Cautionary Note 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
PennyMac Financial Services, Inc.("PFSI") included within this Quarterly Report on Form 10-Q. 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 section entitled "Risk Factors" in Part II Item 1A and in our Annual Report on Form 10-K, 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 SEC. The forward-looking statements contained in this Quarterly Report on Form 10-Q are made as of the date hereof and we assume no obligation to update or supplement any forward-looking statements.
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.
We are a specialty financial services firm primarily focused on the production and servicing of
U.S.residential mortgage loans (activities which we refer to as mortgage banking) and the management of investments related to the U.S.mortgage market. We believe that our operating capabilities, specialized expertise, access to long-term investment capital, and our management's experience across all aspects of the mortgage business will allow us to profitably engage in these activities and capitalize on other related opportunities as they arise in the future. Our primary assets are direct and indirect equity interests in Private National Mortgage Acceptance Company, LLC("PNMAC"). We are the managing member of PNMAC, and we operate and control all of the businesses and affairs of PNMAC, and consolidate the financial results of PNMACand its subsidiaries. We conduct our business in three segments: production, servicing (together, production and servicing comprise our mortgage banking activities) and investment management.
? The production segment carries out lending, acquisition and sale
The Servicing segment performs loan servicing for both newly originated loans
? that we hold for sale and loans that we service for others, including PennyMac
The Investment Management segment represents our investment management
? Activities, which includes the activities related to fixed assets
Acquisitions and dispositions such as sourcing, due diligence, negotiation and
Our principal mortgage banking subsidiary,
PennyMac Loan Services, LLC("PLS"), is a non-bank producer and servicer of mortgage loans in the United States. PLS is a seller/servicer for the Federal National Mortgage Association ("Fannie Mae") and the Federal Home Loan Mortgage Corporation ("Freddie Mac"), each of which is a government-sponsored entity. PLS is also an approved issuer of securities guaranteed by the Government National Mortgage Association("Ginnie Mae"), a lender of the Federal Housing Administration("FHA"), and a lender/servicer of the Veterans Administration("VA") and the U.S. Department of Agriculture("USDA"). We refer to each of Fannie Mae, Freddie Mac, Ginnie Mae, FHA, VAand USDAas an "Agency" and collectively as the "Agencies." PLS is able to service loans in all 50 states, the District of Columbia, Guamand the U.S. Virgin Islands, and originate loans in 49 states and the District of Columbia, either because PLS is properly licensed in a particular jurisdiction or exempt or otherwise not required to be licensed in that jurisdiction. 57
Our investment management subsidiary is
PNMAC Capital Management, LLC("PCM"), a Delawarelimited liability company registered with the SECas an investment adviser under the Investment Advisers Act of 1940, as amended. PCM has an investment management contract with PMT, a mortgage real estate investment trust listed on the New York Stock Exchangeunder the ticker symbol "PMT".
Our results of operations are summarized below:
Quarter ended March 31, 2022 2021 (dollars in thousands, except per share amounts) Revenues: Net gains on loans held for sale at fair value $ 298,459 $ 754,341 Loan origination fees 67,858 104,037 Fulfillment fees from
PennyMac Mortgage InvestmentTrust 16,754 60,835 Net loan servicing fees 286,309 39,720 Net interest expense (23,425) (25,632) Management fees 8,117 8,449 Other 3,432 2,936 Total net revenues 657,504 944,686 Expenses: Compensation 245,547 258,829 Loan origination 75,333 87,392 Technology 34,786 33,672 Servicing (1,246) 19,183 Other 68,564 39,602 Total expenses 422,984 438,678 Income before provision for income taxes 234,520 506,008 Provision for income taxes 60,927 129,140 Net income $ 173,593 $ 376,868 Earnings per share Basic $ 3.11 $ 5.45 Diluted $ 2.94 $ 5.15 Annualized return on average stockholders' equity 20.4% 43.4% Dividend declared per share $ 0.20 $ 0.20 Income before provision for income taxes by segment: Mortgage banking: Production $ 9,775 $ 362,895 Servicing 224,647 141,744 Total mortgage banking 234,422 504,639 Investment management 98 1,369 $ 234,520 $ 506,008 Adjusted Earnings Before Interest, Taxes, Depreciation and Amortization ("EBITDA") (1) $ 168,043 $ 674,308 During the quarter: Interest rate lock commitments issued $ 25,125,503 $ 36,118,713 At end of quarter: Interest rate lock commitments outstanding $ 10,397,958 $ 17,668,145 Unpaid principal balance of loan servicing portfolio: Owned: Mortgage servicing rights and liabilities $ 290,797,891 $ 247,541,723 Loans held for sale 5,125,298 12,959,016 295,923,189 260,500,739 Subserviced for PMT 222,887,371 188,324,162 $ 518,810,560 $ 448,824,901 Net assets of PennyMac Mortgage Investment Trust $ 2,221,938 $ 2,357,143 Book value per share $ 62.19 $ 51.78
To provide investors with information in addition to our results
determined by generally accepted accounting principles in
(“GAAP”), we disclose Adjusted EBITDA as a non-GAAP measure. Adjusted EBITDA (1) is a metric commonly used in our industry to measure performance
and we believe this action provides additional information
useful for investors. Adjusted EBITDA is not a financial measure calculated in
in accordance with GAAP and should not be considered a substitute for net
Income or any other performance measure calculated under GAAP.
