PENNYMAC FINANCIAL SERVICES, INC. Cautionary Statement Regarding Forward-Looking Statements
The following discussion and analysis of financial condition and results of
operations should be read with the consolidated financial statements including
the related notes of
Statements contained in this Quarterly Report on Form 10-Q may constitute
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. These statements involve known and unknown risks,
uncertainties and other factors, which may cause actual results to be materially
different from those expressed or implied in such statements. You can identify
these forward-looking statements by words such as "may," "will," "should,"
"expect," "anticipate," "believe," "estimate," "intend," "plan" and other
similar expressions. You should consider our forward-looking statements in light
of the risks discussed under the heading "Risk Factors," as well as our
consolidated financial statements, related notes, and the other financial
information appearing elsewhere in this Quarterly Report on Form 10-Q and our
other filings with the
Overview
The following discussion and analysis provides information that we believe is relevant to an assessment and understanding of our consolidated results of operations and financial condition. Unless the context indicates otherwise, references in this Quarterly Report on Form 10-Q to the words "we," "us," "our" and the "Company" refer to PFSI.
Our Company
We are a specialty financial services firm with a comprehensive mortgage
platform and integrated business primarily focused on the production and
servicing of
We operate and control all of the business and affairs and consolidate the
financial results of
We were formed as a
One result of the consummation of the Reorganization was that our equity
structure was changed to create a single class of publicly-held common stock as
opposed to the two classes that were in place before the Reorganization. For tax
purposes, the Reorganization was to be treated as an integrated transaction that
qualifies as a reorganization within the meaning of Section 368(a) of the
Internal Revenue Code and/or a transfer described in Section 351(a) of the
Internal Revenue Code.
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We conduct our business in three segments: production, servicing (together, production and servicing comprise our mortgage banking activities) and investment management.
· The production segment performs loan origination, acquisition and sale
activities.
· The servicing segment performs loan servicing for both newly originated loans
we are holding for sale and loans we service for others, including for PMT.
· The investment management segment represents our investment management
activities, which include the activities associated with investment asset
acquisitions and dispositions such as sourcing, due diligence, negotiation and
settlement.
Our principal mortgage banking subsidiary,
Our investment management subsidiary is
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Results of Operations
Our results of operations are summarized below:
Quarter ended March 31,
2020 2019
(dollars in thousands, except per
share amounts)
Revenues:
Net gains on loans held for sale at fair value $ 344,282 $ 84,776
Loan origination fees 57,571 23,930
Fulfillment fees from PennyMac Mortgage Investment
Trust 41,940 27,574
Net loan servicing fees 257,808 80,571
Net interest income 11,052 20,790
Management fees 9,055 7,248
Other 117 2,816
Total net revenue 721,825 247,705
Expenses 307,095 187,414
Income before provision for income taxes 414,730 60,291
Provision for income taxes 108,487 14,156
Net income $ 306,243 $ 46,135
Earnings per share
Basic $ 3.89 $ 0.59
Diluted $ 3.73 $ 0.58
Return on average common stockholders' equity 56.0 % 11.0 %
Income before provision for income taxes by segment:
Mortgage banking:
Production $ 240,131 $ 47,006
Servicing 170,842 11,163
Total mortgage banking 410,973 58,169
Investment management 3,757 2,122
$ 414,730 $ 60,291
During the quarter:
Interest rate lock commitments issued $ 24,804,994 $ 10,134,199 Unpaid principal balance of loans fulfilled for PMT subject to fulfillment fees
$ 16,152,543 $ 8,135,552 At end of quarter: Interest rate lock commitments outstanding$ 9,377,614 $ 3,821,942
Unpaid principal balance of loan servicing portfolio: Owned: Mortgage servicing rights
$ 231,484,161 $ 219,834,361 Mortgage servicing liabilities 2,635,734 1,000,403 Loans held for sale 5,276,688 2,573,121 239,396,583 223,407,885 Subserviced for PMT 144,830,043 101,287,428$ 384,226,626 $ 324,695,313 Net assets of PennyMac Mortgage Investment Trust$ 1,823,368 $ 1,727,589 Book value per share$ 29.85 $ 21.72 56 Table of Contents
During the quarter ended
This sudden and significant increase in unemployment has created financial hardships for many existing borrowers. As part of its response to the Pandemic, the federal government included requirements in the Coronavirus Aid, Relief, and Economic Security ("CARES") Act that we provide borrowers with substantial payment forbearance on loans we service subject to Agency securitizations. As a result of this requirement, we have seen and expect to further see a large increases in delinquencies in our servicing portfolio which will increase our cost to service those loans and require us to finance substantial amounts of advances of principal and interest payments to the holders of the securities holding those loans.
