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PennyMac Mortgage Investment Trust isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good afternoon, and welcome to PennyMac Mortgage Investment Trust Fourth Quarter and Full Year 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 will – this call may contain forward-looking statements that are subject to certain risks identified on Slide 2 of the earnings presentation that may 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. 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.

David Spector: Thank you, operator. Good afternoon and thank you to everyone for participating in our fourth quarter earnings call. PMT produced very strong results in the fourth quarter with sizable contributions from the credit-sensitive strategies and its correspondent production business. These results were partially offset by fair value declines in the interest rate sensitive strategies. Net income to common shareholders was $42 million or diluted earnings per share of $0.44. PMT’s annualized return on common equity was 12% and book value per share increased to $16.13 at December 31st, up from $16.01 at the end of the prior quarter. This strong financial performance marked the culmination of an outstanding year for PMT, demonstrating its resilience in a year of tremendous interest rate volatility and highlighting our management team’s unwavering commitment to managing interest rate risk.

PMT was profitable every quarter in 2023 with annual income contributions from all three of its investment strategies. Net income attributable to common shareholders for the year was $158 million or diluted earnings per share of $1.63. Return on common equity was 11% and book value per share grew 2% net of $1.60 in common share dividends. In 2023, we invested nearly $500 million into new MSR and opportunistic investments, which we believe will perform well over the long-term. As we head into 2024, we will remain disciplined in the deployment of capital and continue to look for opportunistic investments across the residential mortgage landscape. The strength of PMT’s balance sheet has always been a key differentiator among mortgage REITs, and I am very proud of the work our management team has accomplished in 2023.

Not only that we return approximately $170 million to shareholders through common share cash dividends and share repurchases, but we further strengthened the balance sheet with new long-term debt issuances of $659 million and redemptions of $450 million in debt with upcoming maturities. As you can see on Slide 5 of our fourth quarter presentation, the origination market is expected to have dropped in 2023 as mortgage rates have declined from their recent highs and anticipated future rate cuts have increased third-party estimates for industry originations in 2024 to approximately $2 trillion. Much of this anticipated growth is based on expectations for interest rate reductions later on in the year, and we expect the first quarter of 2024 to remain seasonally low before moving into spring and summer home buying season.

Given the current environment, I remain very enthusiastic about the potential performance from PMT’s investment portfolio. More than two-thirds of PMT’s shareholders equity is currently invested in a seasoned portfolio of MSRs and the unique GSE lender risk share transactions we invested in from 2015 to 2020. As the majority of mortgages underlying these assets were originated during periods of very low interest rates, we continue to believe these investments will 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, as well as a substantial accumulation of home equity in recent years due to continued home price appreciation.

MSR investments account for more than half of PMT’s deployed equity. The rates declined during the quarter, the majority of the underlying mortgages remained far out of the money, and we expect the MSR to continue to produce stable cash flows over an extended period of time. The MSR values also benefit from the current interest rate environment as the placement fee income PMT receives on custodial deposits is closely tied to short-term rates. Similarly, mortgages underlying PMT’s large investment in lender risk share have low delinquencies and a low weighted average current loan-to-value ratio of 50%. These characteristics are expected to support the performance of these assets over the long term, and we continue to expect the realized losses over the life of these investments to be limited.

We remain focused on actively managing PMT’s portfolio of opportunistic investments, which we believe have the potential for strong, long-term, risk-adjusted returns. In the fourth quarter, we invested $17 million into floating rate GSE CRT bonds. After quarter end, we sold $56 million of previously purchased floating rate GSE CRT bonds as credit spreads have tightened, making capital available for PMT to deploy into additional opportunistic investments. Slide 8 outlines the runway potential expected from PMT’s investment strategies over the next four quarters. PMT’s current run rate reflects an average $0.31 per share over the next four quarters. This is down modestly from the prior quarter due to the impact of interest rate changes on asset yields compared to financing rates for the interest rate sensitive strategies.

The expected returns on these investments have the potential to improve if short-term rates decline, driving an increase in the overall run rate. I will now turn it over to Dan, who will review the drivers of PMT’s fourth quarter financial performance.

