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

Hello, everyone. Thank you for joining us for this fireside chat with PennyMac's Chairman and CEO, David Spector; and CFO, Dan Perotti. We have a number of prepared questions we will be going through, but if anyone in the audience would like to ask a question, please click on the ask the question button in the upper right-hand corner of your screen and follow the prompts just to make a question. And we will do our best to address it in the time we have today. Additionally, we have also prepared a number of audience polling questions that we would encourage you to answer during the presentation, and we will be publishing the results in our report summarizing the takeaways from the conference. With that out of the way, let's get to the discussion. Dan and David. Thank you both for joining us today.

Thank you, [ Carter ], for hosting us, and thank you, everyone, for joining us.

I'd like to start the conversation today by discussing some of the prevailing macro factors. So can you talk about how those factors are affecting PMT's business and share any outlook that you might have?

Sure. Look, I think over the last 1.5 years, with COVID in the environment we're in, PMT has been very fortunate that it's been the beneficiary of strong risk management of its balance sheet. And so it's been primarily unaffected from continuing to run its day-to-day operations and continuing to assert itself as a leading correspondent aggregator. We've been, I think, growing the servicing portfolio very nicely. We've been managing our interest rate risk and in addition to our credit risk, and we expect to see continued low rates for the foreseeable future as well as growing in strong origination market. PMT, from the beginning, was set up to focus on purchase money originators. And so it's always over-indexed in terms of purchase money originations in terms of its purchases, mortgage servicing rights. And so as we've seen the purchase market grow and the refi market naturally decline to some degree, I think PMT -- and I know PMT has continued to grow share and to do so very profitably. I expect PMT to continue to grow its servicing portfolio and generate mortgage servicing rights. And at the same time, I think PMT is in a really good position as we see the evolution of the opportunity to invest in credit-sensitive assets. For quite some time, PMT was 1 of 2 entities that invest in lender risk share. As you know, that program was put on hold about a year ago and I think in the meantime, we've been in this kind of wait and see mode to see what's going to happen with the leadership at FHFA as well as what's going to come out of the GSEs. But in the meantime, with the change in the capital rules, we saw caps placed on investor homes -- investor loans in second homes that has allowed PMT to evolve its investment in credit-sensitive assets from CRT into private label securitization. Now there's some question of, are we going to see CRT come back, and I'm sure we'll talk about that a little bit later. But I think PMT will continue to stay nimble and evolve as we see changes taking place. And then -- and finally, we always have an eye on rates. And we always have an eye on what's going to happen if rates go up. And we -- our hedge always has a bias to rising rates. And I think that if rates do go up, we're going to have very, very good mortgage servicing rights that will extend in their duration, that will allow PMT to continue to earn the return that it's earned really over the last 7, 8 plus years.

Okay. Great. A lot to get in there -- get into from that. I guess, first, what is your outlook for market share in the correspondent channel, particularly as production shifts to a more purchase-heavy mix?

Yes. So as I had mentioned, I think that as we move to a purchase heavy mix, that is very favorable for PMT. We, from the very beginning, set out to identify originators of purchase money loans, really with an eye towards -- we felt the mortgage servicing rights were more valuable on purchase money loans as they just have a little longer life when rates decline as well as give PMT the opportunity to participate in the refinance economics of those mortgage servicing rights. But I think that we're going to continue to see PMT grow its share as well as focus on builders and community banks, because that's where a lot of these purchase money loans come out of. PMT has over 700 customers. These are long-standing relationships that we have between the management of our correspondent network with these originators. And I think that that's -- I think that obviously, as we see a movement to purchase to a more purchase environment, I think you're going to see consolidation take place in correspondent. And I think out of this consolidation, PMT is just -- is going to continue to grow in its importance as a go-to correspondent aggregator.

Okay. Great. You noted on your call that July had strong correspondent production of $15 billion in acquisitions and $12.8 billion of blocks. Can you give us an update on how that's performed since then? And what your outlook is for the fourth quarter?

Sure. So we recently released our volume through August 31 with the investor presentation on Monday that we filed publicly. So through 8/31, we've originated and locked nearly $30 billion in correspondent acquisition. So on pace or a little bit better than the pace that we had through July that we had disclosed. Additionally, about $20 billion of that is conventional. And so really driving PMT's continued investments in MSR and the gain on sale in its correspondent channel. And so we're pretty pleased with those results. It's a little bit off the pace that we had in Q2. And I think we're seeing a little bit of a decline in the market overall there, given our share of the correspondent market and the changes that we've seen through the overall origination market, but we're very pleased with the pace that we have there going through Q3.

