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Oil Wasn’t the Only Asset That Went to Zero in March

It isn’t exactly news, since the Ocwen (OCN) earnings call was held on May 8th, but I was only just able to make my rounds through recordings for mortgage cos this past week for those I follow. One of my favorite highlights from the calls is Glen Messina, CEO talking about current margins and the ‘cash cost of servicing’. It is at about minute 36:00 if you want to listen to it here: https://edge.media-server.com/mmc/p/nx2pnfmv Here is a transcript of the relevant part:

“In terms of the profitability of new servicing, look, margins in the origination environment we’re in today are at levels few of us have seen in our lifetime. It’s a very robust originations market, both from a volume and a margin perspective. In our portfolio retention channel, the economics are such that fundamentally, MSRs — the cash cost of the MSR is zero. So we are — that MSR has come back — coming back to us without necessarily a cash investment. And margins and correspondent lending, again, are as wide as — and our flow channel’s wide as we’ve seen them in quite a long time. So the cash cost, so to speak, of MSR creation is well below the fair value. There’s a number of dislocations in the market, as you might be able to suspect, that’s kind of driving that. But the returns on MSRs today are some of the best we’ve seen.”

Now, one of my recurring themes I will write about a lot is that servicing rights have no value, and are a liability, not an asset. To be clear, there is a big difference between what Glen is saying when he says servicing rights are worth zero, and what I mean when I say it. What Glen is talking about is that the amount of cash he can get from the government for just the mortgage loan, without selling them the servicing right, is the same or more than he can get in private transactions for both of those things together. What I am saying when I talk about servicing rights not having value and not being a real asset is that fundamentally, I don’t think the activities that comprise residential loan servicing have value, and in fact, have negative value across consumer, mortgage banker and bondholder, serving no one and yet being called servicing. Glen’s comments delight me anyway because, well maybe we are sort of saying the same thing. I can remember in 2008 when servicing also ‘went to zero’, in the Glen sense. I seem to recall a lot of residential housing stock transferred from owner-occupied to investor-owned following that. (checks watch).

Other things that stuck out as general observations to think about:

Change in carry-back rules under the CARES Act. Seem lucrative, won’t help the federal debt any. Doesn’t do much for the folks paying the servicing fee. Why can’t individuals access their own, previously paid taxes in years when their income declines? Think how that might change behavior, and leave a (thoughtful) comment.

PennyMac (PFSI) is an overachiever. At hedging.

Updating on the oil tanker trade, we had earnings and…yeah. Not too exciting. I think last week we speculated that the air was out of the trade and it seems there is confirmation. That was anticlimactic. Anyway, I have FRO through June expiry and NAT all the way to October so we shall see. I have not had opportunity to really get into a post mortem on the trade but I think what we are seeing is the same phenomenon as the futures prices for oil: another sign post saying “not a V” . This tweet from @Chigirl sums it up for me:

Finally, I will confess my failed Tilray (TLRY) trade. It was pure speculation that earnings could surprise to the upside and make the shorts feel awkward. Another air biscuit. Option premium to the gambling Gods.

Teaser to keep you coming back: I am working on a product review for a VPN service provider, Orchid, which operates on a token called OXT. My effort at diving into to the incredible ecosystem of businesses and services in the crypto space. And we’ll be taking a harder look at some residential mortgage servicing stuff.

And, for your final take-away, @PeterMcCormack has produced a ton of great #bitcoin related content, including compressing his comprehensive, 17-part series on What Bitcoin Did into a paltry hour-twenty or so minutes. It can be found here:

https://www.whatbitcoindid.com/podcast/bitcoin-in-one-lesson

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PennyMac Earnings For Breakfast

It is still May 6th, and I am still at the store. It is now about twenty minutes before seven in the evening. I want to write a few words about PennyMac and earnings tomorrow. Obviously, with my history with PennyMac and its management, my views on the company are plagued by biases. Those biases suggest the company operates at a constant deficit in human and intellectual capital which will impede even a successful strategy. And my assessment of the company’s strategy is basically this: PennyMac is not a company built to last. It is a company built on the oldest models for the purpose of exploiting the institutionalized business of mortgage banking. It exists to profit to the very fullest extent possible before the inevitable collapse of the current, anachronistic (and I would add anti-competitive, socialized risk) model of the industry. I don’t judge that as a wrong-headed thing to do. In fact, it cannot be argued against, if one looks at the financial performance of the company so far. I am saying the company is purpose-built, and that purpose is not to lead an industry into the future, but to seek the available excess rents while they exist. While one can chalk up my views of management to the bitterness of a failed work assignment, I think this strategy assessment stands up to scrutiny. If one considers the start of the company, where its money came from, what other business interests that same money had and has in and around the same industry ecosystem, who the leadership team is and what their backgrounds are, I think there is a good argument to say I am right. Time permitting, I will expound more on these questions of origin and interests.

PennyMac’s planned obsolescence is not its only weakness at this point in time and this point in the economic cycle. Or perhaps even because of its mission, it is concentrated in businesses I think are especially vulnerable to sudden disruption, by intervention or by market forces. Specifically, I am talking about correspondent lending and residential mortgage loan servicing. I view these as obviously fragile businesses that are capital intensive and valueless. Again, I will certainly be expounding on these subjects in more detail in the future. Add to these the latest developments in credit risk securities esoterica, financed with leverage, of course, and gorged on by PennyMac and I just could not be more bearish.

Still, is it enough to have conviction for a trade? No. I just don’t have enough insight to say what the trade will be for tomorrow’s earnings. I am on the sidelines, eager for a look at whatever the public docs say and don’t say. Even if I thought I had insight into financial under performance, in this climate of Fed intervention, I’m not sure it would matter. Everyone is getting a bailout if they are big enough to have lobbyists. And PennyMac minds its Washington connections.

If I could share one tradable insight, it would be this: During the first quarter founding partners of the company, acting in coordination with it, took actions as disclosed in published 8-Ks, to dis-invest about 35% of the company’s equity, transferring it to public float. People will argue that these sorts of actions get planned well in advance, and many features of the economic landscape could not have been known by the investors and management at the time the decisions were being made. My point would be that it doesn’t matter. The founders had an exit planned when they went in, and they are beginning to exit. They may be very happy/lucky that they transferred their ownership and its attendant risks to the public just as the markets were about to collapse (and arguably, just as the old model of the mortgage industry is about to disappear). Maybe it is just good fortune. But keep in mind, many sophisticated investors have been aware of the potential impacts of the coronavirus since December, or possibly November of last year. This is doubly true for investors who are well connected politically or who have global financial interests. Even putting all of the pandemic to one side, as though it never had happened, the macro-climate was already in serious distress. Fed interventions have pre-dated the coronavirus by many months. I can easily imagine that the founding investors saw the sun setting on the business model and started to execute their planned exit well before the virus. It was just time.

I don’t know how bad tomorrow’s results will be, or maybe even they will be good. But the rats are leaving the ship. It won’t be staying afloat for long.

Parting gift: another #bitcoin meme that made me laugh over and over… https://twitter.com/i/status/1258070598225408001