Dan Perotti: Thank you, David. Turning to Slide 12, PMT earned $42 million in net income to common shareholders in the fourth quarter, or $0.44 per diluted common share. PMT’s credit sensitive strategies contributed $61 million in pre-tax income. Pre-tax income from PMT’s organically created CRT investments in the fourth quarter totaled $42 million. This amount included $29 million in market-driven fair value gains, reflecting the impact of tighter credit spreads. The fair value of these investments was essentially unchanged from the prior quarter, as fair value gains were offset by runoff. As David mentioned, the outlook for our current investments in organically created CRT remains favorable, with a low underlying current weighted average loan-to-value ratio, and a 60-day delinquency rate of 1.23% as of December 31.

Income from opportunistic investments in CAS and STACR bonds issued by the GSEs totaled $12.8 million in the quarter. The interest rate sensitive strategies contributed a pre-tax loss of $17 million. The fair value of PMT’s MSR investment decreased by $145 million as the decline in mortgage rates increased future prepayment projections. Approximately 78% or $112 million of this MSR decline was offset by changes in the fair value of Agency MBS, interest rate hedges and related income tax effects. Agency MBS fair value increased by $184 million, while interest rate hedges decreased by $94 million. The fair value declines on MSRs and interest rate hedges held in PMT’s taxable REIT subsidiary drove a tax benefit in the fourth quarter. The fair value of PMT’s MSR asset at the end of the quarter was $3.9 billion, down from $4.1 billion at September 30, as growth in the MSR portfolio from loan production was more than offset by fair value declines and runoff from prepayments.

Delinquency rates for borrowers underlying PMT’s MSR portfolio remain low, while servicing advances outstanding increased to $191 million from $80 million at September 30 due to seasonal property tax payments. No principal and interest advances are currently outstanding. Income from PMT’s correspondent production segment was up from last quarter, primarily due to higher margins. Total correspondent loan acquisition volume was $24 billion in the fourth quarter, up 10% from the prior quarter. Conventional loans acquired for PMT’s account totaled $2.5 billion, down 10% from the prior quarter due to seasonal impacts. The weighted average fulfillment fee rate was 20 basis points, unchanged from the prior quarter. PMT reported $41 million of net income across its strategies, excluding market-driven value changes and the related tax impacts, up from $32 million last quarter.

We’ll now open it up for questions. Operator?

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Operator: [Operator Instructions] Your first question is from the line of Bose George with KBW.

Bose George: Hi guys. On Slide 8 where you give the run rate potential ROE, it declined and it looked like it declined on the return on the MSR. Can you just talk about the returns expected this quarter versus last quarter? And then I thought like, as the curve steepens, it should sort of benefit that number, and is that right?

Dan Perotti: Hey, Bose. This is Dan. So the run rate did decline based on the interest rate strategies. Really, what we see there is that the curve – if we’re thinking about the curve for the MSR really did more de-invert – sorry, inverted more if you’re looking at versus really short-term rates, which is where the financing – where we’re financing the MSR. And especially at PMT, where the vast majority of the financing for the MSR is really secured. So we have short rates that are still sticking and it looks like even through the first quarter of the year, probably at the same rates that they’ve been. And meanwhile, the longer-term rates that drive the yield on the MSR came down pretty meaningfully in the fourth quarter.

And so, that sort of compression in the short-term is what drove the reduced expected return over the – in the run rate, which is really over just the next four quarters. As if interest rate or short-term interest rates decline as we in the market are expecting them to, and we see this sort of through the forecast, we expect that overall spread to increase the curve would be invert and that would create a sort of better spread in terms of the ROE, driving higher ROE for the MSRs and the interest rate sensitive strategies overall, and that could lead to a greater expectation or return potential for the interest rate sensitive strategy. So, we do based on what’s sort of forecasted in the market, expect that to evolve over the coming year, but just looking out at the sort of short-ish term, currently, we see some compression in the interest rate sensitive strategies as the while or as the short rate is still sticking up pretty high.

Bose George: Okay. Great. Thanks a lot.

