PennyMac Mortgage Investment Trust - Q1 2024

Transcript

Operator (participant)

Good afternoon and welcome to PennyMac Mortgage Investment Trust First Quarter Earnings Call. Additional earnings materials including the presentation slides that will be referred to in the call are available on PennyMac Mortgage Investment Trust website at pmt.pennymac.com. Before we begin, let me remind you that this call may contain forward-looking statements that are subject to certain risks identified on slide 2 of the earnings presentation that could cause the company's actual results to differ materially, as well as non-GAAP measures that have been reconciled to their GAAP equivalent in the earnings materials. Now I'd like to introduce David Spector, PennyMac Mortgage Investment Trust Chairman and Chief Executive Officer, and Dan Perotti, PennyMac Mortgage Investment Trust Chief Financial Officer.

David Spector (Chairman and CEO)

Thank you, Operator. PMT produced solid results in the first quarter with strong contributions from the credit-sensitive strategy and its correspondent production business. These results were partially offset by net fair value declines in the interest rate-sensitive strategies. Net income to common shareholders was $37 million or diluted earnings per share of $0.39. PMT's annualized return on common equity was 10%, and book value per share was $16.11 at March 31st, essentially unchanged from the end of the prior quarter. While many other mortgage REITs have been negatively impacted by increased levels of interest rate volatility in recent periods, PMT's book value per share has remained relatively comparatively stable due to its diversified portfolio and disciplined approach to hedging. Turning to the origination market, current third-party estimates for total originations in 2024 average $1.8 trillion, reflecting growth from an estimated $1.5 trillion in 2023.

However, we believe these estimates to be optimistic dependent upon multiple interest rate cuts from the Federal Reserve in the second half of the year. With current expectations for market interest rates to remain higher for longer and mortgage rates back up into the 7% range, we expect these third-party estimates will decline further from their current levels. PMT's strong financial performance in recent periods highlights the strength of the fundamentals underlying its long-term mortgage assets and our expertise managing mortgage-related investments in a challenging environment. We remain focused on leveraging PMT's unique relationship with PFSI to actively manage PMT's portfolio. In the first quarter, we took advantage of tighter credit spreads, selling $111 million of previously purchased floating-rate GSE CRT bonds. Importantly, we realized significant gains on these investments with the sales driven by our belief that these investments no longer met our longer-term return requirements.

Additionally, credit spread tightening drove our ability to issue more than $550 million in CRT term notes at attractive terms during and after the quarter-end, effectively refinancing similar notes with extended maturities and reduced spreads. More than 2/3 of PMT shareholders' equity is currently invested in the seasoned portfolio of MSRs and the unique GSE lender risk share transactions we invested in from 2015 to 2020. As the majority of mortgages underlying these assets were originated during periods of very low interest rates, we continue to believe these investments will perform well in the foreseeable future as low expected prepayments extend the expected asset lives. Additionally, delinquencies remain low due to the overall strength of the consumer, as well as the substantial accumulation of home equity in recent years due to continued home price appreciation. MSR investments account for more than half of PMT's deployed equity.

The majority of the underlying mortgages remain far out of the money, and we expect the MSR asset to continue producing stable cash flows over an extended period of time. MSR values also benefit from the current interest rate environment as the placement fee income PMT receives on custodial deposits is closely tied to short-term interest rates. Similarly, mortgages underlying PMT's large investment in lender risk share have low delinquencies and a low weighted average current loan-to-value ratio of 50%. These characteristics are expected to support the performance of these assets over the long term, and we continue to expect that realized losses will be limited. Slide 7 outlines the run rate return potential expected from PMT's investment strategies over the next four quarters. PMT's current run rate reflects a quarterly average of $0.35 per share.

This is up from the prior quarter, driven primarily by higher expected asset yields in the interest rate-sensitive strategies. Now I'll turn it over to Dan, who will review the drivers of PMT's first quarter financial performance.

