Good afternoon, and welcome to PennyMac Mortgage Investment Trust Second Quarter 2023 Live Earnings Q&A Session. Additional earnings materials are available on PennyMac Mortgage Investment Trust website at pmt.pennymac.com. Before we begin, let me remind you that this Q&A session may contain forward-looking statements that are subject to certain risks identified on slide two of the earnings presentation that could cause the company's actual results to differ materially. I would like to remind everyone, we will only take questions related to PennyMac Mortgage Investment Trust or PMT.
The replay of the live Q&A session for PennyMac Financial Services, Inc., or PFSI, will be available shortly on pfsi.pennymac.com. We also ask that you please keep your questions limited to one preliminary question and one follow-up question, as we'd like to ensure we can answer as many questions as possible. If you would like to ask a question during this time, simply press star followed by one on your telephone keypad. If you would like to withdraw your question again, it's star one. 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. Please go ahead.
Thank you, operator, and welcome everybody to PennyMac Mortgage Investment Trust first live earnings Q&A session. As you all know, historically, we've not done a live earnings call, but we believe strongly in the continued evolution of our strong and accessible investor relations process, and that now is an appropriate time to introduce the live element into our earnings process. I believe these Q&A sessions will give stakeholders increased transparency into our business in a timely manner. Although we are introducing a live call, you can rest assured that we and I will maintain our ongoing commitment to investors and analysts via conferences, non-deal roadshows, phone calls, and other industry events. Now, we'd like to begin taking questions. Operator?
As a reminder, if you would like to ask a question, simply press star followed by the one on your telephone keypad. We'll now take our first question from the line of Kevin Barker with Piper Sandler.
Thanks for doing this call. I really appreciate it. I think it's really helpful. Like to dig in a little bit on the correspondent production, it's declined significantly here. I know you switched strategies last year, how you're splitting that between PennyMac Financial and PMT. Could you just talk about, you know, the reasoning for this significant drop and if you expect to keep that production fairly low on a go-forward basis? Thanks.
Yeah. So look, I think that you're right, Kevin. There's a lot that went into the correspondent production story for the quarter. The big one, as you pointed out, was the sale, increased sale, conventional loans from PMT to PFSI. That was a 38% of the total conventional production in Q1, jumping all the way to 70% in Q3. I think that, at least for this quarter, I would expect similar levels, and I would, and I would, you know, suspect it'll, it'll stay that way for, you know, at least a few quarters after, depending on, the, you know, the capital position of PMT and if it raises more capital. Look, it's a capital allocation decision for PMT.
You know, we were very heavily weighted to MSR in our interest rate strategies, and we decided that, you know, we wanted to opportunistically deploy capital into credit investments that came up in the market to bring that more in line. I would you know, I think that, you know, we did a great job of hitting on that initiative and I think, you know, we've opportunistically added to the credit investment strategies. On the margin side, look, I think in PMT, it's an interesting story for this quarter, because I think I know margins would have been higher if PMT not seen a $4.5 million impact on profitability from unannounced GSE pricing changes.
These pricing changes affected PMT in an unfortunate way, and the fact that it had inventory that is, that on its balance sheet at the end of the first quarter, when it sold less loans to PFSI versus in the second quarter. I think we saw that, and then, and in addition, we saw some, you know, other changes that the GSEs presented to us without any pipeline protection or inventory protection. You know, it got all that added up to about, you know, the $4.5 million hit. We've made changes to our pricing methodology to, you know, risk manage that. I think that's the, that's the margin story. I think that as it pertains to the PMT correspondent business.
Look, we're in a really strong competitive position in correspondent. I think, you know, it speaks to the synergistic relationship between PMT and PEP and PFSI. The PFSI, who wants to continue to grow its servicing portfolio and has the capital to do so, can step in and fill the void when PMT wants, you know, wants to get better balance between its credit sensitive strategies and interest rate sensitive strategies. Look, from a customer standpoint, they continue to see themselves in selling, you know, the loan to the same counterparty, and so they're not subjected to any of the noise after the fact that arises of where the loan goes. It's a, I'd expect it to be, I expect the third quarter to be similar to the second quarter, as I said, but I don't see, and I think that's going to be the case.
