PennyMac Mortgage Investment Trust (PMT) Earnings Call Transcript & Summary

Good afternoon, and welcome to the third quarter 2020 earnings discussion for PennyMac Mortgage Investment Trust. The slides that accompany this discussion are available from PennyMac Mortgage Investment Trust 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 President and Chief Executive Officer, who will discuss the company's third quarter results.

Thank you, Isaac. PMT reported net income attributable to common shareholders of $93.3 million, or $0.94 per common share in the third quarter. Our earnings this quarter reflect strong Correspondent Production segment results and a net gain on GSE credit risk transfer investments as credit spreads tighten. PMT reports results through 4 segments: credit-sensitive strategies, which contributed $50 million in pretax income; interest rate-sensitive strategies, which contributed $1.5 million in pretax loss; corresponding production which contributed $86.9 million in pretax income; and corporate with a pretax loss of $13.2 million. PMT's opportunities in correspondent production, interest rate-sensitive strategies and credit-sensitive strategies will be discussed in more detail in the following slides. Book value per common share was $19.95 at September 30, up from $19.39 at June 30. As previously announced, PMT paid a dividend of $0.40 per share for the quarter. PMT's capital deployment this quarter was driven by record conventional loan production volumes, which totaled $27.4 billion in unpaid principal balance, up 45% from the prior quarter and up 64% from the third quarter 2019. New MSR investments for the quarter totaled $265 million, and we delivered to Fannie Mae CRT eligible loans of $1.8 billion in UPB resulting in a firm commitment to purchase $42 million of new CRT securities. We also repurchased approximately 492,000 shares of PMT at a cost of $8.3 million. I am pleased to note that after quarter end, PMT has arranged for sufficient financing to complete the settlement of CRT-6 upon closing, expected in the fourth quarter. Now let's turn to Slide 4 and discuss PMT's unique investment strategies. PMT is a leading producer of conventional conforming mortgage loans, having entered the Correspondent Production business in 2011 after large banks, which have historically dominated the channel, reduced their participation. We will discuss the significant opportunity in the current environment on the next slide. In the Interest Rate-Sensitive Strategy segment, PMT creates new MSR investments through the securitization of conventional correspondent loan production. PMT also invests in agency mortgage-backed securities and other interest rate hedges to mitigate the impacts of interest rate volatility. PMT began organically investing in the credit risk on its high-quality loan production through innovative front end GSE CRT investments in 2015. As of September 30, there were approximately $70 billion in UPB loans underlying PMT CRT investments. New investments in these structures will cease in the fourth quarter. Now let's turn to Slide 5 to discuss PMT's opportunity in the mortgage origination market. Economic forecast for 2020 total originations have now increased to over $3.6 trillion, and forecast for 2021 total originations range from $2.5 trillion to $2.7 trillion. These forecasts indicate a continuation of the robust market, supported by all-time low mortgage rates and expectations that the Federal Reserve will hold interest rates near 0 through 2023. Purchase originations in 2021 are forecasted to increase 5% year-over-year, while refinance originations are expected to return at 2019 levels. PennyMac is well positioned to continue market share growth in the correspondent channel. We've been able to capitalize on this current market environment as a result of our capital structure, risk management disciplines and significant infrastructure and technology investments. Now let's turn to Slide 6 to discuss PMT's investment activity by strategy during the quarter. On Slide 6, we detail investment activity for each of PMT's investment strategies during the third quarter. PMT's capital deployment is focused on correspondent production and the related mortgage servicing rights. CRT investments decreased driven by substantial runoff from prepayment activity and ended the quarter with a fair value of $2.8 billion. PMT's distressed loan and real estate owned portfolio declined further to $44 million in fair value at the end of the third quarter from $52 million at June 30. This portfolio is primarily composed of REO. MSR and ESS investments primarily sourced from the securitization of $27.4 billion in UPB of conventional loan production increased by $207 million net of runoff. As a result of the slight decline in interest rates during the quarter, the fair value of our MSR and ESS investments declined by $16 million. Agency MBS are held by PMT as part of a comprehensive strategy designed to mitigate the interest rate sensitivity of the MSR and ESS assets. The reduction of Agency MBS in the quarter primarily reflects elevated repayments. Overall, PMT's invested equity was roughly flat in the third quarter as the equity for investments in MSRs offset outflows in other assets. Now let's turn to Slide 7 and discuss the run rate return potential from PMT's investment strategies. PMT's run rate potential represents the average annualized return and quarterly earnings potential PMT expects to earn on average each quarter from its strategies over the next 4 quarters. Our expectation for PMT's investment strategies is an average diluted EPS per quarter of $0.58, which will result in an annualized return on common equity of approximately 11%. PMT's equity allocation related to credit-sensitive strategies is expected to average 27% with a run rate annualized potential return on equity of 16%. Our credit-sensitive strategies primarily consist of our investments in CRT with a return potential that increased slightly while equity allocation decreased due to improved expectations for financing terms. The CRT markets continue to reflect uncertainty related to COVID-19 and its associated losses. Equity allocated interest rate-sensitive strategies is expected to average 34%, with an annualized return on equity of 12%, a modest improvement from last quarter. We consider the results in this segment in aggregate as MBS and hedge positions are primarily used to moderate the impact of interest rate volatility on MSR and ESS returns. Equity allocated to the Correspond Production segment is expected to average 18%, with an annualized return on equity of approximately 31%. This is lower than prior projections as conventional margins have normalized and volumes are expected to decrease over the next year. That concludes my presentation, and I'd now like to turn the discussion over to Vandy Fartaj, PMT's Chief Investment Officer, who will review our mortgage investment activities.

