Pennymac Mortgage Investment Trust quarterly report, Q3 FY2013

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PennyMac Mortgage Investment Trust — Q3 2013 Form 10-Q

Business context and reporting period

Quarter and nine months ended September 30, 2013. PMT is an externally managed mortgage REIT with two segments: correspondent lending, which buys and resells newly originated loans, and investment activities, which include distressed loans, real estate owned (REO), mortgage-backed securities (MBS) and mortgage servicing rights (MSRs).

Key financial metrics

  • Q3 results: Net investment income was $86.1 million, down from $90.9 million; pretax income was $36.1 million versus $59.0 million; net income was $39.7 million versus $40.4 million. Diluted EPS was $0.57 versus $0.81. The tax benefit in Q3 2013 contributed to net income exceeding pretax income.
  • Nine-month results: Net investment income was $309.4 million versus $188.6 million; pretax income was $159.9 million versus $121.5 million; net income was $147.5 million versus $89.0 million. Diluted EPS was $2.29, unchanged from 2012.
  • Income composition and margins: Q3 net interest income was $15.8 million versus $11.4 million; nine-month net interest income was $34.1 million versus $30.5 million. Annualized net interest margin was 1.11% for Q3 and 1.30% for nine months, compared with 1.36% and 1.76%, respectively, in 2012. Investment gains, including fair-value changes, were a significant contributor to earnings.
  • Cash flow: Nine-month operating cash use was $432.2 million and investing cash use was $759.5 million, offset by $1.258 billion of financing cash inflows. Cash increased $66.3 million to $100.1 million; short-term investments were $80.9 million.
  • Balance sheet and leverage: Total assets were $4.249 billion, up 66% from year-end 2012; shareholders’ equity was $1.495 billion, up from $1.201 billion. Total liabilities were $2.754 billion. Asset repurchase financing was $1.980 billion, borrowings under forward purchase agreements $229.8 million, asset-backed financing $170.0 million and exchangeable notes $250.0 million. The notes bear 5.375% interest and mature in 2020.
  • Dividends and shares: Dividends declared were $0.57 per share for Q3 and $1.71 for nine months. PMT issued 11.3 million shares in August for approximately $249.4 million net proceeds; period-end shares outstanding were 70.45 million.

Material changes versus prior comparable periods

  • Q3 correspondent lending pretax income shifted from $36.8 million to a $0.3 million loss, while investment activities pretax income rose to $36.4 million from $22.2 million. Nine-month investment activities pretax income increased to $125.6 million from $62.0 million.
  • Q3 gain on loans acquired for sale fell to $11.0 million from $49.8 million, despite higher purchase volume. Management attributed the decline to rising rates, compressed margins and greater competition. Nine-month gains were $84.7 million, slightly above $81.2 million.
  • Mortgage loan investment fair-value gains and portfolio growth lifted nine-month investment income. Assets expanded through $1.0 billion of distressed loan purchases and $26.0 billion of correspondent loan purchases during the nine months.
  • Interest expense more than doubled for Q3, to $19.5 million from $8.3 million, reflecting increased borrowings and the new exchangeable notes. Total expenses rose to $50.0 million from $31.9 million in Q3.
  • REO results moved to a $2.3 million Q3 loss from a $1.3 million gain; nine-month REO results were a $7.5 million loss versus a $7.6 million gain.

Outlook, commentary, risks and unusual items

  • Management described a market of modest economic and housing recovery, but rising mortgage rates and reduced refinancing activity. It expected correspondent lending margins to normalize toward long-term averages in 2013 and 2014, and cited industry forecasts for lower Q4 2013 mortgage originations. These are management observations, not formal company earnings guidance.
  • Management identified continuing distressed-loan opportunities and a potentially significant jumbo-loan market, while noting more competition, weaker private-label securitization pricing and uncertainty about future loan supply and financing availability.
  • Fair-value gains are materially affected by Level 3 estimates and assumptions. Roughly 74% of the fair value of the mortgage loan portfolio was nonperforming at September 30, 2013. Cash realization may lag accounting gains; home values, borrower cures, foreclosure timing and liquidation outcomes remain important uncertainties.
  • Short-term repo and other secured financing exposes PMT to refinancing and collateral-margin calls. About 92% of assets in the financed classes were pledged; the advance rate against pledged assets was 68%. Management said all repo agreements maturing between quarter-end and the report date had been renewed, extended or repaid.
  • Representations-and-warranties liability was $9.1 million, versus $4.4 million at year-end. Pending repurchase claims covered $9.4 million unpaid balance; management said reasonably possible losses beyond the reserve were not material, but acknowledged estimates are judgmental and exposure generally has no stated limit.
  • Subsequent events: a $563 million unpaid-balance distressed-loan purchase commitment remained subject to due diligence and closing conditions; PMT and PLS closed a $62 million excess-servicing-spread co-investment on November 6; a proposed further MSR-related acquisition remained subject to definitive documentation and approvals. The board declared a $0.57-per-share dividend payable November 29, 2013.
  • Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. It reported no material litigation and no material changes to the risk factors in the prior Form 10-K.

Important facts for investors to verify

  • How much reported earnings depended on noncash fair-value gains, and whether those gains convert to cash through payoffs, sales or property liquidation.
  • Performance of the high nonperforming-loan exposure, including loan modifications, defaults after modification, REO valuation losses and liquidation proceeds.
  • Repo facility renewals, collateral requirements, margin-call capacity and compliance with financing covenants as leverage and pledged assets grow.
  • Correspondent lending profitability after higher rates, reduced refinancing volumes, margin compression and related-party fulfillment and servicing costs.
  • Assumptions supporting Level 3 loan and MSR valuations, and the adequacy of representations-and-warranties reserves as loan-sale exposure seasons.
  • Completion and economics of the disclosed pending loan and MSR-related transactions, and the sustainability of the dividend relative to taxable income and cash generation.