Pennymac unit grows profits on servicing, targets TPO growth

The lending and servicing arm of Pennymac made short-term progress in its bid for market share in both business lines during the first quarter, but the latter remained its profit center.

PennyMac Financial Services nearly matched its previous quarter's net income with $30 million in earnings, but its bottom line still is running below the $173.6 million recorded during the same period a year ago.

Also, its affiliated real estate investment trust (the other half of the combined Pennymac entity) reported a return to profitability. PennyMac Investment Trust generated $50 million in earnings. The REIT had reported net losses of $5.8 million and $29.6 million the previous quarter and during the same period a year earlier, respectively.

Meanwhile, PennyMac Financial Services on a pretax basis generated $57 million in servicing income and recorded an origination loss of $20 million that it attributed to the timing of revenue and expense recognition. Equivalent numbers for the previous quarter were $75.6 million and a loss of $9 million, respectively.

"Strong operating profitability in our servicing segment was partially offset by increased losses in our production segment and net fair value declines on [mortgage servicing rights] and hedges, primarily due to elevated hedge costs," Chief Financial Officer Dan Perotti said in a pre-recorded earnings call released late Thursday.

While the company took a loss on originations in the first quarter, with volumes that have remained relatively steady amid industry declines, it has a strong market share. It controls roughly 6.8% of lending overall, Keefe, Bruyette & Woods analysts estimated in a report Thursday.

Pennymac estimated based on Inside Mortgage Finance data that it was the third largest player in production during the first quarter and No. 5 in servicing last year.

Estimates for the share of the market the company held in the servicing and wholesale broker channel inched up a little on a sequential quarter basis to 4.2% and 2.2%. Its biggest gain was in its large correspondent position

The company's correspondent share rose more than two percentage points to 17.1% from 15% the previous quarter, according to company estimates. The number has likely become "meaningfully higher" since quarter-end, Perotti said. 

"Pennymac has …developed many strong relationships with purchase-focused builder-owned mortgage companies which, combined with the exit of correspondent channel participants, has driven the consistency of our acquisition volumes in recent quarters despite a much smaller origination market," Chairman and CEO David Spector said during the earnings call.

The only channel PennyMac Financial Services lost some share in was consumer-direct, where estimates fell to 0.8% from 1.1% on a consecutive-quarter basis. The company is working to boost volume in this channel going forward with low-cost leads from its servicing portfolio. It's also targeting further gains in the broker channel amid exits there.

Third-party origination channels like broker/wholesale and correspondent tend to be more effective in sourcing loans than consumer direct after rates rise. They're generally better equipped to find home purchase loans that become more prominent as refinancing fades in that environment. But thin markets in TPO business lines can be a challenge while the market still has excess capacity and is competitive.

PennyMac has reportedly been able to improve its margins in TPO channels, and between industry downsizing that's occurred and its cost controls, it appears to be in a good position to tackle that challenge, according to analysts at KBW.

"The reported gain-on-sale margin increased in the correspondent and broker channel but declined modestly in the consumer channel, likely driven by market share growth. The mortgage banking trends from the company suggest that gain-on-sale margins have likely bottomed," Bose George, Michael Smyth, Alexander Bond and Thomas McJoynt-Griffith said in the KBW report.

Meanwhile, the challenge the company faces when it comes to servicing and related financing facilities is the possibility of a recession, which could affect in particular its large position in the securitized, government-backed market. Underlying mortgages serviced in that market tend to be more vulnerable to economic stress, and borrowing facilities have been drawing more scrutiny in the wake of the recent banking crisis.

"We think the risk to earnings and valuation is higher unemployment and persistent inflation, which would drag on the outlook for credit costs in the MSR portfolio, although we see the default and severity risk being contained right now," BTIG said in a report on the company by Eric Hagen, Ethan Saghi and Jake Katsikis.

"Given our demonstrated access to liquidity and financing we feel PFSI is extraordinarily well positioned to continue executing even in a potential recessionary environment with high delinquency levels," Perotti said.