PennyMac Mortgage Investment Trust Q3 FY2024 Earnings Call

Good afternoon, and welcome to PennyMac Mortgage Investment Trust Third Quarter Earnings Call. Additional materials, including the presentation slides that will be referred to in the call, are available on the 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 equivalents 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 Trust, Chief Financial Officer.

Thank you, operator. PMT's third quarter financial results reflect solid levels of income, excluding market-driven value changes, bolstered by fair value changes, including associated tax benefits. Net income to common shareholders was $31 million or diluted earnings per share of $0.36. PMT's annualized return on common equity was 9% and book value per share at September 30 was $15.85, down slightly from the end of the prior quarter. Turning to the origination market, current third-party estimates for total originations averaged $2.3 trillion in 2025, reflecting expectations for mortgage rates to decline from current levels, driving growth in both refinance and purchase volumes. PMT's stable performance in recent periods of heightened volatility highlights the strength of the fundamentals underlying its long-term mortgage assets and our expertise managing mortgage-related investments in a changing environment. We continue to focus on PMT's balance sheet. This quarter, I'm pleased to note that we effectively completed the refinancing of $457 million of CRT and MSR term notes, with $514 million of new term notes with lower effective costs and extended durations. Approximately 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 over the foreseeable future as low expected prepayments have extended the expected lives of these assets. Additionally, delinquencies remain low due to the overall strength of the consumer as well as a 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 of these MSRs remain far out of the money and we expect the MSR asset to continue to produce stable cash flows over an extended period of time. While MSR fair values were down slightly from June 30 due to fair value declines and runoff from prepayments, MSR values continue to 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 originated risk share have low delinquencies and a low weighted average current loan-to-value ratio of below 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. Given the capital raised in the third quarter, PMT retained an increased percentage of total conventional correspondent loan production, resulting in approximately $90 million invested in new MSRs, more than double the amount from the prior quarter. In the fourth quarter, we expect PMT will retain a smaller percentage of conventional production as we optimize PMT's capital allocation while also evaluating emerging investment opportunities in the private label securitization market. We believe the mortgage landscape is evolving and increasingly presenting new opportunities for PMT to be a material participant in that market. Volume or pricing limits for the GSEs on certain types of loans, such as non-owner occupied and second homes have driven increased private label securitizations of such loans in recent periods. Additionally, meaningful volumes of jumbo loans are being originated in channels outside of the banks. PMT has long benefited from a synergistic relationship with PFSI and its leading fulfillment and servicing operation to process large volumes of loans at the highest quality standards and positively influence investment performance. Combined, we estimate PMT accounted for approximately 7% of the total production market in the last year with a leadership position in the correspondent channel and a growing presence in direct lending. Through this multi-channel production platform, we have been acquiring and originating growing volumes of loans we think have the potential for PMT to securitize to drive organic investments in newly created private label securities. Given our long-standing relationships with global banks, asset managers, and institutional asset-backed investors, we believe PMT is well-positioned to successfully execute on these activities, especially as the origination market returns to more normalized levels. While we've been selling jumbo loans on a whole loan basis, we've been aggregating agency-eligible non-owner occupied loans with the expectations that PMT will close the securitization of such loans in the fourth quarter, followed by another similar transaction in the first quarter next year. Now I'll turn it over to Dan, who will review the drivers of PMT's third quarter financial performance and PMT's run rate potential.

