PennyMac Mortgage Investment Trust — Q2 2019 Form 10-Q
Business context and period: Unaudited results for the quarter and six months ended June 30, 2019. PMT is an externally managed specialty finance company investing primarily in residential mortgage assets. Its activities include correspondent loan production, credit-sensitive investments and interest-rate-sensitive investments, including mortgage servicing rights (MSRs), mortgage-backed securities (MBS) and credit risk transfer (CRT) arrangements.
Key financial results
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net investment income | $96.4 million | $83.0 million | $203.0 million | $158.7 million |
| Expenses | $63.0 million | $40.7 million | $119.8 million | $78.5 million |
| Pretax income | $33.4 million | $42.3 million | $83.2 million | $80.1 million |
| Net income | $44.2 million | $36.4 million | $97.8 million | $64.6 million |
| Net income attributable to common shareholders | $38.0 million | $30.2 million | $85.3 million | $52.1 million |
| Diluted EPS | $0.50 | $0.47 | $1.17 | $0.82 |
| Common dividend declared per share | $0.47 | $0.47 | $0.94 | $0.94 |
Balance sheet and liquidity: At June 30, 2019, total assets were $9.47 billion, total liabilities $7.52 billion and shareholders’ equity $1.94 billion. Cash was $77.7 million and short-term investments $76.7 million. Borrowings were approximately $7.40 billion; the company’s leverage ratio was 3.81x, versus 3.89x at December 31, 2018. Available borrowing capacity under repurchase agreements was $3.09 billion, mostly uncommitted. Agency-related capital and liquidity measures exceeded stated minimums: net worth $483.6 million versus $275.1 million required; tangible net worth/assets 9% versus 6%; liquidity $106.4 million versus $36.4 million.
Cash flow and margins: For the first six months, operating cash flow was negative $915.0 million, investing cash flow negative $655.6 million and financing cash flow positive $1.59 billion, producing a $17.8 million increase in cash. The negative operating cash flow chiefly reflected growth in loans held for sale. Q2 net interest income was $5.9 million; net interest margin was 0.24% and net interest spread 0.09%, compared with 1.04% and 1.01%, respectively, a year earlier.
Portfolio highlights: At quarter-end, PMT held $2.60 billion of MBS, $2.48 billion of loans acquired for sale, $1.13 billion of MSRs and $2.06 billion of deposits securing CRT arrangements. CRT-related investments totaled approximately $2.2 billion net of the associated interest-only payable; funded CRT loans had $50.4 billion of UPB.
Material changes versus the prior comparable period
- Q2 net income increased 21% year over year, while pretax income fell to $33.4 million from $42.3 million. A $10.9 million income tax benefit, compared with $5.9 million of tax expense in Q2 2018, more than offset the pretax decline.
- Correspondent production improved: Q2 loan sales were $22.3 billion, up from $15.4 billion, and pretax income in that segment increased to $16.2 million from $4.5 million.
- Interest-rate-sensitive strategies swung to a $1.9 million pretax loss from $16.4 million income. Lower rates supported MBS and hedge valuation gains but drove a sharp MSR fair-value decline; Q2 net loan servicing fees were negative $53.6 million versus positive $27.6 million.
- MSR fair value declined $183.5 million in Q2 and $320.8 million in the first half, principally due to market-input changes, including higher expected prepayments; hedging gains partly offset the impact.
- Q2 net gain on investments rose to $87.8 million from $25.5 million, helped by MBS valuation gains and hedging. Net gain on loans acquired for sale increased to $34.2 million from $9.1 million.
- Net interest income fell to $5.9 million from $12.3 million in Q2. The filing attributes the decline to portfolio mix and financing of non-interest-earning assets, alongside higher borrowing balances and costs.
- Total assets increased 21% from year-end 2018, driven mainly by a $914.1 million increase in CRT-secured deposits and an $833.3 million increase in loans held for sale. Notes payable rose to $1.37 billion from $445.6 million.
Outlook, commentary, risks and unusual items
- No specific earnings or financial guidance was provided. Management described an objective of long-term risk-adjusted returns primarily through dividends and secondarily through capital appreciation. It said future portfolio growth will depend over time on access to additional equity capital and financing.
- Management said lower mortgage rates increased loan demand and correspondent production, but also increased refinancing expectations and reduced MSR and excess servicing spread values. Results include substantial noncash fair-value movements; noncash items were 8% of net investment income in Q2 2019 versus 82% in Q2 2018.
- MSRs and other Level 3 assets rely on unobservable valuation assumptions. Management’s sensitivity analysis estimates that a 10% adverse change in MSR prepayment speed would reduce MSR fair value by $57.4 million; the company cautions these scenarios are not earnings forecasts.
- Short-term repurchase financing exposes PMT to renewal, collateral valuation and margin-call risks. Debt agreements impose minimum cash, tangible-net-worth and leverage covenants. The company reported that debt facilities maturing between June 30 and the report date had been renewed, extended or replaced.
- A repurchase agreement incentive program was substantially curtailed during Q2 and was due to expire August 21, 2019 unless extended or terminated earlier. It reduced interest expense by $2.3 million in Q2 and $9.8 million in the first half of 2019.
- PMT issued common shares through underwritten offerings and its ATM program in 2019, receiving $312.3 million and $48.9 million of net proceeds, respectively. Outstanding common shares increased to 78.6 million from 61.0 million at year-end 2018.
- Subsequent events: a July amendment increased a JPMorgan repurchase facility limit from $500 million to $1.0 billion; a proposed sale of approximately $71 million of distressed loans remained subject to due diligence and closing conditions.
- PMT reported no material legal proceedings, no material changes to its 2018 Form 10-K risk factors, and no material change in internal control over financial reporting. It relies on its manager and servicer, both affiliated with PennyMac Financial Services, creating related-party and operational dependence considerations. Maintaining REIT qualification also requires distributions of at least 90% of taxable income, subject to applicable rules.
Important facts for investors to verify
- How much of reported earnings and common EPS reflects realized cash results versus noncash fair-value gains and losses, particularly MSR and hedge movements.
- Whether the MSR portfolio’s value and earnings stabilize if mortgage rates, refinancing activity and prepayment speeds change; review the assumptions and sensitivities in the filing.
- The availability, renewal terms and collateral requirements of short-term and largely uncommitted financing, including compliance with liquidity and net-worth covenants.
- The risk-adjusted returns and potential loss exposure associated with the rapid growth in CRT investments and secured deposits.
- The effect of 2019 share issuance and dilution on per-share book value, earnings and the sustainability of the $0.47 quarterly common dividend.
- Completion and final terms of the proposed $71 million distressed-loan sale, and the impact of the curtailed repurchase financing incentives.