PennyMac Mortgage Investment Trust (NYSE:PMT) Q3 2023 Earnings Call Transcript

PennyMac Mortgage Investment Trust (NYSE:PMT) Q3 2023 Earnings Call Transcript October 26, 2023

Operator: Good afternoon, and welcome to PennyMac Mortgage Investment Trust Third Quarter 2023 Earnings Call. Additional earning material 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 earning material. 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. 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. You may begin.

David Spector: Thank you, operator. PMT had an outstanding third quarter. Annualized ROE was 14%, reflecting very strong financial results and growth in book value per share from the prior quarter due to meaningful income contributions from all three of its investment strategies. As a result, book value per share net of the $0.40 dividend increased to $16.01. As you can see on Slide 4 of the presentation, mortgage rates have continued to increase from record lows in recent years and are now near 8%. As a result, many borrowers who locked in a low fixed rate mortgage in recent years have been incentivized to stay in their homes given their low mortgage payments. This has resulted in an extremely low inventory of homes for sale, driving expectations for the lowest unit origination volume since 1990.

Additionally, we believe quarterly run rate origination volumes are trending lower than the average estimate from third parties for this year of $1.6 trillion. Turning to Slide 5. Though the current origination market remains constrained, I’m very enthusiastic about PMT’s opportunities in this environment. Approximately two-thirds of PMT’s shareholders’ equity is currently invested in a seasoned portfolio of MSRs and the unique GSE lender risk share transactions which we invested in from 2015 to 2020. Given the majority of mortgages underlying these assets were originated during periods of very low interest rates, we believe these investments standard perform well over the foreseeable future as low expected prepayments extend the expected asset life.

Additionally, delinquencies remain low due to the overall strength of the consumer and the substantial accumulation of home equity in recent years due to continued home price appreciation. Mortgage servicing rights investments account for about half of PMT’s deployed equity. The underlying mortgages are far out of the money given current mortgage rates, reducing the sensitivity for MSR fair values. As a result, we expect the MSR asset to produce stable cash flows over an extended period of time. MSR value should also find additional support in a higher for longer environment as the placement fee income PMT receives on custodial deposits is closely tied to short-term interest rates. Similarly, low delinquencies and very low current loan-to-value ratios on the mortgages underlying PMT’s large investment in lender risk share are expected to support the performance of these assets over the long-term and we ultimately expect the realized losses over the life of these investments to be limited.

PMT’s current capital deployment is focused on opportunistic investments that we believe have the potential for strong, long-term risk-adjusted returns. This quarter, we invested nearly $65 million in such investments and we’ll continue to monitor the markets for similar opportunities. Looking at our run rate potential on Slide 7, with expectations for interest rates to remain higher for longer and a de-inversion of the yield curve during the third quarter, potential returns from the interest rate sensitive strategies have improved, driven by higher projected yields relative to financing costs for MSRs and MBS. As such, the run rate return potential expected from PMT’s investment strategies over the next four quarters increased from $0.30 in the prior quarter to $0.35 per share or 9% annualized return on equity.

I will now turn it over to Dan, who will review the drivers of PMT’s third quarter financial performance.

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Daniel Perotti: Thank you, David. Turning to Slide 11. PMT earned $51 million in net income to common shareholders in the third quarter or $0.51 per share. PMT’s credit-sensitive strategies contributed $41 million in pretax income. Income from PMT’s organically created CRT investments this quarter totaled $27 million. This amount included $14.6 million in market-driven fair value gains, reflecting the impact of tighter credit spreads. The fair value of these investments decreased slightly from the prior quarter to $1.1 billion as runoff from prepayments more than offset fair value gains. As David mentioned, the outlook for our current investments in organically created CRT remains favorable with an underlying current weighted average loan-to-value ratio of approximately 50% and a 60-day delinquency rate of 1.18%, both at September 30.

Income from opportunistic investments in CAS and STACR bonds issued by the GSEs totaled $16.3 million in the quarter. The interest rate sensitive strategies contributed $82 million to pretax income. MSR fair values increased due to the higher interest rates, which drove expectations for lower prepayment activity and higher earnings from placement fees on custodial balances. Before recognition of realization of cash flows, PMT’s MSR fair value increased by $263 million. These fair value gains on MSRs held in PMT’s taxable REIT subsidiary also drove the large provision for income tax expense in the quarter. Net fair value losses on Agency MBS, interest rate hedges and the related tax impacts were $254 million, driven by higher interest rates.