Operator: Your next question is from the line of Matthew Howlett with B. Riley.

Matthew Howlett: Hey, thanks for taking my question. First, just on the credit side, I mean, you bought some CRT in the fourth quarter, then you sold a lot of it in the season stuff in January. What’s your view on spreads today with CRT and any update on a securitization program on the horizon, maybe second liens or HELOCs and/or a restart of the CRT? I know the GSEs are out with some of their guidelines today, but just an update on the credit side and where you think you can maybe grow it and what you think it spreads now.

David Spector: Yes, sure. Hey, Matt, it’s David. I think that on the credit sensitive strategies front, we had very strong returns in 2022, and that really speaks to the really great job, Will and the team are doing in terms of actively managing that portfolio. We bought $17 million earlier in the quarter of CAS and STACR bonds. We sold $56 million after quarter end, opportunistically as spreads tightened. And look, we’re going to continue to monitor the market. The sale of the bonds were because the yields were well below our required returns and just redeploying them even to pay down warehouse lines made sense and as a way to have dry powder to be able to invest in credit sensitive assets as we see them. In terms of a securitization program, we’re starting to see some asset securitizations of second liens, albeit the credit pieces of those securitizations don’t meet our required returns at PMT, although we’re monitoring them very, very closely.

And I think that’s something that we’re just going to continue to monitor. I don’t see the GSEs coming back with a lender credit risk program until we see an increase in the overall size of the mortgage market at a minimum. They right now need all the production they can get to support their own CAS and STACR bonds. And so it’s something that we’re continuing to stay in dialogue with them, but I don’t see that. Look, I think we have – we’re in a position where we have dry powder to invest when we see the opportunities and continue to deliver the returns we need to maintain our dividend. We had a great year in PMT overall where we – for the fourth quarter, we delivered 12%, for the year, we were at 11% where earnings exceeded the dividend, and we exceeded the dividend in a nice way.

We had minor book value growth per share, which in the REIT sector says a lot, given the volatility that we saw and speaks to the hedging that we do, as well as the opportunities that we see in the marketplace. So I think by and large, it’s going to be until we can raise capital and I see that as an opportunity that’s going to present itself. Hopefully, at the later parts of the years, we see rates decline, but we continue to actively manage the portfolio.

Daniel Perotti: The other piece that I mentioned, Matt, is that if you look at our portfolio, around 70% of the portfolio is invested in our core assets in terms of MSR and our existing lender credit risk share that we have outstanding, given where interest rates have been and the note rates on those portfolios, the runoff of those is very slow. So our need to sort of redeploy at this point is not huge. So as David mentioned, we’re looking for the opportunities and investing opportunistically where we see those opportunities. But in terms of the overall portfolio, the runoff is not that great at this point in time.

Matthew Howlett: Great. That’s a good point. And then on the subject that sort of allocation of capital, how long will this interplay with PMT selling a big chunk of their conventional production to be the set? How long do you expect you guided to that in the first quarter. Obviously, there’s huge synergies between the two companies? How long do you see that continuing and what will needs to change for PMT to start retaining that production? And of course, David, you brought up the dividend, just any owner’s sense, you want to keep the – in terms of this interplay between buying back stock and just paying that dividend, do you feel like you want to pay the dividend or given the stock is discount to book, what would you see allocating more capital to buybacks? Just curious on that. Thank you very much.

David Spector: Okay. So on the correspondence side, look, I think that it speaks volumes about the synergistic relationship we have with PFSI, that we have the ability to move loans over to PFSI in this period of time, where we have alternative investments at a higher return and we’re trying to pace how we deploy that capital really with an eye towards credit sensitive strategies as opposed to the MSR port is very large and we want to get that more in balance. I think it’s – look, it’s going to – I don’t see it changing in Q1, Q2, it’s a capital allocation issue from the point of view of – should we raise capital and we have more capital to deploy and we want choose to deploy in MSRs, PMT will sell less loans to PFSI.

And I think it’s nothing more complex than that. But I think for now it speaks to more of the active management that we’re taking in the portfolio in PMT and how we think about the split between credit sensitive strategies and interest rate sensitive strategies. Dan, you want to talk about the dividend?

