PennyMac Mortgage Investment Trust (NYSE:PMT)
2014 Credit Suisse Financial Services Forum Conference Transcript
February 11, 2014 4:45 PM ET
Stan Kurland - Founder, Chairman and CEO
David Spector - President and COO
Tapfuma Chibaya - Credit Suisse
Tapfuma Chibaya - Credit Suisse
Good afternoon, everybody. My name is Tapfuma Chibaya, one of the Credit Suisse research analyst working alongside Douglas Harter. Today I have the pleasure of introducing PennyMac Mortgage Trust, PMT, specialized mortgage REITs. Today joining us is Stan Kurland, Founder, Chairman and CEO; and David Spector, President and COO.
With that, I hand over to Stan.
Good afternoon. And I guess, I’m probably the last presenter stand between this group in cocktail. So, hopefully, we’ll get through this into Q&A. But I’m pleased to speak to you today about PennyMac Mortgage Investment Trust and I’d like to begin my comments with an overview of PMT’s strategy.
PMT is tax efficient real estate investment trust that invests in unique set of residential mortgage strategy, focus on what distinguishes PMT and how our investment model and outlook differ from other entities that also classified as mortgage REITs.
We have consistent record of delivering strong earnings per share and dividends for our common shareholders. Our focus is on allocating capital to opportunities and strategies that generate superior returns to shareholders over the long-term.
Unlike most other REITs that invests primarily in mortgage-backed securities. PMT invest in a unique set of multiple residential mortgage strategies, utilizing what we think are very conservative amounts of leverage.
Today our investment strategies are concentrated in distressed whole loans, excess servicing spread, mortgage servicing rights that are generated from our correspondent lending operations.
We continue to deploy capital into new and attractive investment opportunities, including the recent acquisition of the distressed whole loans, excess servicing spread transactions, in addition to retained interest in our private label securitizations.
Finally, these investment strategies are made possible through the unique capabilities of our -- of PMTs manager and servicer PennyMac Financial Services.
Now, let’s look at slide four and discuss PMT’s track record of performance. PMT has established solid record of delivering robust quarterly dividend, as well as growing the company's book value. This is the result of successfully deploying new capital into accretive investments that are generated strong earnings and return on equity.
PMT finished a successful 2013 with a strong fourth quarter results earning $52.7 million in net income or $0.69 per diluted share in the fourth quarter. These results are consistent with the solid record of performance for PMT, which has been established over the last four years. We also increased our dividend to $0.59 per share in the fourth quarter from $0.57 in the prior quarter.
Let’s turn to slide five and look at the performance of PMTs operating segments, investment activities and correspondent lending. On slide five, we show pretax earnings contribution from each segment for the last five quarters.
For the fourth quarter pretax earnings totaled $54.7 million. Of that amount, $48.4 million came from investment activities segment and $6.3 million came from our correspondent lending segment. The investment activity segment encompasses our investment portfolio activities, which include distressed whole loans, mortgage servicing rights, excess servicing spread, mortgage-backed securities and retained interest of our private-label securitization.
In our correspondent lending segment, PMT acquires newly originated loans for mortgage originators, securitizes and sells the loans typically into Fannie Mae and Freddie Mac securities and retains the mortgage servicing rights, MSR. The contribution of each business can vary, but as a whole we believe PMTs business model is designed to deliver solid earnings across different market environments.
Now, let's look at the next slide and take a few moments to review PMTs recent investment and operating highlights. During the fourth quarter, PMT completed several important previously announced acquisitions, including investments totaling $136 million in excess servicing spread and the acquisition of a pool of non-performing whole loans totaling $507 million in unpaid principal balance.
Correspondent loan acquisition volumes totaled $5.8 billion, down 25% from the third quarter and lock volume totaled $6 billion, a decrease of 10% from the third quarter. Higher mortgage rates continued to cause a decline in the U.S. mortgage originations for the quarter with the top lenders reporting volume declines in excess of 35%.
After the end of the quarter, we completed a notable transaction with the sale in January of performing whole loans from PMTs distressed investment portfolio totaling $233 million in UPB. Proceeds from the sale are targeted for reinvestment in higher yielding opportunities such as the pool of non-performing loans totaling $351 million in UPB that we agreed to acquire and expect to settle later this month.