Thank you, David. Let's begin with Slide 9 for a look at our correspondent production highlights. Correspondent acquisitions by PMT in the third quarter were a record $44.3 billion in UPB, up 48% from the prior quarter and 43% year-over-year. 62% of our acquisitions were conventional loans and 38% were government loans. Conventional correspondent acquisitions totaled $27.4 billion in UPB, up 45% from the prior quarter and 64% from the third quarter of 2019. Government loan acquisitions in the third quarter for which PMT earns a sourcing fee from PennyMac Financial, totaled $17 billion in UPB, up 54% from the prior quarter and 18% from the third quarter of 2019. Conventional lock volume was a record $34.4 billion in UPB, up 39% from the prior quarter and up 77% from the third quarter of 2019. PennyMac remained the largest correspondent aggregator in the U.S. in the third quarter, and we saw overall correspondent channel volumes increase from low levels in the second quarter. Margins in the channel continue to benefit from the increased volume of higher-margin, best efforts commitments, which increased to 40% of lock volume or $21.8 billion in UPB, up from $14.3 billion in the second quarter and $6.9 billion in the third quarter of 2019. Volumes remain elevated in October, and total correspondent loan acquisitions for the month were $18.7 billion in UPB. Interest rate law commitments were a record $21.7 billion in UPB. Now let's turn to Slide 10 and discuss trends in PMT's MSR and ESS investments. Despite elevated prepayment activity during the quarter, PMT's MSR assets increased to $1.4 billion in fair value driven by new investments from PMT's record conventional production volumes. As David mentioned earlier, new MSR investments were $265 million. The UPB -- PMT's MSR portfolio totaled $152.4 billion at September 30, up from $145.3 billion at June 30. PMT's ESS investments resulting from bulk, mini-bulk and flow MSR acquisitions by PennyMac financial from 2013 to 2015 decreased to $143 million at September 30 driven by repayments of the underlying loans. The UPB associated with ESS investments totaled $17.1 billion at September 30, down from $18.2 billion at June 30. Now let's turn to Slide 11 and discuss PMT's investments in GSE credit risk transfer. PMT delivered $1.8 billion in UPB of CRT eligible loans to Fannie Mae in the third quarter under our sixth transaction with Fannie Mae. As previously noted, PMT has ceased new investments and expects to settle the transaction in the fourth quarter. On a pro forma basis at September 30, PMT's outstanding CRT investments totaled $2.8 billion, down from $3.1 billion at June 30 from increased prepayment activity and a decrease in the face amount of firm commitment to purchase CRT securities. The 60-plus day delinquency rate was 6%, down from 7.3% in the prior quarter, but remains elevated as a result of hardships related to COVID-19. The expected increase in losses is yet to materialize and realized losses in the third quarter totaled $2.9 million. Cumulative lifetime losses as of September 30 were $15.9 million. The UPB of the loans underlying PMT's CRT agreements was $70.4 billion. Now let's turn to Slide 12, and talk about PMT's financing arrangements for the settlement of CRT-6. PMT's sixth CRT transaction with Fannie Mae is expected to sell in the fourth quarter, and we've made arrangements to obtain sufficient financing from our financing partners in connection with the expected settlement. PMT has in place term financing for all of its other settled CRT investments. These term notes do not contain mark-to-market provisions. It is our expectation that any increased losses on CRT investments do not accelerate amortization of the term notes. The earliest maturity is March 2022, and all notes contain optional 2-year extensions. Now let's turn to Slide 13 for an update on CRT performance. PMT's CRT investments recorded $35 million in fair value gains in the third quarter as fair value gains related to PMT's 3 most recent transactions more than offset fair value losses on PMTT 1 through 3. PMT's role as an investor in credit risk on the loans it acquires and services, creates a strong alignment of interest in assisting distressed borrowers. PMT expects to begin incurring scheduled losses related to COVID-19 on its scheduled loss transactions in the fourth quarter. With respect to PMTT 1 through 3, PMT's estimate of scheduled losses, if all presently delinquent loans proceeded unmitigated to 180 days or more delinquent, has been reduced to $75 million at September 30. The fair value of these investments had a $53 million discount to par. With respect to L Street Securities 2017-PM1, PMT expects that a portion of COVID-related losses will ultimately become reverse credit events if the payment status is reported as current at the conclusion of a forbearance period due to a casualty event or up to 3 months thereafter, if necessary. Fannie Mae has published clarification that the COVID-19 pandemic will be treated as a casualty event. Faster prepayment speeds also benefit PMT's CRT investments as payoffs of the associated loans reduced the potential for realized losses and return principal at par or for CRT-6, reduce the commitment amount for investments held at a discount. Now I'd like to turn the discussion over to Andy Chang, PMT's Chief Financial Officer, who will review the third quarter's financial results.