In the near term, or in subsequent quarters, we expect this development to have a negative effect on the earnings of our servicing segment before taking into account the effect of future developments on the valuation of our MSRs by, among other things, reducing servicing fee income, reducing our ability to earn gains on early buyout loans and reducing the amount of placement fees we earn on custodial deposits related to these loans, increasing our cost to service due to higher delinquency and default rates, as well as increased financing costs due to the need to advance funds on behalf of delinquent borrowers. These effects may be offset by growth in our loan servicing portfolio, increases in the servicing fees we earn from PMT for servicing the delinquent loans in its loan servicing portfolio and gains on early buyout loans as those borrowers reperform.
Before the onset of the Pandemic, the mortgage origination market was
experiencing healthy demand owing to historically low interest rates in
The Pandemic had a substantial negative effect on the investments of PMT. As a
result, PMT recognized a net loss of
The current environment caused by the Pandemic in
For the quarter ended
· increases in production income (Net gains on loans held for sale at fair value,
Loan origination fees and Fulfillment fees from PennyMac Mortgage Investment
Trust); and
· increases in Net loan servicing fees, partially offset by;
· increases in total expenses.
The increases in production income reflect higher production volume and improved profit margins. The increase in Net loan servicing fees was due to a
combination of increased loan servicing fees resulting from growth in
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our loan servicing portfolio and changes in the fair value of our MSRs, MSLs and ESS, net of hedging results, compared to the same period in 2019. The increases in total expenses were mainly due to increases in loan origination and compensation expenses, reflecting the continuing growth of our mortgage banking activities.
During the quarter ended
Our net gains on loans held for sale are summarized below:
Quarter ended March 31,
2020 2019
(in thousands)
From non-affiliates:
Cash loss:
Loans $ 111,757 $ (41,242)
Hedging activities (122,666) (8,927)
Total cash loss (10,909) (50,169)
Non-cash gain:
Change in fair value of loans and derivative financial
instruments outstanding at year end:
Interest rate lock commitments 178,543 16,727
Loans (72,080) (164)
Hedging derivatives (102,891) (25,741)
3,572 (9,178)
Mortgage servicing rights and mortgage servicing
liabilities resulting from loan sales 275,739 114,957
Provision for losses relating to representations and warranties: Pursuant to loan sales
(3,712) (1,067)
Reduction in liability due to change in estimate 1,676 4,210
Total non-cash gain 277,275 108,922
Total gains on sale from non-affiliates 266,366 58,753
From PennyMac Mortgage Investment Trust 77,916 26,023
$ 344,282 $ 84,776
During the quarter:
Interest rate lock commitments issued:
Government-insured or guaranteed mortgage loans $ 19,029,138 $ 8,831,495
Conventional mortgage loans 5,765,876 1,301,243
Jumbo mortgage loans 8,304 -
Home equity lines of credit 1,676 1,461
$ 24,804,994 $ 10,134,199
At end of quarter:
Loans held for sale at fair value $ 5,541,987 $ 2,668,929
Commitments to fund and purchase loans $ 9,377,614 $ 3,821,942
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Our gain on sale of loans held for sale includes both cash and non-cash elements. We receive proceeds on sale that include our estimate of the fair value of MSRs and we incur liabilities for mortgage servicing liabilities (which represents the fair value of the costs we expect to incur in excess of the fees we receive for early buyout of delinquent loans ("EBO loans") we have resold) and for the fair value of our estimate of the losses we expect to incur relating to the representation and warranties we provide in our loan sale transactions.
Non-cash elements of gain on sale of loans
The MSRs, MSLs, and liability for representations and warranties we recognize represent our estimate of the fair value of future benefits and costs we will realize for years in the future. These estimates represented approximately 79%
of our gain on sale of loans at fair value for the quarters ended
Our agreements with the purchasers and insurers include representations and warranties related to the loans we sell. The representations and warranties require adherence to purchaser and insurer origination and underwriting guidelines, including but not limited to the validity of the lien securing the loan, property eligibility, borrower credit, income and asset requirements, and compliance with applicable federal, state and local law.