I think one other thing that I'd add to that, because we did buy a small bulk package of MSRs during the quarter. Really, the, the differentiation there is that PMT on, in terms of the servicing, you know, would prefer stable cash flows, you know, through the life, with, you know, really little refinance, you know, variability in refinance potential refinance expectations. You know, that is the character of the servicing portfolio that we bought for, for PMT.
Obviously, through correspondent, we are purchasing loans that are at prevailing rates. You know, that's why we are selling t he bulk of that through or, you know, an increasing portion through to PFSI, who generally, you know, has stated that their, their objective is to bring on loans at those higher rates while, you know, we purchase a bulk package at lower rates in PMT, which is not generally available through correspondent as well.
Okay. Switching gears just on capital. Leverage is running a little bit higher, I guess, the last few quarters. I mean, it obviously came down this quarter, which is good to see. You know, relative to what we saw, you know, pre-pandemic, and yet you're, you're buying back stock, which, you know, is supporting book value as well. Can you, can you talk about how you weigh, you know, your leverage relative to buybacks and how you're thinking about it just broadly, given the framework of different assets that are on the balance sheet today versus what it's been in the past? Thanks.
In terms of the leverage, as you, as you mentioned, came down pretty significantly quarter over quarter. A portion, you know, a meaningful driver of that was the reduction in the, you know, in the inventory that we were holding on balance sheet for PMT, for the correspondent business. Our, you know, our leverage has increased since, you know, the pre- the, the pre-COVID era. Some of that is around our shift toward the interest rate-sensitive strategy. As we've, you know, moved more toward that interest rate-sensitive strategies, which is primarily a, a pairing between the, you know, the MSR, and agency mortgage-backed securities. The growing size of the, you know, the MSR has, you know, necessitated an increased investment into the agency mortgage-backed securities.
Those Agency mortgage-backed securities generally come at a, you know, high overall leverage ratio, and so that is what has sort of driven up the, you know, the overall leverage ratio over time. To the extent that we see that, you know, allocation declining, we'd expect the, the leverage ratio in, you know, and a reallocation toward credit-sensitive strategies, we would expect that over time to result, you know in a decline in the, you know, in the overall leverage ratio on the balance sheet. With respect to the share repurchases, as you noted, that, you know, would also serve to increase the leverage ratio. You know, we
I think our, our stance toward the, the share repurchases at this point is really more focused around when we see a, you know, a significant deviation, you know, the share price to, you know, to book value, and see, you know, real potential for accretion there. We obviously saw some of that in the first quarter. You know, I think there's less opportunity for that today, but it is something, as you mentioned, that we sort of weigh when we're looking at the, the leverage profile versus, the leverage profile versus the, the potential for, you know, return or accretion on the, on the share repurchases and, and, you know, seek to balance out those, those considerations.
Okay. Thank you for taking my questions.
You know, Kevin, the one thing I'd add to that also is we had really good, I would say, success in, in trimming out the leverage in the second quarter. We, you know, we, we closed the CRT term note deal that doesn't contain margin call provisions. I think that, you know, we extended, I know we extended the, the CRT term notes that were due in May of 2023. We issued a five year term loan secured by Fannie MSR. It's I would say, you know, it's the type of leverage, it's the type of debt that we have that, that also I look at, and then I think given, given the fact that we're terming out the debt as well, is something that we made really, that Will and the team made really good progress on, in the second quarter.
Yeah. Thank you, David. Thank you, Dan.
Thanks, Kevin.
Your next question comes from the line of Bose George with KBW.
Hey, guys. Good afternoon once again. Actually, I wanted to just ask about, you know, the run rate potential ROE, you know, being lower this quarter versus last quarter. I mean, it looks like a big part of that was the MSR expectation coming down. Just curious what, what drove that?
Sure. You know, looking quarter-over-quarter, at really, and, you know, the run rate is really looking at our near-term expectations for returns. Really a lot of that is driven by, our expectation for, you know, for short rates over the next several quarters. If you go back to the beginning of, you know, of Q2 or the end of Q1, the last time, you know, we presented the run rate, really much more of an expectation that short rates would move down in the relatively near term, which would bring down some of the, you know, the funding costs.
on our interest rate-sensitive strategies, which are generally, you know, have, have debt that's tied to, you know, to short rates, to, you know, floating rate debt or to short-term repo, in the case of the Agency MBS. With the expectation that that will remain higher. Then on, you know, on the Agency, you know with an inverted curve and with spreads at the levels that they are, you know, it's constrained our expectation over, you know, over the near term, you know, based on where we are roughly today or a few, you know, last week.
