PennyMac Financial Services, Inc. — FY2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. The filing also reports unaudited fourth-quarter results. PFSI is a mortgage-focused financial services firm with production, servicing and investment-management businesses. On November 1, 2018, a reorganization made PFSI the top-level parent and converted the former noncontrolling units into a single class of publicly held common stock; historical financial statements are those of the predecessor company.
Key financial metrics
| Metric | FY2018 | FY2017 | Change |
|---|---|---|---|
| Total net revenue | $984.6 million | $955.5 million | Up 3.1% |
| Income before income taxes | $267.7 million | $335.9 million | Down 20.3% |
| Net income | $244.4 million | $311.5 million | Down 21.5% |
| Net income attributable to PFSI common stockholders | $87.7 million | $100.8 million | Down 13.0% |
| Diluted earnings per share | $2.59 | $4.03 | Down 35.7% |
| Operating cash flow | $572.4 million | $(883.4) million | Turned positive |
| Cash and short-term investments at year-end | $273.1 million | $207.8 million | Up $65.3 million |
| Total assets / total liabilities | $7.48 billion / $5.82 billion | $7.37 billion / $5.65 billion | Assets up 1.5%; liabilities up 3.1% |
Year-end short- and long-term debt totaled approximately $4.0 billion, excluding the separately reported $1.10 billion liability for mortgage loans eligible for repurchase, which had a corresponding asset. Stockholders’ equity was $1.65 billion. The filing does not present a single company-wide operating margin measure.
Mortgage servicing portfolio UPB grew to $299.3 billion from $245.8 billion, and MSRs on the balance sheet rose to $2.82 billion from $2.12 billion. Loan production was $67.6 billion in UPB, down 2.0% from $69.0 billion. FY2018 segment pretax income was $87.3 million for production, $172.3 million for servicing and $7.0 million for investment management.
Fourth-quarter results
For Q4 2018, net income was $53.0 million, income before taxes was $58.3 million, and net income attributable to PFSI common stockholders was $38.7 million, or $0.65 basic and $0.63 diluted EPS. The quarterly results table reports total net revenue of $251.2 million and expenses of $192.9 million. Compared with Q4 2017, common-stockholder net income fell from $62.3 million and pretax income fell from $121.8 million. The November reorganization changed the ownership and share structure, so per-share and common-stockholder comparisons merit care.
Material changes and management commentary
- Servicing drove improvement: FY net mortgage loan servicing fees increased 45.5% to $445.4 million, reflecting portfolio growth and favorable interest-rate-related valuation effects.
- Production weakened: gains on mortgage loans held for sale fell 36.4% to $249.0 million. Management cited higher rates, weaker borrower demand and competitive pressure on pricing and margins.
- Expenses increased 15.7% to $716.9 million, principally with expansion in production and servicing operations, higher staffing, servicing costs and technology investment.
- Net interest income improved to $71.8 million from a $1.3 million expense, including $48.1 million of financing incentives (versus $9.2 million in 2017). The company expected these incentives to cease in Q2 2019, with a possible partial offset from better production pricing margins.
- Operating cash flow was strongly affected by mortgage inventory movements: mortgage-loan inventory provided $338.8 million of operating cash in 2018, compared with a $1.02 billion use in 2017. Investing activities used $322.6 million; financing activities used $132.0 million.
- The company elected fair-value accounting for all existing MSR classes from January 1, 2018. This increased reported MSRs by $1.48 billion through reclassification; the cumulative transition adjustment increased equity by $776,000. FY2018 MSR fair value declined by $129.4 million overall, including a $303.8 million reduction from cash-flow realization, partly offset by $174.4 million from valuation-input changes.
Outlook, risks and unusual items
No numerical earnings or revenue guidance is provided. Management described plans to grow servicing through production and MSR acquisitions, expand correspondent and consumer-direct lending, grow the new broker-direct channel, and develop products including a recently launched HELOC. The Investment Funds were liquidated during 2018, leaving PMT as the investment-management segment’s sole client.
- Liquidity and funding: Management stated liquidity was sufficient for current needs and that the company complied with Agency and financing covenants at year-end. Many borrowings are short-term and require renewal; facilities include collateral and margin-call provisions. The company reported approximately $7.32 billion in contractual obligations, including loan purchase/origination commitments, debt and interest.
- Rate and valuation exposure: Interest rates affect production, financing costs and MSR values. About 42% of total assets were Level 3 fair-value assets, primarily MSRs, with significant unobservable valuation inputs. A 10% adverse change in pricing spread or prepayment speed was estimated to reduce MSR fair value by approximately $89 million or $94 million, respectively; these sensitivities are not earnings forecasts.
- Concentration and counterparty dependence: PMT is a major source of correspondent-loan purchases, subservicing activity, financing and revenue. The company also depends on Agency approvals, secondary mortgage markets and financing counterparties.
- Repurchase exposure: The year-end liability for representations and warranties was $21.2 million. Loans subject to such representations and warranties had $137.8 billion UPB; management cautioned that claims and losses could rise as loans season.
- Legal and regulatory matters: A purported shareholder filed a class and derivative action challenging the 2018 reorganization; the company and named directors and officers moved to dismiss. Management said ordinary-course proceedings were not expected to materially affect results, while noting ultimate exposure is uncertain.
- Post-year-end activity: PFSI acquired approximately $11.9 billion UPB of Ginnie Mae MSRs in March 2019 and had an agreement to acquire another approximately $4.5 billion, subject to definitive documentation, due diligence and closing conditions.
Important facts for investors to verify
- Whether production margins and volumes can stabilize and offset the expected loss of $48.1 million in annualized financing-incentive income.
- MSR valuation assumptions, hedging performance and sensitivity to rates, prepayments, servicing costs and borrower performance.
- Availability and renewal terms of short-term funding, collateral headroom, margin-call exposure and compliance with lender and Agency covenants.
- The durability and terms of PFSI’s relationship with PMT, including correspondent purchasing, servicing, financing and management agreements.
- Potential growth in representation-and-warranty claims, servicing advances and litigation exposure, including the reorganization-related shareholder action.
- The impact of the reorganization on common-stockholder earnings, taxes and comparability; year-end income taxes payable were $400.5 million, largely reflecting deferred tax liability.