In the event of a breach of our representations and warranties, we may be required to either repurchase the loans with the identified defects or indemnify the purchaser or insurer. In such cases, we bear any subsequent credit loss on the loans. Our credit loss may be reduced by any recourse we have to correspondent originators that sold such loans to us and breached similar or other representations and warranties. In such event, we have the right to seek a recovery of related repurchase losses from that correspondent seller.
The method used to estimate our losses on representations and warranties is a function of our estimate of future defaults, loan repurchase rates, the severity of loss in the event of default, if applicable, and the probability of reimbursement by the correspondent loan seller. We establish a liability at the time loans are sold and review our liability estimate on a periodic basis.
We recorded provisions for losses under representations and warranties relating
to current loan sales as a component of Net gains on loans held for sale at fair
value totaling
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Following is a summary of loan repurchase activity and the UPB of loans subject to representations and warranties:
Quarter ended March 31,
2020 2019
(in thousands)
During the quarter:
Indemnification activity:
Loans indemnified by PFSI at beginning of quarter $ 15,366 $ 8,899
New indemnifications 879 682
Less indemnified loans sold, repaid or refinanced - 117
Loans indemnified by PFSI at end of quarter $ 16,245 $ 9,464
Repurchase activity:
Total loans repurchased by PFSI $ 16,282 $ 4,064 Less:
Loans repurchased by correspondent lenders 6,153 2,920 Loans repaid by borrowers or resold with defects resolved 1,446 907 Net loans repurchased with losses chargeable to liability for representations and warranties$ 8,683 $ 237
Net losses charged to liability for representations and warranties
$ 280 $ 30
At end of quarter:
Unpaid principal balance of loans subject to
representations and warranties $ 186,517,598 $ 133,698,782
Liability for representations and warranties $ 23,202 $ 17,982 During the quarter ended
The level of the liability for losses under representations and warranties is difficult to estimate and requires considerable judgment. The level of loan repurchase losses is dependent on economic factors, purchaser or insurer loss mitigation strategies, and other external conditions that may change over the lives of the underlying loans. Our estimate of the liability for representations and warranties is developed by our credit administration staff and approved by our senior management credit committee which includes our senior executives and senior management in our loan production, loan servicing and credit risk management areas.
Our representations and warranties are generally not subject to stated limits of exposure. However, we believe that the current UPB of mortgage loans sold by us and subject to representation and warranty liability to date represents the maximum exposure to repurchases related to representations and warranties.
Loan origination fees
Loan origination fees increased
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Fulfillment fees from PennyMac Mortgage Investment Trust
Fulfillment fees from PMT represent fees we collect for services we perform on behalf of PMT in connection with the acquisition, packaging and sale of loans. The fulfillment fees are calculated as a percentage of the UPB of the loans we fulfill for PMT.