Thank you, David. PMT earned $31 million in net income to common shareholders in the third quarter or $0.36 per diluted common share. PMT's credit-sensitive strategies contributed $26 million in pre-tax income. Of this, $17 million were from organically created CRT investments, $6 million were from non-agency subordinate MBS, and $3 million were from other opportunistic investments in GSE CRT. 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 below 50% and a 60-day delinquency rate of 1.23%, both as of September 30th. The interest rate sensitive strategies contributed pre-tax income of $500,000. The fair value of PMT's MSR investment decreased by $84 million, as the decrease in mortgage rates drove an increase in future prepayment projections. These fair value declines were offset by the combined impact of changes in the fair value of MBS, interest rate hedges, and related income tax effects. MBS fair values increased by $128 million due to the decline in mortgage rates, and interest rate hedges decreased by $67 million. Fair value declines on MSRs and interest rate hedges held in PMT's taxable REIT subsidiary drove the $15 million tax benefit this quarter. Inclusive of the tax benefit, the interest rate segment contributed approximately $19 million to net income. The fair value of CMC's MSR asset at the end of the quarter was $3.8 billion, down slightly from $3.9 billion at June 30th as fair value declines in runoff from prepayments more than offset new investments from loan production. Delinquency rates for borrowers underlying PMC's MSR portfolio remain low while servicing advances outstanding decreased to $71 million from $83 million at June 30th. No principal and interest advances are currently outstanding. Income from PMT's correspondent production segment was up from last quarter, driven by higher volumes. Total correspondent loan acquisition volume was $26 billion in the third quarter, up 15% from the prior quarter, driven by the larger overall market. Conventional loans acquired for PMT's accounts totaled $5.9 billion, up 167% from the prior quarter due to PMT retaining a larger percentage of the total conventional correspondent production. We expect this percentage to decrease to approximately 15% to 25% in the fourth quarter in order to optimize PMT's capital allocation. Profitability in this segment in recent periods has benefited from the release of liabilities related to representations and warranties provided at the time of securitization as the high volumes of loans produced from 2020 to 2022 have surpassed the three-year window for violations with minimal repurchase related losses. We expect the contribution from the release of liabilities to decline to more normalized levels over the next several quarters. The weighted average fulfillment fee rate was 19 basis points, down from 20 basis points in the prior quarter. PMT reported $35 million of net income across its strategies, excluding market-driven value changes, and the related tax impacts unchanged from the prior quarter. Looking forward, Slide 7 outlines the run rate potential expected from PMT's investment strategies over the next four quarters. PMT's current run rate reflects a quarterly average of $0.37 per share, up from $0.33 per share last quarter, primarily driven by the decline in short-term interest rates, which reduces expected financing costs. If the yield curve steepens further, we expect PMT's overall run rate would continue to increase closer to the $0.40 range, driven by higher overall yields in interest rate-sensitive strategies. Turning to capital, liquidity is in place for repayment in full of the $210 million in exchangeable senior notes due in November. As David mentioned earlier, we strengthened our capital position, refinancing MSR and CRT term notes at more attractive rates and longer durations. At the end of the prior quarter, we issued $355 million of three and a half year MSR term notes at a cost of SOFR plus 275 basis points. In July, proceeds from that issuance were used to refinance $305 million of MSR term notes, which were at a cost of SOFR plus 419 basis points that matured in 2027. In August, we issued $159 million in four-year CRT term notes at a cost of SOFR plus 310 basis points, effectively refinancing $152 million of notes, which were at a cost of SOFR plus 375 basis points that were due to mature in 2025. We'll now open it up for questions.

Thank you. I'd like to remind everyone we will only take questions related to PennyMac Mortgage Investment Trust or PMT. Your first question comes from the line of Jason Weaver with Jones Trading. Please go ahead.

Hey, good afternoon. I just wanted to hone in on one of Dan's remarks there, specifically regarding the steepness of the yield curve and the earnings power of the entire PMT. Would you say that, that changes the calculus for the Board as far as dividend policy goes going forward? And how might that evolve over time?

I think our narrative has been pretty similar around our expected earnings power and how that plays into the dividend evaluation. So we've been in this inverted yield curve environment for a pretty significant amount of time, and to the extent that we see the yield curve invert over time, that should allow for greater earnings power in the interest rate sensitive strategies as the yield on those longer assets, which are all really key off of longer-term rates, and which we mark to market on a monthly basis or a quarterly basis. As those yields increase or become higher relative to the rates at which we're funding those assets, which are generally at spreads over short-term rates, that drives the overall earnings power and could push us back up toward our run rate, back up towards the $0.40 level, as I mentioned in my remarks. That's really been the case over the last several quarters. And we're now starting to see that reinversion really take shape and really see that path back to the $0.40 run rate. And so as for the dividend or as the Board evaluates the dividend, and as we look at the dividend, we've generally endeavored to keep that stable to the extent that we see that path back to $0.40, which now seems more apparent given the changes in the environment that the Fed has begun lowering short-term rates. And then most recently, we've seen this increase in the longer end of the curve. And so really it's flattening out there. So I think we're finally starting to see what we've been talking about for the last few quarters come to fruition, which really translates into the dividend and the run rate moving towards it sort of plays into the narrative that we've had and the stability that we've maintained for the dividend over time.

Okay. Thank you for that. And just as a follow-up, I was curious if maybe more open-ended. But if you're thinking about any emerging opportunities to shift your equity allocation possibly more towards the credit-sensitive strategies, given that the shift in monetary policy?

Yes. Look, I think, Jason, as you point out, and as I mentioned in my opening remarks, I do think there's a very good opportunity to increase our investment in credit-sensitive assets. We're seeing a lot of good securitization activity in investor loans and second homes away from the GSEs, and as I mentioned, we're looking to close the deal in this quarter and aggregating to do another deal right after the New Year. And look, this is what PMT was back in 2009 when we IPO-ed PMT. This was the investment thesis that we were going to see a return to private label securitization. It's taken a lot longer than we thought it would, but I think we're seeing it very clearly. I like the activity that we're seeing in PFSI in terms of jumbo loan originations. I think there are opportunities between those currently executing those as whole loans, but I think there could be opportunities to securitize those loans as well as buy loans into correspondent to securitize. And so I think the aggregation for jumbo loan deals, given the power of these two great companies, is one where if we meet our required returns, we can proceed with jumbo loan securitizations. So I do believe that as I think about it, we've got this great CRT investment that's rolling off capital and the ability to redeploy it into credit-sensitive strategies is something that I would like to pursue, and it's something that, as I mentioned, we'll be kicking off this quarter.

