PennyMac Mortgage Investment Trust — Q1 2013 Form 10-Q
Business context and period. This unaudited filing covers the quarter ended March 31, 2013, with comparisons to Q1 2012 and balance-sheet comparisons to December 31, 2012. PennyMac is an externally managed mortgage investment trust operating in correspondent lending and investment activities. It buys and resells newly originated mortgages, and invests in distressed mortgage loans, real estate acquired through loan resolution (REO), and mortgage servicing rights (MSRs). Amounts below are in U.S. dollars; financial statement amounts are converted from thousands to millions unless stated otherwise.
Financial performance and condition
- Income: Net investment income was $119.1 million, up from $46.6 million. Net income was $53.3 million versus $19.1 million; diluted EPS was $0.90 versus $0.65. The declared dividend was $0.57 per share, compared with $0.55.
- Income drivers: Net gains on investments were $64.0 million, primarily fair-value gains on mortgage loans, compared with $11.5 million in Q1 2012. Gains on loans acquired for sale were $29.3 million, up from $13.4 million. Interest income was $16.9 million, versus $16.4 million. REO results shifted to a $3.3 million loss from a $3.7 million gain.
- Expenses and yields: Total expenses rose to $63.1 million from $22.1 million, reflecting higher loan fulfillment, financing, servicing, and management costs as the business expanded. Investment-portfolio annualized yield was 5.00%, down from 6.27%; the reported cost of interest-bearing liabilities was 3.51%, compared with 3.71%. The filing does not provide a single company-wide operating margin.
- Balance sheet: Total assets were $2.93 billion, up 14% from year-end; shareholders’ equity was $1.22 billion versus $1.20 billion. Mortgage loans held at fair value were $1.37 billion, correspondent loans held for sale were $1.12 billion, and MSRs totaled $180.4 million. Book value per share was $20.72.
- Debt and liquidity: Repurchase-agreement liabilities were $1.62 billion, compared with $1.26 billion at year-end. Facility capacity was $2.7 billion; 91% of the relevant asset classes were pledged, at a 69% advance rate. Borrowings were short-term, with maturities within one year, and subject to collateral margin calls. Cash was $19.4 million and short-term investments were $45.0 million at quarter-end.
- Cash flow: Operating cash flow was negative $225.1 million, investing cash flow negative $114.5 million, and financing cash flow positive $325.3 million; cash declined $14.4 million to $19.4 million. Operating cash use principally reflected purchases of mortgage loans held for sale exceeding sale proceeds. Reported income also included substantial fair-value gains that do not necessarily represent current cash receipts.
Material changes versus the prior comparable period
- Correspondent loan purchases increased to $8.85 billion from $1.86 billion; loan sale proceeds were $8.68 billion versus $1.93 billion. The larger pipeline and sales drove higher fulfillment fees and greater short-term funding needs.
- Investment activities expanded: average mortgage-loan investment balances rose, and the company purchased $200.5 million of distressed loans, compared with minimal investment purchases in Q1 2012. Investment gains increased sharply, supported by loan valuation changes and payoffs.
- MSR carrying value rose to $180.4 million from $126.8 million at year-end, while the underlying serviced loan balance reached $16.64 billion. Servicing income increased substantially with portfolio growth.
- On February 1, 2013, the management agreement changed its incentive-fee basis from core earnings to GAAP net income subject to return thresholds and a cumulative high-watermark mechanism. Q1 included the first recorded incentive fee, $2.1 million; total management fees were $6.5 million versus $1.8 million.
- Effective February 1, servicing fees shifted from a balance-based formula to fixed monthly per-loan amounts, and correspondent fulfillment fees were revised. These agreements are with affiliates, including the external manager and servicer.
Outlook, management commentary, and risks
- Management cited modest economic growth, improving housing prices and mortgage activity, and opportunities in distressed loans and jumbo lending. It also noted increased competition and compressed correspondent loan pricing margins. The filing provides no earnings or EPS guidance.
- Management said current liquidity was sufficient for short-term needs, while noting continued growth depends on financing availability and potentially additional equity. It was pursuing warehouse, repurchase, term-financing, securitization, and equity alternatives; success and capacity were not assured.
- Key exposures include borrower defaults and delinquencies, foreclosure and resolution delays, home-price declines, interest-rate and prepayment changes, illiquid markets, valuation-model uncertainty, and reliance on short-term, collateralized borrowings subject to renewal and margin calls. About 67% of mortgage-loan fair value was nonperforming; about 40% of investments excluding correspondent loans were described as nonperforming assets.
- Fair-value gains were a major contributor to quarterly earnings. Mortgage loans and MSRs rely materially on Level 3 estimates and unobservable assumptions; changes in home values, discount rates, defaults, or prepayments could materially change reported values and income.
- Loan sales carry representation-and-warranty exposure. The recourse liability increased to $6.2 million from $4.4 million; the company repurchased $648,000 of loans in the quarter with no reported loss. Management said reasonably possible losses beyond the recorded liability were not material, but noted estimates are judgmental and exposure can change.
- Management reported no material legal proceedings and no material changes to the risk factors in its 2012 Form 10-K. Disclosure controls were judged effective; no material change in internal control over financial reporting was reported.
Subsequent events
- On April 30, 2013, subsidiary PennyMac Corp. issued $250 million of 5.375% exchangeable senior notes due 2020, fully and unconditionally guaranteed by the trust. Proceeds were intended for business and investment activities, debt repayment, or general purposes.
- On May 8, 2013, amendments to two Credit Suisse repurchase facilities revised financial covenants, including minimum tangible net worth and cash requirements, leverage limits, and profitability tests.
- The board declared a $0.57-per-share dividend payable May 31, 2013 to holders of record May 16, 2013. A separate April commitment to acquire approximately $294.1 million of mortgage loans remained subject to due diligence and closing conditions.
Most important facts for investors to verify
- How much of earnings growth is recurring cash income versus fair-value changes, and how realized loan recoveries compare with prior valuation estimates.
- Whether correspondent lending volume and margins remain sustainable after fulfillment costs, hedging results, and affiliate servicing arrangements.
- Short-term repo renewal, covenant compliance, available borrowing capacity, margin-call exposure, and the use and impact of the $250 million notes.
- Distressed-loan performance, foreclosure timelines, REO valuation losses, and the concentration and quality of collateral.
- MSR valuation assumptions and sensitivity to refinancing, prepayment, servicing costs, and interest-rate changes; also review related-party fees and the revised incentive-fee formula.
- Representation-and-warranty claims and recourse liability trends as the much larger volume of loans sold seasons.