Dan Perotti (CFO)

Thank you, David. PMT earned $37 million in net income to common shareholders in the first quarter, or $0.39 per diluted common share. PMT's credit-sensitive strategies contributed $61 million in pretax income, including $48 million from PMT's organically created CRT investments. This amount included $36 million in market-driven fair value gains, reflecting the impact of tighter credit spreads. The fair value of these investments was up slightly from the prior quarter as fair value gains more than offset the decline from runoff. As David mentioned, the outlook for our current investments in organically created CRT remains favorable, with a low underlying current weighted average loan-to-value ratio of 50% and a 60-day delinquency rate of 1.11%, both as of March 31st. Income from opportunistic investments in CAS and STACR bonds issued by the GSEs totaled $8.9 million in the quarter.

As mortgage credit spreads continued to tighten during the quarter, the go-forward returns on some of the opportunistic investments that we had previously made fell below our thresholds, and so we sold $111 million of these CAS and STACR investments during the quarter. The interest rate-sensitive strategies contributed a pretax loss of $27 million. The fair value of PMT's MSR investment increased by $72 million as the increase in mortgage rates drove a decline in future prepayment projections and an increase in projections of future earnings on custodial balances. These fair value gains were more than offset by changes in the fair value of MBS interest rate hedges and the related tax effects during the quarter. MBS fair value decreased by $44 million, and interest rate hedges decreased by $70 million. Net fair value declines on assets held in PMT's taxable REIT subsidiary drove a tax benefit of $15 million.

The fair value of PMT's MSR asset at the end of the quarter was $4 billion, up slightly from $3.9 billion at December 31st as growth in the MSR portfolio from fair value gains, loan production, and MSR acquisitions more than offset runoff from prepayments. Delinquency rates for borrowers underlying PMT's MSR portfolio remain low, while servicing advances outstanding decreased to $110 million from $191 million at December 31st. No principal and interest advances are currently outstanding. Income from PMT's correspondent production segment was up slightly from last quarter as higher margins offset the impact of lower volumes. Total correspondent loan acquisition volume was $18 billion in the first quarter, down 23% from the prior quarter driven by our focus on profitability over volume. Conventional loans acquired for PMT's account totaled $1.8 billion, down 29% from the prior quarter.

The weighted average fulfillment fee rate was 23 basis points, up from 20 basis points in the prior quarter. PMT reported $28 million of net income across its strategies, excluding market-driven value changes and the related tax impacts, down from $41 million last quarter, primarily due to lower average yields on its interest rate-sensitive assets during the quarter. Turning to capital, we issued $306 million of new three-year CRT term notes during the quarter, effectively refinancing recently matured term notes. And in April, we issued $247 million of new three-year CRT term notes, which refinanced $213 million of notes that were due to mature in 2025, extending the maturities and reducing the spreads for the financing for our CRT assets. We'll now open it up for questions. Operator?

Operator (participant)

I would like to remind everyone, we will only take questions related to PennyMac Mortgage Investment Trust or PMT. We also ask that you please keep your questions limited to one preliminary question and one follow-up question as we'd like to ensure we can answer as many questions as possible. So if you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you'd like to withdraw your question again, it's star one. And your first question comes from the line of Jason Weaver of JonesTrading. Your line is now open.

Jason Weaver (Analyst)

Hi. Thank you for taking my question. So I was curious about how you view the sustainability of the dividend looking forward. I thought I heard in David's prepared remarks something about a $0.35 earnings run rate. Excuse me if I'm misconstruing that.

Dan Perotti (CFO)

Sure. So sort of similar to what we've seen in prior quarters, our run rate is slightly below our current dividend level. However, we did see the run rate increase during the quarter, really driven by the deinversion of the yield curve and the longer-term portion of the yield curve moving up, which moves up the asset yields on our MSRs and MBS portfolio and drives higher returns in our interest rate-sensitive strategies. As we see the yield curve continue to normalize or deinvert, which we expect to happen over the next few periods, we expect that we could see further benefit in the interest rate-sensitive strategies or our projection for the interest rate-sensitive strategies to get back to that $0.40 projection or above. And so when we look at the $0.40 dividend, another sort of tenet of our dividend philosophy is around stability of the dividend.