We've heard from some of your competitors that the correspondent margins picked up a little bit in 3Q. Is that consistent with what you're seeing, maybe just address kind of the overall competitive dynamics in that channel?

I'd say, correspondent has continued to be pretty competitive marketplace in terms of Q3. The -- overall, I think we've seen margins that are roughly in line and across the correspondent space overall. I think, overall, in terms of the dynamics that we've seen in the conventional space, a little bit of bifurcation, given some of the changes that had previously been in place surrounding investor loans. And so able to find certain sort of pockets of margin relating to those types of loans that the GSEs were not able to purchase, given the restrictions that were in place from the PSPAs. But that overall, that conventional correspondent margins we've seen to be -- continue to be competitive in Q3.

Okay. And what can you say about the mix between purchase and refi in that production, given that we're seeing rates kind of fall from 2Q levels?

We've seen an increasing proportion of purchased loans as we go into Q3 overall. I think that would generally be expected just from the seasonality of the housing market as well. Q3 tends to be the strongest in terms of correspondent, at least in terms of purchase money activity. So we did -- we have seen -- we saw the trend in Q2 with more of it toward purchase volume, and we've continued to see that going through in Q3.

Okay. Great. Turning back to the macro outlook. What impact do you expect Fed tapering to have on your interest rate sensitivity strategy?

So overall, in our interest-rate-sensitive strategy, I'd say Fed tapering, were not as interest rate-sensitive as some of the other mortgage REITs may be to fed tapering and the overall shape of the yield curve. As David went through, we have a very developed hedging program. So the overall level of rates in terms of changes to the market value of our portfolio is not necessarily impactful in that we have pretty substantial hedges around the -- that protective value of the overall portfolio. However, we do see some of the dynamics come into play with respect to the interest-rate-sensitive strategies relating to as yields increase overall on -- that helps to increase the overall running yield of our interest-rate-sensitive strategies, both on the MSR side as well as the agency MBS that we use to offset or hedge against interest rate changes in that strategy. And additionally, as interest rates increase, if we have Fed tapering, we'd expect a bit less volatility in terms of the changes in value of the MSR portfolio and a bit less prepayment volatility, which should lead to a bit more stability in the overall GAAP income of the strategy than we've seen potentially in the last couple of periods as we've had at current rate levels, a pretty sensitive MSR asset and some volatility in the fair values there.

Okay. You kind of touched on it a little bit there, but what impact, if any, does the Fed tapering have on your hedging strategy, particularly within your investment portfolio?

Yes. So I would -- I think, look, we've always hedged the MSR from day 1. And I think that that's -- to be able to hedge the size portfolio that we have, that's really the only way to do it. We have always looked at the performance of the asset and hedged accordingly across a range of outcomes. And so we look at it, call it, up 100 basis points in rate and down 100 basis points in rate. And we've always done so with a bias towards rising rates. Because I think, generally, in a sell-off or a rising rate environment, very -- there's a lot less good things can happen than bad things. Having said that, we run a -- versus PFSI, we run a little flatter position in the REIT. But I think that as a result, you see periods of time like when last Q1 and Q2, we had hedge gains. And I think as we've seen rates go up at times, you have hedge losses to offset the increases in value with the MSR. But I think to Dan's point, it just leads to greater stability of the performance of the asset and the GAAP earnings. And I think it's really important as we manage the REIT in terms of maintaining the dividend and maintaining the yield to try to hedge out the volatility that you can get with on hedged mortgage servicing rights.

How are prepayment speeds compared to your expectations through the quarter?

So prepayment speeds over the last couple of periods have been a bit faster than our expectations. And you can see that in the overall impact to the fair value -- the fair value of the MSR and some of our commentary around the impact on the earnings of the interest-rate-sensitive strategy and our changes in MSR value versus our hedges. Prepayment speeds, we are expecting to decline over time, absent a continued rally of interest rates. We do have a declining portion of the overall mortgage universe that's in the money to refinance. And so we do expect some more stability and declining prepayment speeds over time. However, we do expect and we've seen based on the prepayment speed releases that have come out over the past couple of months, that prepayments do remain somewhat elevated. We have seen a recent rally or removal of the adverse market refinance fee that occurred at the beginning of the quarter that have driven some additional prepayment activity. And we did identify that -- related to that, in the third quarter, we do expect, specifically related to the adverse market refinance fee, an impact on our MSR fair value-based on that due to the fact that we expect that to drive some additional prepayment volume in the coming months, given the increased number of borrowers that that gives refinance incentive, too.

