PennyMac Financial Services, Inc. Reports First Quarter 2018 Results

PennyMac Financial Services, Inc. (NYSE: PFSI) today reported net income of $66.9 million for the first quarter of 2018, on revenue of $238.2 million. Net income attributable to PFSI common stockholders was $16.6 million, or $0.67 per diluted share. Book value per share increased to $20.74, from $19.95 at December 31, 2017.

First Quarter 2018 Highlights

• Pretax income was $73.0 million, down from $121.8 million in the prior quarter; the prior quarter’s results included a $32.0 million benefit related to remeasurement of tax-related items that did not recur
  • First quarter results reflect higher mortgage rates which drove an increased earnings contribution from the servicing segment and a decrease from the production segment driven by lower production margins
• Production segment pretax income was $17.2 million, down 69 percent from the prior quarter and 64 percent from the first quarter of 2017
  • Total loan acquisitions and originations were $14.3 billion in unpaid principal balance (UPB), down 16 percent from the prior quarter and 4 percent from the first quarter of 2017
  • Correspondent government and direct lending interest rate lock commitments (IRLCs) totaled $10.9 billion in UPB, down 8 percent from the prior quarter and 2 percent from the first quarter of 2017
• Servicing segment pretax income was $54.9 million, up 71 percent from the prior quarter and 309 percent from the first quarter of 2017
  • Servicing segment pretax income excluding valuation-related changes was $36.3 million, up 29 percent from the prior quarter and 63 percent from the first quarter of 20171
  • Completed previously announced acquisition of a bulk portfolio of Ginnie Mae and conventional conforming mortgage servicing rights (MSRs) with UPB of $3.2 billion
  • Servicing portfolio grew to $255.3 billion in UPB, up 4 percent from December 31, 2017, and 26 percent from March 31, 2017
• Investment Management segment pretax income was $1.0 million, down from $1.5 million in the prior quarter and $1.1 million in the first quarter of 2017
  • Net assets under management were $1.5 billion, down 2 percent from December 31, 2017, and 1 percent from March 31, 2017
• Issued $650 million of 5-year term notes at attractive rates under Ginnie Mae MSR financing structure, refinancing $400 million of 3-year term notes issued in February 2017

“We had good results in a challenging market environment,” said President and CEO David Spector. “Our earnings were driven by strong performance in our servicing segment. We expect this segment to continue to be a larger contributor to PennyMac Financial’s earnings and to benefit from higher interest rates and the continued growth of our loan servicing portfolio. The earnings contribution of our production segment decreased significantly, driven by heightened competition among originators and aggregators as market participants lowered margins to fill their existing operational capacity. Another influencing factor was our desire to deploy capital into additional investments in mortgage servicing rights.”

The following table presents the contribution of PennyMac Financial’s Production, Servicing and Investment Management segments to pretax income:

Production Segment

Production includes the correspondent acquisition of newly originated government-insured mortgage loans for PennyMac Financial’s own account, fulfillment services on behalf of PennyMac Mortgage Investment Trust (NYSE: PMT) and direct lending through the consumer direct and broker direct channels.

PennyMac Financial’s loan production activity for the quarter totaled $14.3 billion in UPB, of which $10.1 billion in UPB was for its own account, and $4.2 billion in UPB was fee-based fulfillment activity for PMT. Correspondent government and direct lending IRLCs totaled $10.9 billion in UPB.

Production segment pretax income was $17.2 million, a decrease of 69 percent from the prior quarter and 64 percent from the first quarter of 2017. Production revenue totaled $85.2 million, a decrease of 35 percent from the prior quarter and 23 percent from the first quarter of 2017. The quarter-over-quarter change resulted from a $32.5 million decrease in net gains on mortgage loans held for sale, driven by lower margins from higher mortgage rates and heightened competition among industry participants.

The components of net gains on mortgage loans held for sale are detailed in the following table:

PennyMac Financial performs fulfillment services for conventional conforming loans acquired by PMT in its correspondent production business. These services include, but are not limited to: marketing; relationship management; the approval of correspondent sellers and the ongoing monitoring of their performance; reviewing loan data, documentation and appraisals to assess loan quality and risk; pricing; hedging and activities related to the subsequent sale and securitization of loans in the secondary mortgage markets for PMT. Fees earned from the fulfillment of correspondent loans on behalf of PMT totaled $11.9 million in the first quarter, down 38 percent from the prior quarter and 28 percent from the first quarter of 2017. The decrease in fulfillment fee revenue was driven by lower acquisition volumes by PMT and a reduction in the weighted average fulfillment fee, reflective of the more competitive market environment. For the first quarter, the weighted average fulfillment fee rate was 28 basis points, down from 33 basis points in the prior quarter.

