PennyMac Mortgage Investment Trust

NYSE:PMT

Earnings Call Transcript 2023-Q1

[Isaac Garden, executive]

Good afternoon, and welcome to the first quarter discussion for PennyMac Mortgage Investment Trust. The slides that are accompanying this discussion are available on PennyMac Mortgage Investment Trust's website at pmt.pennymac.com.

Before we begin, let me remind you that our discussion contains forward-looking statements that are subject to the risks identified on Slide 2 that could cause our actual results to differ materially.

Now I'd like to introduce David Spector, PMT's Chairman and Chief Executive Officer, who will discuss the company's first quarter 2023 results.

[David Spector, executive]

Thank you, Isaac. PMT reported strong earnings in the first quarter of 2023, as solid results from its credit-sensitive strategies and income excluding the impacts of market-driven fair value changes, were partially offset by fair value declines in its interest rate-sensitive strategies, which drove a tax benefit.

Net income to common shareholders was $50 million or $0.50 per common share, representing an annualized return on equity of 14%. Net of the $0.40 dividend, book value per share was up to $15.96. PMT spent $8 million on share repurchases in the first quarter, and it remains an attractive use of capital when PMT's share price is well below book value per share.

Dan Perotti, Senior Managing Director and Chief Financial Officer, will review additional details of PMT's financial performance later on in this discussion.

With mortgage interest rates currently still above 6%, the most recent third-party forecast for 2023 originations range from $1.6 billion to $1.8 trillion, down meaningfully from 2022. While many industry participants have taken the appropriate steps to reduce capacity, the pace of that reduction has been slow, and we believe overcapacity still remains. That being said, average quarterly origination forecast for the remainder of 2023 are meaningfully higher than the industry's estimated origination volumes in the first quarter, consistent with our own expectations as we move into the more typical home buying season.

Originations in 2024 are currently expected to approach more normalized levels with estimates suggesting an origination market above $2 trillion. It is our expectation that mortgage REITs with diversified investment portfolios, efficient cost structures and strong risk management practices such as PMT, are best positions to manage through the volatility presented by the current market environment.

Throughout April, market credit spreads have continued to tighten, and we continue to see improvements in the structured product markets. This has driven additional capital deployment and opportunistic investments. Year-to-date, PMT has invested $64 million in these investments, including $52 million after the quarter end. The underlying fundamentals of our lender risk share investments remain strong, consisting of seasoned loans with low current LTVs having benefited from the strong home price appreciation we've seen in recent years.

With delinquency rates at pre-COVID levels and current strong employment data, recent realized losses on our CRT investments have remained limited. The return potential for PMT's credit-sensitive strategies remain strong and improved slightly from the prior quarter as we recently issued new CRT term notes to finance the balance of CRT investments previously financed with securities repurchase agreements. Dan will expand further on this during his section of the discussion.

Signs of increasing inflation are slowing, and we believe the Federal Reserve is getting closer to the end of its tightening cycle, which we expect will benefit PMT's interest rate-sensitive strategies, assuming volatility declines. Additionally, higher short-term rates have increased earnings from custodial balances and deposits in recent quarters. Deposit balances are trending higher from the seasonal loans in the first quarter, driving our expectations for continued strong performance for the remainder of 2023.

Over the long term, we believe the underlying performance of PMT's MSR portfolio will be strong, supported by PFSI's industry-leading servicing capabilities, workflows and proprietary technology. The return potential for our MSRs is essentially unchanged from our expectations last quarter, reflecting low and relatively stable expected prepayment speeds.

Turning to correspondent production. PennyMac has many strong relationships with purchase-focused build-their-own mortgage companies which, combined with the exit of other channel participants, has driven the consistency of our acquisition volumes in recent quarters despite a much smaller origination market. Investments made by our manager, PFSI, have resulted in an extremely low cost structure, allowing us to operate efficiently. While we estimate that we represented approximately 17% of the correspondent channel over the past 12 months, we believe our market share has been meaningfully higher in more recent periods as sellers seek higher-quality partners like PennyMac.

While our position in the correspondent market remains strong, we expect to continue to actively manage PMT's capital deployment among its credit and interest rate-sensitive strategies. We will continue to leverage our synergistic relationship with PFSI. And beginning in the second quarter, PMT is expected to sell PFSI an increased proportion of its newly originated conventional correspondent production. At the same time, we are evaluating new credit investments and other market opportunities such as bulk MSRs with low coupons, stable cash flows and low expected prepayment activity that complement PMT's current investment portfolio.

PFSI's interest in building its own servicing portfolio with current coupon mortgages enables us to maintain PMT's strong and consistent bid in the correspondent channel, while actively managing its capital allocation. As such, our projected equity allocation for correspondent activities over the coming quarters has decreased, while our projection for the return on equity of the correspondent activity that we will continue to engage in has increased.

On Slide 7 of our first quarter earnings presentation, we illustrate the run rate potential from PMT's investment strategies, which represents the average annualized return and quarterly earnings potential that PMT expects over the next 4 quarters. As you can see, we expect the quarterly run rate return for PMT's strategies to average $0.40 per share or an 11% annualized return on common equity, reflecting performance expectations in the current mortgage market.

Now I'd like to turn the call over to Dan Perotti, Senior Managing Director and Chief Financial Officer, who will review the drivers of PMT's first quarter financial results.