We're not looking to move the dividend to exactly match to our projections quarter to quarter since they move as the market moves. And we see the potential for the run rate to continue to move toward that $0.40 dividend level. And so our expectation is to keep the $0.40 dividend level stable for now, unless or until we see the market move in such a way that we don't expect the run rate to continue moving toward that $0.40 dividend level. But at present, and especially given the trajectory that we've seen during the quarter and the normalization of the yield curve, our expectation is that we'd maintain the $0.40 dividend for the current period and most likely the next few periods.

Jason Weaver (Analyst)

All right. That's helpful. Thank you for that. And then just noting the CRT sales, I was curious about your priorities for new capital deployment given the rates outlook today, whether that is maybe tilted more towards interest rate strategies still and less into CRT?

Dan Perotti (CFO)

Yeah. I think that's fair to say. We've seen more opportunity and have invested some into low-rate MSR portfolios over the past couple of periods. As we discussed earlier, we've seen credit spreads tighten pretty significantly in the CRT area or in mortgage credit and where some of those investments have fallen below our return thresholds. And especially if we continue to see a normalization of the yield curve, we think probably the opportunities lie more in the interest rate-sensitive strategies than in the credit-sensitive strategies, barring some change in the overall environment. But the way that we view it, I think in previous periods we've talked about, we would prefer to have a bit more balance in terms of the credit-sensitive strategies and interest rate-sensitive strategies. Our interest rate-sensitive strategies, we currently have a greater allocation toward.

Our first priority is investing into assets where we believe the risk-adjusted return is the highest and meets our hurdles. That presently seems to be more in the interest rate-sensitive strategies.

Jason Weaver (Analyst)

Okay. Thanks again. I'll hop back in the queue.

Operator (participant)

Your next question comes from the line of George Bose of KBW. Your line is now open.

Bose George (Analyst)

Hey, guys. This is Bose. Actually, I just wanted to follow up on the sort of the return expectation. The increase, a lot of it looked like it was based on a higher return expectation on the MSR. And so is that a slower prepayment expectation with higher rates, or yeah, just curious what kind of drove that piece?

Dan Perotti (CFO)

Not so much a higher or a lower prepayment expectation necessarily, but our valuation methodology as interest rates increase, it has an impact on the expected prepayment speeds of the MSR as well as the projected custodial income. But also we value our MSRs at a spread over the risk-free rate. So as risk-free rates increase, our overall yield or discount rate on the MSR also increases. And so we would expect to earn, even if the cash flows were the same or similar, a greater yield as we move forward due to the fact that we're discounting those cash flows at a higher rate to get to the value that we're at today. And similarly with the MBS, because we mark the MBS to market as interest rates increase and the yield on MBS increase, we'd also expect that MBS return to be higher as we move forward.

Bose George (Analyst)

Okay. Great. Thanks. And then you talked about the benefit from the yield curve sort of deinverting. But does that have to happen with the yield curve with long rates remaining relatively elevated, like if there's a shift down, kind of a parallel shift down in the curve, and then the curve deinverts, does that sort of hurt you to some degree? So is kind of a higher for longer with a yield steeper curve better?

Dan Perotti (CFO)

I think overall for PMT, just because overall asset returns would be higher, we would generally be preferable if we were flatter and higher rather than flatter and lower. But the overall, either way would be beneficial for the interest rate-sensitive strategies, whether since most of our financing is floating rate and based off of short rates, if short rates move down relative to the longer-term asset yields, that is beneficial as well. But if yield curve shape being constant, just because overall yields on the assets would be higher, technically, I think the higher rate environment with the same steepness of the yield curve would be preferable to a lower rate environment for the returns of the strategy. But either one would be better than an inverted curve.

Bose George (Analyst)

Yep. Yep. Okay. Great. Thanks.

