Pennymac Mortgage Investment Trust quarterly report, Q2 FY2017

PennyMac Mortgage Investment Trust — Q2 2017 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2017. Amounts are in U.S. dollars; financial statement amounts are in millions unless noted. The company is an externally managed mortgage REIT, with correspondent loan production, credit-sensitive investments and interest-rate-sensitive investments. Management says its portfolio is shifting from distressed loans toward correspondent-production-related CRT investments and mortgage servicing rights (MSRs).

Financial results and position

Metric	Q2 2017	Q2 2016	Six months 2017	Six months 2016
Net investment income	$84.0	$47.6	$148.4	$99.8
Net income (loss)	$28.8	$(5.3)	$57.5	$9.2
Net income attributable to common shareholders	$26.4	$(5.3)	$54.6	$9.2
Diluted EPS	$0.38	$(0.08)	$0.78	$0.12
Net interest income	$14.0	$15.2	$24.9	$37.5
Total expenses	$52.1	$55.8	$94.0	$96.9

Q2 net investment income included net gains on investments of $27.6 million, net gains on mortgage loans acquired for sale of $17.3 million, net mortgage servicing fees of $15.7 million and net interest income of $14.0 million. Six-month amounts were $44.3 million, $36.3 million, $27.4 million and $24.9 million, respectively.
Common dividends declared were $0.47 per share for Q2 and $0.94 for the first half, unchanged per share from the comparable 2016 periods. Series A preferred dividends were $2.3 million for Q2.
At June 30, total assets were $6.01 billion, total liabilities $4.56 billion and shareholders’ equity $1.45 billion. Book value was $20.04 per common share, versus $20.26 at year-end 2016.
Cash was $69.9 million and short-term investments $77.4 million. Six-month cash flows were $287.2 million provided by operations, $129.3 million provided by investing and $381.0 million used in financing; cash increased $35.4 million to $69.9 million.
Repurchase-agreement debt was $3.50 billion; total secured borrowings were $4.19 billion. The company reported a 3.05x leverage ratio, down from 3.58x at year-end, and a 77% advance rate against pledged assets. Q2 net interest margin was 1.17%, versus 1.37% a year earlier; net interest spread was 0.91%, versus 0.98%.

Material changes versus comparable periods

Net income improved from a Q2 2016 loss to Q2 2017 profit, primarily as investment results swung to a $27.6 million gain from a $15.5 million loss. CRT gains and substantially smaller ESS valuation losses drove the improvement. CRT-related gains, including the change in the related interest-only security payable, were $32.9 million in Q2 2017 versus $7.8 million in Q2 2016.
Correspondent-production pretax income declined to $8.1 million from $17.2 million in Q2 and to $20.6 million from $28.8 million for the first half. Loan purchase volume grew, but tighter margins from heightened competition in a smaller origination market more than offset volume growth.
Net interest income fell to $14.0 million from $15.2 million in Q2 and to $24.9 million from $37.5 million for the first half. Management cited runoff in higher-yielding distressed loans and financing growth for non-interest-earning MSRs and CRT investments. Interest expense rose to $38.4 million in Q2 from $36.6 million.
Assets declined $347 million from December 31, 2016. Mortgage loans acquired for sale, distressed mortgage loans and real estate owned (REO) decreased; MBS and CRT deposits increased. Distressed loans at fair value fell to $1.18 billion from $1.35 billion, while REO fell to $207 million from $274 million.
Management redefined operating segments into correspondent production, credit-sensitive strategies, interest-rate-sensitive strategies and corporate; prior-year segment comparisons were restated.

Outlook, risks and unusual items

No quantitative earnings or operating guidance is provided. Management targets long-term risk-adjusted returns primarily through dividends and secondarily through capital appreciation, and says future portfolio growth depends in part on financing and additional equity capital.
Q2 and first-half net investment income included substantial noncash items: 99% and 106%, respectively, of net investment income. These included fair-value changes and MSRs recognized when loans are sold; reported earnings therefore do not directly represent cash generated in the periods.
Interest-rate, prepayment, credit-spread and housing-price changes can affect the fair value of MBS, MSRs, ESS, CRTs and distressed loans. The company uses material Level 3 valuation inputs, which are estimates; management cautions that sensitivity analyses are not earnings forecasts. Margin calls can require cash or additional collateral when pledged asset values fall.
Liquidity and funding risks include short-term secured facilities, refinancing needs, collateral requirements and limited financing availability for MSRs and ESS. At June 30, reported available repurchase capacity was $2.66 billion, including $500 million of temporary credit-limit increases expiring through September 30, 2017; a portion of capacity was uncommitted. Minimum cash, net-worth, profitability and leverage covenants also apply.
Contractual obligations totaled $6.84 billion, including $1.93 billion of commitments to purchase loans and $247.9 million of commitments to fund CRT deposits. The company said facilities maturing between June 30 and the report date had been renewed or extended. It reported no off-balance-sheet arrangements and no legal matters expected by management to have a material adverse effect.
After quarter-end, the company agreed to sell $149 million UPB of performing loans from its distressed portfolio, with settlement scheduled for August; completion remains subject to due diligence and customary conditions. In July, it issued Series B preferred shares, receiving approximately $188.7 million in total net proceeds after the underwriters’ over-allotment exercise.
In March, PMT issued $115 million of 8.125% Series A preferred shares. The preferred dividend rate becomes floating after March 15, 2024. The company’s REIT status requires compliance with tax tests and generally distributing at least 90% of taxable income.
Management reported effective disclosure controls and no material change in internal control over financial reporting. Risk factors were reported as unchanged from the 2016 Form 10-K.

Most important facts for investors to verify

How much of reported profit reflects recurring cash earnings versus fair-value gains, particularly CRT valuation gains and MSRs recognized on loan sales.
Whether correspondent-production margins recover amid competition, and how production growth affects fulfillment costs, funding needs and repurchase exposure.
CRT portfolio performance, collateral funding commitments and sensitivity to credit spreads and mortgage-loan losses.
Availability and renewal terms of short-term financing, the status of temporary and uncommitted repo capacity, and headroom under liquidity and debt covenants.
Whether the proposed $149 million loan sale closes, and how the Series B preferred issuance and ongoing common and preferred dividends affect capital and per-share economics.
Performance and valuation assumptions for distressed loans, REO, MSRs and ESS, including prepayment, home-price and discount-rate estimates.