Pennymac Financial Services, Inc. quarterly report, Q3 FY2020

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Pennymac Financial Services, Inc. — Q3 2020 Form 10-Q

Reporting period: Quarter and nine months ended September 30, 2020; filed November 6, 2020. PFSI operates mortgage production, servicing and investment management businesses, including services provided to affiliated mortgage REIT PennyMac Mortgage Investment Trust (PMT).

Financial performance and key metrics

  • Q3 revenue and earnings: Total net revenue was $1.120 billion, up from $436.3 million a year earlier. Net income was $535.2 million versus $121.5 million; diluted EPS was $7.03 versus $1.51. Annualized return on average common equity was 77.6%, compared with 26.2%.
  • Nine-month results: Total net revenue was $2.663 billion versus $987.0 million; net income was $1.194 billion versus $240.3 million; diluted EPS was $15.00 versus $3.01. Annualized return on average common equity was 63.8%, versus 18.2%.
  • Revenue drivers: Q3 net gains on loans held for sale were $855.3 million, compared with $235.7 million. Net loan servicing fees were $132.8 million versus $66.2 million. Q3 net interest expense was $10.2 million, compared with net interest income of $27.1 million.
  • Expenses: Q3 total expenses rose to $391.7 million from $270.2 million, including compensation of $202.4 million versus $141.1 million and servicing expense of $71.1 million versus $47.9 million. Management attributed increases mainly to business growth, higher staffing and COVID-related servicing demands.
  • Non-GAAP measure: Adjusted EBITDA was $769.8 million for Q3 and $1.689 billion for the first nine months, versus $221.3 million and $478.0 million, respectively, in 2019. The company cautions this measure is not a substitute for GAAP earnings or cash available.
  • Cash flow: Operating activities used $3.924 billion in the first nine months, compared with $1.690 billion used in 2019, primarily reflecting mortgage-loan inventory and related operating needs. Investing activities provided $924.6 million and financing activities provided $3.340 billion. Cash and restricted cash increased $340.7 million to $529.2 million.
  • Balance sheet and debt: Total assets were $31.181 billion, liabilities $28.164 billion and equity $3.017 billion at September 30. Reported short- and long-term debt were $7.794 billion and $1.944 billion, respectively. The balance sheet also included $17.184 billion of loans eligible for repurchase and an equal liability.
  • Liquidity: Cash and short-term investments totaled $631.3 million. Repurchase-agreement borrowing capacity was reported at $2.958 billion, but only $17.1 million was committed and the remainder was uncommitted. Management said liquidity was sufficient for current needs and reported compliance with applicable debt covenants and Agency capital and liquidity requirements.

Material changes versus the prior comparable period

  • Higher production volume and gain-on-sale margins drove much of the earnings increase. Management attributed the stronger mortgage market to low interest rates, elevated demand and temporary industry capacity constraints early in the pandemic.
  • The servicing portfolio grew to $401.9 billion in unpaid principal balance from $368.7 billion at year-end 2019. For the first nine months, MSR fair-value changes were a $1.372 billion loss, partly offset by $1.027 billion of MSR hedging gains; MSR carrying value fell to $2.334 billion from $2.927 billion.
  • COVID-19-related borrower forbearance increased delinquencies and servicing advances. The filing reports 9.2% of loans in PFSI’s predominately government-insured or guaranteed MSR portfolio were both in forbearance and delinquent at September 30. Serviced loans 90 or more days delinquent and not in foreclosure were $29.9 billion, compared with $4.3 billion at December 31, 2019.
  • Assets eligible for repurchase and their matched liabilities rose substantially, reflecting delinquent-loan activity and CARES Act forbearance. Repurchase-agreement debt at period end was $7.267 billion, up from $4.142 billion at year-end 2019.
  • On September 29, PFSI issued $500 million of 5.375% senior notes due 2025 and terminated its unused $150 million revolving credit agreement. An additional $150 million of the notes was issued on October 19, after quarter end.
  • PFSI repurchased $248.2 million of common stock in the first nine months under an expanded $500 million authorization. It declared dividends totaling $0.39 per share for the nine-month period; a further $0.15-per-share dividend was announced after quarter end.

Outlook, risks and unusual items

  • The filing gives no company-specific earnings or EPS guidance. Management cited industry mortgage origination forecasts of approximately $3.6 trillion for 2020 and $2.5–$2.7 trillion for 2021. Fannie Mae and Freddie Mac were expected to impose a 50-basis-point adverse-market refinance fee on most refinances beginning December 1, 2020.
  • Management expects pandemic-related delinquencies and forbearance to reduce servicing income and increase servicing costs, advances and financing needs. It said these effects may be offset by servicing-portfolio growth and gains when early-buyout loans reperform; outcomes remain uncertain.
  • Interest-rate and prepayment changes can materially affect production margins, MSR values and hedging results. Significant portions of fair-value assets and liabilities use Level 3 inputs, including unobservable assumptions, making reported values sensitive to management estimates. The filing notes hedges may not perform similarly in the future.
  • Short-term secured funding creates refinancing and margin-call exposure. A decline in collateral value can require cash or additional collateral, often within one business day. PFSI also relies on continued access to lenders and capital markets.
  • Unsecured senior notes increase indebtedness and contain restrictive covenants, including limits on dividends, repurchases, additional debt and asset transfers. The company’s contractual commitments to purchase and originate loans were $18.9 billion at quarter end.
  • Contingencies: A shareholder-related Delaware case had a proposed $6.85 million settlement pending court approval; PFSI said its share would be covered entirely by insurance. A separate Black Knight dispute was ordered to arbitration, remains pending, and potential loss could not be reasonably estimated.

Important facts for investors to verify

  • How much of reported earnings came from production gains, fair-value estimates and hedging, and whether those drivers persist as rates and refinancing activity change.
  • Trends in forbearance, delinquencies, early-buyout loans, servicing advances and the availability and cost of advance financing.
  • Liquidity and refinancing capacity under secured facilities, especially the uncommitted portion of reported repurchase capacity, upcoming maturities and potential margin calls.
  • Whether MSR valuation assumptions, hedge effectiveness and representations-and-warranties reserves remain appropriate as loan performance and market conditions evolve.
  • The terms and covenant implications of the additional $150 million note issuance, future dividends and share repurchases, and resolution of the pending legal matters.