Dan Perotti: Sure. With respect to the dividend and sort of the trade-off that you mentioned, Matt, so where we’ve seen the price to book in recent periods where we’ve been moving closer to price to book, we have not seen the repurchase of shares as attractive as we obviously have historically made share repurchases where we see that disconnect become meaningful. But I think in order for us to look at repurchasing more shares in a significant way we want – that we would want to see, but we wouldn’t do that unless we saw the share price to book or the price to book ratio drop from where it is today. We believe for PMT and we’ve stated this before that having a stable dividend is sort important and meaningful. We do see a path consistent with what I was discussing earlier and what we’ve discussed before for our run rate to move back toward the current dividend level.

At this point, we don’t think that it warrants a change in the dividend. And so we expect to, at least in the near-term, have our dividend level remain consistent. If we do see – if we don’t see a path for the run rate back to that $0.40 per share, then that would precipitate us reevaluating that. But given what sort of the market expects and how that would impact the earnings potential of our portfolio, we do see that path as a likely potential in the future.

Operator: Your next question is from the line of Kevin Barker with Piper Sandler.

Kevin Barker: Hello, again. Just wanted to follow up on, you sold some CRT this quarter. Do you see any opportunities to make some structural changes that could potentially enhance the ROE of the business to bring it closer to the $0.40 dividend run rate, particularly with you have a couple of debt maturities coming due here in 2024. Could you potentially move some assets, pay down that debt and maybe shift the balance sheet a bit? Just additional color there on what you’re considering? Thanks.

David Spector: So with respect to the maturities in 2024, so we have a couple of secured maturities, specifically a CRT maturity that’s upcoming. That we expect to look to probably put some of the securities on repo for a period of time and then look to refinance that. The market has improved a bit for the financing of our credit risk transfer securities into the types of structures that we’ve had previously. And so view – we see that as an opportunity there. And that could somewhat improve the return profile, but that’s for a limited part of the portfolio. As we look out further into the maturities, we do have a maturity of our convertible debt later in 2024. We’ve partially addressed that last year with our baby bond issuance.

We have seen the baby bond market be somewhat active in terms of issuance in the mortgage REIT space. That’s a potential there or additional – or another convertible debt issuance. Or potentially if neither of those is attractive to your point with respect to the overall earnings of the portfolio, then it could look to be lever and we do have the ability to do that without really significantly repositioning the portfolio. At this point in time, I don’t think we’re considering a significant shift in terms of the overall makeup of the portfolio. We think what we have in both cases, like I said, on the credit sensitive side generates meaningful returns even at the tighter spreads. And we’ve repositioned or rotated out of the assets where we didn’t think that the risk adjusted returns were commensurate with where we want it to be invested.

On the interest rate sensitive side, I think that’s really again a matter of the shape of the yield curve at this point in time, which is really expected to normalize. And that’s where we expect to drive up the return profile in that case. So, no significant shift in terms of the makeup of the portfolio, I wouldn’t say we’re contemplating currently.

Kevin Barker: I realize you’ve made comments around the shape of the curve, but is there any way you can quantify the impact of Fed rate cuts relative to your earnings? Now, obviously it could shift quite a bit, but is there any way to simply look at it from a Fed rate cut perspective?

Dan Perotti: Yes. The – I mean, the way that you would generally look at it, if you assume that the Fed rate cuts are baked in more or less, and that the longer term in the current period, and that the longer-term yields wouldn’t move significantly to the extent that the Fed follows the path that’s sort of currently contemplated. If there’s six rate cuts or something along those lines baked in toward – through the year, that’s a point and a half that would come off of our floating rate debt on MSRs, which is a several $100 million. So it adds a meaningful amount. So the other assets, the interest rate sensitive assets, the returns, our expected returns wouldn’t change, or the amount that they’re earning, our cost on the debt would decline meaningfully in terms of several million dollars just from those interest rate cuts. I think that’s the way to think about it.

Kevin Barker: Thank you, Dan.

Dan Perotti: Yes.