Okay. Great. At this point in the refinance cycle, how sensitive has your MSR portfolio been to smaller changes in the mortgage rate where you see it at 5 basis points to 10 basis points on a weekly basis?

It's generally the overall fair value is fairly sensitive at this point in the -- at this point in mortgage rates or interest rates. We've declined down a bit from the rates that we had seen in Q2. And again, with the removal of the adverse market refinance fee, it brings in another section of borrowers that are sort of cuspier the money, and that tends to increase the sensitivity of the mortgage servicing portfolio. When you have those a greater proportion of those borrowers that are -- as we talk about in the money or able to refinance or on the cusp of being able to refinance. And so given the size of our MSR portfolio, which has grown pretty significantly over the past year, you do have relatively significant changes in value for 5 basis point and 10 basis point move in interest rates. However, we do take that into account in terms of our hedging of the portfolio and the hedges that we have on against it. So overall, we're matched off versus that higher sensitivity, but we can't see additional changes in value and changes in prepayment speeds from incremental declines from here as so many of the borrowers, the note rates on the loans, given how much refinancing activities happened over the past couple of years are pretty compressed in the overall mortgage market.

I think just to add to Dan's point on a macro basis, obviously, as we been range-bound here for a period of time. A movement of 10 basis points in rate is going to -- could be meaningful on a macro basis. Now it takes time to affect itself in terms of prepayment speeds, and it's not always immediate. But it's as you would expect.

Okay. How should we expect binded returns to trend as the relatively high returns CRT business runs off?

So, CRT overall declines, I think a couple of pieces here. So one is that in terms of our credit-sensitive strategies, as David mentioned, we are intending to add additional assets to that strategy, which should continue to -- should replace some of the earnings that we're seeing decline from the runoff of the CRT investment. Additionally, we continue to add MSR, which we expect to have an overall interest rate or overall yields in terms of its contribution to the interest-rate-sensitive strategy also in the double-digits. And then I further sort of with reference back to CRT, it has performed well over time. We do expect it to continue to perform well. But a lot of its performance over the past few quarters has been somewhat of a recovery from the fair value impacts that it took in the beginning half of last year. I think overall, as interest rates increase and stabilize and prepayment speeds decline, we'll see greater stability in terms of the returns of the interest-rate-sensitive strategies, again, at those double-digit returns and yields, bolstered by the correspondent business that should continue to allow us to deliver significant meaningful returns from PMT or for PMT as we move forward, even with the shift in the allocation to our different strategies.

Okay. You kind of touched on some of the alternatives there for your previous CRT investments. But have there been any discussions at the FHFA about reversing the decision to end new lender risk share transactions?

Yes, there have been. I think that, first of all, we've spent some time ourselves, speaking with the new director and the staff in terms of some of the goals and objectives that they're laying out under the new administration. I think that it goes without saying we like lender risk share, but I think more importantly, I think lender risk share is vitally important for the GSEs and the U.S. taxpayer. If you just look at the alignment of interest that takes place in terms of our origination or purchase of the loan, to our underwriting of the loan, to our sale and servicing of the loan, I think the tail of the tape is going to be that the performance of our lender risk share is going to be better than kind of the more generic stacker CAS bonds, given the fact that we service the loans, and we have an investment in the loans. So I think that putting aside the fact that allows us to raise capital and deploy capital and grow the balance sheet and all the things that we like as investors in PMT, I think it is such a superior benefit to the enterprises. We've spent a lot of time going over this with the enterprise is. And I think that they -- I like what I'm hearing in terms of their appreciation for CRT. There's some hurdles that we need to get over including the PSPAs and the new capital standards that came out. But we're spending a lot of time with our teams going over this. And I'm really hopeful that we can see something positive coming out for CRT. Having said that, with the wind-down of CRT that took place last year, we've also spent time really focusing on private-label securitization. And so I think what we've done with the non-owner-occupied loans, we're going to look to leverage going forward with a more kind of robust jumbo program as well as I think there's going to be opportunities to create investments, head of loans that we could otherwise sell to the GSEs. So it's not all for not if they do reverse core some lender risk share. I just think that we've always focused on credit-sensitive investments from the beginning of PMT, and it's something that we're just going to continue to look to expand the opportunities to organically create those investments.

