Q3 2023 PennyMac Mortgage Investment Trust Earnings Call
Participants
Daniel Stanley Perotti; Senior MD & CFO; PennyMac Mortgage Investment Trust
David A. Spector; Chairman of the Board & CEO; PennyMac Mortgage Investment Trust
Bose Thomas George; MD; Keefe, Bruyette, & Woods, Inc., Research Division
Eric J. Hagen; MD & Mortgage and Specialty Finance Analyst; BTIG, LLC, Research Division
Kevin James Barker; MD & Senior Research Analyst; Piper Sandler & Co., Research Division
Matthew Erdner
Presentation
Operator
Good afternoon, and welcome to PennyMac Mortgage Investment Trust Third Quarter 2023 Earnings Call. Additional earning material, including the presentation slides that will be referred to in the call are available on 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 equivalent in the earning material.
I would like to remind everyone we will only take questions related to PennyMac Mortgage Investment Trust, or PMT. (Operator Instructions) Now I'd like to introduce David Spector, PennyMac Mortgage Investment Trust Chairman and Chief Executive Officer; and Dan Perotti, PennyMac Mortgage Investment Trust Chief Financial Officer. You may begin.
David A. Spector
Thank you, operator. PMT had an outstanding third quarter. Annualized ROE was 14%, reflecting very strong financial results and growth in book value per share from the prior quarter due to meaningful income contributions from all 3 of its investment strategies.
As a result, book value per share net of the $0.40 dividend increased to $16.01. As you can see on Slide 4 of the presentation, mortgage rates have continued to increase from record lows in recent years and are now near 8%. As a result, many borrowers who locked in a low fixed rate mortgage in recent years have been incentivized to stay in their homes given their low mortgage payments.
This has resulted in an extremely low inventory of homes for sale, driving expectations for the lowest unit origination volume since 1990. Additionally, we believe quarterly run rate origination volumes are trending lower than the average estimate from third parties for this year of $1.6 trillion.
Turning to Slide 5. Though the current origination market remains constrained, I'm very enthusiastic about PMT's opportunities in this environment. Approximately 2/3 of PMT's shareholders' equity is currently invested in a seasoned portfolio of MSRs and the unique GSE lender risk share transactions which we invested in from 2015 to 2020.
Given the majority of mortgages underlying these assets were originated during periods of very low interest rates, we believe these investments stand to perform well over the foreseeable future as low expected prepayments extend the expected asset life. Additionally, delinquencies remain low due to the overall strength of the consumer and the substantial accumulation of home equity in recent years due to continued home price appreciation.
Mortgage servicing rights investments account for about half of PMT's deployed equity. The underlying mortgages are far out of the money given current mortgage rates, reducing the sensitivity for MSR fair values. As a result, we expect the MSR asset to produce stable cash flows over an extended period of time.
MSR value should also find additional support in a higher for longer environment as the placement fee income PMT receives on custodial deposits is closely tied to short-term interest rates. Similarly, low delinquencies and very low current loan-to-value ratios on the mortgages underlying PMT's large investment in lender risk share are expected to support the performance of these assets over the long term and we ultimately expect the realized losses over the life of these investments to be limited.
PMT's current capital deployment is focused on opportunistic investments that we believe have the potential for strong, long-term risk-adjusted returns. This quarter, we invested nearly $65 million in such investments and we'll continue to monitor the markets for similar opportunities.
Looking at our run rate potential on Slide 7, with expectations for interest rates to remain higher for longer and a de-inversion of the yield curve during the third quarter, potential returns from the interest rate sensitive strategies have improved driven by higher projected yields relative to financing costs for MSRs and MBS.
As such, the run rate return potential expected from PMT's investment strategies over the next 4 quarters increased from $0.30 in the prior quarter to $0.35 per share or 9% annualized return on equity.
I will now turn it over to Dan, who will review the drivers of PMT's third quarter financial performance.
Daniel Stanley Perotti
Thank you, David. Turning to Slide 11. PMT earned $51 million in net income to common shareholders in the third quarter or $0.51 per share. PMT's credit-sensitive strategies contributed $41 million in pretax income. Income from PMT's organically created CRT investments this quarter totaled $27 million.
This amount included $14.6 million in market-driven fair value gains, reflecting the impact of tighter credit spreads. The fair value of these investments decreased slightly from the prior quarter to $1.1 billion as runoff from prepayments more than offset fair value gains.
As David mentioned, the outlook for our current investments in organically created CRT remains favorable with an underlying current weighted average loan-to-value ratio of approximately 50% and a 60-day delinquency rate of 1.18%, both at September 30.
Income from opportunistic investments in CAS and STACR bonds issued by the GSEs totaled $16.3 million in the quarter. The interest rate sensitive strategies contributed $82 million to pretax income. MSR fair values increased due to the higher interest rates, which drove expectations for lower prepayment activity and higher earnings from placement fees on custodial balances.
Before recognition of realization of cash flows, PMT's MSR fair value increased by $263 million. These fair value gains on MSRs held in PMT's taxable REIT subsidiary also drove the large provision for income tax expense in the quarter. Net fair value losses on agency MBS, interest rate hedges and the related tax impacts were $254 million, driven by higher interest rates.