Our expectation for what we see as the, you know, the returns over the next, the next few periods, given the effectively the spread between our funding costs, at what's expected to be higher short-term rates and the yield on our long-term, you know, our long-term assets, and the spreads that are commensurate there. You know, if we do see changes in that, if we see a, you know, really a, a greater steepening of the yield curve or becoming less inverted, or, spreads widen out somewhat, that could, you know, that could meaningfully improve our expectations for the, the returns, you know, go forward on the, on the interest rate-sensitive strategies.
Well, okay, thanks. Then actually, the run rate, you know, EPS is obviously, I think it was $0.30, quite a bit below the dividend. Just, you know, curious if that's something, you look at, or this is, you know, sort of whatever, transitory, and so you kind of wait to see, how things kind of shape up going forward.
Yeah. Look we've been pretty public in saying that we've always tried to keep the dividend tied to GAAP earnings. At the same time, we wanna make it, you know, we try to keep it consistent, and we try not to be reactive on a quarter-by-quarter basis. You know, we feel that it's important for, for those to understand where we see the run rate at the moment. We're gonna, we're gonna, you know, wait and see where, where we are at the end of next quarter.
You know, I think that, you know, having, having it tied to GAAP earnings, of course, always having the cash to pay it. We wanna just, we wanna make it predictable to the extent we can. I think that, that, you know, for us it's just I think a, a way to, you know, let you and other shareholders know that, you know, this is where we're at, and we'll address it, you know, when we come back around next quarter, and then, then we'll, you know, decide what we wanna do.
Okay, makes sense. Great. Thanks.
Thanks.
Your next question comes from the line of Matthew Howlett with B. Riley Securities.
Oh, hey, guys. Thanks for taking the question. Thanks for the call.
Yeah.
Hey, David, just to follow on the core EPS dividend question. Historically, you've sort of said there's a caveat that taxable EPS runs ahead of the core, the GAAP income. Is that still the case? Could you disclose sort of where taxable income is growing at PMT?
Yeah. The taxable income, given that, you know, that we've seen this increase in the, in our interest rate-sensitive strategies, and a lot of the, you know, the MSR is, is based in the TRS. The taxable income in the REIT, you know, although we had a, a bit of a timing mismatch that we disclosed last year where that was ahead, was not, is not necessarily, you know, running ahead of, you know, GAAP income this quarter to date.
To David's, to David's point, since a lot of the business is in the, in the TRS, generally, you know, we look at the GAAP EPS as sort of the, and our expectations there over time as the, you know, the driver, unless we're, otherwise, you know, otherwise, you know, compelled to look at it differently via the, you know, via the taxable income. But that's not necessarily, a constraining factor, in this case, currently.
Gotcha. On, on the subject of, of taxable income and, and earnings power going forward, you obviously made a lot of credit investments in, in the quarter, almost $100 million in the CRT and the jumbo securitization. What spreads are you seeing there? Assuming they tightened towards the quarter, what's the outlook on the organic production via CRT or even a jumbo securitization program that you've done, or you've done home equity in the past and maybe close to the second? Just curious on the organic outlook for credit production.
Yeah, look, so, you know, Matt, I think that, you know, we had really strong returns in the credit-sensitive strategies, and I think that speaks to, you know, the credit spread tightening that we saw take, take place. I think that, you know, we have been, you know, pretty active this year in opportunistically buying credit-sensitive assets. We've deployed greater than $100 million in capital against credit-sensitive investments. Look, we've seen, you know, spreads come in, and so that's, that's worked out well for us. We're always looking at evaluating opportunities in the market, and we'll you know, and we're gonna continue to do so.
I think on the CRT front, look, I think that, you know, the, the, the return of front-end lender risk is, is not, you know, in the, in the short, in the short term or medium term. I will tell you that, you know, we continue to talk to the GSEs and FHFA about it. It's an interesting issue in the fact that I think that given the size of the mortgage market, the GSEs need as much collateral as they can to provide the critical mass that they need in, in, issuing STACR and CAS.
