There haven't been many bright spots for investors in the financial sector during the COVID-19 crisis, but some companies have managed to prosper. One of them is PennyMac Financial Services (PFSI -6.38%), a mortgage lender and servicer.
The company has posted a year-to-date return of 23% through June 17, which beats the S&P 500 and the average return in the financial sector. Of course, investors want to know if this is a short-term blip fueled by stimulus or other factors, or if PennyMac is a solid long-term buy. Let's take a look.
PennyMac posts record earnings in Q1
PennyMac is coming off a strong first quarter where it posted record earnings of $3.73 per share, up from $0.59 per share in the first quarter of 2019, on $721 million in revenue and $306 million in net income. Also, PennyMac serviced $384 billion in loans in the first quarter, up 18% year over year.
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This was driven by two major forces -- low interest rates and the Federal Reserve's asset-purchasing program to pump liquidity into the mortgage market. This led to an increase in new mortgage loans.
Mortgage origination volume spiked to $35.4 billion, a jump of 113% from the first quarter of 2019. The company's book value increased 14% in the quarter to $29.85 per share. It has also led to an increase in mortgage refinancings, which should continue as interest rates stay low.
Mortgage servicing challenges
However, the COVID-19 crisis has created some challenges for mortgage servicers, which handle the administrative side of residential mortgage loans. Due to the hardships caused by the pandemic, the federal government granted forbearance to people who couldn't pay their mortgages due to job loss or reduction in income. Since servicers make money on fees, those fees aren't paid when payments aren't made. Plus, it costs more to service the loans when there are missed payments. In addition, mortgage servicers are required to advance taxes and insurance on these loans, while some even have to front principal and interest payments, which is a further drain.
What has set PennyMac apart from its competitors is its strong capital position. It had to make $260 million in advances as of April 30 but still had $1.4 billion in available liquidity, plus another $600 million with Credit Suisse to tap into for advances. Many of its competitors don't have that type of liquidity to navigate this crisis.
"PFSI's strong balance sheet, low leverage and disciplined approach to liquidity management have been critically important in this market environment. And our strong risk management discipline has resulted in an increase in our total liquidity since February," PennyMac's president and CEO, David Spector, said on the first-quarter earnings call.
Is PennyMac a buy?
With interest rates expected to remain low for the next two years, at least, PennyMac should expect to see an increase in refinancings and loan originations.
With PennyMac's excellent liquidity, it should be able to navigate the downside risk of the current market environment better than most. Forbearance and nonpayments will still present a challenge on the servicing front over these next few quarters, but with state economies opening back up, it should not be as big of a potential drag on earnings. Plus, the stock has a very low valuation, trading at about 5.2 times earnings. Add it all up and PennyMac is a good, solid buy right now -- particularly for those looking to add a financial stock to their portfolio.
