PennyMac Mortgage Investment Trust (PMT) Q1 2021 Earnings Call Transcript

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PennyMac Mortgage Investment Trust (PMT -0.95%)
Q1 2021 Earnings Call
May 06, 2021, 5:00 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Isaac Garden

Good afternoon, and welcome to the first-quarter 2021 earnings discussion for PennyMac Mortgage Investment Trust. The slides that accompany this discussion are available from PennyMac Mortgage Investment Trust's website at www.pennymac‐reit.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. Thank you.

Now, I'd like to introduce David Spector, PMT's chairman and chief executive officer, who will discuss the company's first-quarter 2021results.

David Spector -- Chairman and Chief Executive Officer

Thank you, Isaac. PMT produced another strong quarter of financial results with net income attributable to common shareholders of $65.4 million or diluted earnings per share of $0.67. These strong results were driven by strong correspondent production results and the continued improvement in the fair value of its GSE credit risk transfer investments. Additionally, PMT's CRT investments continued to benefit from the elevated prepayment speeds we are seeing across the industry.

MSR fair value gains were more than offset by fair value declines on Agency MBS and interest rate hedges due to significant prepayment activity and elevated hedge costs driven by market volatility. PMT paid a common dividend of $0.47 per share. Book value per share increased 3% to $20.90 from $20.30 at the end of the prior quarter, partially due to strong earnings and partially due to the issuance of senior exchangeable notes.In the current and evolving market environment, PMT is uniquely positioned as the largest correspondent lender in the country to continue to create organic investments in MSRs sourced from the high-quality conventional production of loans it delivers to the GSEs. In addition to benefiting from the historically large origination market we are currently in, PMT also benefits from the investments in technology and fulfillment capacity made by its manager and services provider, PennyMac Financial.

Further, PMT's investments in MSR and CRT benefit from PFSI's expertise in managing credit risk utilizing a variety of loss mitigation strategies. Our high-quality loan production in the quarter resulted in the creation of more than $400 million in new, low‐rate mortgage servicing rights, and PMT ended the quarter with approximately $2.4 billion in fair value of MSRs, which we expect will perform well in a rising rate environment. Also, this quarter, we further strengthened PMT's balance sheet, issuing senior exchangeable notes and term asset‐backed financing to replace less favorable short‐term securities repurchase agreements. We issued $659 million of three‐year term notes associated with PMT's sixth CRT transaction and the entirety of PMT's CRT investments is now financed with term notes that do not contain margin call provisions, providing stable financing throughout much of the expected life of the asset.

We also issued $350 million in five-year Fannie Mae MSR term notes to support the growing MSR portfolio. This term financing also more closely aligns to the expected life of the asset. And finally, we issued $345 million of five‐year senior exchangeable notes, upsized from an initial $200 million offered with strong support from institutional investors. This issuance with an initial conversion price of $21.69 represents an attractive premium to PMT's book value per share at issuance.

In addition, the option value of the conversion premium contributed partially to the increase in PMT's book value during the quarter. With that, I will now turn it over to Andy Chang, PMT's senior managing director and chief operating officer.

Andy Chang -- Senior Managing Director and Chief Operating Officer

Thank you, David. I will discuss the mortgage origination landscape and how we believe we have positioned PMT to continue delivering attractive risk‐adjusted returns to our shareholders. The origination market continues to be historically strong as mortgage rates remain near record lows despite the increases in the 10‐year treasury yield since the start of the year. Recent economic forecasts for 2021 originations range from $3.3 trillion to $4 trillion, while average forecasts for 2022 originations remain strong at $2.6 trillion.

It is worth noting that in each of 2021 and 2022, purchase originations are expected to total $1.7 trillion, almost 40% higher than 2019 levels. So, while refinance origination volumes are expected to decline significantly over time as a result of higher interest rates, we believe PMT is well-positioned to continue organically creating investments, especially as we are one of the largest producers of purchase money loans in the U.S. We believe favorable dynamics continue to drive significant opportunities for PMT in correspondent production. As the GSEs implement the latest amendments to their preferred stock purchase agreements, we expect these changes to favor scaled and well‐capitalized market participants such as PMT.

Additionally, we expect the $1.5 billion annual limit per client on cash window deliveries into each of the GSEs to drive more volume into the correspondent channel. Finally, we expect limitations placed on the GSEs' ability to guarantee certain types of loans to create a heightened need for private capital over time, providing opportunities for increased investment from companies like PMT that have established expertise in the mortgage capital markets and private label securitizations. PMT's capital deployment is currently focused on the large opportunity in conventional correspondent production and the related high‐quality mortgage servicing rights. As you can see on Slide 7 of our presentation, during the first-quarter run-off from prepayments on our CRT investments was more than offset by net new MSR investments.