You know, as you, as you may or may not recall, there was, there was some difference of opinion on the value of the, of the front-end credit risk nature that we took on lender credit risk share versus, you know, they, they let loans season for nine months before they issue in STACR or in CAS. I think, you know, we put on a forward trade, there's a value there. There's just some differences in how we and they perceive value. Having said that, we know one thing for sure when it comes to GSEs and FHFA, and that there's always change.
You know, we're continuing to have the discussions, and I think given, given our correspondent, you know, presence and, and market share dominance, I think that we, we believe that if CRT comes back, we'd be able to pivot quickly to be able to capitalize on that, given, given, you know, our, our, our share and correspondent. As it pertains to other opportunities, look, I think that, you know, they see the progress that we're making in PFSI in our closed-end seconds. You can see a path to being, you know, to those being sold to PMT to securitize and, and retain, you know, the subordinate bonds. I think that that's, that's something we're keeping an eye on.
I think, as I mentioned earlier, that bank regs that came out, you know give me a kind of a, a kind of a bullish view on what that could mean for securitization. I think with that will mean, you know, greater opportunity in, in buying jumbos and securitizing jumbos. Look, you know, we've seen some of the banks that have been either seized or, or pulled back were, were, you know, pretty strong in jumbo loan lending. We're you know as we've always done, we keep a close watch on that. You know, we're not gonna go down in credit, okay? We're not gonna get into, you know, you know, non-QM or, you know kind of more the cuspier part of the mortgage space.
There's you know I think that we're, we're looking for we're continuing to look for the credit investments, to be able to, you know, kind of take advantage of the core skills that the management team has, led by Will, and the team i n our capital markets group. I think that, you know we're in a really good place in terms of kind of getting more balance between the credit-sensitive strategies and the interest rate-sensitive strategies.
I appreciate that. I was going to ask about the, the new bank rules. It sounds like you guys are, are well positioned for that. Really appreciate it. Thanks, David and Dan.
Thanks, Matt.
Your next question comes from the line of Doug Harter with Credit Suisse.
Thanks. Just touching on that last comment about balance. You know, and just as you look forward, what is the right balance, you know, as you think about it, and, you know, at what point might you kind of, you know, retain more of the MSR, you know, creation, you know, just as you kind of think about, you know, finding that balance?
Yeah, look, I think it always like, you know, from, from my perspective, it always starts out with return. Okay, where's the, where's the highest return? That's always gonna be the driving factor in how we manage PMT. I think that return, you know, there's a, there's a day one return, there's a range of outcomes return, as you think about it. I think that, you know, I know that when we were approaching 60% in the interest rate-sensitive strategies, it felt really kind of, kind of at a level where we need to get it more in bounds. We brought that down into the, into the low 50s this quarter.
I think that, you know, it's something that, as it stands now, I think the returns that we're getting on credit risk, on credit-sensitive strategies, meet our hurdle rate, in the REIT. I think that, you know, as, as exhibited by the fact we bought a small MSR portfolio, if we see MSRs that meet our return targets, we're, we're absolutely gonna invest in those. I think on the, you know, on the correspondent business, it's t ough.
It's tough to, you know. I think, I think we're seeing conventional ROEs and the, you know, and kind of the new issue ROEs in kind of the mid-single digits, maybe a smidge higher. I think, you put leverage on that, and I think that, it comes inside of the credit-sensitive returns. I think it's, it's something that it's not a hard and fast rule. We know that we were much lower than 50% just a few years back. We're kind of taking it on a quarter-by-quarter basis to try to get it more in line.
Yeah. I think, you know, overall, generally speaking, yeah, we'd like, we'd like them to be between credit sensitive and interest rate sensitive over time, more even. Certainly, in the past, credit sensitive has been a greater proportion of PMT's investment book. You know, as David said, we are also mindful of the relative returns, and if we see an opportunity in, in interest rate sensitive, you know, it's not going to preclude us from, from taking advantage of that.
