PennyMac Mortgage Investment Trust Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
October 26, 2023

Key Takeaways

  • Positive Sentiment: PMT delivered 14% annualized ROE in Q3 with book value per share rising to $16.01 after paying a $0.40 dividend.
  • Negative Sentiment: Mortgage rates near 8% and record‐low home inventory drove origination volumes toward their lowest level since 1990.
  • Positive Sentiment: About two-thirds of equity is invested in seasoned MSRs and GSE lender risk-share assets, which benefit from low prepayment speeds and delinquencies to produce stable long-term cash flows.
  • Positive Sentiment: Run-rate return potential rose from $0.30 to $0.35 per share, reflecting a 9% annualized ROE outlook over the next four quarters.
  • Negative Sentiment: Net fair value losses of $254 million on Agency MBS and related hedges were driven by higher interest rates, partially offsetting MSR fair value gains.
AI Generated. May Contain Errors.
Earnings Conference Call
PennyMac Mortgage Investment Trust Q3 2023
00:00 / 00:00

There are 6 speakers on the call.

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's Mortgage Investment Trust or PMT. We also ask that you please keep your questions limited to one preliminary question and one follow-up as we'd like to ensure we can answer as many questions as possible.

Operator

Now I'd like to introduce David Spector, PennyMac Mortgage Investment Trust's Chairman and Chief Executive Officer and Dan Periatti, PennyMac's Mortgage Investment Trust's Chief Financial Officer. You may begin.

Speaker 1

Thank you, operator. PMT had an outstanding 3rd 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 Extremely low inventory of homes for sale driving expectations for the lowest unit origination volume since 1990.

Speaker 1

Additionally, we believe quarterly run rate origination volumes are trending lower than the average estimate from third parties for this year of $1,600,000,000,000 Turning to Slide 5, though the current origination market remains constrained, I'm very enthusiastic about PMT's opportunities in this environment. Approximately 2 thirds of PMT shareholders' equity Is currently invested in the 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 stand to 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.

Speaker 1

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 and lender risk share are expected to support the performance of these assets over the long term.

Speaker 1

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 $65,000,000 in such investments and will 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 Q3, 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 4 quarters increased from $0.30 in the prior quarter to $0.35 per share or 9% annualized return on equity.

Speaker 1

I will now turn it over to Dan, who will review the drivers of PMT's 3rd quarter financial performance.

Speaker 2

Thank you, David. Turning to Slide 11, PMT earned $51,000,000 in net income to common shareholders in the 3rd quarter or 0 point contributed $41,000,000 in pre tax income. Income from PMT's organically created CRT investments this quarter totaled $27,000,000 This amount included $14,600,000 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 $1,100,000,000 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 of approximately 50% and a 60 day delinquency rate of 1.18%, both at September 30.

Speaker 2

Income from opportunistic investments in CAS and Stacker Bonds issued by the GSEs totaled $16,300,000 in the quarter. The interest rate sensitive strategies contributed $82,000,000 to pre tax 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 $263,000,000 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 $254,000,000 driven by higher interest rates.

Speaker 2

The fair value of PMT's MSR asset at the end of the quarter was $4,100,000,000 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 $80,000,000 from $94,000,000 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 $4,500,000 due to changes in GSE pricing.

Speaker 2

Total correspondent loan acquisition volume was $22,000,000,000 in the 3rd quarter, up 2% from the prior quarter. Conventional loans acquired for PMT's account totaled $2,800,000,000 down 9% from the prior quarter due to the ongoing sales of The weighted average fulfillment fee rate was 20 basis points, up from 18 basis points in the prior quarter. PMT reported $32,000,000 of net income across its strategies, excluding market driven value changes and the related tax impacts, up from $25,000,000 last quarter. As you can see on Slide 13, in the Q3, we also took several steps to further strengthen PMT's balance sheet. These included the upsize of a previously issued Fannie Mae term loan from $155,000,000 to $370,000,000 The redemption of $450,000,000 in Fannie Mae MSR term notes due in 2025 and the opportunistic issuance of $54,000,000 in unsecured senior debt at very attractive terms.

Speaker 2

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?

Operator

Withdraw your question, please press star 1. Your first question comes from the line of Bose George from KBW. Please go ahead.

Speaker 3

Hey, everyone. Good afternoon. Actually going to Slide 7, if the yield curve continues to deinvert 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 An ROE that could cover the dividend?

Speaker 2

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 the inversion of the yield curve. We've seen Some additional deinversion here as we've moved 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 the inversion continue to happen.

Speaker 3

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 GSE pricing change or it was yes, how would you characterize this quarter?

Speaker 2

Yes. This quarter, I think we would characterize as somewhat more normalized. To your point, last quarter, we had the negative The GSE pricing change that did not recur this quarter and the 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 the characterization is right that it's a more sort of normalized result than we saw in the prior quarter.

Speaker 3

Okay, great. Thank you.

Operator

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

Speaker 4

Great. Thanks for taking my questions. I noticed that the MSR is 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?

Speaker 2

I don't think there's any this is Dan again. I don't think there's anything in there that would necessarily You know, 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.

Speaker 2

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 out are part of the MSR value. And so as the market and the yield curve adjusted is 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.

Speaker 4

That's very 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 AUC products?

Speaker 1

Hey, Kevin, it's David. Well, I think that we bought a little bit of Cadence Stacker in the Q3 And we bought $58,000,000 in sub bonds, albeit it's not really credit because we're buying more, I would say, at the top of the credit stack. But suffice it to say, I think that given what we're seeing with the capital regs that have come up for banks, I expect there to be more securitization. Out of that, I'm hopeful that we'll see opportunities for PMT. PMT is really positioned well.

