PennyMac Mortgage Investment Trust — Q1 2012 Form 10-Q
Business context and reporting period
Unaudited results cover the quarter ended March 31, 2012; comparisons are with Q1 2011 unless stated otherwise. PennyMac is an externally managed mortgage REIT with two segments: investment activities in distressed mortgage assets and correspondent lending, which purchases newly originated loans for resale. Amounts below are in millions of dollars except per-share data.
Financial performance and position
- Income: Net investment income was $46.6, up from $17.3. Net income was $19.1 versus $7.6; diluted EPS was $0.65 versus $0.35. The company declared dividends of $0.55 per share, compared with none in Q1 2011.
- Income drivers: Investment gains and gains on correspondent loans acquired for sale totaled $24.9, including $13.4 of correspondent-loan gains. Interest income was $16.4 and REO results contributed $3.7. Correspondent lending generated $10.3 of pre-tax income; investment activities generated $14.3.
- Expenses and taxes: Total expenses rose to $22.1 from $9.0, including $6.1 of affiliate loan-fulfillment fees and $6.7 of interest expense. Income-tax provision increased to $5.5 from $0.6; the reported effective rate was 22.5% versus 7.7%.
- Cash flow: Operating activities provided $56.5, investing activities provided $100.9, and financing activities used $155.6. Cash increased $1.8 to $16.4. Operating cash flow benefited chiefly from reduced correspondent-loan inventory; investing cash flow included the $50.0 Treasury security maturity and proceeds from asset liquidations.
- Balance sheet and liquidity: Total assets were $1,378.0, liabilities $782.1, and shareholders’ equity $596.0 at quarter-end. Book value was $19.21 per share. Cash and short-term investments totaled $79.8. Financing borrowings reported in the balance-sheet categories included $501.4 under repurchase agreements and $127.6 under forward purchase agreements; the company also had $115.6 of unsettled MBS purchases.
- Portfolio and leverage: Mortgage loans at fair value were $667.5; loans under forward purchase agreements were $105.0; REO and related forward-purchase REO were $104.9 combined; MBS were $174.6. Mortgage-loan financing and forward purchase arrangements expose the company to margin calls and refinancing risk.
Material changes versus the prior comparable period
- Correspondent lending expanded sharply: loan purchases increased to $1.86 billion from $19.6 million, and sales proceeds were $1.93 billion versus $19.2 million. This segment contributed about 42% of Q1 2012 pre-tax income. Quarter-end loans held for sale were $155.3 million.
- Net income growth reflected larger investment and lending activity, higher mortgage-loan interest income, and fair-value gains. The $13.4 million gain on loans acquired for sale included $12.9 million of MSRs received in loan sales, making a significant portion noncash.
- Investment gains were $24.9 million versus $10.0 million. Mortgage-loan gains included $4.8 million from payoffs; MBS recorded a $0.4 million gain versus a $0.4 million loss.
- Expenses increased with portfolio and lending growth, affiliate fulfillment and servicing charges, and financing costs. Interest expense rose to $6.7 million from $2.3 million.
- At March 31, 68% of the fair value of the investment mortgage-loan portfolio was nonperforming, down from 75% at December 31, 2011. The portfolio’s fair value declined to $667.5 million from $696.3 million over that same period.
- Equity increased to $596.0 million from $546.0 million, supported in part by $45.7 million net proceeds from issuing 2.53 million shares. Liabilities declined from $840.0 million at year-end.
Outlook, commentary, risks and unusual items
- Management said current liquidity was sufficient for short-term needs, while pursuing additional warehouse, repurchase, term-financing, securitization and equity capacity. It noted that correspondent-lending growth depends on financing availability and capital to fund loans not financed by lenders.
- Management described distressed-loan supply and newly originated agency-eligible loan purchases as opportunities. It also cited modest economic growth, unemployment of 8.2% at quarter-end, restrictive underwriting and expected foreclosure activity to increase as lenders address process issues. No formal earnings or dividend guidance is provided.
- Important risks include distressed borrower credit, housing-price declines, foreclosure delays, uncertain asset-resolution cash flows, illiquid markets and significant Level 3 fair-value estimates. About 74% of the investment mortgage-loan portfolio’s estimated fair value related to loans with unpaid principal exceeding current property value. Most assets were valued using significant unobservable inputs.
- Short-term secured financing is subject to renewal, collateral-value changes and margin calls. Management reported all known contractual obligations mature within one year and stated that matured repurchase agreements had been renewed or extended. The filing says financing REO can be difficult and could stress capital and liquidity during foreclosure cycles.
- Related-party exposure is material: PCM manages the company and affiliate PLS services loans and performs fulfillment work. The management agreement’s base fee was $1.8 million for the quarter; fulfillment fees payable to the affiliate were $6.1 million.
- Subsequent events: the board declared another $0.55-per-share dividend payable May 31, 2012. The company completed a $56.5 million mortgage-loan purchase on April 27. Additional announced purchase commitments totaling approximately $159.4 million remained subject to due diligence, closing conditions and adequate capital. The Citi repo facility was extended to April 19, 2013.
- The company reported no material adverse legal proceedings and no material changes to the prior annual report’s risk factors. Management concluded disclosure controls were effective; no material change in internal control over financial reporting was reported.
Important facts for investors to verify
- How much reported earnings depended on noncash fair-value gains and MSRs received in loan sales, and how those estimates perform against realized outcomes.
- Availability, renewal terms and covenant compliance for short-term secured financing, including exposure to margin calls and the ability to fund forward-purchase commitments.
- Credit quality, resolution timelines and recoveries for the distressed-loan and REO portfolios, especially collateral values and foreclosure progress.
- Correspondent-lending profitability after affiliate fulfillment costs, hedging results, representation-and-warranty claims and funding requirements.
- Dividend sustainability relative to taxable income, liquidity needs, capital raising and REIT distribution requirements.
- Concentrations in Level 3 valuations and affiliated counterparties, and the terms and completion status of subsequent loan commitments.