I guess as you look at the, at the landscape, you know, there, there seem to be a fair amount of, of loans, you know, kind of lower coupon, discount loans that are some probably high in credit quality, you know, is that, you know, from banks. Is that something that, that you would seriously consider for PMT?
It would be. I think that's as I think about the servicing that we'd want to bring into PMT, I think that's more suited for PMT. I think it's, it's, it's got a, you know, it's got a, it's got a longer life. It's gonna be a more predictable, you know, pace of cash flows. It's not as reliant on recapture, as, as kind of current note rate. So it's a much more pure investment from, from that angle. We're not, you know, we're seeing, we're seeing, you know, we are seeing some packages, and we bought one of those, and it's something that we keep our eye out for, for PMT, is the you know, conventional low rate servicing, is right kind of in their, kind of in their wheelhouse. I think you've kind of hit it on, on what we think is better suited for PMT.
I guess what about on the, on the loan side, you know, jumbo loans or, or something of that nature, you know, that might come out of banks?
Look, I think, I think buying seasoned jumbo loans is not really an area where that PMT... We're gonna look at it. You know, we'll keep those guys busy looking at things, but I just think that, you know, right now there's, there's still a pretty good bank bid for that. I think that, you know, we're seeing, you know, we're, we're seeing private equity participation in that space as well. I don't, I don't, I don't think that, you know, seasoned jumbo loans will be an area that, that, that you'll see us overly active in.
Great. Thank you.
Your next question comes from the line of Eric Hagen with BTIG.
Hello again. I think a couple questions here. For the CRT portfolio, you know, so much of that risk has been delevered at this point. Like, is there a way to relever that collateral in between the debt rolling over or coming due? Second question here, I mean, how much more liquidity or capital do you think you'd need to scale up a servicing portfolio from here? Like, after you layer in the MBS and any rate hedges on top of that, would you say that there's, like, a rule of thumb for every, you know, $1 billion of incremental servicing, we're using, you know, X amount of capital or liquidity to support that growth?
Sure. With respect to the CRT, you know, we've, we've generally speaking, I, I guess, in a, in a global sense, it has been delevered, right? You know, looking through to the, to the homeowner, where you've got CLTVs on a lot of it, or, you know, LTVs on a lot of the underlying loans have gone down pretty substantially. You've got, you know, 50% LTV and so forth. With, with respect to the, you know, the value of the, you know, the assets that we hold at the credit, you know, the credit risk pieces that we hold, you know, we're, you know, sort of able to, to relever those by issuing notes. We did some in this past quarter.
You know, there are very old deals we have, you know, on repurchase agreements that are, are based on the, you know, the value of, of the, the pieces that we hold. You know, I don't think that those have necessarily been, you know, tremendously delevered from an investment point of view. Although, you know, the way we think about it is that the risk has been substantially, you know, has substantially decreased versus, you know, when we originally entered into the contract.
With respect to, you know, with respect to investment in MSR, you know, roughly speaking, if you look at the, the, you know, the leverage that we're able to apply at least on a, on a marginal basis in terms of the MSR, you know, really at about a, you know, call it a two to one, a two to one basis, that probably takes into, you know, that roughly takes into account, like, you know, on the, on the value of the MSR. To your point, if you're buying, you know, $1 billion of MSR, call, you know, call it a, depends on the servicing strip, depends on the, you know, the exact type of the MSR, but, you know, just for, for round numbers, call it, you know, 1.5 points.
Overall, you know, on a, on a $1 billion, you know, roughly, you know, roughly 15, you know, $15 million of, you know, of capital, gross. 2/3 of that, you know, comes down to a, you know, call it a $5 million, you know, equity investment. That would roughly also account for any margin call reserves or, you know, and the incremental amount of MBS that would be required to hedge that. I think that's the, the rough, you know, the rough estimate there.
Yep, that's helpful. Thank you, guys, very much.
Sure.
We have no further questions at this time. I'll now turn it back to Mr. Spector for closing remarks.
Thank you, operator. I'd like to thank all of you for participating in our, in our first live earnings call, and, it's been a, it's been a, a good two calls here we've had today for both companies. If you have any questions, you know, we're here for you, and I look forward to speaking with all of you in the near future. Thanks again, everybody.
This concludes today's conference call. You may now disconnect.