Operator: [Operator Instructions] Your next question is from the line of Kevin Barker with Piper Sandler. I do apologize. Your next question is from Eric Hagen with BTIG.

Eric Hagen: Okay. Thanks for taking my question. Hey, looking at Slide 19, with around 240 odd-million of liquidity buffer relative to the FHFA requirement, can you share how much you’ve seen that liquidity buffer fluctuate, especially when rates are volatile? And how close maybe you got to that threshold during periods of higher volatility like we saw last fall?

Dan Perotti: Yes. No, our liquidity has been pretty stable. Part of what we look at in terms of our hedge profile is the impact that interest rate shifts can have on liquidity. And we keep a reserve as part of our liquidity forecasting, and our amounts of required liquidity in terms of managing the business that accounts for interest rate volatility and the impacts that could have on our liquidity available. But if you look at our liquidity that’s been on the balance sheet in the last couple of quarters, I believe we’ve kept it at a pretty stable level there, which is 2x what the requirement is. So that really has not been an issue even given the interest rate volatility that we’ve seen over the past couple of quarters.

Eric Hagen: Right. Okay. And then on Slide 12, it looks like you have about $1.3 billion of capital in the interest rate sensitive strategies. Can you split apart how much is in the MSR versus the MBS and hedges and maybe how much capital you see yourselves allocating to MBS and hedges going forward?

David Spector: Yes. So the vast majority of the capital in there is allocated to the MSRs. It’s the most capital intensive asset. I think that we stated earlier in the presentation that 56% of the shareholders’ equity is in the MSRs and so that’s over $1 billion of that $1.2 billion. The agency MBS, if we just look at them on their face, even though it’s a significant portfolio the haircut on that is relatively low. So it doesn’t take nearly as much equity. And there’s also, that’s similar for the rest of the assets that are in this section. So it’s really predominantly the MSRs. And even if we add significantly to the agency MBS portfolio on a standalone basis in terms of the equity allocated, although we may have to increase our reserves depending on the interest rate sensitivity and how much we would want to hold for margin calls on its face wouldn’t increase the equity allocation that much to hold additional MBS there.

Eric Hagen: Yes. That makes sense. Thank you, guys.

Operator: Your next question is from the line of Jason Weber with JonesTrading.

Jason Weber: Hi, guys. Thanks for taking my question. So as of today, can you give us some sort of current context on the level of spreads and overall incremental ROE potential on new CRT such as the STACR bonds that you were buying?

David Spector: I mean, the – where we’ve seen sort of new STACR and CAS today, I mean, as was mentioned we just sold a bit of those. So I think it’s fair to say it doesn’t, in terms of – with those assets, it wasn’t commensurate with the sort of return profile that we have in the mid teens for the CRT and sort of the target that we’ve had there. But overall, including the margin call reserves that we would look to hold on the CRT that’s out in the market, probably high single or low double digits, is what we see in sort of current market or recent trades that fluctuates. And so, opportunistically in the fourth quarter, we invested where we saw attractive spreads that met our return hurdles. But that’s sort of the most recent color in terms of what we’ve seen.

Jason Weber: Thanks. And I apologize if this was addressed during the prepared remarks, but where would you ballpark book value change year-to-date?

David Spector: We don’t typically – sort of give a mark for that, but overall, if you look at historically where we’ve been, in terms of overall book value, it’s been pretty stable over the past few quarters. That’s been really the benefit of having the hedging program that we’ve had is that we don’t see the type of, even with interest rates being pretty volatile, we don’t see that our book value fluctuate in the same way that certain other portfolios do. So overall, just give the color. It’s pretty stable book value quarter-to-date.

Jason Weber: All right, thank you for the color.

Operator: We have no further questions at this time. I will now turn the call back over to Mr. Spector for closing remarks.

David Spector: Thank you, Operator. And thank you all for joining us this afternoon. I appreciate the questions and the time. And I encourage investors and analysts and with any additional questions to contact our Investor Relations team by email or phone. And thank you all very much for staying up at the late hour on the east coast. Have a good day.

Operator: This concludes today’s call. Thank you for joining. You may now disconnect your lines.