Business context and reporting period
PennyMac Mortgage Investment Trust (PMT) filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2015. PMT is an externally managed mortgage-focused REIT with two principal activities: correspondent production, purchasing and reselling newly originated loans, and investments in distressed loans, real estate acquired through loan resolution, mortgage-backed securities (MBS), mortgage servicing rights (MSRs) and excess servicing spread (ESS).
Financial performance and position
Amounts below are in millions of dollars except per-share data.
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Net investment income | $90.8 | $106.5 | $198.2 | $303.7 |
| Net interest income | $23.7 | $19.2 | $54.2 | $65.4 |
| Net income | $38.8 | $54.9 | $74.4 | $168.0 |
| Diluted EPS | $0.49 | $0.69 | $0.95 | $2.13 |
| Dividends declared per share | $0.47 | $0.61 | $1.69 | $1.79 |
- Quarterly net interest margin was 1.77% and net interest spread 1.84%, versus 1.94% and 1.21%, respectively, in Q3 2014. Nine-month net interest margin was 2.32% versus 2.33%; spread was 1.28% versus 1.50%.
- At September 30, assets were $5.59 billion, liabilities $4.08 billion and shareholders’ equity $1.51 billion. Total assets rose 14.2% from December 31, 2014. Book value was $20.52 per share.
- Cash was $89.3 million and short-term investments $31.5 million. Nine-month cash flow was $(526.2) million from operations, $(69.2) million from investing and $608.4 million from financing, producing a $12.9 million net increase in cash.
- Borrowings included $2.86 billion under repurchase agreements, $183.0 million in FHLB advances, $192.3 million in notes payable, $150.0 million due to PennyMac Financial Services, Inc. (PFSI), $234.3 million of VIE asset-backed financing and $244.8 million carrying value of exchangeable notes. Reported leverage was 2.59x, compared with 2.01x at year-end 2014.
- Repo facilities had $1.38 billion of stated available capacity at quarter-end. PMT reported $1.16 billion in commitments to purchase mortgage loans. The filing says liquidity was sufficient for current needs, while noting collateral, covenant and refinancing constraints.
Material changes versus comparable periods
- Net income fell 29% in Q3 and 56% for the first nine months year over year; diluted EPS also declined. Management attributed the decrease principally to lower investment-segment results and reduced fair-value gains on mortgage loans, amid moderating home-price appreciation and slower loan resolutions.
- Correspondent loan purchases increased to $15.1 billion in Q3 and $35.9 billion year to date, from $8.4 billion and $20.8 billion, respectively, in 2014. Mortgage loans held for sale reached $1.05 billion, including $373.8 million pending sale to PLS.
- ESS increased to $418.6 million from $191.2 million at year-end, reflecting $271.5 million of purchases year to date. MSRs reached $423.1 million from $357.8 million; REO rose to $353.6 million from $303.2 million.
- Repo borrowings increased from $2.73 billion at year-end to $2.86 billion; PMT also added FHLB advances, MSR-backed notes and related-party ESS financing during 2015.
- PMT repurchased 1.0 million shares for approximately $16.0 million under a newly authorized $150 million repurchase program. Declared dividends were $0.47 per share for Q3, down from $0.61 a year earlier.
Outlook, commentary, risks and unusual items
- Management described U.S. housing activity as stable and cited improving home sales and prices, but noted intensifying competition in correspondent lending and less attractive pricing for distressed-loan acquisitions. PMT said it was being patient in evaluating distressed-loan investments.
- Management expected purchase loans to become a larger share of originations and cited an industry forecast of $1.6 trillion in 2015 mortgage originations. This is an industry forecast, not PMT earnings guidance. The filing provides no specific company earnings or dividend forecast.
- PMT completed a $1.2 billion credit-risk-transfer delivery and had another transaction expected to involve approximately $4.0 billion of loans early in 2016, subject to due diligence, customary closing conditions and regulatory approvals; size was not assured.
- Key exposures include distressed borrowers and real estate values, high Level 3 fair-value estimation uncertainty, prepayment and interest-rate risk affecting MSRs and ESS, hedging effectiveness, short-term secured funding and margin calls, and dependence on affiliated manager and servicer PFSI entities. About 73% of non-VIE mortgage-loan fair value originated in 2005–2007; 46% had current loan-to-value above 100%.
- After quarter-end, repo agreements with Citi were amended to extend maturities to October 20, 2016 and increase aggregate maximum purchase-price capacity to $1.075 billion, including $925 million committed, subject to covenants. Separately, PMT sold additional jumbo-securitization certificates in October.
- Management reported no litigation expected to have a material adverse effect and no material change to the prior annual report’s risk factors. Disclosure controls were assessed as effective; no material change in internal control over financial reporting was reported.
- Q3 results included $70.3 million of net fair-value gains on items measured under the fair-value option, before related financing and other effects. Fair-value and other noncash items make reported earnings less directly indicative of cash realization. A new accounting standard required debt issuance costs to be presented as deductions from debt; adoption changed balance-sheet presentation, not income or cash flow.
Important facts for investors to verify
- How much of earnings and book value depends on Level 3 valuation assumptions, and how realized cash proceeds compare with recognized gains.
- Repo renewal terms, collateral haircuts, margin-call exposure, covenant headroom and the availability of committed versus uncommitted borrowing capacity.
- Performance and cash conversion of the distressed-loan portfolio, including delinquency, foreclosure, REO resolution timing and credit losses.
- MSR and ESS sensitivity to refinancing and prepayment speeds, and the extent to which hedges offset those exposures.
- Economics and execution status of the proposed $4.0 billion credit-risk-transfer transaction, plus the effect of continued correspondent-production growth on liquidity and financing needs.
- Related-party transaction terms and the sustainability of dividends relative to taxable income, cash generation and capital requirements.