The fair value of PMT's MSR asset at the end of the quarter was $4.1 billion from June 30 as fair value increases and newly originated MSR investments more than offset runoff from prepayments. Delinquency rates for borrowers underlying PMT's MSR portfolio remain low and servicing advances outstanding decreased to $80 million from $94 million at June 30. No principal and interest advances are currently outstanding as prepayment activity continues to sufficiently cover remittance obligations.
Income from PMT's correspondent production segment was up from last quarter, primarily due to higher margins. The prior quarter also included a negative impact of $4.5 million due to changes in GSE pricing. Total correspondent loan acquisition volume was $22 billion in the third quarter, up 2% from the prior quarter.
Conventional loans acquired for PMT's account totaled $2.8 billion, down 9% from the prior quarter due to the ongoing sales of certain conventional loans to PFSI. The weighted average fulfillment fee rate was 20 basis points, up from 18 basis points in the prior quarter.
PMT reported $32 million of net income across its strategies, excluding market-driven value changes and the related tax impacts, up from $25 million last quarter. As you can see on Slide 13, in the third quarter, we also took several steps to further strengthen PMT's balance sheet.
These included the upside of a previously issued Fannie Mae term loan from $155 million to $370 million, the redemption of $450 million in Fannie Mae MSR term notes due in 2025 and the opportunistic issuance of $54 million in unsecured senior debt at very attractive terms. Finally, while there has been significant interest rate volatility since quarter end, PMT's book value per share is little changed as a result of our hedge discipline. We'll now open it up for questions. Operator?
Question and Answer Session
Operator
(Operator Instructions) Your first question comes from the line of Bose George from KBW.
Bose Thomas George
Actually, going to Slide 7. If the yield curve continues to de-invert or even whatever normalizes, does that -- would that continue to push up the return? And is that a way that you potentially get back to your ROE that could cover the dividend?
Daniel Stanley Perotti
Bose, this is Dan. Yes, that's exactly right. During the quarter -- quarter-over-quarter, the primary factor that drove up what we see as the run rate potential was that de-inversion of the yield curve, we've seen some additional de-inversion here as we've -- as we move further into Q4, and we would expect that to have the same impact as we saw during last quarter, which could get us back to your point, up to a $0.40 type of run rate to the extent that we see further that de-inversion continues to happen.
Bose Thomas George
Okay. Great. And then on the mortgage banking return this quarter, I mean, would you characterize this quarter as somewhat more normal than last quarter as being impaired by the GSE pricing change? Or how would you characterize this quarter?
Daniel Stanley Perotti
Yes, this quarter, I think we would characterize as somewhat more normalized. To your point, last quarter, we had the negative impact of the GSE pricing change that did not recur this quarter. And the -- in terms of the margins and other impacts on the channel. I think we're seeing something fairly similar going into Q4 here.
So I'd say I think your characterization is right that it's a more sort of normalized result than we saw in the prior quarter.
Operator
Your next question comes from the line of Kevin Barker from Piper Sandler.
Kevin James Barker
I noticed that the MSR has marked up fairly high relative to some of the peers. Now obviously, you hedge it to protect that value. But is there anything that's really driving some of that value and is there anything there that could create slight risk despite the hedging that you put in place?
Daniel Stanley Perotti
I don't think there's any -- this is Dan again. I don't think there's anything in there that would necessarily constitute a more significant risk than what we've seen in the past. In fact, given how far out of the money the borrowers are underlying the MSR, the prepayment sensitivity is lower than what we've seen historically.
And so the sort of the hedging risk there is lower. Really what's driving at this point given that so many -- so much of the borrowers -- so many of the borrowers are far out of the money, what's driving a lot of the value or potential additional value at this point really has to do with the escrow -- the earnings on the escrow balances, which are a part of the cash flows from that projected at our part of the MSR value.
And so as the market and the yield curve adjust to this higher-for-longer sort of scenario, that increases the expected value of those escrow balances and that -- those cash flows associated with that. But that is all incorporated into our sensitivity of the MSR asset and what we're hedging against to the extent that we see interest rate changes or volatility.
Kevin James Barker
Helpful color. And then also, obviously, CRT was a major investment for you for a long period of time. Are you seeing any other avenues for investment in credit out there that might be attractive, whether it's other GSE products or potentially even non-GSE or non-agency products?
David A. Spector
Kevin, it's David. Look, I think that we've brought a little bit of CAS and STACR in the third quarter. And we bought $58 million in sub bonds, albeit it's not really credit because we're buying more I would say, at the top of the credit stack.
But suffice it to say, I think that given what we're seeing with the capital regs that have come up for banks, I expect there will be more securitization. Out of that, I'm hopeful that we'll see opportunities for PMT.
PMT is really positioned well we do see an increased amount of securitization. And I think there's going to be potential for jumbo securitization -- and I think that right now, we're -- for all the closed end second production is being done in PFSI, that product is being sold (inaudible) but others are securitizing that, albeit at returns that are -- that don't meet PMT's minimum return. But ultimately, I can see there being an opportunity for securitization of close-end seconds where there is a retained investment for PMT.
