The past year has been extremely difficult for companies in the mortgage industry. As the Federal Reserve hiked the Fed funds rate at the most aggressive pace in decades, mortgage originators struggled with ever-declining volumes. That led to mortgage real estate investment trusts (mortgage REITs) being beset by interest rate volatility.
PennyMac Mortgage Investment Trust (PMT 1.83%) is an originator and mortgage REIT, and it would seem a likely candidate to get hit as well. And yet it reported an increase in book value in the first quarter of 2023. What is this REIT doing right?
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PennyMac uses an unusual strategy
PennyMac Mortgage Trust is a mortgage REIT with a three-pronged strategy. It uses these three different strategies to help it excel no matter the market environment, allowing the company to earn decent returns in all of them. This feat is easier said than done in the mortgage space, particularly over the past year as the Federal Reserve's monetary tightening policy has made life miserable for everyone in this business.
PennyMac's first strategy is credit sensitive. The company creates credit risk transfer (CRT) securities from Fannie Mae and Freddie Mac. These credit risk transfer securities are basically a way for Fannie Mae to pass along some of the credit risks on loans it guarantees. In many ways, they resemble an insurance policy.
In the first quarter of 2023, credit-sensitive strategies accounted for about 64% of PennyMac Investment Trust's revenues. This is because mortgage delinquencies are hovering around all-time lows due to a combination of a super-strong labor market and robust home price appreciation over the past three years.
Mortgage servicing was a drag in Q1
PennyMac Mortgage Trust's second strategy is mortgage servicing, which is interest rate sensitive. PennyMac Mortgage Trust holds a large mortgage servicing book. Mortgage servicing is an unusual asset in that it is based on the right to earn a fee for performing a service.
Mortgage servicers administer the mortgage on behalf of the mortgage investor. The servicer sends out the monthly bills, ensures property taxes are paid, and works with the borrower in the event of default. The servicer is compensated 0.25% of the mortgage balance per year. On a typical $400,000 mortgage, the servicer gets paid $1,000 per year.
The right to perform this service is worth something, and it is capitalized on the balance sheet as an asset.
During the first quarter of 2023, mortgage servicing actually lost money for two reasons. First, interest rates fell during the quarter, which made the asset worth less. Second, many of PennyMac's underlying loans were refinanced. When the loan is refinanced, the right to perform that service no longer exists, and that asset is written down to zero. Last year though, it was mortgage servicing that carried the day for PennyMac as rates rose.
Finally, PennyMac Mortgage Trust earned money from correspondent mortgage lending. PennyMac Mortgage Trust buys mortgages from smaller lenders, securitizes them, and then flips them into the market for a small gain and generally retains the mortgage servicing asset. Since the mortgage business has been a tough slog due to higher interest rates, the correspondent line made a small profit but was not a big driver.
PennyMac reported an increase in book value per share
PennyMac Mortgage Trust reported that book value per share rose from $15.78 at the end of the fourth quarter to $15.96 in the new first quarter. That's a win, since many other companies in the mortgage space reported declines in book value per share.
Net income for the quarter came in at $0.50 per share, which covers the quarterly dividend of $0.40. PennyMac Mortgage Trust cut its dividend last year from $0.47 to $0.40, which gives the company a dividend yield of 13.6%. Given the coverage, the dividend looks safe for now.
As long as mortgage delinquencies stay low, credit-sensitive strategies should continue to produce good returns. If rates fall, PennyMac Mortgage Trust will probably see further declines in its mortgage servicing book, but origination volume should help make up for it. Now that the Federal Reserve might be pausing interest rate hikes, the outlook for the mortgage REIT space has improved. PennyMac Mortgage Trust's dividend looks safer than those of most other mortgage REITs.
All this suggests this stock is worth a closer look for those interested in the mortgage REIT space.