Turning to Slide 7, we see that PMTs portfolio of mortgage assets has continued to grow and diversify. PMTs long-term mortgage investments grew 63% in 2013 as a result of significant new investments we made in distressed whole loans, MSRs, excess servicing spread and retained interest from our securitization of prime jumbo loans.
PMT funded these investments with new equity capital raise in August and also by continuing to build out our capital structures through the issuance of convertible debt in April. We believe that PMTs current leverage ratio of 1.8 times remains prudent and relatively low compared to other REITs.
Now, I'd like to turn to Slide 8 and continue the discussion of PMTs balance sheet and how our strategy of pursuing multiple investments is beneficial for risk management. The various mortgage assets that PMT invests in have different sensitivities to interest rates. Some of our investments such as MBS decline in value with increases in interest rates, other assets such as MSRs and excess servicing spread tend to rise in value with higher interest rates. These offsetting sensitivities moderate the overall balance sheet exposure to interest rate movements.
The chart on Slide 8 shows PMT’s global interest rate risk exposure resulting from the sensitivity of our long assets and our MSR and ESS, it’s the excess servicing spread and investment hedge positions. The horizontal access represents changes in interest rates, assuming a hypothetical instantaneous parallel shock in the yield curve. The vertical access represents an estimated change in the value of the balance sheet expressed as a percentage of shareholders’ equity.
What you see from this chart is that the sensitivity of the long asset positions is positive to a downward interest rate shock, while the sensitivity of the MSRs, ESS and investment hedges is negative. We estimate that for a 100 basis point instantaneous decline in interest rates, the net loss in value would be less than 1% of PMT’s shareholders equity.
Distressed whole loans are not included in this analysis as they are primarily sensitive to changes in home prices and less directly affected by changes in interest rates. This example illustrates the power of PMT’s strategy of pursuing investments with differing --with different risk profiles which allow -- which along with disciplined interest rate risk management help produce a solid investment return over the long-term across a variety of market conditions.
Let’s now look at Slide 9 and discuss one of PMTs key investment strategies and our history of resolving distressed mortgage loans. We have a successful track record in resolving distressed whole loans. Distressed loan investments have been the primary target for PMT since its inception in 2009. PMT, in fact, was founded on the idea of making this investment strategy which had typically been accessed through private equity available to the broader investing public.
Over the past four years, PMT has acquired over $5 billion in UPB of distressed whole loans in 41 separate pools. We have a deep understanding of the asset class and that experience gives us significant insight into how this collateral will perform over time. We use performance data from previous acquisitions to inform our analysis in bidding on potential new investments in order to focus on pools that fit PMT’s business model.
We pursue several different resolution paths for distressed mortgage loans. One resolution path is where the loan pays off either through the borrower becoming current and paying the loan off or more likely through the modification and subsequent pay off through a negative equity refinance transaction.
Another resolution path is short sale which is used frequently as an alternative to foreclosure in which an agreement is negotiated with the borrower to sell their home for an amount that is less than the outstanding amount owed on the mortgage.
Deeds-in-lieu is also an alternative to foreclosure where the borrower agrees to deed the property over to PMT rather than go through the foreclosure process. This type of transaction often includes cash payments to the borrowers as incentives for a negotiated resolution.
The last resort and typically the least desirable outcome for PMT is foreclosure. PMT has successfully, employed alternatives to foreclosure, including modifications, short sales, deed and lieu of foreclosure and 65% of the loan resolutions over PMT's history.
The chart on slide 9, shows the resolution trend for the stress pools purchased by PMT going back to the first quarter of 2010, as you can see PMT has a strong history of effectively investing and resolving these loans.
Turning to slide 10, I'd like to review the outlook across the market in the key areas in which PMT participates. Mortgage rates rose in the second half of 2013 from historic lows, leading to a significant decline in refinance activity and heightened competition.
As we started 2014, industry forecast were predicting $1.2 trillion in new mortgage originations with 60% of the total volume coming from purchase money originations. Recent indicators suggest that the purchase money market demand will be supported by -broad-based economic improvement across the U.S. and continued home price appreciation.
At current interest levels home affordability remained high, and housing inventory is low which points to a strong housing market. In recent weeks, interest rates have declined which may yield additional refinance activity.
