PennyMac Mortgage Investment Trust — Q2 2013 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2013. Amounts below are in U.S. dollars; financial statement amounts are generally in millions unless stated otherwise.
Business context
PMT is an externally managed mortgage investment trust with two segments: correspondent lending, which purchases and resells newly originated loans, and investment activities, which focus on distressed mortgage loans, real estate acquired in settlement of loans (REO), and mortgage servicing rights (MSRs). The trust has elected REIT tax treatment and intends to distribute at least 90% of taxable income.
Financial performance and position
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Net investment income | $129.7 | $64.4 | $248.7 | $111.1 |
| Income before taxes | $67.9 | $38.0 | $123.8 | $62.6 |
| Net income | $54.5 | $29.6 | $107.8 | $48.6 |
| Diluted EPS | $0.86 | $0.79 | $1.75 | $1.46 |
| Dividends declared per share | $0.57 | $0.55 | $1.14 | $1.10 |
- Net investment income included $91.3 million of combined investment and correspondent-loan gains in Q2 and $184.5 million year to date. Investment gains included $38.8 million and $94.4 million, respectively, of valuation gains on mortgage loans and loans under forward purchase agreements. Fair-value changes are a significant, partly noncash component of earnings.
- Correspondent loan purchases were $8.9 billion in Q2 and $17.8 billion year to date, versus $3.5 billion and $5.4 billion in 2012. Q2 net gain on loans acquired for sale was $44.4 million, including $51.1 million of MSRs received as sale consideration.
- Interest income was $26.8 million in Q2 and $43.7 million year to date. Total expenses rose to $61.8 million in Q2 and $124.9 million year to date, reflecting business and portfolio growth, financing costs, servicing and related-party fulfillment and management fees.
- Assets were $3.44 billion at June 30, up 35% from year-end 2012; shareholders’ equity was $1.24 billion, versus $1.20 billion. Book value was $21.06 per share.
- Cash was $27.6 million and short-term investments were $73.2 million. Six-month operating cash flow was negative $440.6 million, investing cash flow negative $50.1 million and financing cash flow positive $484.5 million; cash declined $6.1 million from year-end.
- Borrowings included $1.566 billion under asset repurchase agreements, $244.0 million under forward purchase agreements and $250 million of exchangeable senior notes. Total liabilities were $2.20 billion. The company reported approximately $3.0 billion of total borrowing facility capacity; 97% of assets in financed classes were pledged, at a 63% advance rate.
Material changes versus the prior comparable period
- Net income and diluted EPS increased year over year, alongside substantial growth in both business segments. Investment-loan valuation gains rose, while correspondent-lending volume expanded sharply.
- Rising mortgage rates in Q2 2013 and tighter pricing margins reduced cash gains on correspondent loan sales compared with the prior-year period. Hedging gains contributed materially to reported correspondent results.
- MSRs carried at amortized cost or fair value totaled $226.9 million at June 30, compared with $126.8 million at year-end. Their underlying unpaid loan balance grew to $19.9 billion from $12.2 billion.
- On April 30, PMT’s subsidiary issued $250 million of 5.375% exchangeable senior notes due 2020, guaranteed by PMT and exchangeable into PMT common shares.
- Effective February 1, management and servicing agreements with affiliates were amended. The management agreement introduced tiered base fees and a revised performance incentive based on GAAP net income and return thresholds; PMT recorded $3.9 million of incentive fees in Q2. Servicing fees shifted to fixed monthly per-loan amounts.
Outlook, commentary, risks and unusual items
- Management cited improving home prices and continuing opportunities in distressed loans and jumbo lending, but said mortgage originations were expected to decline; industry estimates cited for second-half 2013 production totaled about $500 billion. PMT provided no specific earnings or dividend guidance.
- Management said future growth depends partly on access to financing and, over time, additional equity capital. Short-term secured funding creates refinancing and margin-call exposure; asset-value declines can require cash or additional collateral. Facility renewals are important to ongoing liquidity.
- Portfolio risks include distressed borrowers and collateral, foreclosure delays, geographic and counterparty concentrations, uncertain loan-resolution cash flows, interest-rate and prepayment changes, and reliance on fair-value models using significant unobservable inputs. Approximately 67% of the fair value of the mortgage-loan portfolio was nonperforming at June 30.
- Correspondent loan sales carry representations-and-warranties exposure. The recourse liability was $7.7 million; loans with $19.8 billion unpaid principal balance were subject to representations and warranties, and $824,000 was subject to pending repurchase claims. Management said reasonably possible losses beyond the reserve were not material, while noting estimates require judgment and activity could increase.
- REO results were a $1.9 million loss in Q2 and a $5.2 million loss year to date, mainly reflecting valuation adjustments. No material legal proceedings were reported. Management stated disclosure controls were effective and reported no material change in internal control over financial reporting.
- Subsequent events: a $494 million unpaid-principal-balance distressed-loan pool was acquired July 26; a $393 million jumbo pool was acquired and financed August 2; Citi repo agreements were amended July 25 to extend maturities to July 2014 and increase aggregate capacity, subject to an $850 million distressed-loan limit. The board declared a $0.57-per-share dividend on August 6, payable August 30.
Most important facts for investors to verify
- How much reported earnings depended on fair-value marks and hedging gains, and whether those gains convert to cash through loan resolutions and sales.
- Current availability, maturities, collateral terms and covenant headroom across repurchase and other financing facilities, including exposure to margin calls and refinancing.
- Performance of the distressed portfolio: defaults, modifications, foreclosure timelines, recoveries, REO valuation changes and concentration in older or underwater loans.
- MSR valuation assumptions and sensitivity to prepayment speeds, discount spreads and servicing costs; reported carrying value is materially below estimated fair value.
- Related-party economics and governance, including fees paid to the external manager and servicer, and the effect of the February 2013 agreement changes.
- Whether subsequent loan acquisitions and the declared dividend can be funded while maintaining required liquidity and REIT distribution compliance.