing transactions that are consistent with our return assumptions and thresholds.

We ask that our shareholders remain cognizant of the long time frames associated with our unique approach to this segment of the mortgage marketplace. At this time, I would like to turn the presentation over to our CFO, Anne McCallion, for review of our financial performance.

Anne D. McCallion

Our unaudited statement of operations for the quarter ended December 31, 2009 and for our initial five months of operations is shown on slide nineteen. Because the proceeds of our stock offering have been invested in short-term mortgage-backed securities and money market funds pending acquisition of suitable longer term investments, our primary source of revenue for 2009 was interest income, which amounted to $1.6 million for the quarter and $2.1 million since our operations began.

The company incurred $2.6 million in expenses for the quarter and $4.2 million since the commencement of operations. The primary components of expense are management fees and compensation, which consists of reimbursement for services associated with being a public real estate investment trust, trustee fees, and stock based compensation. PMT reported a net loss of $1.2 million, or $0.07 per share, for the quarter and $1.9 million, or $0.11 per share since its commencement of operations.

Our manager’s activities in our first five months of operations fall generally into three categories: Building the requisite operating systems, processes, and governance structure; overseeing and administering our day to day operations and investment activities; and building the infrastructure that will allow us to source assets through non-traditional channels and transactions. In this regard, our manager has hired new staff, deployed existing staff, invested in technology, and developed external relationships to facilitate such investments. Examples include commencing the building of a conduit platform, working with PLS to design and deliver customized condo financing solutions, and working to design securitization programs tailored to portfolio holders’ requirements.

PMT’s unaudited balance sheet as of December 31, 2009 is shown on slide twenty. PMT entered the quarter with $324 million in assets. At year-end, virtually all of PMT’s assets were deployed in short-term money market funds, mortgage-backed securities, and residential whole loans, which were acquired in late December. Included in PMT’s liabilities are $2.9 million payable to its manager and $5.9 million payable to its underwriters. These amounts relate to underwriting fees for the company’s recent stock offering. Our manager paid $2.9 million of underwriting fees on our behalf at the time of the stock offering and will be reimbursed when a certain financial performance threshold is met. Upon meeting this threshold, we will pay our underwriter the $5.9 million in fees that were deferred at the time of the IPO.

Finally, slide 21 lays out several key points regarding our dividend policy. We intend to qualify as a real estate investment trust under the Internal Revenue Code of 1986, commencing with our initial taxable period which ended on December 31, 2009. In order to maintain our tax status as agreed, we plan to distribute at least 90% of taxable income in the form of qualifying distributions to shareholders. When generating taxable income, we expect to make distributions on a quarterly basis, subject to the direction and approval of our Board of Trustees. We will consider several factors in determining the timing, form, and amount of those distributions. Actual cash flows from our whole loan and securities portfolios will have a significant impact on dividends.

As Stan has discussed, our core business involves several activities subject to lengthy timetables. For example, the loan acquisition and boarding process could take up to 90 days to complete and additional time is required to initiate contact with borrowers and to obtain the borrowers’ consent to the appropriate value enhancement alternative. Only after the solution is implemented does PMT begin to realize the economic value of, and cash flows associated with these activities.

In addition, IRS rules regarding requalification and prohibited transactions causes us to hold certain assets and conduct particular business activities including some of those related to servicing and securitization within PMT’s taxable REIT subsidiary, or TRS. TRS activities may impact retaxable income in several ways. For example, interest income from loans made by PMT to its TRS will increase retaxable income as it is earned. However, the net income of the TRS would be included in retaxable income only at the time that the TRS pays a dividend to PMT.

As we move forward, we will make every effort to provide our shareholders with timely information regarding expectations for, and declarations of dividends.


This concludes management’s presentation of results for the fourth quarter 2009. Thank you for joining us. Please forward any questions or comments to We look forward to receiving and responding to your feedback.

Question-and-Answer Session

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