58 Table of Contents
We define "Adjusted EBITDA" as net income plus provision for income taxes, depreciation and amortization, excluding decrease (increase) in fair value of mortgage servicing rights ("MSRs") net of mortgage servicing liabilities ("MSLs"), due to changes in the valuation inputs we use in our valuation models, increase (decrease) in fair value of excess servicing spread ("ESS") payable to PMT, hedging losses (gains) associated with MSRs, stock-based compensation and interest expense on corporate debt or corporate revolving credit facilities and capital lease. We believe that the presentation of Adjusted EBITDA provides useful information to investors regarding our results of operations because each measure assists both investors and management in analyzing and benchmarking the performance and value of our business. However, other companies may define Adjusted EBITDA differently, and as a result, our measures of Adjusted EBITDA may not be directly comparable to those of other companies.
Adjusted EBITDA measures have limitations as an analytical tool and should not be viewed in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are:
a) They do not reflect all cash expenditures, future capital needs
expenses or contractual obligations;
b) they do not reflect significant interest expense or liquidity needs
necessary to make interest or principal payments on our debts; and
c) they are not adjusted for any non-cash income or expenses
reflected in our consolidated cash flow statement.
Because of these limitations, Adjusted EBITDA measures are not intended as an alternative to net income as an indicator of our operating performance and should not be considered as measures of cash available to us to invest in the growth of our business or measures of cash that are available to us are available to us to fulfill our obligations.
The following table shows a reconciliation of Adjusted EBITDA to Net Income, the most directly comparable financial measure calculated and presented in accordance with GAAP, for each of the periods presented:
Quarter ended March 31, 2022 2021 (in thousands) Net income
$ 173,593 $ 376,868Provision for income taxes 60,927 129,140 Income before provisions for income taxes 234,520 506,008 Depreciation and amortization
7,011 7,632 Increase in fair value of MSRs less MSLs due to changes in valuation inputs used in valuation models
(324,066) (306,126) Fair value increase of ESS payable to PennyMac Mortgage Investment Trust
- 1,037 Hedging losses associated with MSRs 217,860 442,151 Stockbased compensation
9,275 10,877 Interest expense on corporate debt or corporate revolving credit facilities and finance leases
23,443 12,729 Adjusted EBITDA
$ 168,043 $ 674,30859 Table of Contents Business Trends
Due to significant inflationary pressures, the
U.S. Federal Reserveraised the Federal Funds rate in the first quarter of 2022 and is expected to continue to raise interest rates through the year as well as reduce the federal government's overall portfolio of Treasuryand mortgage-backed securities. These resulting mortgage interest rate increases are expected to drive a decline in the size of the mortgage origination market from an estimated $4.4 trillionin 2021 to a current forecast range from $2.6 trillionto $3.1 trillionfor 2022 according to leading economists. These lower overall projected mortgage transaction volumes and higher interest rates are expected to drive a decrease in our mortgage production activities and increase competition in the mortgage production business year over year, while also leading to declines in prepayment speeds in our mortgage servicing portfolio from the elevated levels experienced in 2021. We expect to reduce business expenses to align with the lower projected mortgage production activities for the remainder of the year.
Income before provisions for income taxes
For the quarter ended
March 31, 2022, income before provision for income taxes decreased $271.5 millioncompared to the same period in 2021. The decrease was primarily due to a $455.9 milliondecrease in Net gains on loans held for sale at fair value, a $36.2 milliondecrease in Loan origination fees and a $44.1 millionin fulfillment fees from PMT due to lower production volume and gain on sale margins during the quarter ended March 31, 2022compared to the same period in 2021, partially offset by a $246.6 millionincrease in Net loan servicing fees reflecting improved hedging results.