Got it. That's very helpful color. Thanks again, guys.

Thank you, Jason.

Your next question comes from the line of Bose George with KBW. Please go ahead.

Hey, everyone. Good afternoon. I have a couple of follow-up questions. First, regarding the steepening curve with the 10-year selling off, do you feel indifferent about how this steepening affects your returns?

So yes, we're fairly agnostic to how the curve steepens. It's really when we're looking at the interest rate sensitive strategies, the relationship between the longer end of the curve and the shorter end of the curve. So whether interest rates come down or longer-term rates go up — and when I say shorter-term rates, I mean, really, financing rates — that drives that spread overall and the interest rate sensitive strategies to be larger and drive that income potential or return potential for the strategy. So, either way or both are helpful. And we're fairly agnostic to exactly which way or both it happens.

Okay. Great. Thanks. And then you noted you've been selling the jumbos out of PFSI. Can you just talk about the returns that those were securitized? I assume you're selling them just because securitization has not kind of hit the hurdle rates that you're targeting? And can you just talk about how close that math is getting?

That's right. I want to complete a securitization of investor loans and second homes and really build on that. It's something we need to reignite. We did a jumbo securitization around 2013, so we have the experience. We just need to reignite it. It's getting close to our return target, though it's not there yet. Given the amount of jumbo loan activity in the marketplace, the ability to quickly aggregate for a securitization is encouraging for jumbo loans. When securitizing investor loans and second home loans eligible for delivery to the agencies, if there's a disruption in the private label market, we can deliver those loans to the GSEs, which hedges the spread risk—this isn't the case with jumbo loans. It's crucial for us to aggregate quickly and get into the market for securitization to mitigate the spread risk associated with general loan securitization. Once we complete our first securitization, we can continue to expand that operation. I don’t see private label securitization declining. The banks have indicated they'll be less active in jumbo loans except for prime customers. There will be opportunities for jumbo securitizations. I don’t believe the GSEs will lower their pricing on investor loans in second homes, and I see opportunities there as well. As you can tell, I’m excited about the opportunities in P&C since PFSI and PMT together represent 7% of the mortgage market. The ability to aggregate the loans isn't the issue; over time, we will continue to enhance our expertise and capability to securitize loans with subordinate bond investments.

Great. That's helpful. Thank you.

Your next question comes from the line of Doug Harter with UBS. Please go ahead.

Thanks. David, one of the areas you didn't touch on as possible securitization would be second liens, we've obviously PennyMac is originating those as well. Can you just talk about if the execution there has come close to hurdle rates or would still have a ways to go to be attractive?

We do — it does have a ways to go. As you can tell from as I'm talking today to you, everyone on the phone, at the top of the waterfall in investor loans in the second half, those meet our return targets. Secondly is jumbo loans, which is getting very close, I think the second liens, we're still seeing a tremendous bid on a whole loan basis going to other market participants who have a lower cost of capital. It's one that we'll continue to look at, and we monitor all of these markets. But suffice it to say, if there was a market disruption or we saw the ability to invest in there, there's nothing to prevent us from doing that securitization.

Great. As you consider the amount of capital that can be invested in these opportunities, how should we view the level of MSR retention that PMT is expected to maintain in the upcoming quarters?

Look, I think that we've done a really nice job keeping the MSR investment — the UPB of the MSR portfolio rather flat over the last two to three years as we've been faced with the capital constraints of PMT. I look at the run-off from our CRT investments as the capital that we can use to redeploy into the credit-sensitive strategies to maintain that at a pretty constant level. At the end of the day, as we continue to produce returns that we've seen over the past two years, I'm confident that we'll be able to raise additional capital. That's something we've been focused on at PMT, really focused on delivering returns that exceed the dividend yield that will allow us to continue to see PMT's share price go up, so we can issue common equity or we can issue other forms of equity. But clearly, we have enough capital to ramp up the securitization effort, as I mentioned from the capital running off from CRT, and we will continue to produce the returns.

Great. Thank you, David.

Your next question comes from the line of Matthew Howlett with B. Riley. Please go ahead.

Hi, David. Hi, Dan. Thanks for taking my question.

Thanks, Matt.

Just a follow-up on the last question. Would you expect PMT eventually to retain more to get back to that 50-plus percent retention of conventional correspondent production? Or do you have so many opportunities? It sounds like you just have this incredible subset. Does it make sense to just sell – looking to selling to PFSI and free up capital for the securitization effort and other things?

