PennyMac Mortgage Investment Trust (PMT) is a mortgage REIT. As such, it usually pays a dividend yield much higher than the market average. But real estate is cyclical, and thus mortgage origination flows fluctuate with demand. In addition, higher interest rates depress demand. In 2022, high inflation and Chairman Powell’s and the United States Federal Reserve’s response of draining liquidity and increasing interest rates pushed mortgage rates much higher in a short time. The result was widening credit spreads, combined with low demand and overcapacity, which caused PMT’s dividend payout coverage to decline. The reduced dividend safety resulted in a dividend cut by PMT.

Overview of PennyMac Mortgage Investment Trust (PMT)

PennyMac Mortgage Investment Trust was founded in 2009 and is headquartered in Westlake, California. The company operates as a real estate investment trust (REIT) with assets related to mortgages.

The firm operates through three segments: Credit Sensitive Strategies, Interest Rate Sensitive Strategies, and Correspondent Production. The Credit Sensitive Strategies segment invests in credit risk transfer (CRT) agreements, CRT securities, distressed loans, real estate, and non-agency subordinated bonds. The Interest Rate Sensitive Strategies segment invests in mortgage servicing rights, excess servicing spreads, agency, and senior non-agency mortgage-backed securities (MBS) and engages in hedging. The Correspondent Production segment purchases, aggregates, and resells newly originated prime credit residential loans directly or MBS.

Total revenue was $303.8 million in 2022 and the past twelve months.

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Source: PennyMac Investor Relations

Dividend Cut Announcement

PMT announced a dividend cut on December 7, 2022. The company reduced the quarterly dividend by nearly 15% to $0.40 from $0.47 per share. Specifically, the REIT’s management stated,

“PMT’s objective is to distribute its income through quarterly dividends that reflect the earnings per share we expect from our current investment strategies,” said Chairman and CEO David Spector. “While the dividend was reduced as a result of current projections for PMT’s earnings and taxable income, we believe a quarterly dividend of $0.40 per common share remains an attractive component of PMT’s total return potential. Additionally, we remain confident in our ability to continue successfully managing investments across a diverse set of mortgage-related strategies to drive increased shareholder value over the longer-term.”

The announcement indicated that revenue would be lower, impacting the REIT’s ability to pay dividends. That said, the last sentence suggests the firm may increase the dividend over a more extended period.

Challenges

PMT’s main issue is higher mortgage rates caused by the U.S. Federal Reserve’s actions to remove liquidity from the bond market and increase the Federal Funds rate in response to high inflation. In turn, higher mortgage rates have likely resulted in lower demand and losses on specific strategies.

Higher Mortgage Rates

The Fed’s action has caused mortgage rates to surge. According to Freddie Mac, the 30-year fixed rate mortgage was over 7%, and the 15-year adjustable-rate mortgage (ARM) was more than 6.25% at their peak. Borrowing rates have declined since the highs at the end of 2022 on better inflation readings. 

But mortgage rates have never doubled in one year before. Both rates were significantly lower in late 2021, with the 30-year FRM below 3% and the 15-year ARM at nearly 2%. The rapid increase has increased credit spreads, affecting credit sensitive strategies. 

Next, demand is down combined with over capacity. The firm forecasts $1.6 to $1.9 trillion in mortgage originations in 2023, down from nearly $2.6 trillion in 2022 and more than $4.8 trillion in 2021. Regarding overcapacity, PMT stated,

“While many industry participants have taken the appropriate steps to reduce capacity, it has been happening slowly and we believe overcapacity still remains. It is our expectation that mortgage REITs with diversified investment portfolios, efficient cost structures and strong risk management practices such as PMT are best positioned to manage through the volatility presented by the current market environment.”

For perspective, PennyMac’s revenue before provision for loan losses was about $1,408 million in 2020, but it was only around $303 million in 2022. Moreover, interest expense is rising; in 2022, it was twice that in 2018.

Dividend Safety

PennyMac is a mortgage REIT. Accordingly, the firm must meet the minimum requirements for paying its dividend as a REIT. Specifically, it must distribute a minimum of 90% of taxable income in the form of shareholder dividends each year.

Despite the dividend cut, PMT likely intends to maintain its REIT status. That said, Q4 2022 was weak, and PennyMac had a loss of ($0.07) per share caused by higher interest expense, hedging losses, and lower gains in the portfolio, causing negative fair value marks. 

The bottom line is that higher interest expenses and widening credit spreads affected the ability to pay the dividend. The dividend yield was elevated, too, before the cut. The forward value is still more than 10%, a value suggesting distress.

But after the cut, the dividend safety has increased slightly. The annual dividend now requires about $142.4 million ($1.60 yearly dividend x 89 million shares) compared to $167.32 million in 2022. In addition, the firm must also pay about $30 million in preferred share dividends. On the plus side, the company is buying back shares below book value, reducing the cash flow for required for dividends.

Mostly, the cut has placed the dividend in better standing. However, if mortgage rates remain high and overcapacity for loan origination does not compress, the firm may cut the dividend again. Notably, PMT cut the dividend before when demand was low. That said, PMT has paid a dividend every year since 2010.

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Source: Portfolio Insight*

Final Thoughts on PennyMac (PMT) Dividend Cut

Despite the dividend cut, the new rate is only partially safe. Mortgage rates remain high, and the U.S. central bank may further raise rates. Home affordability is low, too, because of surging house prices and income growth rates trailing inflation. Moreover, mortgage originations are cyclical, as one recalls from the subprime mortgage crisis. 

Notably, investors have been selling the stock since late-2021 in anticipation of lower demand and higher interest rates. Those following a dividend growth strategy or seeking REITs for income should undeniably look elsewhere.

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