[Daniel Perotti, executive]

Thank you, David. PMT reports results through 4 segments: credit-sensitive strategies, which contributed $57.3 million in pretax income; interest rate-sensitive strategies, which contributed $7 million in pretax loss; correspondent production, which contributed $1.8 million in pretax income; and the corporate segment, which had a pretax loss of $13.3 million. PMT also recorded an income tax benefit of $22 million.

During the quarter, PMT repurchased more than 600,000 shares of common stock for $8 million at an average price of $11.85, significantly below current book value per share. And through April 25, PMT repurchased an additional nearly 700,000 shares for $8 million at $12.08 per share.

I would like to start by discussing PMT's credit-sensitive strategies, which primarily consist of investments in organically created CRT from PMT's production, investments in non-agency subordinate bonds from private-label securitizations of PMT's production and opportunistic investments in GSE CRT. Income from PMT's organically created CRT investments this quarter totaled $45.4 million. This amount included $30.9 million in market-driven fair value gains, reflecting the impact of tighter credit spreads. Gains on PMT's organically created CRT investments also included $16.6 million in realized gains and carry, $1.3 million of net realized losses recognized during the period, $14.2 million in interest income on cash deposits and $15 million of financing expenses.

The fair value of PMT's organically created CRT investments as of March 31 was $1.1 billion, essentially unchanged from the prior quarter as increases from fair value gains offset declines from prepayments. 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 54%. The 60-plus day delinquency rate for these investments decreased slightly to 1.18% at March 31 from 1.25% at December 31.

During and after the first quarter, we invested $64 million in additional opportunistic investments, which include $55 million in GSE CRT bonds in the credit-sensitive strategies and an additional $9 million in fixed-rate bonds from a recently completed jumbo securitization in the interest rate-sensitive strategies. We will continue closely evaluating potential opportunities like these across the mortgage landscape.

PMT's interest rate-sensitive strategies consist of our investments in MSRs sourced from our correspondent production and investments in Agency MBS, non-Agency senior MBS and interest rate derivatives with offsetting interest rate exposure. The interest rate-sensitive strategies contributed a pretax loss of $7 million in the quarter, which was more than offset by a related tax benefit.

As you can see on Slide 13 of our first quarter earnings presentation, MSR fair values before recognition of realization of cash flows declined by $46 million. Net fair value increases on Agency MBS, interest rate hedges and the related tax impacts were $32 million. PMT reported an income tax benefit of $22 million in the first quarter, primarily due to fair value declines on MSRs and interest rate hedges, which are held in PMT's taxable subsidiary.

The fair value of PMT's MSR investments at the end of the first quarter was $4 billion, down slightly from the end of the prior quarter as $101 million of new investments was more than offset by runoff from prepayments and fair value declines. The UPB of loans underlying PMT's MSR investments increased slightly as new production volumes exceeded payoffs. Delinquency rates for borrowers underlying PMT's MSR portfolio remain low, consistent with our expectations for a conventional loan portfolio in a normalized environment. Servicing advances outstanding for PMT's MSR portfolio decreased to $121 million at March 31 from $178 million at December 31, consistent with the seasonal declines from year-end. No principal and interest advances are currently outstanding as prepayment activity continues to sufficiently cover remittance obligations.

PMT's correspondent production segment contributed $1.8 million of pretax income for the quarter. Segment pretax income as a percentage of interest rate lock commitments was 2 basis points, down from 9 basis points in the prior quarter, and the weighted average fulfillment fee rate was 18 basis points, unchanged from the prior quarter. Total correspondent loan acquisition volume was $20.2 billion in the first quarter, down only 3% from the prior quarter. 53% or $10.7 billion were conventional loans and 47%, or $9.5 billion were government loans. Purchase volume was 94% of total acquisitions, up slightly from last quarter.

Conventional loans acquired for PMT's account were $6.6 billion, down 2% from the prior quarter. Acquisition volumes remained strong in April. Total fundings for the month are estimated to be $6.3 billion and locks are estimated to be $6.8 billion. PMT's Corporate segment includes interest income from cash and short-term investments, management fees and corporate expenses. The segment's contribution for the quarter was a pretax loss of $13.3 million.

PMT reported $35 million of net income across its strategies, excluding market-driven value changes and the related tax impact. A key driver of PMT's long-term success and solid performance relative to peers has been the innovative financing structures we have in place to finance our MSR and CRT assets. This quarter, we took steps to further strengthen our balance sheet by extending the maturity of the secured Fannie Mae MSR term notes originally due in April by 2 years and by issuing $235 million of new 2-year CRT term notes after quarter end to finance the CRT investments previously financed with securities repurchase agreements. Consistent with all our other CRT term notes, these new notes do not contain margin call provisions, mitigating cash exposure risks associated with fluctuations in market values.

With that, I'll turn the discussion back to David for some closing remarks.

[David Spector, executive]

Thanks, Dan. We continue to see attractive opportunities to deploy capital into new investments as well as the repurchase of our shares well below book value. Given PMT's seasoned investment portfolio with solid underlying fundamentals and a strong balance sheet, I remain optimistic for continued strong financial performance in 2023. We encourage investors with any questions to contact our Investor Relations team by e-mail or phone. Thank you.

[Isaac Garden, executive]

This concludes PennyMac Mortgage Investment Trust's first quarter earnings discussion. For any questions, please visit our website at pmt.pennymac.com or call our Investor Relations department at [phone]. Thank you.