PennyMac Mortgage Investment Trust (PMT) Q1 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the PennyMac Mortgage Investment Trust First Quarter 2012 Earnings Conference Call. [Operator Instructions] I would now like to turn the conference over to your host for today, Mr. Stan Kurland, Chairman and CEO.

Thank you. Before we begin, please take a moment to review the forward-looking disclaimer statement on Slide 2. Let's now turn to Slide 3 and review PMT's first quarter of 2012 highlights. The first quarter benefited from solid operational performance across our primary business segments. Our correspondent lending business delivered another outstanding quarter by substantially growing volume and building the necessary infrastructure and relationships essential for future growth. Moreover the performance of our distressed mortgaged investment portfolio was strong with liquidations in modification activity up substantially, underscoring our unique ability to realize attractive returns through monetization of these loans. The quarter's results demonstrates our success in executing on our strategy and realizing our vision to become a leading non-bank financial intermediary and we remain well positioned to capitalize on opportunities before us as the mortgage landscape continues to evolve. Our success in growing our correspondent lending segment is one example that clearly demonstrate our ability to execute on the opportunities available in today's mortgage market and to also deliver attractive returns through the monetization of our investments in distressed mortgage loans. We generated another quarter of strong pretax earnings performance driven by robust growth from our correspondent lending group and higher liquidation activity in our distressed mortgage investment portfolio. We are pleased with both the level and the composition of the first quarter's results and we see opportunity for continued growth in 2012. For the first quarter, PMT reported earnings of $0.65 per diluted share on net income of $19.1 million down slightly from the fourth quarter. Revenue growth for the quarter was strong growing 19% offset by increased expenses and income taxes. Return on average equity for the quarter was 13%, down slightly from the fourth quarter. The Board of Trustees declared a dividend of $0.55 per share for the quarter representing an annualized yield of 12% as of the closing price on March 30, 2012. Correspondent funding volume reached $1.8 billion and locks were nearly $2.4 billion, an increase of 81% and 79% from the fourth quarter of 2011. Our manager, PCM and fulfillment provider PLS have done an exceptional job of not only growing our correspondent lending activities at an accelerated rate but also increasing our inventory turn overtime during the quarter. The ability to fund at accelerated levels must be balanced with proper fulfillment activities and secondary marketing activities to maximize returns. Turning to our distressed mortgage investing business, at the end of the first quarter PMT agreed to purchase $90 million in unpaid principal balance of non-performing loans. This pool settled at the end of April. After the end of the quarter, we entered into agreements to purchase 2 additional pools totaling $248 million of UPB. The first pool is approximately $40 million in UPB and has similar characteristics to the pool that we settled in April. The second pool of approximately $200 million in UPB consists primarily of performing and re-performing loans with only about 10% of the pool non-performing. The distressed mortgage loans investment strategy remains an attractive opportunity for PMT and PCM continues to evaluate opportunities. The fact that we did not settle any distressed loan acquisitions in this first quarter underscores our selectivity and the less predictable flow of our acquisition timing. During the first quarter, PMT raised $47 million of incremental equity through PMT's controlled equity offering program. As we continue to grow our business, we plan to continue to utilize this program to raise incremental capital. The growing contribution of correspondent segment in the first quarter earnings reflects the evolution of our business model and it is notable that correspondent lending in the first quarter represented 42% of pretax earnings. We anticipate that we will continue growing this business. And in fact, we have raised our correspondent funding outlook for the second quarter. And I will discuss this in greater detail later in my presentation. But first let's turn to Slide 4 and discuss PMT's structure. PMT is a unique enterprise that invests in distressed residential mortgages and engages in more traditional mortgage banking related activities. This combination allows PMT to engage in opportunistic investments in the distressed market, while capitalizing on the emerging opportunities that's the market converges towards a more normalized market; also unique, are PMT's relationships with PLS, its servicer and fulfillment provider and PCM its investment manager. The result is a synergistic combination that we believe maximizes shareholder returns. We conduct what could be considered traditional mortgage banking activities specifically correspondent lending and a taxable REIT subsidiary. Whereas much of the distressed mortgage investment