Production segment expenses were $68.0 million, a 10 percent decrease from the prior quarter and a 9 percent increase from the first quarter of 2017. The quarter-over-quarter decrease was primarily driven by reductions in incentive-based compensation and corporate overhead, which is allocated across segments based upon their relative profitability.

Servicing Segment

Servicing includes income from owned MSRs, subservicing and special servicing activities. Servicing segment pretax income was $54.9 million compared with $32.0 million in the prior quarter and $13.4 million in the first quarter of 2017. Servicing segment revenues totaled $146.1 million, an increase of 13 percent from the prior quarter and 64 percent from the first quarter of 2017. The quarter-over-quarter increase was primarily due to an increase in net loan servicing fees, driven by MSR fair value gains resulting from the sharp rise in interest rates during the first quarter, net of hedge results, and an elevated level of revenue related to the reperformance of government-insured and guaranteed loans bought out of Ginnie Mae pools in prior periods.

Net loan servicing fees totaled $116.8 million and included $160.7 million in servicing fees reduced by $61.2 million in realization of MSR cash flows. Valuation-related gains totaled $17.3 million, which includes MSR fair value gains of $127.8 million, associated hedging losses of $103.6 million and changes in fair value of the excess servicing spread (ESS) liability resulting in a $6.9 million loss. The MSR fair value gains resulted from expectations for lower prepayment activity in the future due to higher mortgage rates. Before January 1, 2018, PennyMac Financial carried the majority of its MSRs at the lower of amortized cost or fair value. Beginning January 1, 2018, the Company elected to account for all MSRs at fair value prospectively.

The following table presents a breakdown of net loan servicing fees:

Servicing segment revenue also included $35.2 million in net gains on mortgage loans held for sale from the securitization of reperforming government-insured and guaranteed loans, compared with $29.9 million in the prior quarter and $24.1 million in the first quarter of 2017. These loans were previously purchased out of Ginnie Mae securitizations as early buyout loans (EBO) and brought back to performing status through PennyMac Financial’s successful servicing efforts, primarily with the use of loan modifications. Net interest expense totaled $6.3 million, a decrease of 24 percent from the prior quarter and 36 percent from the first quarter of 2017. Interest income increased by $3.8 million from the prior quarter, driven by growth in capitalized interest resulting from higher modifications of EBO loans during the quarter. Interest expense increased by $1.8 million from the prior quarter, driven by the accelerated recognition of costs related to the refinancing of MSR-backed term notes.

Servicing segment expenses totaled $91.3 million, a 6 percent decrease from the prior quarter and a 21 percent increase from the first quarter of 2017. The quarter-over-quarter decrease was driven by a reduction in expenses related to the buyout of defaulted government loans from securitizations and a reversal in the provision for credit losses from improved loan performance.

The total servicing portfolio reached $255.3 billion in UPB at March 31, 2018, an increase of 4 percent from the prior quarter end and 26 percent from a year earlier. Servicing portfolio growth during the quarter was driven by the Company’s loan production activities, supplemented by a $3.2 billion UPB bulk portfolio acquisition. Of the total servicing portfolio, prime servicing was $254.4 billion in UPB and special servicing was $0.9 billion in UPB. PennyMac Financial subservices and conducts special servicing for $77.5 billion in UPB, an increase of 3 percent from December 31, 2017. PennyMac Financial’s owned MSR portfolio grew to $173.5 billion in UPB, an increase of 4 percent from the prior quarter end.

The table below details PennyMac Financial’s servicing portfolio UPB:

Investment Management Segment

PennyMac Financial manages PMT and two private Investment Funds for which it earns base management fees and may earn incentive compensation. Net assets under management were $1.5 billion as of March 31, 2018, down 2 percent from December 31, 2017, and 1 percent from March 31, 2017.

Pretax income for the Investment Management segment was $1.0 million, compared with $1.5 million in the prior quarter and $1.1 million in the first quarter of 2017. Management fees, which include base management fees from PMT and the private Investment Funds, decreased 4 percent from the prior quarter and increased 7 percent from the first quarter of 2017. No incentive fee was paid by PMT during the quarter, consistent with the prior quarter and the first quarter of 2017.

The following table presents a breakdown of management fees and carried interest:

Investment Management segment expenses totaled $5.9 million, an increase of 34 percent from the prior quarter and 39 percent from the first quarter of 2017, primarily due to a change in accounting for expenses reimbursed by PMT under the Company’s management agreement with PMT. Beginning January 1, 2018, PennyMac Financial is required to include such expense reimbursements in its net revenue and the expenses reimbursed in its expenses. Previously, PennyMac Financial accounted for such reimbursements as reductions to its expenses.

Consolidated Expenses

Total expenses for the first quarter were $165.2 million, a 7 percent decrease from the prior quarter and a 16 percent increase from the first quarter of 2017. The quarter-over-quarter decrease was driven by lower total expenses in the production and servicing segments.