Thank you, Vandy. Let's turn to Slide 15 and discuss the third quarter results and return contributions by strategy. PMT's activities in the third quarter reflected a net income attributable to common shareholders of $93.3 million or an annualized return on common equity of 19%, net of all expenses. In total, credit-sensitive strategies contributed $50 million of pretax income or a 27% annualized return on equity for the quarter. Within the segment, CRT investments contributed pretax income of $51.4 million, which I will expand upon later. Interest rate-sensitive strategies, which include the performance of our MSRs, ESS and agency and non-agency senior MBS positions and related interest rate hedges, together contributed a pretax loss of $1.5 million or a negative 1% annualized return on equity for the quarter. The segment results were primarily driven by losses on premium Agency MBS from prepayments, and a decrease in MSR fair value, largely offset by other income from our interest rate-sensitive strategies. While we show the income contribution for each of these interest rate-sensitive strategies separately, they are managed together as the interest rate sensitivity of the MSRs and ESS has typically been inversely correlated to that of the MBS and our interest rate hedges. Correspondent production contributed $86.9 million to pretax income or a 68% annualized return on equity for the quarter driven by record production volumes. The Corporate segment contributed a pretax loss of $13.2 million. Finally, we recorded $22.7 million in income tax expense driven by increased income in PMT's taxable REIT subsidiary. Now let's turn to Slide 16 to discuss the performance of PMT's CRT investments in the third quarter. PMT's CRT investments contributed $51.4 million of pretax income in the third quarter, consisting of $10.6 million in gains from market-driven value changes and $40.8 million of income, excluding market-driven value changes. Market-driven value changes on our existing CRT investments included fair value gains of $14.5 million, reflecting a modest overall tightening of credit spreads and the impact of elevated prepayment speeds. Net losses on mortgage loans acquired for sale were $3.9 million. These fair value losses were recognized upon loan delivery during the third quarter under the firm commitment to purchase CRT securities. Income excluding market-driven value changes consisted of net realized gains and net interest expense related to our CRT investments. For the quarter, realized gains and carry on CRT investments totaled $48.1 million and losses recognized were $2.9 million. Interest income earned on cash deposits securing CRT investments was $300,000, while interest expense related to the financing of these investments was $4.6 million. Now let's turn to Slide '17 and discuss the delinquency trends we see in PMT's MSR portfolio and forbearance outcomes. As you can see on the slide, the 30-plus day delinquency rate for PMT's MSR portfolio was 4.7%, down from 6.3% at June 30. The percentage of loans in forbearance within PMT's MSR portfolio decreased to 3.9% at September 30 from 6.1% at June 30 as new forbearance plans were more than offset by the 43% of borrowers in forbearance plans at June 30, who have since exited. Of the 26% of borrowers who re-performed, half were GSE payment deferral options and half were or became current. Servicing advances outstanding were approximately $47 million at September 30, up from $38 million at June 30 as delinquencies extended. No principal and interest advances are outstanding as prepayment activity remains sufficient to cover the GSE's requirement. And with that, I'll turn the discussion back over to David for some closing remarks.

Thank you, Andy. PMT delivered strong earnings during the third quarter, driven by record correspondent production volumes and continued recovery in the fair value of its credit risk transfer investments. Earnings per share again exceeded the quarterly dividend and as a result, book value per share increased to $19.95. Volumes in PMT's market-leading correspondent production business increased substantially, driving strong segment earnings and new MSR investments totaling $265 million. PMT's investments in credit risk transfer continue to benefit from the improvements in the market value for risk assets and elevated prepayment speeds. We remain focused on leveraging PMT's market position along with PennyMac Financial's expertise and technology platform to continue to deploy capital in attractive investments and deliver strong risk-adjusted returns to shareholders.

This concludes PennyMac Mortgage Investment Trust's third 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.