In our production segment, revenues reflect effects of increasing interest rates on both demand for mortgage loans and gain on sale margins during the quarter ended
March 31, 2022compared to the strong demand due to the historically low interest rate environment that prevailed during the same period in 2021. During the quarter ended March 31, 2022, we recognized Net gains on loans held for sale at fair value totaling $298.5 million, a decrease of $455.9 millioncompared to the same period in 2021. The decrease was primarily due to a lower production volume, lower gain on sale margins across all production channels and a decrease in redelivery gains as a result of lower EBO loan volume and modifications during the quarter ended March 31, 2022compared to the same
period in 2021. 60 Table of Contents
Our net gains on loans held for sale are summarized below:
Quarter ended March 31, 2022 2021 (in thousands) From non-affiliates: Cash gains: Loans
$ (944,221) $ 82,712Hedging activities 890,087 736,225 Total cash gains (54,134) 818,937 Non-cash gains: Change in fair value of loans and derivative financial instruments outstanding at end of quarter: Interest rate lock commitments (284,294)
(339,086) Loans 220,430 105,222 Hedging derivatives (189,308) (273,687) (253,172) (507,551) Mortgage servicing rights and mortgage servicing liabilities resulting from loan sales 616,302
Provision for losses related to representations and warranties: In accordance with loan sales
Reductions in liability due to change in estimate 3,169 3,685 Total non-cash gains 362,245
Total gains on sale from non-affiliates 308,111
From PennyMac Mortgage Investment Trust (primarily cash) (9,652)
$ 298,459 $ 754,341During the quarter: Interest rate lock commitments issued: By loan type: Government-insured or guaranteed mortgage loans $ 17,133,215 $ 25,146,879Conventional conforming mortgage loans 7,974,275
10,971,834 Jumbo mortgage loans 18,013 -
$ 25,125,503 $ 36,118,713By production channel: Consumer direct $ 9,111,513 $ 13,384,216Broker direct 3,526,629 5,670,798 Correspondent 12,487,361 17,063,699 $ 25,125,503 $ 36,118,713At end of quarter:
Loans held for sale at fair value
$ 5,119,234 $ 13,385,789Commitments to fund and purchase loans $ 10,397,958
$ 17,668,14561 Table of Contents
Non-cash elements of gain on sale of loans held for sale
Our gains on loans held for sale include both cash and non-cash elements. We recognize a significant portion of our gains on loans held for sale when we make commitments to purchase or fund mortgage loans. We recognize this gain in the form of interest rate lock commitments ("IRLC"). We adjust our initial gain amount as the loan purchase or origination process progresses until the loan is either funded or cancelled. We also receive non-cash proceeds on sale that include our estimate of the fair value of MSRs and we incur liabilities for mortgage servicing liabilities (which represent the fair value of the costs we expect to incur in excess of the fees we receive for the early buyout of delinquent loans ("EBO loans") we have resold to third party investors) and for the fair value of our estimate of the losses we expect to incur relating to the representations and warranties we provide in our loan sale transactions. 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 206% of our gain on sale of loans held for sale at fair value for the quarter ended
March 31, 2022, as compared to 61% for the quarter ended March 31, 2021. These estimates change as circumstances change and changes in these estimates are recognized in income in subsequent periods. Subsequent changes in the fair value of our MSRs significantly affect our results of operations.
Fixed-interest obligations, mortgage servicing rights and mortgage servicing liabilities
The methods and key inputs we use to measure and update our measurements of IRLCs, MSRs and MSLs are detailed in Note 6 - Fair value - Valuation Techniques and Inputs to the consolidated financial statements included in this Quarterly Report.
Representations and Warranties
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 losses on the loans. Our credit losses 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. Our representations and warranties are generally not subject to stated limits of exposure. However, we believe that the current unpaid principal balance ("UPB") of loans sold by us and subject to representation and warranty liability to date represents the maximum exposure to repurchases related to representations and warranties. 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. 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. 62
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
$4.1 millionfor the quarter ended March 31, 2022compared to $10.1 millionfor the quarter ended March 31, 2021. The decrease in the provision relating to current loan sales is primarily attributable to a reduction in loan sales. We also recorded reductions in the liability of $3.2 millionduring the quarter ended March 31, 2022compared to $3.7 millionduring the quarter ended March 31, 2021. The reductions in the liability resulted from previously sold loans meeting performance criteria established by the Agencies which significantly limit the likelihood of certain repurchase or indemnification claims.