As David mentioned, PMT's position as an industry‐leading producer of mortgage loans gives us a unique ability to create attractive, high‐quality organic investments in MSRs at low interest rates. Furthermore, PennyMac Financial's history in successfully executing loss mitigation strategies in its role as the servicer of the loans underlying these investments creates a strong alignment of interests. On Slide 9, we illustrate the run‐rate return potential from PMT's investment strategies, which represents the average annualized return and quarterly earnings potential that PMT expects over the next four quarters. In total, we expect a quarterly run‐rate return for PMT's strategies of $0.50 per share or a 9.5% annualized return on equity.

This run‐rate potential estimate is down slightly from what we showed last quarter. In our credit-sensitive strategies, a slight reduction in our expected CRT returns reflects credit spreads that have tightened. In contrast, the return potential for our interest rate-sensitive strategies has improved modestly, driven by expectations for higher carry-on agency MBS. The change in PMT's run‐rate expected return is also driven by a shift in equity allocation toward the interest rate-sensitive strategies from the correspondent production segment as a result of expectations for lower origination market volumes over the next year.

Now, I'd like to turn the call over to Vandy Fartaj, PMT's senior managing director and chief investment officer, who will discuss the drivers of PMT's first-quarter investment performance.

Vandy Fartaj -- Senior Managing Director and Chief Investment Officer

Thank you, Andy. Let's begin with highlights in our correspondent production segment. Total correspondent acquisition volume in the quarter was $51.2 billion in UPB, down 10% from the prior quarter and up 72% year over year. Sixty-six percent of PMT's acquisition volumes were conventional loans, essentially unchanged from the prior quarter.

We maintained our leadership position in the channel as a result of our consistency, competitive pricing, and the operational excellence we continue to provide to our correspondent partners. PMT ended the quarter with 727 correspondent seller relationships, up from 714 at December 31. Conventional lock volume in the quarter was $34 billion in UPB, down 14% from the prior quarter and up 78% year over year. Margins in the channel have normalized and PMT's correspondent production segment pre-tax income as a percentage of interest rate lock commitments was 10 basis points, down from 13 basis points in the prior quarter.

Acquisition volumes remained strong in April, with $18.5 billion in UPB of total acquisitions and $15.6 billion in UPB of total locks. PMT's interest rate-sensitive strategies consists of our investments in MSR sourced from our correspondent production, and investments in agency MBS, non‐agency senior MBS, and interest rate hedges with offsetting interest rate exposure. The fair value of PMT's MSR asset at the end of the first quarter was $2.4 billion, up from $1.8 billion at the end of the prior quarter. The substantial increase in the fair value of our MSR investments reflects both new MSR investments and fair value gains that resulted from higher interest rates.

Notably, during the quarter PMT sold its remaining investment in ESS back to PFSI at fair value. The capital that resulted from the sale of this investment is expected to be redeployed into attractive MSR investments. Now, I would like to discuss the drivers of performance in PMT's credit-sensitive strategies, which primarily consist of investments in CRT. The total UPB of loans underlying our CRT investments as of March 31 was $48 billion, down significantly quarter over quarter as a result of elevated prepayments.

Fair value of our CRT investments at the end of the quarter was $2.58 billion, down slightly from $2.62 billion at December 31 as fair value gains largely offset the decline in asset value that resulted from prepayments. The 60-day delinquency rate underlying our CRT investments was essentially unchanged quarter over quarter as the overall number of delinquent loans declined roughly in proportion with prepayments. PFSI's position as the manager and servicer of loans underlying PMT's CRT investments gives PMT a strategic advantage given we can work directly with borrowers who have loans underlying PMT's investments and have experienced hardships related to COVID‐19. PFSI uses a variety of loss mitigation strategies to assist delinquent borrowers, and because of the scheduled loss transactions, notably PMTT1‐3 and L Street Securities 2017‐PM1, trigger a loss if a borrower becomes 180 days or more delinquent, we have deployed additional loss mitigation resources and continue to assist those borrowers at risk.

With respect to PMTT1‐3, which comprises 6% of the fair value of PMT's overall CRT investment, if all presently delinquent loans proceeded unmitigated to 180 days or more delinquent, additional losses would be approximately $34 million. Through the end of the quarter, losses to date totaled $7 million. As a reminder, mortgage obligations underlying PMTT1‐3 become credit events at 180 days or more delinquent regardless of any grant of forbearance. Moving on to L Street Securities 2017‐PM1, which comprises 18% of the total fair value of PMT's CRT investment, such losses will become reversed credit events if the payment status is reported as current after a forbearance period due to COVID‐19.

