PennyMac Mortgage Investment Trust (NYSE:PMT) Q1 2024 Earnings Call Transcript

PennyMac Mortgage Investment Trust (NYSE:PMT) Q1 2024 Earnings Call Transcript April 24, 2024

PennyMac Mortgage Investment Trust beats earnings expectations. Reported EPS is $0.39, expectations were $0.32. PennyMac Mortgage Investment Trust isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good afternoon, and welcome to PennyMac Mortgage Investment Trust first-quarter earnings call. Additional earnings materials, including the presentation slides, that will be referred into the call, are available on PennyMac Mortgage Investment Trust’s 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 bear GAAP equivalent in the earnings materials. Now, I’d like to introduce David Spector, PennyMac Mortgage Investment Trust’s Chairman and Chief Executive Officer; and Dan Perotti, PennyMac Mortgage Investment Trust’s Chief Financial Officer.

David Spector: Thank you, operator. PMT produce solid results in the first quarter, with strong contributions from the Credit Sensitive Strategies in its correspondent production business. These results were partially offset by net fair value declines in the Interest Rate Sensitive Strategies. Net income of common shareholder 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 31, essentially unchanged from the end of the prior quarter. While many other mortgage rates have been negatively impacted by increased levels of interest rate volatility in recent periods, PMT book value per share has remained relatively comparatively stable due to its diversified portfolio and disciplined approach to hedges.

Turning to the origination market, current third party estimates for total originations in 2024 averaged $1.8 trillion, reflecting growth from an estimated $1.5 trillion in 2023. However, we believe these estimates to be optimistic and dependent upon multiple interest rate cuts in 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. And in the first quarter, we took advantage of tighter credit spreads, selling $111 million of previously purchased floating rate GSE CRT bonds. Importantly, they will realize significant gains on these investments with the sales driven by our belief that these investments no longer met our longer-term return requirement. Additionally, credit spread tightening drove our ability to issue more than $550 million and CRT term notes at attractive terms during and after the quarter-end, effectively refinancing similar notes with extended maturities and reduced spreads. More than two thirds of PMT shareholders’ equity is currently invested in a 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 receive a custodial deposits is closely tied to short-term interest rates.

Similarly, mortgages underlying PMT’s large investment in lender risk share of low delinquencies in 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 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: 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, that’s fair value gains more than offset the decline from runoff. As David mentioned, the outlook for our current investments is inorganically 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 31.

Income from opportunistic investments in cash and stock or 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 rate 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 31, 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 31. 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 PMC’s accounts totaled $1.8 billion, down 29% from the prior quarter. The weighted average fulfilment 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 mature term notes.

And in April, we issued $247 million of new three-year CRRT 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?

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Q&A Session

Operator: [Operator Instructions]. And your first question comes from the line of Jason Weaver of Jones Trading.

Jason Weaver: 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 $0.35 earnings run rate. Excuse me if I’m mishearing that.

David Spector: Sure. So 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 inversion 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 drive higher returns in our interest rate sensitive strategies. As we see the yield curve continued to normalize or be invert, 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 $0.4 projection or above.

And so, when we look at the $0.4 dividend, another tenant 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 $0.4 dividend level. And so our expectation is to keep that $0.4 dividend level stable for now, unless or until we see the market move in such a way that that we don’t expect the run rate to continue moving toward that $0.4 dividend level. But at present, and especially given the trajectory of that we’ve seen during the quarter and the normalization of the yield curve, our expectation is that we maintain the $0.4 dividend for the current period and most likely the next few periods.

Jason Weaver: 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 rate outlook today, whether that is maybe tilted more towards interest rate strategy still and less into CRT?

David Spector: I think that’s fair to say. We’ve seen some 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 tightened pretty significantly in the CRT area or in mortgage credit, where some of those investments and falling below our return thresholds. I mean, especially as we continue to see a normalization of the yield curve, we think probably the opportunities lie more in the interest rate sensitive strategies than on 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. But our first priority is investing into assets where we have believed the risk adjusted return is the highest and meets our hurdles. And that presently seems to be more of the interest rate sensitive strategies.

Operator: Your next question comes from the line of George Bose of KBW.

George Bose: Hey, guys, this is Bose. I just wanted to follow-up on the return expectation. Is the increase a lot of it looked like it was based on a higher return expectation on the MSR. So is that a slower prepayment expectations at higher rates or — just curious what kind of drove that piece?

David Spector: I’m not so much a higher or lower prepayment expectation necessarily, but our valuation methodology as interest rates increase, it has an impact on the — expected prepayment the MSR, as well as the projected custodial income, but also that we value our MSRs at a spread over the risk-free rates. So as risk-free rates increase, our overall yield or discount rate on the on the MSR also increases. And so we would expect to earn even if the cash flows were the same or similar on a greater yield as we move forward, due to the fact that working and 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 market interest rates increase in the yield on MBS increase, we’d also expect that MBS return to be to be higher as we move forward.

George Bose: Okay, great, thanks. And then you talked about the benefit from the yield curve or de-inverts, but does it have to happen with the yield curve with long rates remaining relatively elevated like events and a shift down a parallel shift down in the curve? And then the curb de-inverts, does that does that hurt you to some degree, so it’s a higher for longer with the yield steeper curve better from the?

David Spector: 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 overall, either way, it would be beneficial for the interest rate sensitive strategies, whether where us 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 the 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 speed this 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 here.

