PennyMac Mortgage Investment Trust — Q1 2014 Form 10-Q
Reporting period: Quarter ended March 31, 2014; comparative period is Q1 2013 unless noted. Amounts below are in U.S. dollars. PMT is an externally managed mortgage investment trust with correspondent lending and investment activities; it has elected REIT tax treatment.
Financial results and key metrics
| Metric | Q1 2014 | Q1 2013 / prior date |
|---|---|---|
| Net investment income | $76.6 million | $107.8 million |
| Income before taxes | $36.3 million | $55.9 million |
| Net income | $37.9 million | $53.3 million |
| Diluted earnings per share | $0.50 | $0.90 |
| Declared dividends per share | $0.59 | $0.57 |
| Net interest income | $19.6 million | $5.6 million |
| Net interest margin / spread | 2.40% / 1.57% | 1.11% / (0.36)% |
| Total assets, March 31 | $4.23 billion | $2.93 billion at March 31, 2013 |
| Total liabilities / shareholders’ equity, March 31 | $2.68 billion / $1.54 billion | — |
| Cash, March 31 | $11.9 million | $27.4 million at Dec. 31, 2013 |
| Net cash from operating activities | $113.3 million | $(225.1) million |
Net income included substantial fair-value effects: management reported $35.9 million of non-cash fair-value adjustments across investment, servicing and correspondent-lending items. Net investment income is not equivalent to cash earnings.
- Debt and funding: At March 31, borrowings included $1.89 billion under repurchase agreements, $216.6 million under forward purchase agreements, $166.5 million of non-recourse VIE financing and $250 million of 5.375% exchangeable senior notes due 2020. Repurchase and forward-purchase funding is predominantly short-term and subject to collateral and margin requirements.
- Liquidity: Reported available repurchase borrowing capacity was $2.06 billion, including $1.20 billion committed and $865 million uncommitted. The company reported total facility size of about $3.2 billion; capacity and access depend on counterparties, collateral and covenants.
- Cash flows: Investing activities used $0.5 million and financing activities used $128.3 million. Cash declined $15.5 million during the quarter. Operating cash flow improved markedly from Q1 2013, which management attributed mainly to lower cash invested in correspondent-loan inventory.
- Balance-sheet changes: Total assets fell $83.4 million from year-end 2013, as loans held for sale and cash declined, partly offset by increases in REO, excess servicing spread and mortgage servicing rights. Equity increased to $1.54 billion, including approximately $80.1 million of net proceeds from common-share offerings.
Material changes versus Q1 2013
- Net income declined about 29%; diluted EPS fell from $0.90 to $0.50. Management attributed the reduction to lower income in both operating segments.
- Correspondent-loan purchases fell to $5.04 billion from $8.85 billion, while net gain on loans acquired for sale declined to $10.0 million from $29.3 million. Management cited higher mortgage rates, weaker refinancing demand, increased competition and narrower production margins.
- Investment net gains decreased to $42.6 million from $64.0 million, principally reflecting lower valuation gains on distressed-loan investments and reduced appreciation in underlying property values. The investment portfolio and average interest-earning assets were substantially larger than a year earlier.
- Net interest income rose to $19.6 million from $5.6 million, supported by portfolio growth and a higher net interest spread. Interest expense also rose, to $19.8 million from $11.2 million.
- REO-related losses increased to $6.6 million from $3.3 million. REO carrying value reached $186.9 million, up from $84.5 million a year earlier; management cited slower property appreciation and a larger inventory.
- Loan servicing fees payable to affiliate PennyMac Financial Services, Inc. (PFSI) rose to $14.6 million from $7.7 million, while fulfillment fees fell with lower correspondent volume. Management fees to PFSI were $8.1 million, including $2.6 million of incentive fees.
Outlook, risks and unusual items
- Outlook: No company earnings or dividend guidance is provided. Management expected industry mortgage originations to decline in 2014, remained selective on distressed-loan purchases, and said future growth would depend partly on loan supply, financing availability and additional equity capital. It expected short-term financing to remain important until longer-term funding became more accessible.
- Portfolio and valuation risk: About 76% of the fair value of PMT’s mortgage-loan portfolio was nonperforming. Many assets are valued using Level 3 models and unobservable assumptions; estimated values are sensitive to home prices, defaults, prepayments and discount rates. A hypothetical 10% decline in home values implied an estimated $158.3 million reduction in fair value for the specified mortgage-loan portfolio.
- Funding and liquidity risk: Repurchase arrangements can require rapid margin payments if collateral values fall; short-term facilities must be renewed or replaced. Covenant requirements include minimum unrestricted-cash and tangible-net-worth levels. PMT stated that financing capacity and future funding arrangements are not assured.
- Other risks: Distressed-loan resolution can be delayed by borrower outcomes, servicing performance, foreclosure processes and regulation. MSR and excess-servicing-spread values are exposed to prepayment and interest-rate changes. Correspondent loan sales carry representation-and-warranty repurchase exposure; the recorded liability was $10.9 million, with $12.1 million UPB subject to pending repurchase claims.
- Related parties and REIT status: PMT relies on affiliated PFSI for management, servicing and fulfillment and pays related-party fees. REIT status generally requires distribution of at least 90% of taxable income, limiting retained capital. The quarter’s declared dividend of $0.59 per share exceeded diluted EPS of $0.50.
- Subsequent events: On May 8, 2014, PMT purchased nonperforming loans with $37.9 million UPB. PFSI signed a letter of intent for a $3.5 billion-UPB Ginnie Mae MSR portfolio; PMT intended to acquire about $26 million of related excess servicing spread, subject to due diligence, definitive agreements and closing conditions.
- Management reported no legal proceedings believed likely to have a material adverse effect, no material changes to the prior annual report’s risk factors, and effective disclosure controls as of quarter-end. All repurchase agreements maturing between March 31 and the report date were extended, renewed or repaid.
Important facts for investors to verify
- How much reported income was realized in cash versus generated by Level 3 valuation marks, and whether those marks ultimately convert to cash on loan or property liquidation.
- Current committed funding availability, facility renewal terms, covenant headroom, counterparty concentration and potential margin-call needs.
- Performance and cash recovery of nonperforming loans and REO, including property-value assumptions, resolution timelines and losses on modified loans.
- Dividend coverage and funding sources, given the $0.59 declared dividend versus $0.50 diluted EPS and the REIT distribution requirement.
- Trends in correspondent-loan volume and gain margins, and the status and economics of the proposed Ginnie Mae MSR/ESS transaction.
- Related-party servicing, fulfillment and management fees, including the incentive-fee terms and the potential for conflicts of interest.