Daniel Stanley Perotti
Another factor that's sort of important to note that we called out this quarter, is just -- if you look at our current investments in the mortgage servicing rights and the GSE credit risk transfer, which 50% and 15% of our shareholders' equity together 65%.
Those are all based in very low note rate -- have very low note rate borrowers underlying those investments. They're running off very slowly for that reason, and they both have very strong credit characteristics of the underlying borrowers to drive them.
And so as we are waiting for some of these other trends to develop or we're seeing some of these other trends develop, we have this really strong base of assets that is running off at a slow rate that we expect to perform really well over time.
Kevin James Barker
So ideally, over the long term, how would you want PMT's balance sheet structured from an equity investment standpoint, credit sensitive strategies versus interest rate sensitive strategy.
David A. Spector
I don't -- Kevin, I think that we always optimize for is return on equity. So I would start there. We've -- the 50% mortgage servicing rights is higher than we'd like. Now albeit some of that -- a lot of that is because of the write-up of the asset.
And I think if you saw a rate decline, you would see it get much more in line or much closer to where the credit risk is. I think all things being equal, if returns are identical to 1 another, then you could say, okay, maybe a 50-50 split -- but I think the ROE is always going to be the driving factor.
And then the ongoing -- if we can find the investment that is ongoing when we're creating franchise value for PMT as well as we saw going all the way back to NPLs or then followed on by the CRT we did from 2015 to 2020, that's something that we would definitely be supportive of. But as you know, I think that suffice it to say, right now, we see the 50%, 15% split between mortgage servicing rights and CRT as 1 that we'd like to get a little bit more in balance.
Operator
(Operator Instructions) Your next question comes from the line of Eric Hagen from BTIG.
Eric J. Hagen
Just a question around risk management and managing just rate risk and leverage and such. How much more MBS do you think you need to maybe add to the portfolio for given an increase in the MSR portfolio from here?
Like are there levels of spreads for -- on the MBS side where you can -- it looks to get more aggressive there and even raise leverage? And how much room do you have to raise leverage in that portfolio?
Daniel Stanley Perotti
Eric, it's Dan. Yes, given the increase in the MSR portfolio, we may add incrementally to the agency MBS portfolio. We've added certainly incrementally in terms of some of the non-agency MBS, as David mentioned. But it's not necessarily -- it's not necessary per se to add substantially due to the change in the MSR to balance out from a REIT test perspective, if that's where you were going.
To the extent that we do see spreads widen and that investment as attractive, we could add additional agency MBS. We do -- our overall leverage ratio is around 5x currently. So we do have some ability to continue to increase that but we aren't necessarily looking to substantially increase our agency MBS portfolio unless we saw that as a really significant opportunity.
Eric J. Hagen
Yes, totally understood. Second question, I mean, just looking at the liquidity requirement, on Slide 18, you have a cushion of around $200 million of liquidity. Do you feel like that's a comfortable cushion just given the size of the balance sheet? How sensitive would you say that kind of liquidity, that regulatory liquidity is to higher interest rates and wider spreads?
Daniel Stanley Perotti
Yes. Q2 -- so when we are looking at our hedging position, we look at both our liquidity as well as the balance sheet value and hedge for both of those. Yes we do think that, that cushion is very sufficient to be able to manage to -- in terms of managing our liquidity for the balance sheet size that we have.
It would take a pretty substantial increase in spreads to put a meaningful dent into that liquidity that we're holding here. And we do have a little bit of additional overall liquidity that we can tap that isn't on the balance sheet today. So this doesn't represent the maximum size of the liquidity where we have a bit more that we could tap as well if we did see a spread widening or something to that -- of that nature.
Eric J. Hagen
Yes. Did you guys give an update for your book value through October? And if I missed it, I apologize.
Daniel Stanley Perotti
Yes, we did. It's a little -- it's really a little changed from what we saw at the end of the quarter.
Operator
(Operator Instructions) Your next question comes from the line of Matthew Erdner from JonesTrading.
Matthew Erdner
I believe you didn't repurchase any shares during the quarter, if that's true, let me know. And then how are you guys weighing share repurchases versus deployment of capital, given where the stock has traded over the past couple of quarters.
Daniel Stanley Perotti
Yes, this is Dan. Yes, we did not repurchase any shares over the quarter that is something that we look at as a potential deployment of our capital. Certainly, the shares were trading during most of Q3 higher than they have been over the recent couple of weeks.
And I would say that we find share repurchase is more attractive, meaningfully more attractive at the levels that we're seeing today than we did at some of the levels that we saw over the -- during Q3. So that could result in some activity versus to your point, we did not repurchase any shares during Q3.
Operator
We have no further questions at this time. I'll now turn the call back to Mr. Spector for closing remarks.
David A. Spector
Again, I want to thank everyone for joining us here today for our Q3 earnings. If you have any questions or comments, please don't hesitate to reach out to our Investor Relations team, and I look forward to speaking with all of you in the near future. Take care.
Operator
This concludes today's conference call. Thank you for your participation, and you may now disconnect.