Following is a summary of our fulfillment fees:
Quarter ended March 31,
2020 2019
(in thousands)
Fulfillment fee revenue $ 41,940 $ 27,574 Unpaid principal balance of loans fulfilled subject to fulfillment fees
$ 16,152,543 $ 8,135,552 Average fulfillment fee rate (in basis points) 26 34
Fulfillment fees increased
Net Loan Servicing Fees
Following is a summary of our net loan servicing fees:
Quarter ended March 31,
2020 2019
(in thousands)
Net loan servicing fees:
Loan servicing fees:
From non-affiliates $ 198,653 $ 166,790
From PennyMac Mortgage Investment Trust 14,521 10,570
Other 28,755 22,017
241,929 199,377
Change in fair value of mortgage servicing rights, mortgage servicing liabilities and excess servicing spread financing net of hedging results
15,879 (118,806)
Net loan servicing fees $ 257,808 $ 80,571
Average loan servicing portfolio $ 377,294,965 $ 308,212,285
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Change in fair value of mortgage servicing rights and excess servicing spread
are summarized below:
Quarter ended March 31,
2020 2019
(in thousands)
Realization of cash flows $ (114,919) $ (92,475)
Other changes in fair value of mortgage servicing
rights and mortgage servicing liabilities (920,294) (164,939)
Change in fair value of excess servicing spread 14,522 4,051
Hedging results 1,036,570 134,557
Total change in fair value of mortgage servicing
rights, mortgage servicing liabilities and excess
servicing spread financing net of hedging results $ 15,879 $ (118,806)
Average balances:
Mortgage servicing rights $ 2,562,205 $ 2,843,028
Mortgage servicing liabilities $ 29,384 $ 8,188
Excess servicing spread financing $ 169,195 $ 211,661
At quarter end:
Mortgage servicing rights $ 2,193,697 $ 2,905,090
Mortgage servicing liabilities $ 29,761 $ 7,844
Excess servicing spread financing $ 157,109 $ 205,081 Following is a summary of our loan servicing portfolio:
March 31, December 31,
2020 2019
(in thousands)
Loans serviced
Prime servicing:
Owned:
Mortgage servicing rights
Originated $ 173,171,678 $ 166,188,825
Acquired 58,312,483 59,598,279
231,484,161 225,787,104
Mortgage servicing liabilities 2,635,734 2,758,454
Loans held for sale 5,276,688 4,724,006
239,396,583 233,269,564
Subserviced for PMT 144,734,874 135,288,944
Total prime servicing 384,131,457 368,558,508
Special servicing for PMT 95,169 125,724
Total loans serviced $ 384,226,626 $ 368,684,232 Net loan servicing fees increased
As discussed above, the decreasing interest rate environment, along with
expectations of higher costs to service loans in the coming months and increased
returns demanded by market participants in response to the uncertainties created
by the Pandemic, resulted in a 36% reduction in fair value (as measured by the
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There can be no assurance that our hedging activities will continue to perform in a like manner in the future. As discussed above, we expect the effects of the Pandemic and the requirements of the CARES Act to reduce our servicing income and to increase our servicing expenses due to the increased number of delinquent loans, and significant levels of forbearance that we have and continue to grant, as well as the resolution of loans that we expect to ultimately default as the result of the Pandemic.
Net Interest Income
Net interest income decreased
· increases in interest expense on repurchase agreements, reflecting the
expiration of a master repurchase agreement in August 2019 that provided us
with incentives to finance mortgage loans approved for satisfying certain
consumer relief characteristics as provided in the agreement. We recorded $9.3
million of such incentives as reductions in Interest expense during the quarter
ended March 31, 2019 . An increase in average borrowing balances during the
quarter ended March 31, 2020 to fund a higher volume of loan inventory compared
to the same period in 2019 also contributed to the increase in the interest
expense; and
· increases in interest shortfall on repayments of loans serviced for Agency
securitizations, reflecting increased loan payoffs as a result of the lower
interest rates in 2020 as compared to 2019, partially offset by;
· increases in interest income on loans held for sale due to larger average loan
inventory balances during the quarter ended March 31, 2020 as compared to 2019.
Management fees and Carried Interest
Management fees and Carried Interest are summarized below:
Quarter ended March 31,
2020 2019
(in thousands)
Management fees:
PennyMac Mortgage Investment Trust:
Base management $ 9,055 $ 6,109
Performance incentive - 1,139
$ 9,055 $ 7,248
Net assets of PMT at end of quarter $ 1,823,368 $ 1,727,589 Management fees increased
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Expenses
Compensation
Our compensation expense is summarized below:
Quarter ended March 31,
2020 2019
(in thousands)
Salaries and wages $ 89,315 $ 67,058
Incentive compensation 45,981 19,175
Taxes and benefits 20,772 15,836
Stock and unit-based compensation 12,368 4,531
$ 168,436 $ 106,600
Head count:
Average 4,289 3,461
Quarter end 4,458 3,459
Compensation expense increased
Loan origination
Loan origination expense increased
Servicing
Servicing expenses increased
compared to
The EBO program reduces the ongoing cost of servicing defaulted loans that have
been sold into Ginnie Mae MBS when we purchase and either sell the defaulted
loans or finance them with debt at interest rates below the Ginnie Mae MBS
pass-through rates. While the EBO program reduces the ultimate cost of servicing
such loan pools, it results in loss recognition when the loans are purchased. We
recognize the loss because purchasing the mortgage loans from their
Provision for Income Taxes
Our effective income tax rate was 26.2% during the quarter ended
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