Pennymac Mortgage Investment Trust quarterly report, Q2 FY2018

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PennyMac Mortgage Investment Trust — Q2 2018 Form 10-Q

Business context and reporting period

Quarter and six months ended June 30, 2018. PMT is an externally managed specialty finance REIT investing in residential mortgage assets. Its business spans correspondent loan production, credit-sensitive investments and interest-rate-sensitive investments, including mortgage servicing rights (MSRs), mortgage-backed securities (MBS) and excess servicing spread (ESS). Management said the investment focus was shifting from distressed mortgage assets toward assets generated through correspondent production.

Financial results and key metrics

  • Q2 earnings: Net investment income was $83.0 million, down from $84.0 million a year earlier. Net income was $36.4 million versus $28.8 million; net income attributable to common shareholders was $30.2 million versus $26.4 million. Diluted EPS was $0.47 versus $0.38. Annualized return on average common equity was 9.6% versus 7.9%.
  • First-half earnings: Net investment income was $158.7 million versus $148.4 million; net income was $64.6 million versus $57.5 million. Common-attributable income was $52.1 million versus $54.6 million, while diluted EPS was $0.82 versus $0.78. Annualized return on average common equity was 8.3% versus 8.1%.
  • Income drivers: Q2 net servicing fees were $27.6 million, net gain on investments $25.5 million, net interest income $12.3 million, net gain on loans acquired for sale $9.1 million, and mortgage loan origination fees $8.9 million. For the first half, those figures were $83.7 million, $25.5 million, $18.4 million, $16.8 million and $15.9 million, respectively.
  • Interest margins: Net interest margin was 1.04% in Q2, down from 1.17%; first-half margin was 0.84%, down from 1.07%. Net interest spread was 1.01% versus 0.91% in Q2 and 0.74% versus 0.87% for the first half.
  • Dividends: Common dividends declared were $0.47 per share for Q2 and $0.94 for the first half, unchanged from the comparable 2017 periods. Preferred-share dividends were $6.2 million in Q2 and $12.5 million for the first half.
  • Balance sheet at June 30: Total assets were $6.68 billion, up 19% from December 31, 2017; shareholders’ equity was $1.55 billion and book value per common share was $20.27. Cash was $63.0 million. Major assets included $1.70 billion of MBS, $1.79 billion of loans held for sale, $1.01 billion of MSRs and $651.2 million of CRT deposits.
  • Debt and leverage: Total liabilities were $5.13 billion. Repurchase-agreement borrowings were $3.78 billion; notes payable were $445.1 million, including $450 million principal issued in April 2018 and secured by MSR-related collateral. Exchangeable senior notes had $250 million principal and a 5.375% coupon, due May 2020. Leverage, defined by PMT as borrowings divided by equity, was 3.24x, up from 2.55x at year-end.
  • Cash flow, first half: Operating cash flow was negative $591.3 million and investing cash flow negative $409.5 million, while financing provided $986.2 million. Cash declined $14.6 million to $63.0 million. The filing attributes operating cash-flow movements largely to mortgage-loan inventory and investment cash flows.

Changes versus comparable periods

  • Q2 common EPS increased to $0.47 from $0.39; first-half diluted EPS rose to $0.82 from $0.78, although first-half common-attributable income declined to $52.1 million from $54.6 million.
  • Servicing fees grew substantially as the servicing portfolio expanded and higher interest rates supported MSR valuations. Average servicing portfolio was $76.8 billion in Q2 versus $61.4 billion a year earlier.
  • Net gains on loans acquired for sale fell to $9.1 million in Q2 from $17.3 million, and to $16.8 million for the first half from $36.3 million. Management cited higher mortgage rates, weaker loan demand and greater pricing competition.
  • Investment gains were lower year to date: MBS and distressed-loan valuations were affected by rising rates and higher investor yield requirements. CRT gains remained a significant positive contributor.
  • Expenses declined 22% in Q2 and 16% in the first half, primarily reflecting lower correspondent fulfillment fees, including a lower average fee rate charged by affiliated servicer PLS.
  • At January 1, 2018, PMT changed all MSR classes to fair-value accounting. Adoption increased MSR assets by $19.7 million, income-tax payable by $5.3 million and equity by $14.4 million. The change makes reported MSR-related earnings more sensitive to valuation assumptions.

Outlook, risks and unusual items

  • No specific earnings or dividend guidance was provided. Management said it believes liquidity is sufficient for current needs and expects investment capacity to depend on cash generated from investments, borrowing availability and potentially additional equity capital.
  • Interest-rate movements affect MBS, MSR and loan valuations differently; hedging may not fully offset those exposures. Fair-value results rely substantially on Level 3 estimates and unobservable assumptions. The filing states non-cash items were 116% of Q2 net investment income and 125% of first-half net investment income.
  • Funding is materially dependent on short-term secured facilities, collateral values and margin requirements. At June 30, available repurchase borrowing capacity was $2.28 billion, of which $1.76 billion was uncommitted. Lenders may require margin payments or terminate facilities; a consumer-relief repo arrangement providing $3.5 million of Q2 interest-expense incentives could be terminated early.
  • CRT arrangements expose PMT to mortgage credit losses and market-value changes; related deposits and derivative assets were substantial, with $597.1 million of commitments to fund CRT deposits. Distressed-loan outcomes depend on borrower performance, housing values, servicing and foreclosure resolution.
  • PMT depends on affiliated manager PCM and servicer PLS, creating related-party and operational concentration. Management fees were $5.7 million in Q2; no performance incentive fee was incurred in the quarter or first half.
  • Subsequent events included a nonbinding letter of intent to sell $99 million UPB of performing distressed-portfolio loans, temporary increases to certain Deutsche Bank and Bank of America facility limits, and an August BNP Paribas repurchase facility of up to $200 million, of which $100 million was committed.
  • PMT reported no material legal proceedings and no material changes to the risk factors in its 2017 Form 10-K. Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting.

Most important facts for investors to verify

  • Whether recurring cash earnings support common and preferred distributions, given substantial non-cash income and negative operating cash flow.
  • How MSR, MBS and CRT fair values perform as rates, prepayments, credit spreads and servicing costs change.
  • Availability, renewal terms and collateral requirements for short-term financing, including the proportion of borrowing capacity that is uncommitted.
  • Whether the correspondent-production transition can sustain volume and margins amid higher rates and competitive pricing.
  • Progress and realized proceeds from distressed-asset liquidations, and potential losses under loan representations, warranties and CRT obligations.
  • Completion and terms of the proposed distressed-loan sale and the post-quarter financing changes; the proposed sale remained subject to due diligence and closing conditions.