PennyMac Mortgage Investment Trust — 2012 Form 10-K
Reporting period: Fiscal year ended December 31, 2012; the filing also reports fourth-quarter results. Amounts below are U.S. dollars unless noted. This is an annual report, not a standalone fourth-quarter filing.
Business context
PennyMac is an externally managed mortgage investment trust with two segments: correspondent lending, which purchases and resells newly originated loans, and investment activities, which acquire distressed mortgage loans, real estate acquired through loan resolution (REO), and mortgage servicing rights (MSRs). The Manager, PCM, and primary servicer, PLS, are affiliates. The company has elected REIT tax treatment.
Financial performance and position
| Metric | 2012 | 2011 |
|---|---|---|
| Net investment income | $335.2 million | $128.6 million |
| Income before income taxes | $186.8 million | $72.5 million |
| Net income | $138.2 million | $64.4 million |
| Diluted earnings per share | $3.14 | $2.41 |
| Dividends declared per share | $2.22 | $1.42 |
| Total assets at year-end | $2.56 billion | $1.39 billion |
| Shareholders’ equity at year-end | $1.20 billion | $546.0 million |
- Fourth-quarter 2012 net income was $49.2 million, or $0.83 per diluted share, versus $19.6 million, or $0.69 per diluted share, in fourth-quarter 2011.
- 2012 net investment income included $147.7 million of gains on loans acquired for sale, $103.6 million of net gains on investments, and $72.4 million of interest income. Income reflected significant fair-value gains; it should not be read as equivalent to cash generated.
- Correspondent loan purchases rose to $22.4 billion from $1.3 billion in 2011. The company recognized $147.7 million of gains on loans acquired for sale, including $134.7 million of MSRs received as sale proceeds. Year-end correspondent loan inventory was $975.2 million.
- Distressed mortgage loan purchases were $542.8 million, down from $647.6 million. At year-end, investment mortgage loans were valued at $1.19 billion, including $786.0 million of nonperforming loans; REO was $88.1 million and MSRs were carried at $126.8 million.
- Cash and short-term investments totaled $72.8 million at year-end. Operating activities used $820.4 million of cash, investing activities used $111.4 million, and financing activities provided $951.0 million; cash increased $19.2 million overall.
- Repurchase-agreement borrowings were $1.26 billion, up from $631.3 million. The company reported $843.9 million of unused borrowing capacity, dependent on eligible collateral and its ability to meet margin requirements. Debt was predominantly short-term and subject to covenants and margin calls.
- Interest expense was $31.6 million versus $16.9 million; the reported average interest cost declined to 3.48% from 3.74%. Total expenses rose to $148.3 million from $56.1 million, including $62.9 million of affiliate loan-fulfillment fees related to correspondent lending growth.
- No conventional operating-margin measure is clearly provided in the filing. The effective tax provision rose to $48.6 million from $8.1 million, including deferred tax expense associated largely with MSRs.
Material changes and unusual items
- Correspondent lending expanded sharply and became a major earnings contributor; the company purchased $22.4 billion of newly originated loans and sold or transferred loans with approximately $21.7 billion of proceeds in 2012.
- Assets grew 85%, funded by $608.2 million of net share-issuance proceeds and increased borrowings. Shares outstanding rose to 58.9 million from 28.4 million.
- The company sold its entire MBS portfolio during 2012 and held no MBS at year-end.
- MSRs increased substantially, but the company recorded a $7.5 million impairment provision on amortized-cost MSRs. Net loan servicing fees were negative $0.6 million, compared with positive $0.02 million in 2011.
- On May 16, 2012, the management-fee calculation base was changed to GAAP shareholders’ equity. Amendments effective February 1, 2013 revised management and servicing fees; the new incentive-fee arrangement may result in future incentive fees.
Outlook, risks, and contingencies
- Management said liquidity was sufficient for at least the next 12 months, assuming repurchase and warehouse facilities could be renewed or increased; the filing provides no assurance that financing will remain available. It gives no quantified earnings or dividend guidance.
- Management described modest improvement in housing and economic indicators but noted ongoing uncertainty. It expected distressed-loan supply and refinance-driven originations to change as the economy and mortgage market evolve.
- Key exposures include borrower defaults, falling home values, lengthy foreclosure resolution, prepayment and interest-rate changes, and valuation uncertainty. Much of the investment portfolio is illiquid and valued using significant unobservable inputs.
- Short-term repurchase financing exposes the company to refinancing, counterparty, covenant and collateral-margin risks. A substantial majority of mortgage investments were pledged as collateral; falling collateral values could require additional cash or asset sales.
- The company depends on Fannie Mae, Freddie Mac and Ginnie Mae markets for correspondent loan sales. It was not a Ginnie Mae-approved issuer and relied on affiliate PLS to purchase government-insured or guaranteed loans.
- Citigroup-related entities were a significant source of distressed assets: approximately $504.8 million of 2012 purchases came from or through Citigroup subsidiaries. This creates seller and counterparty concentration to monitor.
- PCM and PLS manage and service the business under affiliate agreements, creating reliance and potential conflicts. The company has no employees of its own.
- Management reported no material legal proceedings at year-end. Management and the auditor concluded internal control over financial reporting was effective; the financial-statement audit opinion was unqualified.
- Subsequent to year-end, the company declared a $0.57-per-share dividend payable March 1, 2013, and PCM committed to acquire approximately $121.3 million of mortgage loans, subject to due diligence and customary closing conditions.
Important facts for investors to verify
- How much of 2012 earnings and distributable cash came from realized cash gains versus noncash fair-value changes and MSRs received in loan sales.
- Whether short-term financing facilities were renewed on acceptable terms after filing, and the sensitivity of liquidity to margin calls, collateral haircuts and covenant headroom.
- The performance and valuation assumptions for nonperforming loans, REO and MSRs, including foreclosure timelines, home-price assumptions, prepayment speeds and the MSR impairment outlook.
- The sustainability of correspondent-lending volume and gain margins after the exceptional increase in 2012, including affiliate fulfillment costs and repurchase or indemnification claims.
- The size and terms of affiliate fees and the practical effect of the February 2013 management, servicing and MSR agreements, including potential incentive compensation.
- Dividend coverage by REIT taxable income and cash available for distribution; the filing states that no minimum dividend level is established and future distributions are discretionary.