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Executive Chairman Stanford L. Kurland concluded, “The mortgage origination market is in a period of significant transition, with interest rates increasing meaningfully from the end of last year, resulting in a reduction of refinancing volumes. As the market continues to normalize, we believe PennyMac Financial is positioned to perform well as a result of our comprehensive mortgage banking platform and leading production and servicing businesses. We continue to pursue opportunities that are expected to help us grow. These include growth in our consumer direct channel and our recently launched broker channel. We also are focused on the expansion of our product menu to better serve our customers and drive additional volume, including a re-emphasis on jumbo loans and developing loan products to help borrowers access home equity. Technology is the foundation for these initiatives. We are investing in technology to drive greater efficiencies, while at the same time focusing on continually improving interaction with our customers to ensure the successful execution of our growth strategies and our ability to deliver strong profitability into the future.”

Management’s slide presentation will be available in the Investor Relations section of the Company’s website at www.ir.pennymacfinancial.com beginning at 1:30 p.m. (Pacific Daylight Time) on Thursday, May 3, 2018.

About PennyMac Financial Services, Inc.

PennyMac Financial Services, Inc. is a specialty financial services firm with a comprehensive mortgage platform and integrated business focused on the production and servicing of U.S. mortgage loans and the management of investments related to the U.S. mortgage market. PennyMac Financial Services, Inc. trades on the New York Stock Exchange under the symbol “PFSI.” Additional information about PennyMac Financial Services, Inc. is available at www.ir.pennymacfinancial.com.

This press release contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, regarding management’s beliefs, estimates, projections and assumptions with respect to, among other things, the Company’s financial results, future operations, business plans and investment strategies, as well as industry and market conditions, all of which are subject to change. Words like “believe,” “expect,” “anticipate,” “promise,” “plan,” and other expressions or words of similar meanings, as well as future or conditional verbs such as “will,” “would,” “should,” “could,” or “may” are generally intended to identify forward-looking statements. Actual results and operations for any future period may vary materially from those projected herein and from past results discussed herein. Factors which could cause actual results to differ materially from historical results or those anticipated include, but are not limited to: the continually changing federal, state and local laws and regulations applicable to the highly regulated industry in which we operate; lawsuits or governmental actions that may result from any noncompliance with the laws and regulations applicable to our businesses; the mortgage lending and servicing-related regulations promulgated by the Consumer Financial Protection Bureau and its enforcement of these regulations; our dependence on U.S. government-sponsored entities and changes in their current roles or their guarantees or guidelines; changes to government mortgage modification programs; the licensing and operational requirements of states and other jurisdictions applicable to the Company’s businesses, to which our bank competitors are not subject; foreclosure delays and changes in foreclosure practices; certain banking regulations that may limit our business activities; our dependence on the multifamily and commercial real estate sectors for future originations of commercial mortgage loans and other commercial real estate related loans; changes in macroeconomic and U.S. real estate market conditions; difficulties inherent in growing loan production volume; difficulties inherent in adjusting the size of our operations to reflect changes in business levels; purchase opportunities for mortgage servicing rights and our success in winning bids; changes in prevailing interest rates; increases in loan delinquencies and defaults; our reliance on PennyMac Mortgage Investment Trust (NYSE: PMT) as a significant source of financing for, and revenue related to, our mortgage banking business; any required additional capital and liquidity to support business growth that may not be available on acceptable terms, if at all; our obligation to indemnify third-party purchasers or repurchase loans if loans that we originate, acquire, service or assist in the fulfillment of, fail to meet certain criteria or characteristics or under other circumstances; our obligation to indemnify PMT and the Investment Funds if its services fail to meet certain criteria or characteristics or under other circumstances; decreases in the returns on the assets that we select and manage for our clients, and our resulting management and incentive fees; the extensive amount of regulation applicable to our investment management segment; conflicts of interest in allocating our services and investment opportunities among us and our advised entities; the effect of public opinion on our reputation; our recent growth; our ability to effectively identify, manage, monitor and mitigate financial risks; our initiation of new business activities or investment strategies or expansion of existing business activities or investment strategies; our ability to detect misconduct and fraud; our ability to mitigate cybersecurity risks and cyber incidents; our exposure to risks of loss with real estate investments resulting from adverse weather conditions and man-made or natural disasters; and our organizational structure and certain requirements in our charter documents. You should not place undue reliance on any forward- looking statement and should consider all of the uncertainties and risks described above, as well as those more fully discussed in reports and other documents filed by the Company with the Securities and Exchange Commission from time to time. The Company undertakes no obligation to publicly update or revise any forward-looking statements or any other information contained herein, and the statements made in this press release are current as of the date of this release only.

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