Yes. Exactly, Matt. I think that's really the idea behind the reduction in terms of the allocation of conventional correspondent that we mentioned from 42% in the past quarter to the 15% to 25%. As we see opportunities in the securitization market and are aggregating for those opportunities, it's ensuring that we're not crowding out by adding on additional MSR through the conventional correspondent retention. I think it's exactly as you described, opening up a little bit of capital room to aggregate and retain the interest on those securitizations, and that's leading to that reduction on the correspondent side. As David mentioned, if we deliver returns as we expect and are able to raise additional capital that could be a catalyst to increase that proportion of the conventional loans that are retained again and invest in additional MSR alongside greater concentration in the credit-sensitive assets. But that's sort of as we move forward, and we see those opportunities moving forward.

Thanks for that. Is the goal, I remember, I've been covering PMT for a long time, and you wrote a 50/50 credit interest rate five, six, seven years ago. It's going to take time. I'd love to see it be a regular issue when the non-securitization market is going to be great. How long does it — where do you want to take the credit segment? I mean, do you want PMT looking out five years to be 50/50? Or is this going to be dependent on the market?

Look, I think it's — look, we're an investment vehicle in PMT, and we want to deliver the highest return to our shareholders, and that's going to drive our decision-making. Having said that, I'm with you, Matt, I like to see a better balance between the credit sensitive strategies and the interest rate sensitive strategy segments, and so the ability to do more and more securitizations to increase the amount of investments in credit-sensitive strategies is one that we're highly focused on. But at the end of the day, it's going to be returns, and it's going to be the return on common equity that we want to continue to be above 10% on that, if not higher, and do it in a meaningful way. I do think that it could take a little bit of time, but we're clearly well on our way to getting there.

Yes, it's great to see that. As you mentioned, David, PMT has made progress, and it seems the non-agency market is poised for significant growth. In terms of interest rate strategies, with the steepening trend and repo rates beginning to decline, it appears the Fed may implement further cuts. Regarding the refinancing of these CRTs on the MSR term, how much potential is still there? What additional cost savings can we expect?

I think, generally speaking, on the refinancing of the debt side, it depends a little bit on what happens in the market and where spreads go. There may be additional opportunities. Obviously, we have acted on the opportunities that we've seen thus far. We don't necessarily see anything imminently on the horizon in terms of refinancing further in terms of those term notes or term loans that we have. But we have seen pretty significant spread tightening over the past few quarters. That's what led to some of these refinancings. To the extent that we see further spread tightening, that could prompt us to look at doing some further refinances. In the near-term, we think we've done some pretty good work here that will benefit us as we're moving forward, and there isn't necessarily anything specifically on the horizon that we're looking at.

You had the company in a great position. I really appreciate it. Thanks, guys.

Thanks, Matt.

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

Hey thanks. Just one thing, did you say what the source of cash or liquidity is to retire the debt that's coming due next month? And is the expectation to carry lower leverage for a period of time? Or how are you thinking about that?

So, the source of funds for repaying the debt due next month is drawing on our secured lines, and so we've positioned the liquidity really more or less ready to be able to retire that debt. Sorry, what was the second part of your question, Eric? I didn't hear that clearly.

Well, it sounds like the leverage is going to be unchanged. Does the draw that you made to retire that is that reflective at on the balance sheet at the end of the third quarter?

Yes, it's not reflected at $930 million. So, yes, during the month this month. But yes, you're right, overall leverage would be pretty similar to September 30; we're basically swapping secured debt for that convertible issuance.

Okay, super. All right. Thank you.

Your next question comes from the line of Bose George with KBW. Please go ahead.

Hey, thanks for the follow-up. Just wanted to see if you could provide some color on the types of buyers in the whole loan market for both for the jumbos and the second liens?

Look, we're seeing a wide range of buyers. I think that we're able to sell these loans to insurance companies where some of the private equity shops are setting up their own conduits and doing their own aggregation and securitization. Similarly, on the PFSI side, when we sell second liens, we see similar buyers. There is a wide range of buyers. The thing that impresses me is the depth of the market. That's why, quite frankly, I'm fairly confident, very confident in our own ability to securitize because I think there's a very deep bid for these loans, deeper than I've seen in quite some time. I think there's a need for structured assets and structured investments. The ability, quite frankly, to organically create the opportunities is one that's really unique in the marketplace. It's not banks, and I will tell you that. It's all the usual cast of characters that we've seen in the past.

Okay. Great. Thanks a lot.

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

Well, thank you, operator. Thank you all for joining us today. I really appreciate the time and the questions that were asked. If you have any follow-up questions, please feel free to reach out to our Investor Relations group. They will follow up with you and me. Have a good day, and again, thanks a lot for the time.

This does conclude today's conference call. Thank you for your participation, and you may now disconnect.