activities are conducted in a qualified REIT. Having the TRS within the PMT structure allows us to engage in activities that would not otherwise be REIT eligible. To maintain our election as a REIT, we must meet several tasks including the requirement that the taxable REIT sales equity cannot exceed 25% of REIT assets. One other ways that we meet this requirement is by maintaining the size of REIT qualifying investments. Such investments could include MBS or ABS and pools of performing mortgage loans. Our capital is one strategy, focuses on allocating capital to those opportunities we believe meets shareholder return objectives. Some of the opportunities require incremental and steady infusions of capital and others require more substantial intermediate inflows. During the first quarter we raised approximately $47 million of additional equity through our controlled equity offering plan. These offerings were done incrementally throughout the quarter and the proceeds were used to fund the ongoing growth of our activities. In the current environment a significant portion of our growth is generated by correspondent lending business and we are investing MSRs generated through the sale of the correspondent loans. We believe that the correspondent business and the MSRs generated from that activity are accretive to the earnings and present an effective use of (technical difficulty) to further enhance shareholder value. Our controlled equity offering is a cost effective efficient means to meet our needs and this regard and will likely be a tool that we would use again in the future as new opportunities arise. For larger and more immediate capital needs we'd likely raise capital through a more traditional equity offering. Let's turn to Slide 6, to see the opportunities that PMT is currently evaluating and our outlook for each area. The table on Slide 6 is similar to the one we've shown in the past and we've listed foreign investments opportunities. Three of which we are currently participating in and one bulk servicing right acquisitions that we are contemplating. Additionally, we've outlined the range of illustrative gross ROEs that we estimate can be derived from these opportunities. I mentioned at the beginning in my presentation that we purchased one additional pool and entered into agreements on 2 other pools. We believe that the flow of residential mortgage pools for review will remain steady and possibly increase given The AG settlement resolution announced in February. We also see opportunities to continue growing the correspondent lending business. Last quarter, we targeted reaching $1 billion in loan fundings per month by the end of 2012. And I'm pleased to announce that we are ahead of schedule. We are now targeting fundings of $1 billion per month by the end of the second quarter and we are reassessing our targets for the end of the year. Helping to drive the volume will be additional refinance volume, driven by the Home Affordable Refinance Program known as HARP. And I'll talk of it more about the opportunity in just a minute. Lastly, I want to mention the significant opportunities we've seen acquiring seasoned agency mortgage servicing rights through bulk purchases. As we've mentioned previously, some banks may be looking to shed MSRs for several reasons, including capital release and expense reduction. PennyMac's unique capabilities and expertise in this asset provide us the opportunities to derive added value by recapturing the MSR on loans that are eligible for HARP 2.0 refinancing. Let's turn to Slide 7 to discuss HARP 2.0 in greater detail. HARP was enacted by the Federal Housing Finance Agency in April 2009 and help certain borrowers who were precluded from refinancing their mortgage to a lower mortgage rate because they own more on their mortgage than their home is worth. However, for a variety of reasons, the original HARP program fell short of its original goals. The new retooled HARP 2.0 was announced last December, and the new version fixes many of the issues that were limiting the HARP 1.0 effectiveness. The most important revision was to remove 125% loan to value cap, which expanded the eligibility of the program to a much larger population of borrowers. In fact, industry experts estimate that HARP could account for between 1 million and 2 million additional refinance transactions and could comprise as much as 20% of 2012's mortgage origination volume. PMT can participate in this opportunity in 2 ways. The first is to our correspondent lending channel. We have the capabilities, infrastructure and expertise necessary to help our correspondent lenders maximize the effectiveness of their outreach under the HARP 2.0 program, and we can be instrumental in helping drive this additional volume. The second way PMT can participate in the opportunity I touched on earlier, which is the bulk acquisition of servicing rights for seasoned agency loans. Our strategy would be to recapture new MSRs generated by refinancing programs in HARP 2.0. The new MSR asset would likely be originated in a very low interest rate environment and represent a very attractive investment due to the low probability of future prepayment. I would now like to turn over to Anne McCallion, PMT's Chief Financial Officer, to discuss the company's first quarter results in more detail. Anne?