Below is a summary of loan buyback activity and RPs of loans subject to representations and warranties:
March 31, 20222021 (in thousands) During the quarter: Indemnification activity:
Loans indemnified at beginning of quarter
$ 15,079 $ 13,788New indemnifications 5,641
Less indemnified loans sold, repaid or refinanced 779
Loans indemnified at end of quarter
$ 14,239Repurchase activity: Total loans repurchased $ 17,529 $ 17,986Less:
Loans repurchased by correspondent lenders 7,458
Loans repaid by borrowers or resold with defects resolved 5,496
Net loans repurchased with losses chargeable to liability for representations and warranties
Losses attributed to liability for representations and warranties
At end of quarter: Unpaid principal balance of loans subject to representations and warranties
$ 271,146,169 $ 220,865,034Liability for representations and warranties $ 42,794
During the quarter ended
March 31, 2022, we repurchased loans totaling $17.5 million. We recorded losses of $1.6 millionnet of recoveries during the quarter ended March 31, 2022. If the outstanding balance of loans we purchase and sell subject to representations and warranties increases, the loans sold continue to season, economic conditions change, correspondent lenders become unwilling or unable to repurchase defective loans, or investor and insurer loss mitigation strategies are adjusted, the level of repurchase and loss activity may increase.
Loan origination fees decreased
$36.2 millionduring the quarter ended March 31, 2022compared to the same period in 2021. The decreases were primarily due to a decrease in the volume of loans we produced.
PennyMac Mortgage Investment Trust Fulfillment Fees
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 were calculated based on the number of loans we fulfill for PMT.
Shipping fees have been reduced
compared to the same period in 2021. The decrease was mainly due to a decrease in lending volume.
63 Table of Contents Net Loan Servicing Fees Our net loan servicing fee income has two primary components: fees earned for servicing the loans and the effects of MSR and MSL valuation changes, net of hedging results as summarized below: Quarter ended March 31, 2022 2021 (in thousands) Loan servicing fees
$ 291,258 $ 259,445Effects of MSRs and MSLs (4,949) (219,725) Net loan servicing fees $ 286,309 $ 39,720Loan Servicing Fees
Below is a summary of our credit administration fees:
Quarter ended March 31, 2022 2021 (in thousands) Loan servicing fees: From non-affiliates
$ 244,809 $ 210,753From PennyMac Mortgage Investment Trust 21,088 19,093 Other Late charges 11,956 8,964 Other 13,405 20,635 25,361 29,599 $ 291,258 $ 259,445Average loan servicing portfolio MSRs and MSLs $ 285,217,528 $ 244,623,917Subserviced for PMT $ 221,886,632 $ 181,228,135Loan servicing fees from non-affiliates generally relate to our MSRs which are primarily related to servicing we provide for loans included in Agency securitizations. These fees are contractually established at an annualized percentage of the unpaid principal balance of the loan serviced and we collect these fees from borrower payments. Loan servicing fees from PMT are primarily related to PMT's MSRs and are established at monthly per-loan amounts based on whether the loan is a fixed-rate or adjustable-rate loan and the loan's delinquency or foreclosure status as detailed in Note 4 - Transactions with Related Parties to the consolidated financial statements included in this Report. Other loan servicing fees are comprised primarily of borrower-contracted fees such as late charges and reconveyance fees. The increases in loan servicing fees from non-affiliates and from PMT for the quarter ended March 31, 2022was primarily due to growth of our loan servicing portfolio as compared to the same period in 2021. The decreases in other loan servicing fees for the quarter ended March 31, 2022, was primarily due to decreases in fees related to borrower early loan payoffs resulting from the reduction in prepayment activity we experienced in the current rising interest rate environment as compared to the same period in 2021. 64
Mortgage Servicing Rights and Mortgage Servicing Obligations
We have elected to carry our servicing assets and liabilities at fair value. Changes in fair value have two components: changes due to realization of the contractual servicing fees and changes due to changes in market inputs used to estimate the fair value of MSRs and MSLs. We endeavor to moderate the effects of changes in fair value by entering into derivatives transactions and, until
March 2021, by financing certain of our purchases of MSRs with the sale of a portion of the MSR assets' cash flows to PMT in the form of ESS. Change in fair value of MSRs, MSLs and ESS and the related hedging results are summarized below: Quarter ended March 31, 2022 2021 (in thousands) MSR and MSL valuation changes: Realization of cash flows $ (111,155) $ (82,663)Other changes in fair value of mortgage servicing rights and mortgage servicing liabilities 324,066
Change in fair value of excess servicing spread -