Operator: Your next question comes from the line of Matt Howlett from B. Riley Securities.

Matt Howlett: Hey, thanks for taking my question. The first question is just on, it must be frustrating with the stability you’ve put out and book value and earnings to be trading it. At a discounted book, you comment in this mortgage rate group is trading well below book and not in the group is trading above group. And I know it must be frustrating. My questions for you, David, is that the buyback again, how willing you would be to go into share buyback shares at a 20 plus percent discount to book? And then I’ll tie that into, what do you have to be in the market to refinance the November 24?

David Spector: Yeah, so look, there’s things we can control and things we can’t control. I can’t control the share price. [Technical Difficulty] influenced the results for the company. To your point, we produce really good results, especially if you look back the last five, six quarters. And so I continue to have to we have consists of all we continue to post the results, the share price will take care of itself. And so that’s something that we remind people hear all the time. I think we had a limited amount of capital and we’re going to deploy judicious up. And I think that you note as we look at 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 and the staff is discounted.

I don’t know — what that discount percentage is dependent at the point in time. But suffice it to say we can be patient. And we have well. We’ve always been patient will continue to be patient.

Dan Perotti: 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 debt maturities in our liquidity forecast things. 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 raised additional capital. That being said, we are looking for opportunities to raise capital that would replace some of that convertible debt convertible debt that matures in 2024. We’ve not found what we viewed to be the right opportunity yet that supports our supports financing costs goals, but we’ll continue to look at that different avenues, whether that be baby bond, which we issued last year, convertible debt, potentially more depending on the market dynamics, to your point if we eventually move above the book value potential equity raise.

But we’re not we’re not looking to do a dilutive equity raise in order to refinance that maturity. And, as I mentioned, fully reserved for that in terms of being able to use secured debt to refinance it if we don’t buy another opportunity that attracts us between them maturity end.

Matt Howlett: Great, thanks. And just one last one, — with the current interplay between PFSI that the selling of conventional loans to PFSI, and then you out there sort of buying bulk packages. How long will that interplay continue to make? Is there a certain rate level where you start not selling loans on it? Presumably you’re buying lower coupon bulk and you’re selling a higher coupon kind production, the PFSI, there’s some late level stuff that you change that interplay or go back to where it’s been historically?

David Spector: Look, I think it’s a matter of function of capital. And with the capital allocation decision you present. Obviously, as we continue to raise more capital, we had more capital to deploy that would factor into the decisioning. I don’t see changing its haven’t changed in Q2, I missed this rarely see a change in Q3. But I think, for some reason, we raised a bunch of capital, we would look to we look to address certain. I think it speaks to the great synergistic relationship between the two enterprises and having that PMT as an opportunity to deploy capital in current period MSR as well as capital desire to do something PFSI’s there being that they wanted to continue to grow the servicing portfolio.

Operator: Your next question comes from the line of Eric Hagen from BTIG.

Eric Hagen: Hey, guys, thanks a lot. Has PMC ever sold any MSRs? And do you ever looked at that as like a viable option to generate liquidity? Or is it maybe not really a reasonable option just given the marketing assets higher than what we see in the rest of the market?

David Spector: Well, look, we’re an investment vehicle. That’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’s investment vehicle, and I think that the reason we solve this CRT was because it was bought in a period of time where spreads were wide and that’s been that’s been the strategy of PMT going back to last year, to strategically deploy capital and credit sensitive assets. And you know, I think given the fact that the return on that on those assets went below the required return, we felt it was an opportunity to sell the investments we’ve seen over a period of time with PMT can’t be a serial issuer capital, so it has to be mindful of having capital to deploy in strategic investments. And so I think it’s below the required returns that decision was made to sell. But having said that, there’s nothing that precludes PMT from selling servicing. It’s just not something that was on the docket.

Dan Perotti: Yes. I mean, I think that it when we look at the core investments of PMT between the MSR and our historical credit risk transfer and that comprising, I think, around 70% of our total equity deployed, we view those as the anchor investments of the company. And given how the characteristics, those investments dose, the low interest rate, and so no running off at a at a slow pace on the positive credit characteristics and the synergy with PFSI’s operations, in the case that there were some vision 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 CRT is that 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, and that’s something that we could considered. But we generally think of those are two sort of core assets for the company. And given the current position, far out of the money, stable cash flows, low credit exposure, I generally think that it probably makes sense to maintain those.

Eric Hagen: Yeah, that’s a helpful answer. And on the secured leverage side, how much of the funding is fixed versus floating rate at this point? Thank you, guys.

Dan Perotti: On the secured side, all of our debt on the secured side is floating rate.

Eric Hagen: Okay, so are you thinking about any hedges that will kind of protecting their returns?

Dan Perotti: So — when we look at hedging and I mean, the way that we think about is generally against our asset base, obviously our asset base, we mark everything to market. And so that 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 from a GAAP perspective. For example, neutralize the impact of you know, of short rate changes.

Eric Hagen: All right. Thank you, guys, so much. Appreciate it.

Dan Perotti: One other one other another detail on that it’s 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 at our earnings rate on those are generally tied to short rates. And so that is also an offset to a floating rate nature of a lot of the secured debt. And then on the CRP side, the assets are floating rate and so it makes sense to pair them with the floating rate debt.

Operator: [Operator Instructions]. And your next question comes from the line of Douglas Harter of UBS.