Thank you, Stan. As shown on Slide 9, for the first quarter, PMT reported net income of $19.1 million or $0.65 per diluted share on net investment income of $46.6 million. The net income decline of 3% from the fourth quarter of 2011 was largely attributable to a decrease in net gain on investments and an increase in PMT provision for income taxes. The company's correspondent activities are conducted in PMT's taxable REIT subsidiary for we expect PMT's income tax expense to increase as this segment's profit grows. A significant portion of this tax expense relates to the value of the mortgage servicing rights received pursuant to sales of correspondent loans and is deferred rather than payable currently. A major contributing factor to PMT's decline in net gain on investments was that home values underlying our loan portfolio decreased more than projected during the first quarter of 2012 as opposed to home values declining less than projected in the fourth quarter. To a lesser extent, valuations were also down due to a smaller overall portfolio of non-performing loans resulting from PMT's liquidation activity and no acquisitions during the first quarter. Interest income increased 35% over the fourth quarter of 2011 for a couple of reasons. As modifications on non-performing loans are completed, capitalized interest is recognized. Since the first quarter had a large number of modifications, this increased the interest recognized in the period. Note that since our loans are carried at fair value, any change in value between the old bond and the modified bond is included in net gain on investments. Interest income also rose due to the increase in correspondent loans, but earned interest income in inventory as the volume of loans funded increased. Let's turn the page and look at PMT's balance sheet highlights from the quarter. Mortgage assets declined slightly during the quarter as of our turnover of the inventory of mortgage acquired for sale increased. In addition, our portfolio of distressed mortgages experienced strong liquidation activity while at the same time, there were no new additions to these investments during the first quarter. With the transaction entered into during the quarter and completed in April and assuming the 2 transactions entered into April are completed. We expect to see mortgage assets increase in the second quarter. Shareholders' equity increase 9% in the first quarter predominantly from the $47 million, raised through the company's controlled equity offering program. Let's now turn to Slide 11, to see the breakdown at PMT's pretax income by segment. Pretax income for PMT was $24.6 million with $14.3 million coming from our investment activity segment and $10.3 million coming from our correspondent lending segment. Income from investment activities was driven by interest earned and net gains on income investments. As mentioned earlier, that those benefited from our heightened modification activity and a performance of our portfolio of distressed mortgage loans. Correspondent lending activities are driven predominantly by the volume of locks and fundings. This volume drove the segments net gain on mortgage loans acquired for sale to $13.4 million in the first quarter compared to $7.4 million in the fourth quarter of 2011. Interest income for correspondent lending was $2.8 million for the first quarter as a greater volume of loans produced income while [indiscernible] warehoused prior to their sale. Issue continued to increase as PMT's correspondent volume increases. These activities were offset the loan fulfillment fees paid to PLS of $6.1 million. These fees cover a wider array of activities ranging from infrastructure and relationship development through the processing, funding, packaging, quality control and sale of the loans. Let's turn to Slide 12 for further break down of the largest line item on the correspondent lending segments P&L, net gain on mortgage loans acquired for sale. PMT's net gain on mortgage loans acquired for sale in the first quarter increased 74% as volume continued to expand. Included in this line item is the value of mortgage servicing is acquired when the loans were sold. PMT contracts with PLS to sub-service the loans. The next largest items in net gain on mortgage loans acquired for sale is the market value adjustment of the pipeline, inventory and hedges. The company locks interest rates on loans, it is acquiring and is hedging the change in value that may occur between loss in sale. The market value adjustments of the pipeline and inventory offset by hedging costs contributed $10.3 million in the quarter. The Rep & Warrant provision provided for potential future losses from loans that are repurchased for breach of any representations or warranties that we may have made and are unable to recovers such losses from our correspondent sellers. Let's turn to Slide 13, and take a look PMT's growing portfolio at MSRs in more detail. As our correspondent lending [indiscernible] continue to grow, the size of PMT's investment and mortgage servicing rights will grow as well. We have elected to account for MSRs with no rates equal to or less than 4.5% as the lower of cost or market or low COM. MSRs with note rates above 4.5% are accounted for a fair value since the risk profile of those loans differs and they have a probability of prepaying. Accounting for them at fair value takes into account volatility. With