Hedging results (217,860)
Total change in fair value of mortgage servicing rights, mortgage servicing liabilities and excess servicing spread financing net of hedging results
$ (4,949) $ (219,725)Average balances: Mortgage servicing rights $ 4,311,413 $ 2,931,683Mortgage servicing liabilities $ 2,679 $ 46,060Excess servicing spread financing $ - $ 87,451At end of quarter: Mortgage servicing rights $ 4,707,039 $ 3,268,910Mortgage servicing liabilities $ 2,564
Changes in realization of cash flows are influenced by changes in the level of servicing assets and liabilities and changes in estimates of the remaining cash flows to be realized. During the quarter ended
March 31, 2022, realization of cash flows increased primarily due to the growth in our investment in MSRs partially offset by a reduction in the rate at which the MSRs are expected to be realized as a result of slower prepayment expectations in 2022 as compared to 2021. Other changes in fair value of MSRs increased similarly during both the quarter ended March 31, 2022and the quarter ended March 31, 2021due to significant increases in interest rates and resulting decreases in expected future prepayment speeds in each period. Hedging results reflect valuation losses attributable to the effects of interest rate increases on the fair value of the hedging instruments during the quarters ended March 31, 2022and 2021. The loss from hedging activities decreased during the quarter ended March 31, 2022compared to the same period in 2021 primarily due to the higher hedging cost as a result of market volatility during the quarter ended March 31, 2021. 65
Below is a summary of our credit service portfolio:
March 31, December 31, 2022 2021 (in thousands) Loans serviced Prime servicing: Owned: Mortgage servicing rights and liabilities Originated
$ 268,886,759 $ 254,524,015Acquired 21,911,132 23,861,358 290,797,891 278,385,373 Loans held for sale 5,125,298 9,430,766 295,923,189 287,816,139 Subserviced for PMT 222,864,324 221,864,120 Total prime servicing 518,787,513 509,680,259
Special servicing subserviced for PMT 23,047
28,022 Total loans serviced
$ 518,810,560 $ 509,708,281Delinquencies: Owned servicing (1): 30-89 days $ 6,924,722 $ 6,943,32790 days or more 7,811,438 9,838,648 $ 14,736,160 $ 16,781,975Delinquent loans in COVID-19 pandemic-related forbearance: 30-89 days $ 1,134,056 $ 1,111,15190 days or more 2,337,820 2,732,089 $ 3,471,876 $ 3,843,240Subserviced for PMT (1): 30-89 days $ 1,213,755 $ 1,164,78290 days or more 1,199,376 1,810,910 $ 2,413,131 $ 2,975,692Delinquent loans in COVID-19 pandemic-related forbearance: 30-89 days $ 219,981 $ 171,11490 days or more 487,985 638,703 $ 707,966 $ 809,817
Includes past-due loans on COVID-19 pandemic-related forbearance plans that were (1) requested by borrowers applying for payment facilitation under the
CARES Act. Net Interest expense
Net interest expense decreased
a reduction in the placement fees we receive in connection with custody funds that we manage
? managed due to lower average deposit balances held, partially compensated
through increased earnings rates;
a reduction in interest lost on repayments of loans serviced for the agency
? Securitisations reflecting lower loan repayments as a result of the decline
borrower refinancing activity due to the higher interest rate environment;
partially offset by
? an increase in interest rates on unsecured senior notes.
66 Table of Contents
PennyMac Mortgage Investment Trust management fees
Management fees have gone down
compared to the same period in 2021. The decrease was due to the decrease in PMT’s average equity, on which base management fees are based. We have not earned any performance bonuses in the past quarters
Compensation expenses are summarized below:
Quarter ended March 31, 2022 2021 (in thousands) Salaries and wages
$ 147,144 $ 143,700Incentive compensation 54,298 72,655 Taxes and benefits 34,830 31,597 Stock and unit-based compensation 9,275 10,877 $ 245,547 $ 258,829Head count: Average 6,924 6,882 Quarter end 6,308 7,075
Compensation expenses have decreased
Loan origination expense decreased
$12.1 millionduring the quarter ended March 31, 2022compared to the same period in 2021. The decrease was primarily due to decreased lending activities during the quarter ended March 31, 2022compared to the same period during 2021. Servicing Servicing expenses decreased $20.4 millionduring the quarter ended March 31, 2022compared to the same period in 2021. This decrease in servicing expenses was primarily due to a larger reversal of the provision for estimated servicing advance losses recorded in prior periods during the quarter ended March 31, 2022. The reduction reflects the recent improvements in the performance of
our servicing portfolio. Marketing and advertising
Marketing and advertising costs increased
Working costs have increased
Provision for income taxes
Our effective income tax rate for the quarter was 26.0%
compared to 25.5% in the same period in 2021.
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