Speaker 1

We do An increased amount of securitization. I think there's going to be potential for jumbo securitization. And I think that Right now, we're for all the close end second production being done in PFSI, that product is being sold co loan, But others are securitizing that, albeit at returns that aren't that don't meet PMT's minimum return. But ultimately, I can see There being an opportunity for securitization of closed end seconds where there is a retained investment for PMT.

Speaker 2

Another factor that's sort of important to note that we called out this quarter It's just if you look at our current investments in the mortgage servicing rights and the GSE credit risk transfer, which 50% and 15% of our shareholders' equity together, 65%. Those are all based in Very low note rates, have very low note rate borrowers underlying those investments. They're running off very slowly For that reason and they both have very strong credit characteristics of the underlying borrowers to drive them. And As we are waiting for some of these other trends to develop or we're seeing some of these other trends develop, we have this really strong base Of assets that is running off at a slow rate that we expect to perform really well over time.

Speaker 4

So ideally over the long term, how would you want PMT's balance sheet structured From an equity investment standpoint, credit sensitive strategies versus interest rate sensitive strategy?

Speaker 1

I think that what we always optimize for is return on equity. I always start there. The 50% mortgage servicing rights is higher than we'd like now, albeit some of that a lot of that's because of the write up of the asset. And I think if you saw a rate decline, you would see it get much more in line or much closer to where the credit risk is. I think all things being equal, if returns are identical to one another, then you can say, okay, maybe a fifty-fifty split.

Speaker 1

But I think the ROE is always going to be the driving factor. And then the ongoing if we can find the investment It's ongoing and we're creating franchise value for P and T as well as we saw going all the way back to NPLs or then Followed on by the CRT we did from 2015 to 2020, that's something that we would definitely be supportive of. But it's as you know, I think that suffice it to say, right now we see the 50%, 15% split between Mortgage Servicing Rights and CRT is one that we'd like to get a little bit more in balance.

Speaker 4

Okay, great. Thank

Operator

Your next question comes from the line of Eric Haven from BTIG. Please go ahead.

Speaker 5

Hey, again. How are we doing? Just a question around risk management and Managing this rate risk and leverage and such, how much more MBS do you think you need to maybe add to the portfolio for Yes. Given increase in the MSR portfolio from here, like are there levels of spreads for on the MBS side where you can It looks to get more aggressive there and even raise leverage and how much room do you have to raise leverage in that portfolio?

Speaker 2

Hey, Eric, it's Dan. Yes, given the increase in the MSR portfolio, We may add incrementally to the Agency MBS portfolio. We've added Certainly incrementally in terms of some of the non agency MBS as David mentioned. But it's not necessarily It's not necessary per se to add substantially due to the change in the MSR to balance out from A REIT test perspective, if that's where you were going. To the extent that we do see spreads wide and that investment as attractive, We could add additional agency MBS.

Speaker 2

We do our overall leverage ratio is around Five times currently. So we do have some ability to continue to increase that, But we aren't necessarily looking to substantially increase our Agency MBS portfolio unless we saw that as a really significant opportunity.

Speaker 5

Yes, totally understood. Hey, second question, I mean, just looking at the liquidity requirement On Slide 18, you have a cushion of around $200,000,000 of liquidity. Do you feel like that's a comfortable cushion just given the size of the balance sheet? And how sensitive would you say that kind of liquidity, that regulatory liquidity is to higher interest rates and wider spreads? Thanks guys.

Speaker 2

Yes. Due to so when we are looking at our hedging position, we look at both our liquidity as well As the balance sheet value and hedge for both of those, yes, we do think that that cushion is very sufficient to be able To manage to in terms of managing our liquidity for the balance sheet size that we have. It would take a pretty substantial increase in spreads Put a meaningful dent into that liquidity that we're holding here. And we do have a little bit of additional overall liquidity that we can tap that isn't on the balance sheet today. So this doesn't represent the maximum size of the liquidity where we have a bit more that we could tap as well if we do we did see a spread widening or something to that of that nature.

Speaker 5

Yes. Hey, did you guys give an update for your Book value through October, if I missed it, I apologize. Thank you.

Speaker 2

Yes, we did. It's a little it's really little changed From what we saw at the end of the quarter.

Speaker 5

All right, fantastic. Thank you guys very much.

Operator

Your next question comes from the line of Matthew Nirn from Jones Trading. Please go ahead.

Speaker 1

Hey, guys. Thanks for taking the question. I believe you didn't repurchase any shares during the quarter. If that's true, let me know. And then how are you guys weighing share repurchases versus deployment of capital given where the stock has traded over the past couple of quarters?

Speaker 2

Hey, this is Dan. Yes, we did not repurchase any shares over the quarter. That is Something that we look at as a potential deployment of our capital. Certainly, the shares were trading during most of Q3 higher than they Have been over the recent couple of weeks and I would say that we find share repurchases more attractive, Meaningfully more attractive at the levels that we're seeing today than we did at some of the levels that we saw over the during Q3. So that could result in some activity Versus to your point, we did not repurchase any shares during Q3.

Speaker 1

Got you. Thank you.

Operator

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

Speaker 1

Again, I want to thank everyone for joining us here today for our Q3 earnings. If you have any Questions or comments, please don't hesitate to reach out to our Investor Relations team and I look forward to speaking with all of you in the near future. Take care.

Powered by Quartr