Operator (participant)

Your next question comes from the line of Matt Howlett from B. Riley Securities. Please go ahead.

Matthew Howlett (Analyst)

Oh, hey. Thanks. Thanks for taking my question. The first question just is on, it must be frustrating with the stability you've put out in book value at earnings to be trading at a discount to book. I mean, you're kind of in this mortgage rate group that's trading well below book and not in the group that's trading above book. And I know it must be frustrating. My question for you, David, is the buyback, again, how willing would you be to go and start buying back shares at a 20%+ discount to book? And then I'll tie that into, when do you expect to be in the market to refinance the November 2024?

David Spector (Chairman and CEO)

Yeah. So there's things we can control and things we can't control. And I can't control the share price. That's the only work to influence the results of the company. And to your point, we've produced really good results, especially you look back the last five, six quarters. And so I continue to insist that as long as we continue to post the results, the share price will take care of itself. And so that's something that we remind people here all the time. I think, look, we have a limited amount of capital, and we're going to deploy it judiciously. And I think that as we look at it in the marketplace, if we see opportunities to continue to deploy capital to meet our required return, we'll do so. I think that we've shown that we will buy back stock when the stock is discounted.

I don't think what that discount percentage is depends on the point in time. But suffice it to say, we can be patient, and we have, well, we've always been patient. We'll continue to be patient.

Dan Perotti (CFO)

And then with respect to the 2024 maturity, we continue to look for opportunities to raise additional capital, but we have fully reserved for the retirement of that maturity in our liquidity forecasting. So we have sufficient secured financing based on our current assets to be able to retire that maturity, even if we do not raise additional capital. That being said, we are looking for opportunities to raise capital that would replace some of that convertible debt that matures in 2024. We've not found what we view to be the right opportunity yet that supports our basically financing cost goals. But we'll continue to look at the different avenues, whether that be baby bond, which we issued last year, convertible debt potentially, or depending on the market dynamics, to your point, if we eventually moved above book value, potential equity raise.

We're not looking to do a diluted equity raise in order to refinance that maturity. We've, as I mentioned, fully reserved for that in terms of being able to use secured debt to refinance it if we don't find another opportunity that attracts us between that maturity and now.

Matthew Howlett (Analyst)

Great. Thanks. And just one last one. With the current interplay between PFSI, the selling of conventional loans to PFSI, and then you're out there sort of buying bulk packages, and how long will that interplay continue? I mean, is there a certain rate level where you'd start not selling loans? I mean, presumably, you're outbuying lower coupon bulk, and you're selling the higher coupon current production to PFSI. Is there some rate level where you sort of stop that you change that interplay or go back to where it's been historically?

David Spector (Chairman and CEO)

Look, I think, Matt, it's really a function of capital, and it's a capital allocation decision. Obviously, if we were to raise more capital and we had more capital to deploy, that would factor into the decisioning. I don't see it changing. It's not going to change in Q2, and I don't necessarily see it changing in Q3. But I think if for some reason we raise a bunch of capital, we would look to, we'd look to address it. And I think it speaks to the great synergistic relationship between the two enterprises that PMT has this opportunity to deploy capital in MSRs when it in current-period MSRs when it has capital and the desire to do so, and then PFSI is there, being that they want to continue to grow the servicing portfolio.

Matthew Howlett (Analyst)

Makes total sense. Thanks, guys. I really appreciate it.

David Spector (Chairman and CEO)

Thanks, Matt.

Operator (participant)

Your next question comes from the line of Eric Hagen from BTIG. Your line is now open.

Eric Hagan (Analyst)

Hey, David. Thanks a lot. Hey, has PMT ever sold any MSRs, and do you ever look at that as a viable option to generate liquidity, or is it maybe not really a reasonable option just given the market and the assets kind of higher than what we see in the rest of the market?

