PennyMac Financial Services, Inc. — Q1 2019 Form 10-Q
Reporting period: Quarter ended March 31, 2019. Unaudited consolidated results. PennyMac operates mortgage production, servicing and investment management businesses; PMT is a major affiliate and business counterparty.
Financial performance and position
| Metric | Q1 2019 | Q1 2018 / prior date |
|---|---|---|
| Total net revenue | $247.7 million | $238.2 million |
| Net income | $46.1 million | $66.9 million |
| Net income attributable to PFSI common stockholders | $46.1 million | $16.6 million |
| Basic / diluted EPS | $0.59 / $0.58 | $0.70 / $0.67 |
| Income before tax | $60.3 million | $73.0 million |
| Annualized return on average common equity | 11.0% | 13.6% |
| Total assets | $7.82 billion | $7.48 billion at Dec. 31, 2018 |
| Stockholders’ equity | $1.70 billion | $1.65 billion at Dec. 31, 2018 |
Revenue mix and operating costs: Net servicing fees were $80.6 million versus $116.8 million; mortgage loan gains were $84.8 million versus $71.4 million; fulfillment fees from PMT were $27.6 million versus $11.9 million; and net interest income was $20.8 million versus $5.9 million. Expenses rose to $187.4 million from $165.2 million. The effective tax rate increased to 23.5% from 8.3%.
Cash flow and liquidity: Operating cash flow was negative $134.2 million, compared with positive $537.4 million; investing cash flow was negative $92.8 million; financing cash flow was positive $216.0 million. Cash and restricted cash ended at $144.9 million, down $11.0 million during the quarter. Cash plus short-term investments totaled $293.6 million. Management said liquidity was sufficient for current needs. Reported available repurchase borrowing capacity was $2.83 billion, including $2.21 billion uncommitted.
Debt and funding: Balance-sheet borrowings included $2.15 billion under asset repurchase agreements, $547.9 million under mortgage-loan participation agreements and $1.29 billion of notes payable. Repo balances increased from $1.93 billion at year-end; notes payable were broadly unchanged. The company also reported $1.09 billion each of mortgage loans eligible for repurchase and the related liability. Facilities are largely secured and subject to financial covenants and collateral margin calls.
Mortgage platform: Servicing portfolio unpaid principal balance was $324.7 billion, up from $299.3 billion at year-end 2018 and $255.3 billion a year earlier. MSRs were valued at $2.91 billion at quarter-end. Commitments to purchase and fund mortgage loans were $3.8 billion. PFSI reported $3.82 billion of interest-rate lock commitments issued during the quarter.
Material changes and management commentary
- Net income fell $20.8 million year over year, primarily because servicing-related fair-value results worsened, expenses increased and taxes rose after the November 2018 reorganization.
- Servicing fees before fair-value changes increased, supported by portfolio growth. However, lower interest rates contributed to a net $118.8 million negative change in fair value of MSRs, servicing liabilities and excess servicing spread financing, after hedging, versus a $43.9 million negative change in Q1 2018. MSR fair value declined $259.0 million before additions and other activity.
- Mortgage-loan gains improved by $13.4 million, which management attributed primarily to better production margins. PMT fulfillment-fee revenue more than doubled as fulfilled loan volume increased.
- Production segment pretax income increased to $47.0 million from $17.2 million; servicing segment pretax income declined to $11.2 million from $54.9 million. Investment management pretax income was $2.1 million versus $1.0 million.
- The tax rate and reported common-stockholder income are affected by the reorganization, which converted prior noncontrolling interests into PFSI common equity. Accordingly, the 2018 and 2019 common-stockholder income and EPS figures are not directly comparable without considering the changed ownership and share structure.
- Effective January 1, 2019, lease accounting adoption added a $58.6 million right-of-use asset and a $79.3 million operating lease liability, with no income-statement effect and no restatement of 2018.
Outlook, risks and contingencies
- No formal earnings or operating guidance is provided. Management expected financing incentives under a repurchase agreement expiring August 2019 to cease accruing in Q2 2019; it expected the loss to be partially offset by improved mortgage production margins.
- Management identifies interest-rate and prepayment changes as material risks to MSR and servicing results. MSRs and other significant fair-value items rely on Level 3 estimates and unobservable inputs; disclosed sensitivity analyses are not earnings forecasts.
- Liquidity and refinancing risks include short-term funding maturities, lender margin calls and reliance on continued access to financing. Management reported compliance with borrowing covenants and Agency capital and liquidity requirements at quarter-end.
- PMT generated 31% of net revenue, versus 15% in Q1 2018, underscoring affiliate concentration and exposure to PMT production, servicing and financing arrangements.
- The company reported ordinary-course litigation and regulatory matters, with no expected material adverse effect according to management. A putative shareholder class and derivative action challenges the 2018 reorganization; a motion to dismiss was filed March 1, 2019. The company also disclosed $17.98 million of representation-and-warranty loss liability against a large population of loans subject to such claims.
- Management stated that no material subsequent events requiring disclosure occurred through issuance of the financial statements. No material changes to the previously disclosed risk factors were reported.
Important facts for investors to verify
- How much of future servicing earnings may be affected by interest rates, prepayments and MSR fair-value estimates, and how effective hedges are in practice.
- Whether improved production margins offset the expected loss of repurchase-agreement incentives, and whether the recent production gains persist.
- Funding availability, facility renewals, uncommitted borrowing capacity and potential collateral calls, particularly given short maturities.
- The durability of PMT-related revenue and the terms, concentration and counterparty risks of affiliate arrangements.
- Comparability of year-over-year earnings and EPS after the 2018 reorganization, including the change in tax treatment and share count.
- Developments in the shareholder litigation and potential representation-and-warranty claims or repurchase losses.