Turning to distressed [total] loans we continue to see opportunities for PMT to deploy capital in 2013, PMT doubled its investment in distressed loan pools over the prior year, and new sellers and opportunities continued to emerge. Our discussion with sellers and market participants suggest that distressed total loan activity will be strong in 2014, however there's likely to be continued competition for these assets including the establishment of vehicles to invest in REO looking to gain ownership of the properties through the resolution of the mortgage loans.
With respect to home prices we remain optimistic regarding future home price appreciation, however, we expect that the rate of home-price appreciation to moderate from the very robust levels of 2013.
In correspondent lending, the mortgage market contraction is difficult for existing participants and it continues to create barriers to entry for new participants seeking to enter the market. However, we see considerable opportunity to grow acquisition volume by offering our capabilities to smaller originators like in benefit from the broad array of programs and delivery options that PennyMac provides.
Currently the origination market remains dominated by agency loan programs and we do not anticipate significant near-term changes to conforming loan-limits or further clarity regarding the future of the GSCs. The majority of today's jumbo mortgage activity is being driven by banks, originating or acquiring loans for their own balance sheet.
We continue to pursue opportunities to acquire both MSR portfolios such as the two agency portfolios we completed in the fourth quarter with PMT co-investing in the excess servicing spread of these portfolios. We see MSR opportunities from a variety of sellers and believe that opportunities exist for additional MSR acquisitions and excess servicing spread transactions over the year.
On slide 11 I would like to review our recent investment in distressed whole loans. Here we show PMT’s acquisition volume over the last five quarters by unpaid principal balance in addition to the acquisitions expected to sell in the first quarter. With acquisitions of $507 million in UPB in the fourth quarter, PMT’s distressed whole loan acquisitions in 2013 totaled $2.2 billion of UPB compared to $1 billion in 2012.
Recently we entered into an agreement to acquire additional $351 million in unpaid principal balance of nonperforming whole loans which we expect to see and we expect to see a continued supply of distressed whole loans coming to market.
Now let’s move on to slide 12 and turn to the correspondent lending activities. Correspondent loan acquisitions totaled $5.8 billion in the fourth quarter, a decline of 25% from the prior quarter. Correspondent lock volume in the fourth quarter was $6 billion, a 10% decline from the prior quarter. For the full year of 2013, correspondent acquisitions totaled $31 billion, a 42% increase from the levels of 2012.
In January, loan acquisition volumes were $1.7 billion while lock volumes totaled $1.5 billion. Our correspondent lending business is focusing on a variety of strategic initiatives to grow volume and optimize profitability. The changing mortgage origination landscape has shifted volume to smaller originators creating opportunities to focus on the needs of -- on this underserved segment of the correspondent market.
PennyMac offers a broad array of programs and delivery options including our best efforts, commitments. We also have recently started acquiring loans in New England and we are executing on our strategies to grow relationships and volume in the Northeast. Finally we are focused on initiatives to capture greater share of volume from our existing relationships.
Turning to slide 13, I would like to highlight the significant growth of PMT’s investment in MSRs which has been supplemented by the investment in excess servicing spread, or ESS. PMT’s MSR asset growth occurs through the investment in MSRs when newly originated loans acquired by PMT’s correspondent lending business are securitized and sold. ESS results from PMT’s co-investment and agency MSRs acquired by PennyMac Financial from third party sellers, PMT acquires the rights to receive the excess servicing spread cash flows over the life of the underlying loans without the operational requirements that come with owning the MSRs.
MSRs and ESS are attractive investments for PMT and will provide meaningful returns overtime. We expect organic growth in MSR investments from the ongoing acquisition of loans by PMT’s correspondent lending business to continue supplemented by additional investments in excess servicing spread in the future.
So, with that, to the formal part of this presentation and now entertain any questions that you might have. Any questions? Okay.
Tapfuma Chibaya - Credit Suisse
So I will kick it off. Yeah. So, Stan, we have had quite a bit of commentary from the big banks pulling back from correspondent lending, I just wondering to get your thoughts what guide has been in terms of volume and margins and maybe market share in the correspondent lending space?