David Spector (Chairman and CEO)

Well, look, I think, look, we're an investment vehicle. It's not something that we've historically looked at. That's not to say we couldn't do it. But I think we look at PMT as an investment vehicle. And I think that the reason we sold the CRT was because it was bought in a period of time where spreads were wide. And that's been the strategy of PMT going back the last year, is to strategically deploy capital in credit-sensitive assets. And I think given the fact that the return on those assets went below the required return, we felt it was an opportunity to sell the investments. It's in a period of time where PMT can't be a serial issuer of capital. So it has to be mindful of having capital to deploy in strategic investments.

When it gets below the required return, the decision was made to sell. Having said that, there's nothing to preclude PMT from selling servicing. It's just not something that is on the docket.

Dan Perotti (CFO)

Yeah. I mean, I think that when we look at the core investments of PMT between the MSR and our historical credit risk transfer and that comprising a, I think, around 70% of our total equity deployed, we view those as sort of the anchor investments of the company. And given how the characteristics of those investments, both the low interest rate and so running off at a slow pace, the positive credit characteristics, and the synergy with PFSI's operations, in the case that there were some sort of issue, and we saw that come up during COVID where we were able to implement some innovative programs for our borrowers to enable us to minimize the losses on our CRTs that would be realized, we think that it makes sense to generally maintain both of those assets.

But as David said, to the extent that we saw an environment in which we thought that it was beneficial to PMT to sell a portion of the MSRs, then that's something that we could consider. But we generally think of those as our two sort of core assets for the company. And given the current position, far out of the money, stable cash flows, low credit exposure, generally think that it probably makes sense to maintain those.

Eric Hagan (Analyst)

Yep. That's a helpful answer. Hey, on the secured leverage side, how much of the funding is fixed versus floating rate at this point? Thank you, guys.

Dan Perotti (CFO)

On the secured side, all of our debt on the secured side is floating rate. Okay. And should we think of any hedges that kind of protect the interest rate risk there?

So our hedging, when we look at that, I mean, the way that we think about it is generally against our asset base, obviously, our asset base. We mark everything to market. And so the discount rate on the assets incorporates the short-term rates as well. And so our hedges, we think of as effectively hedging the short-term as well as the long-term part of the rate sensitivity over time. But we don't have any specific hedges against our debt that, from a gap perspective, for example, neutralize the impact of short-rate changes.

Eric Hagan (Analyst)

All right. Thank you guys so much. Appreciate it.

Dan Perotti (CFO)

Sorry. One other detail on that is just that if you think of the MSRs, our earnings on the escrow balances on the MSRs are also generally floating rate or tied to short rates.

Our earnings rate on those are generally tied to short rates. And so that is also an offset to the floating rate nature of a lot of the secured debt. And then on the CRT side, the assets are floating rate. And so it makes sense to pair them with the floating rate debt. Thank you guys so much. Appreciate it.

Operator (participant)

Again, if you would like to ask a question, please press star one on your telephone keypad. Your next question comes from the line of Douglas Harter of UBS. Please go ahead.

Douglas Harter (Analyst)

Thanks. As you guys are thinking about investment opportunities, how are you thinking about sort of a credit investment in closed-end seconds or the second liens that PennyMac is originating?

David Spector (Chairman and CEO)

Look, we're looking at the execution opportunities to or we're looking at the investment opportunities of prioritizations that are being done with closed-end seconds and jumbos because I think that PFSI is seeing increased activity and origination in both asset classes. And considering that we don't see the investment opportunity meeting the required return that PMT needs or is set out. But suffice it to say that if we're just particularly spread-wide and there was an opportunity to invest, there's enough activity going on in PFSI that PMT could do a securitization. And I think it's I think it's just a function from a PFSI standpoint, they're looking for best execution. For PMT, they're looking to achieve their required return.

Dan Perotti (CFO)

Great. Thank you, David.

Operator (participant)

We have no further questions at this time. I'll now turn it back to Mr. Spector for closing remarks.

David Spector (Chairman and CEO)

Thank you. Thank you all for joining us today. If you have any additional questions, please don't hesitate to reach out to our IR department. We appreciate your time, and I'm looking forward to speaking to all of you in the near future. Take care.