today's rates at historical loans prepayment risk on recent production is relatively low. However, in other interest [indiscernible] environments the value of this asset can be volatile. And this is typically mitigated through the purchase of derivative instruments for hedging purposes. At present, we are not hedging our MSR assets. Now let's turn from the correspondent activities to investing activities and take a look at PMT valuation changes for the first quarter on Slide 14. You can see the breakdown of our home loan investment income in the table on the top right of the slide. Of the total $14.8 million in changes reflected in [indiscernible] and REO's carrying values, $6.3 million was due to valuation changes. And $8.5 million was due to gains on dispositions. Because we account for our portfolio of mortgage loans held for investment at fair value, changes in fair value are including the results of our operations each period. We've accounted our REOs at the lower of cost or market. So any declines in property value are generally also recognized in earnings each period. These changes in value are non-cash items when recognized in our operations. However, when it is monetized, significant cash flows are generally realized. If you take a look at the graph on the right, you can see an example of the appropriateness of our valuations. One liquidation option for loans that reach their finalization is an REO sale. As you can see from the graph valuation changes have led to very little gain or loss from REO disposition in 2011. However, in the first quarter PMT realized a gain on REO of $3.7 million. This was largely due to our new strategy surrounding holding and improving REO. There are certain geographic areas where PLS has determined that making additional improvements to the properties should result in higher returns to PMT, even though properties maybe held longer as a result. The total gain on REO disposition was $6.7 million for the first quarter offset by a reduction in valuation of $2.9 million related to low COM adjustments. I would now like to turn it over to David Spector, PMT's President and Chief Operating Office, to go over the operation on activities of the first quarter.

Thank you, Anne. Let's now turn to Slide 16, to discuss the first quarter operational results of correspondent lending business in greater detail. As Stan and Anne have mentioned the correspondent lending segment is contributing in increasing amount of PMT's pretax income, a direct result of its growing volume. Total correspondent fundings are $1.8 billion during the first quarter compared to $991 million in the fourth quarter, an 81% quarter-over-quarter increase. Conventional corresponding loans with the leading loan product originated during the quarter representing 55% of all fundings. For the month of April, fundings were approximately $800 million with locks eclipsed into $1.3 billion mark. As Stan previously mentioned, we are targeting to reach approximately $1 billion in fundings per month by the end of the second quarter and are currently reevaluating our year-end targets given the current market opportunities. Prime conventional conforming loans funded in the first quarter had weighted average FICO scores of approximately 770 with less than 2.5% having FICO score below 680. You can also see that a large majority of our correspondent productions in California. As we continue to grow our correspondent partnerships across the country we expect greater geographical diversification. Let's now take a closer look at the portfolio of correspondent partners on Slide 17. During the first quarter PMT approved 17 new correspondent partners and deactivated 13. The deactivated clients are typically those who have stopped delivering loans to us or the volume is too low to justify continuation of the relationship. Our current clients consistent mostly of independent mortgage companies with some financial institutions and national builders as well. These companies are partners with PennyMac and show our focus on efficiency and quality control. They also tend to be well established companies with over half of our volume coming from companies with net worth exceeding $10 million. As we continue to grow PMT's correspondent volume, we will look to expand the number of clients while remaining focused on the quality of all of our client relationships. Let's now take a look at how our investment activities in distress mortgage assets performed during the quarter on Slide 19. Volumes of home loans available for purchase were fairly steady throughout the quarter. PMT's investment measure PCM reviewed over $5 billion in unpaid principal balance of distress home loans, which is up approximately 60% from the amounts reviewed in the fourth quarter of 2011. Looking forward, opportunities are still present with respect to the purchase of distressed mortgage pools. As Stan mentioned earlier, PMT purchase $90 million distressed whole loans that settle in April and introduced 2 additional purchase agreements selling $240 million that are expected to settle in the second quarter. Investment opportunities for distressed mortgage assets continues to indicate attractive return levels and the flow of distressed whole loans available for purchases likely to remain steady. Banks continue to work through the distressed portfolios and with the AG settlement completed, there may be an