PMT recorded $14 million in net losses reversed in the first quarter as $43 million of losses reversed more than offset the $29 million in additional realized losses. We believe the majority of the remaining losses have the potential to reverse if the payment status of the related loan is reported as current after the conclusion of the CARES Act forbearance. We estimate that an additional $32 million of these losses were eligible for reversal as of March 31 subject to review by Fannie Mae and we expect this amount to increase as additional borrowers exit forbearance and reperform. We estimate that only $6 million of the losses outstanding had no potential for reversal.

This market expectation of significant future loss reversals resulted in the fair value of L Street Securities 2017‐PM1 exceeding its face amount by $46 million at the end of the quarter. The most common method for borrowers to exit forbearance to date has been a COVID‐19 payment deferral. This allows the borrower to defer the amount owed of the payment deferral to the end of the loan term and the loan is deemed current after the borrower makes a specified number of mortgage payments. Now, I would like to turn the call over to Dan Perotti, our senior managing director and chief financial officer, who will review our quarterly financial results.

Dan Perotti -- Senior Managing Director and Chief Financial Officer

Thank you, Vandy. PMT reports results through four segments: credit-sensitive strategies, which contributed $134.3 million in pre-tax income; interest rate sensitive strategies, which contributed $64.6 million in pre-tax loss; correspondent production, which contributed $35.6 million in pre-tax income; and the corporate segment, which had a pre-tax loss of $14.2 million. The contribution from PMT's CRT investments totaled $135.7 million. This amount included $98.1 million in market‐driven value gains, reflecting the impact of credit spread tightening and elevated prepayment speeds.

As a reminder, faster prepayment speeds benefit PMT's CRT investments as payoffs of the associated loans reduce potential for realized losses and return principal at par for investments currently held at a discount. Net gain on CRT investments also included $42.7 million in realized gains and carry, $13.3 million in net losses reversed, primarily related to L Street Securities 2017‐PM1, which Vandy discussed earlier, $200,000 in interest income on cash deposits, $15.9 million of financing expenses, and $2.5 million of expenses to assist certain borrowers in mitigating loan delinquencies they incurred as a result of dislocations arising from the COVID‐19 pandemic. PMT's interest rate sensitive strategies contributed a loss of $64.6 million in the quarter. MSR fair value increased $338 million during the quarter.

$380 million in fair value gains as a result of lower expectations for prepayment activity in the future driven by higher mortgage rates was partially offset by $42 million in other valuation losses, primarily driven by elevated levels of prepayment activity. Fair value declines on Agency MBS and interest rate hedges totaled $448 million and included $29 million in hedge costs driven by market volatility that also impacted hedge effectiveness in the quarter. Valuation-related losses in the quarter were somewhat offset by income excluding market‐driven value changes, as servicing fees increased from the prior quarter primarily due to a larger servicing portfolio and as PMT continues to benefit from increasing recapture income from PFSI. We believe, over time, our results have demonstrated successful hedging of mortgage servicing rights in volatile markets.

PMT's Correspondent Production segment contributed $35.6 million to pre-tax income for the quarter, down from $52.7 million in the prior quarter as gain on sale margins normalized. 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 pre-tax loss of $14.2 million. Finally, we recognized a provision for tax expense of $19.4 million in the first quarter, compared to a tax benefit of $9 million in the prior quarter.

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

David Spector -- Chairman and Chief Executive Officer

Thank you, Dan. As we look at the evolving mortgage landscape, we believe PMT remains uniquely positioned to capitalize on the current environment characterized by elevated production volumes. Additionally, we expect changes to the GSE preferred stock purchase agreements limiting cash window deliveries to make the role of well‐capitalized correspondent lenders like PMT increasingly important to a healthy mortgage market. Finally, we look forward to further discussing our outlook for the business at our upcoming Investor Day for PennyMac Mortgage Investment Trust and PennyMac Financial.

We encourage investors with any questions to reach out to our Investor Relations team by email or phone. Thank you.

Isaac Garden

This concludes PennyMac Mortgage Investment Trust's first-quarter earnings discussion. For any questions, please visit our website at www.pennymac-reit.com or call our Investor Relations department at 818‐224‐7028. Thank you.

Duration: 20 minutes

Call participants:

Isaac Garden

David Spector -- Chairman and Chief Executive Officer

Andy Chang -- Senior Managing Director and Chief Operating Officer

Vandy Fartaj -- Senior Managing Director and Chief Investment Officer

Dan Perotti -- Senior Managing Director and Chief Financial Officer

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