I think, definitely over the course of the last several year seen the large banks pulling away from correspondent lending that is basically pursuing activities that relate to their core customer base and any of loans that come to correspondent necessarily the desired customer base of the large money-centered banks, so they have reduced their correspondent initiatives also additional capital requirements around some of the assets in mortgage servicing rights.
And generally resulting in a retreat from the larger banks, we entered the market in -- started in 2009, we are now the largest non-bank correspondent lender and we would anticipate that the banks will continue to retreat and with very little view on the horizon that banks are going to reenter into the space. All right. It looks we are, yes?
Well, I think, that the issue is that there has been some very rapid growth and significant bulk transactions and there is concern among regulators, as well as, I think, the GSE that relates to conforming Fannie, Freddie, Ginnie servicing that there is adequate capacity for smooth transitions or transfer to take place.
Our transfers that we completed in the fourth quarter went very smoothly and we had adequate staffing and time to grow the operations. It was regard to Auckland, they have grown very quickly and I think that perhaps some are being targeted around this issue.
I don't think it's going to be a broad-brushed issue, I think it’s very specific to the capacity of an originator. Our capacity is all today continued within operations in the United States, and that's very favorable position to be. And particularly with the GSEs, I want to see servicing jobs retained in the United States.
I think that the size of transfers needs to be managed, so that they're not overwhelming in any months. And I think perhaps that the kind of $39 billion transfer was a bit worrisome, but it's -- these activities of transferring problem servicing is very advantageous to borrowers, as well as to the GSEs where they can have servicers that are more or better prepared to focus on problem in higher touch servicing activities, then it would be I think a bad decision for the markets to discontinue the evolution of moving some of those more difficult servicing into servicers that can pay better attention to it.
Well, I know we observed some things last week that I heard of in it. It does seem that there are some REITs that are trading below the market value of their assets. And if you have a REIT with a similar strategy, it would seem appropriate to look at buying the stock of another REIT, you’re ending up with the same asset class. I think it's opportunistic on the part of a REIT that doing it but may not resolve the issue of the REIT that has a declining asset base and increasing fixed cost relative to their returning assets. But I think it's kind of looking at some of those things that are happening in the market. They do have to wonder why more people aren’t buying up some of these REIT stocks.
I missed part of the question, just about higher levels of regulation and…?
So in the creation of PennyMac and its activities, we’ve structured I think couple of really important initiatives. One is that the company’s operations and this is under PennyMac Financial Services. The manager and the service provider for PMT is a legacy free operation. It was built from scratch and all of the activity that it has is loan acquisitions in the case of PMT that were acquired over the last four years. And we have extraordinary levels of QC and diligence and process procedure governance that is designed to create an ongoing operation. It doesn’t create legal issues or regulatory issues.
The other distinction for the company is that PMT is an investment activity and it has no employees. And it doesn’t have operation that it does for itself. Those activities are done by PFSI. And so at least PMT without a lot of operational risk associated with the assets.
But we are in a highly regulated environment and there is a lot of focus on the conduct around the origination and servicing of mortgages. And it is important to make certain method of governance initiative, the procedures, the quality control around the mortgage activities are state-of-the-art. That’s what leads -- attempted to create at PennyMac and it’s really captured in the fact that it’s a legacy free enterprise.
Tapfuma Chibaya - Credit Suisse
Given the NPL opportunity that you guys see in 2014, can you maybe walk us through how you guys think about financing that between monetizing, performing tools that does raise in capital?
So as I mentioned the market appears to be very robust in terms of NPLs, may also be considerable in terms of the investment opportunities for mortgage servicing rights as well. The lot -- portion of our growth can be -- potential growth can be financed by increasing the leverage on assets that we have in place.
As I mentioned we have only leverage to 1.8 times equity and there is a room within the asset classes that we have to expand a leverage particularly around the mortgage servicing and excess servicing strips.
And so that will produce part of the capital for expanding our asset base. And as we look at transactions and if they are accretive to our shareholders, we’ll look to increase the equity base of the company as long as we see the appropriate investments. Well, anyone else? Okay. Well, thanks for listening to our presentation.
Tapfuma Chibaya - Credit Suisse
Great. Thank. We have a breakout session in [lawn 1] to spread outside, then cocktail is right between here at the main hotel area. So if you just walk toward the main hotel area for the cocktail.
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