Could you further discuss some of the opportunities you do see from the private label security market created by this GSE dynamic? And maybe size it up a little bit better for investors?

Yes. So look, I think, obviously, on the non-owner-occupied front, we ourselves have invested in about -- I want to say about the $750 billion of securitizations. There's more -- I think there's more on the horizon. And I think it starts there. And so I think that even if they reverse course on that, I think it's an investment that we like. And I think it's something that I would look to continue to invest in. I think that there's going to be opportunity in high balance securitizations. And I think that there's always been this phenomenon that there's the cost of executing in a GSE security for a high bow loan is higher than for a standard loan. And so we've seen others in the marketplace, securitize those and either sell off a subordinate bond or retain the subordinate bond. And that's something that we'll look to continue as well.

Okay. Got it. Can you maybe discuss how you've worked with borrowers as they've exited some of their COVID-related deferrals and forbearance programs? And what impact that might have on expected losses in CRT investments?

Sure. So in terms of working with borrowers as they've exited the deferrals or the forbearance programs. We've been very active from the beginning in terms of our ability to work with borrowers to help resolve their issues as they move through the forbearance process. And having our PFSI as the servicer and the partner there to really be able to actively engage with the borrowers and find sort of the best paths for them has led to a lot of our success. We were able to get borrowers actively into forbearance very quickly at the onset of COVID. And as we've moved through, have been very successful in rehabilitating borrowers as well. And so we've seen our delinquencies trend significantly and sequentially lower over time. And that has helped to minimize the impact and help to bolster as we've seen period-over-period, the fair value of our CRT assets and continue as those continue to recover from the impact in fair value that they saw at the onset of the pandemic. Additionally, the home price appreciation that we've seen over the past year or a few years at this point, have really helped to reduce the expected losses that we would take on the CRTs, even in the event of a borrower that is not able to get back on their feet from a modification or other type of resolution out of forbearance. So for the smaller set of loans that do -- are unable to -- or borrowers that are unable to rehabilitate and resume making payments -- resume making regular payments on a modified basis, the fact that home prices have appreciated so significantly, really leads to a lot of options for those borrowers to avoid foreclosure and ultimately to lead to a loss to the CRT, given that most of these borrowers have a lot of embedded equity, are able to sell their home and effectively get out with equity as opposed to some of the dynamics that we saw in the last crisis, where so many of the borrowers were underwater and that possibility didn't really exist. And so given those dynamics that are at play, we're expecting that the significant portion, the majority of our borrowers will avoid ultimate sort of credit events and losses and really lead to pretty positive credit outcomes for the CRTs.

Okay. Have you seen any indication that the recent spread of the Delta variant is leading to increased mortgage credit stress?

The -- obviously, we've seen some -- a lot in the news and so forth about the spread of the Delta variant, and how it's had some impacts on certain businesses and borrowers. Overall, we haven't seen a significant shift thus far in the performance of our portfolio that seems to be related to the Delta variant or a meaningful -- any sort of meaningful reversal that -- of the progress that we've seen to date since the onset of the pandemic where folks continue to -- have continued to recover sequentially or the portfolio has continued to improve period-over-period.

Okay. Going back to the GICs for a minute. Outside of the -- some of the changes you've already talked about, what are your expectations for broader GSE reform and what impact might it have on your business?

So look, I think that we have a new director that is listening to all of the constituents and really kind of listening to the points of view for the changes that we saw over the past couple of years under the prior administration. We're already seeing some action. We saw the elimination of the adverse market fee and we saw it done in a rather quick, quick fashion. We're starting to see reversals of other policies in place. I think there's a lot that's being looked at. And I think they're more positive for us than others. I think that getting CRT reviewed and seeing if there's an opportunity for us to restart that is something that's at the top of our list. I think that there were some things like the investor loan caps and the caps on the cash windows were slightly positive to PMT. But I generally believe that we've seen a change in the correspondent space where people, when they think about best execution are not just going to be looking at the loan level price, but they're also going to be looking at different outlets. And so you can -- as an originator, you can sell loans to the Fannie and Freddie cash window, but you're also going to want to sell loans to PMT. And so I'm not generally as concerned about removal of the caps on the cash window on that front. And I think equally as important, I think the GSEs are going to be open to change. And one of the things that we saw was that it was very much kind of battened down the hatches, and there was no really no discussion with the GSEs of kind of the evolving mortgage market. And the GSEs have always played a vital role in being a governor of the mortgage market, and I'm really hopeful that we can see kind of a resumption of that role that they play. So I think I'm encouraged by what I'm hearing and what I'm seeing, and I'm hopeful that we can continue to see things evolve to benefit PMT.