The fair value of PMT’s MSR asset at the end of the quarter was $4.1 billion from June 30 as fair value increases and newly originated MSR investments more than offset runoff from prepayments. Delinquency rates for borrowers underlying PMT’s MSR portfolio remain low and servicing advances outstanding decreased to $80 million from $94 million at June 30. No principal and interest advances are currently outstanding as prepayment activity continues to sufficiently cover remittance obligations. Income from PMT’s correspondent production segment was up from last quarter, primarily due to higher margins. The prior quarter also included a negative impact of $4.5 million due to changes in GSE pricing. Total correspondent loan acquisition volume was $22 billion in the third quarter, up 2% from the prior quarter.

Conventional loans acquired for PMT’s account totaled $2.8 billion, down 9% from the prior quarter due to the ongoing sales of certain conventional loans to PFSI. The weighted average fulfillment fee rate was 20 basis points, up from 18 basis points in the prior quarter. PMT reported $32 million of net income across its strategies, excluding market-driven value changes and the related tax impacts, up from $25 million last quarter. As you can see on Slide 13, in the third quarter, we also took several steps to further strengthen PMT’s balance sheet. These included the upside of a previously issued Fannie Mae term loan from $155 million to $370 million, the redemption of $450 million in Fannie Mae MSR term notes due in 2025 and the opportunistic issuance of $54 million in unsecured senior debt at very attractive terms.

Finally, while there has been significant interest rate volatility since quarter end, PMT’s book value per share is little changed as a result of our hedge discipline. We’ll now open it up for questions. Operator?

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Q&A Session

Operator: [Operator Instructions] Your first question comes from the line of Bose George from KBW. Please go ahead.

Bose George: Hey, everyone. Good afternoon. Actually, going to Slide 7. If the yield curve continues to de-invert or even whatever normalizes, does that – would that continue to push up the return? And is that a way that you potentially get back to your ROE that could cover the dividend?

Daniel Perotti: Hey, Bose. This is Dan. Yes, that’s exactly right. During the quarter, quarter-over-quarter, the primary factor that drove up what we see as the run rate potential was that the inversion of the yield curve, we’ve seen some additional de-inversion here as we’ve – as we move further into Q4, and we would expect that to have the same impact as we saw during last quarter, which could get us back to your point, up to a $0.40 type of run rate to the extent that we see further that de-inversion continues to happen.

Bose George: Okay. Great. Thanks. And then on the mortgage banking return this quarter, I mean, would you characterize this quarter as somewhat more normal than last quarter as being impaired by that – the GSE pricing change? Or how would you characterize this quarter?

Daniel Perotti: Yes, this quarter, I think we would characterize as somewhat more normalized. To your point, last quarter, we had the negative impact of the GSE pricing change that did not recur this quarter. And in terms of the margins and other impacts on the channel you think we’re seeing something fairly similar going into Q4 here. So I’d say I think your characterization is right that it’s a more sort of normalized result than we saw in the prior quarter.

Bose George: Okay. Great. Thank you.

Operator: Your next question comes from the line of Kevin Barker from Piper Sandler. Please go ahead.

Kevin Barker: Great. Thanks for taking my questions. I noticed that the MSR has marked up fairly high relative to some of the peers. Now obviously, you hedge it to protect that value. But is there anything that’s really driving some of that value and is there anything there that could create slight risk despite the hedging that you put in place?

Daniel Perotti: I don’t think there’s any – this is Dan again. I don’t think there’s anything in there that would necessarily constitute a more significant risk than what we’ve seen in the past. In fact, given how far out of the money the borrowers are underlying the MSR, the prepayment sensitivity is lower than what we’ve seen historically. And so the sort of the hedging risk there is lower. Really what’s driving at this point given that so many – so much of the borrowers – so many of the borrowers are far out of the money, what’s driving a lot of the value or potential additional value at this point really has to do with the escrow, the earnings on the escrow balances, which are a part of the cash flows from that projected at our part of the MSR value.

And so as these market and the yield curve adjust to this higher for longer sort of scenario, that increases the expected value of those escrow balances and those cash flows associated with that. But that is all incorporated into our sensitivity of the MSR asset and what we’re hedging against to the extent that we see interest rate changes or volatility.

Kevin Barker: That’s great. Helpful color. And then also, obviously, CRT was a major investment for you for a long period of time. Are you seeing any other avenues for investment in credit out there that might be attractive, whether it’s other GSE products or potentially even non-GSE or non-Agency products?