increase in the amount of loans available for purchase. Let's now turn to Slide 20 for an in-depth look at how PMT's loan acquisitions have progressed since the beginning of 2010. With respect to the slide for number of quarters now and believe it provides investors with a quick snapshots of how the loans are progressing to the resolution process. As you can see 49% loans PMT acquired in the first quarter of 2010 remained in the portfolio, meaning that over half of the portfolio is liquidated over the past 2 years. If you exclude [indiscernible] in this ratio in the pool factor for non-performing loans will be 35%. These re-performing loans also be able to enhance company's returns which can be achieved through sale or securitization of re-performing loans to investors or to refinance. Borrowers who remain current may have actually qualified for the FHAs negative equity refinance program, which will make the loan immediately sellable. The lowest of loans of PLS is not able to modify in recurrent, we will continue to work with the borrowers to progress them through a resolution path. Let's turn to Slide 21 and take a closer look at the first quarter's modification in payoff activity. Modification activity in the first quarter was very strong as PLS continues to utilize the home affordable modification program or HAMP, in other programs to help give borrowers a more affordable payment. These modifications are closely monitored for any receiptivism [ph] and PLS continues to work diligently to keep these borrowers current. This activity contributed to the quarterly increase in interest income that Anne mentioned earlier on in the presentation. The HAMP program provides a variety of options for servicers to help borrowers including interest rate reductions, capitalization of missed payments, principal forbearance and in certain cases principal reduction. This program has been very effective for PMT to help borrowers and to ultimately realize attractive returns as these loans liquidate through refinance or potential sale transactions. Now let's turn to Slide 22 for closer look at our resolution activity. This slide takes a look at PMT's short sales, deeds-in-lieu and completed foreclosure sales. If borrowers are unable to qualify for modification and cannot come current, then they are likely on the path to foreclosure. The 2 alternatives to foreclosure are short sales transactions and deeds-in-lieu. Short sales represent the selling of the property whereby the proceeds for short of the balance of the mortgage. Upon completion of the sale of a home, the lender agrees to accept less than the full amount of the mortgage. A deed-in-lieu occurs when the lender has come to an agreement with the borrower to deed over the property to the lender and avoids the lengthy foreclosure process. Both of these activities represent alternative foreclosure and benefits both the borrower and the lender. The lender mitigates the additional cost and time and revenue go through the foreclosure process. The borrowers' credit is damaged less than if a foreclosure would have occurred. In the end, both of these outcomes are advantages over foreclosure for both parties. Short sales remain the second largest liquidation activity, although down 14% from the fourth quarter they remain a significant part of overall liquidation activity. Deeds-in-lieu, while sadly down for the quarter, remain up substantially from the third quarter. But those loans which we are not able to provide a resolution they are passed through to the foreclosure process. If a third party did not mean to resume price on the property, PMT obtains possession of the property for foreclosure sale. As you can see by the chart, foreclosures sales have been fairly steady over the last 4 quarters with the first quarter slightly down from the fourth quarter of 2011. When loans put through a foreclosure sale, they become REO. Let's turn to Slide 23 to see REO progress, how we are [indiscernible] our REOs. $26.7 million of the value of the REO properties at the end of the fourth quarter were liquidated in the first quarter. As you can see from the high-lighted column in the middle of the table, most of the liquidations were aged more than 3 months. Our total inventory was down slightly in the first quarter, it's notable that the average age of the portfolio increased by 30 days, partially as a result of our rehabilitations strategy for these properties. Let's now turn to Slide 24 to see the cash generated through the activities in our distresses mortgaged investments. Cash proceeds in the liquidation distressed mortgage loans increased 25% over the fourth quarter to $68.4 million. This is largely attributable to the higher sale activities and strong home order demand as the housing season began earlier this year than last year with the warmer winter months. These proceeds are utilized for distribution payments, debt service and reinvestment opportunities like the ones outlined earlier in the presentation. I'll now turn it back over to Stan.

We would like to thank all of our current and future shareholders for listening to this earnings presentation. I would like to invite all those investors who have questions to submit them to our Investor Relations department via email or phone. If we receive substantial numbers of questions we will post a question and answer document on our website. We thank you again for your time.