All right. Outside of the GSEs, are there any other policy proposals moving around the halls of Congress or other regulating entities that would have a material impact on PMT?

I don't see -- I don't see any. I will tell you that there will -- there's always looking out there, the capital standards for non-banks. I generally believe that getting standards in place is vitally important. We've operated PMT in kind of a risk framework akin to a bank, just in terms of how we think about liquidity and reserving and margin calls. And look, I think you saw our investors with the beneficiaries of that last March, when we had the COVID, the COVID event take place and you saw other REITs not as fortunate as PMT. We -- I think the capital standards will come out. I think PMT, you can say, could be somewhat of a beneficiary given the fact we have scale, and that's already in place. But I think the entire sector with beneficiaries by stronger and just more transparent capital standards. I think that's the one thing that the FHFA was looking to take the lead on. We've seen Ginnie Mae try to take the lead in on the government side, but I think they're going to work hand-in-hand, and that's the one area where I do think you'll see some evolution take place over the next year or 2.

Okay. Understood. Looking at the dividend. How should we think about the dividend level going forward given your current outlook?

So overall, in the -- also in the investor presentation as well as our earnings that we released a month ago, we have a run rate sort of expectation for earnings of around $0.49. That's absent certain fair value impacts such as the impact of the adverse market refinance fee. And we have our dividend level at $0.47. So overall, we feel like the ongoing earnings power of PMT continues to support the dividend. We don't really see a -- expect any significant changes in the near future. And that overall, the earnings power would tend to, over time, produce some amount of book value accretion in addition to providing the $0.47 dividend that we had prior to COVID that we reduced it somewhat during 2020, but reimplemented at the $0.47 level at the -- toward the end of last year if we had in place for a few quarters now. Additionally, in relation to the run rate of $0.49, obviously, we also look at our taxable income in the REIT. A lot of the fair value impacts that we see related to MSRs are really take place in our taxable REIT subsidiary, which isn't directly providing the taxable income into -- that were sort of required to distribute or what's driving our distribution requirements. So that taxable income is something that we continue to look to and continues to support the $0.47 dividend.

Okay. Understood. And finally, what are your priorities for capital deployment at PMT, with the stock trading, just a slight discount to book value, what is your appetite for share buybacks?

Yes. So look, I don't -- I am not adverse to share buybacks. I think, as a matter of fact, when you look back in our history, from 2015 to 2018, we repurchased 20% of our stock. And so we look at it in just a very kind of economic way, if the expected returns to support share repurchases will engage in share repurchases. And having said that, we do want to deploy capital in PMT, and we want to grow PMT and growing PMT's balance sheet is very important to me. We're going to continue to grow the MSR coming out of correspondent. That's a capital deployment, not only from the MSRs point of view but to run a responsible correspondent unique capital. You need capital to deal with the haircuts, you need capital deal with margin, margin calls. And so that's something that we'll continue to look to deploy capital. On the credit-sensitive side, we're showing that we have an appetite to invest in subordinate bonds coming out of non-owner-occupied securitizations. As I mentioned earlier, we'll be looking to do other securitizations. And obviously, if CRT comes back, that's a huge opportunity to deploy capital. And then finally, you need capital to manage the liquidity and capital management framework that we have in place in PMT. And once again, we were the beneficiaries of that as investors over the last 18 to 24 months when we've seen increasing amounts of volatility. So we'll continue to look, as I said, we want to grow PMT, we want to deploy capital only in a way that's really accretive to our shareholders. And I think our history and track record says that that's what we will end up doing.

All right. Got it. Well, that does it for me on PMT. David and Dan will both be joining us again here in 10 minutes or so to talk about PFSI. I believe track for us. So I hope you can join us there. But I do want to thank you both for your time on PMT and for sharing your thoughts.

Thank you, [ Carter ]. And once again, thank you, everyone. I want to thank everyone for joining us today.

Thank you very much.