PennyMac Mortgage Investment Trust — Q1 2016 Form 10-Q
Reporting period: Quarter ended March 31, 2016; financial statements are unaudited. Amounts below are in U.S. dollars; financial statement amounts are generally in millions unless otherwise noted.
Business context
PMT is an externally managed mortgage-focused REIT with two segments: correspondent production, which purchases and resells newly originated mortgage loans and retains servicing rights, and investment activities, which include distressed loans, mortgage-backed securities (MBS), mortgage servicing rights (MSRs), excess servicing spread (ESS), credit risk transfer agreements (CRT), and real estate. PLS and other PennyMac Financial Services, Inc. (PFSI) affiliates provide significant servicing, fulfillment, and management services.
Financial performance and condition
| Metric | Q1 2016 | Q1 2015 / prior date |
|---|---|---|
| Net investment income | $52.2 million | $37.7 million |
| Expenses | $41.2 million | $41.5 million |
| Income before tax | $11.0 million | Loss of $3.8 million |
| Income tax benefit | $3.5 million | $11.3 million |
| Net income; diluted EPS | $14.5 million; $0.20 | $7.5 million; $0.09 |
| Net interest income | $22.4 million | $14.9 million |
| Net interest margin / spread | 2.14% / 1.90% | 1.43% / 0.77% |
| Net mortgage loan servicing fees | $15.6 million | $8.0 million |
| Net gain on loans acquired for sale | $15.0 million | $10.2 million |
| Net gain (loss) on investments | $(3.9) million | $3.4 million |
| Assets / shareholders’ equity, March 31 | $5,820 million / $1,415 million | Assets at Dec. 31, 2015: $5,827 million; equity: $1,496 million |
| Cash / short-term investments, March 31 | $67.0 million / $47.5 million | Cash at Dec. 31, 2015: $58.1 million; short-term investments: $41.9 million |
| Book value per share | $20.59 | $20.28 at Dec. 31, 2015 |
| Declared dividend per share | $0.47 | $0.61 |
Net income improved primarily as both segments increased pretax results: correspondent production earned $10.9 million versus $4.4 million, while investment activities moved to $0.1 million pretax income from an $8.2 million loss. Production purchases were $10.2 billion, up from $8.4 billion. Net servicing fees nearly doubled, supported by a 25% increase in the average servicing portfolio to $43.3 billion.
Cash flows were $(39.6) million from operations, $93.1 million from investing, and $(44.6) million from financing, producing an $8.9 million increase in cash. The filing notes that substantial reported income is noncash: noncash items equaled 87% of net investment income in Q1 2016. These included capitalized loan-modification interest, fair-value adjustments, and MSRs received as sale proceeds.
At March 31, liabilities totaled $4,406 million. Major funding included $3,245 million of repurchase-agreement obligations, $62 million of mortgage-loan participation financing, $206 million of notes payable, $345 million of VIE asset-backed financing, $245 million of exchangeable notes, and a $150 million note payable to PFSI. Repo debt carried a 2.46% weighted-average rate at quarter-end; the period’s average repo rate was 2.23%. Cash plus short-term investments totaled $114.5 million. Repo facilities had $1.235 billion of stated available capacity, of which $176 million was committed and $1.059 billion uncommitted; availability is subject to collateral, covenants, and market conditions.
Material changes and unusual items
- ESS fell to $322.0 million from $412.4 million at year-end. PMT recorded a $17.6 million loss on PFSI-related ESS, reflecting lower mortgage rates and higher expected prepayments. It sold $59.0 million of ESS to PLS after terminating the Fannie Mae and Freddie Mac spread-acquisition arrangements.
- MSRs totaled $455.1 million in carrying value. The quarter included $17.7 million of impairment on amortized-cost MSRs and an $11.4 million fair-value decline on fair-value MSRs; hedging gains partly offset these effects.
- PMT repurchased 5.2 million shares for $64.5 million in Q1 at an average $12.50 per share. The authorization was raised to $200 million; cumulative program repurchases reached $80.8 million. Shares outstanding declined to 68.7 million from 73.8 million at year-end.
- PMT repaid all $183 million of FHLB advances outstanding at year-end after a regulatory rule required its captive insurance subsidiary to terminate FHLB membership; those advances are no longer available.
- CRT activity increased: PMT deposited $66.7 million of restricted cash, and UPB subject to CRT guarantees rose to $5.9 billion from $4.5 billion. The quarter included a $4.1 million net CRT loss.
- The company declared $0.47 per share in dividends, versus $0.20 diluted EPS. The filing reports $35.0 million of cash dividends paid during the quarter.
- Subsequent to quarter-end, PMT reported closing in May a sale of approximately $419.3 million UPB of mortgage loans, with about $100.4 million in net cash proceeds after fees and repayment of associated financing. It also repurchased 100,000 shares in April for $1.4 million.
Outlook, management commentary, and risks
Management gave no specific earnings or dividend guidance. It described long-term opportunities in correspondent production, GSE credit-risk transfer, and MSRs, while remaining selective about distressed-loan purchases because recent pricing was less attractive. Management cited an industry forecast averaging $1.6 trillion of 2016 mortgage originations, below 2015, and a limited jumbo-securitization market. It stated that liquidity was sufficient for current needs and that it continued to pursue additional financing, but did not assure that new capacity would be obtained.
- Funding and liquidity: Most financing is short term; repo agreements carry margin-call provisions and require renewal or replacement. A decline in collateral values may require rapid cash or additional collateral. Limited MSR/ESS financing could constrain investment or liquidity.
- Valuation and market risk: Many assets rely on Level 3 fair values and unobservable assumptions. Lower rates can accelerate prepayments and reduce MSR/ESS values; credit-spread widening can pressure CRT and other credit-sensitive assets. Distressed-loan results depend on home prices, borrower performance, servicing, and timely foreclosure or liquidation.
- Credit and operating risk: The portfolio includes distressed loans and geographically concentrated exposures. Repurchase and indemnification claims can arise from loan-sale representations and warranties; the related liability was $18.7 million, against $43.5 billion UPB subject to representations and warranties.
- Related parties and REIT status: PMT relies on PFSI affiliates for management, servicing, and fulfillment, creating dependence and potential conflicts. REIT qualification requires meeting complex tests and generally distributing at least 90% of taxable income.
- Other disclosures: Management reported no legal proceedings expected to have a material adverse effect, no material change to the risk factors in the 2015 Form 10-K, and effective disclosure controls. No off-balance-sheet arrangements or guarantees were reported.
Investor facts to verify
- How much of reported earnings converts into cash, given noncash items equal to 87% of Q1 net investment income, and whether dividends remain sustainable relative to cash generation and REIT distribution requirements.
- The actual committed and usable borrowing capacity, upcoming facility maturities, covenant headroom, collateral haircuts, and sensitivity to repo margin calls.
- Whether the May loan sale’s reported net proceeds and realized value matched the quarter-end estimates, and how remaining distressed-loan and REO valuations perform.
- The assumptions and sensitivities behind Level 3 MSR, ESS, and distressed-loan fair values, including prepayment speeds, discount rates, home-price forecasts, and the effect of further rate or credit-spread moves.
- Future repurchase and indemnification claims, recoveries from correspondent sellers, and whether growth in loans subject to representations and warranties increases losses beyond the recorded liability.
- The economics and governance of PFSI-related arrangements, including the ESS termination, servicing and fulfillment fees, and the $150 million affiliate note.