PennyMac Financial Services, Inc. — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019; unaudited. PFSI is a mortgage banking and investment management firm whose activities include mortgage production, servicing, and management of PMT. Unless noted, amounts below are in millions of dollars.
Financial performance and condition
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Total net revenue | $303.0 | $244.3 | $550.7 | $482.5 |
| Income before tax | $99.6 | $74.7 | $159.9 | $147.7 |
| Net income | $72.7 | $68.4 | $118.8 | $135.3 |
| Net income attributable to PFSI common stockholders | $72.7 | $17.8 | $118.8 | $34.5 |
| Diluted EPS | $0.92 | $0.70 | $1.50 | $1.38 |
| Net interest income | $18.0 | $22.5 | $38.8 | $28.4 |
- Revenue drivers: Q2 net gains on loans held for sale were $147.5 million, up from $60.9 million; loan origination fees were $36.9 million versus $24.4 million; and PMT fulfillment fees were $29.6 million versus $14.6 million. Management attributed the gains to higher production volume and improved margins.
- Servicing: Net loan servicing fees were $59.1 million versus $113.7 million in Q2 and $139.7 million versus $230.5 million for the first half. Lower interest rates drove substantial MSR fair-value losses, partly offset by hedging and growth in servicing fees. The servicing portfolio reached $334.5 billion of unpaid principal balance, up from $299.3 billion at year-end 2018.
- Expenses and taxes: Total expenses rose to $203.4 million in Q2 from $169.6 million; compensation and loan origination expenses increased notably with business growth. The Q2 effective tax rate was 27.0%, versus 8.4%, reflecting the post-November 2018 reorganization and taxation of income previously allocated to noncontrolling interests.
- Cash flow: First-half operating cash flow was negative $881.9 million, versus positive $595.9 million in 2018, primarily reflecting the cash effects of increased loans held for sale. Investing cash flow was positive $160.4 million and financing cash flow positive $797.6 million. Cash and restricted cash increased $76.1 million to $232.0 million.
- Balance sheet and debt: Total assets were $8.40 billion and stockholders’ equity $1.78 billion at June 30, 2019, compared with $7.48 billion and $1.65 billion at year-end 2018. Reported borrowings included $2.75 billion under repurchase agreements, $523.2 million under loan participation agreements, $1.29 billion of notes payable, and $28.3 million of capital lease obligations. Loans held for sale were $3.51 billion; MSRs were $2.72 billion.
- Liquidity: Cash and short-term investments totaled $306.9 million, including cash pledged to creditors. Repurchase facilities had $2.24 billion of stated remaining capacity, of which $2.16 billion was uncommitted. The company reported compliance with debt covenants and Agency capital and liquidity requirements; it stated that liquidity was sufficient for current needs.
Material changes and interpretation
- Q2 revenue increased 24% and pretax income increased 33% year over year. First-half revenue increased 14% and pretax income increased 8%.
- First-half net income fell to $118.8 million from $135.3 million, despite higher pretax income, primarily because of the higher effective tax rate following the corporate reorganization.
- Comparisons of common-stockholder income are affected by the reorganization: no income was allocated to noncontrolling interests in 2019, whereas $50.6 million in Q2 2018 and $100.9 million in first-half 2018 were allocated to noncontrolling interests. Accordingly, the large year-over-year increase in attributable income is not directly comparable to the change in consolidated net income.
- Total liabilities increased $794.6 million from year-end, chiefly as higher loan inventory required more financing. Lease accounting adoption added recognized operating lease assets and liabilities; it did not affect reported income or cash flows.
Outlook, risks, contingencies, and unusual items
- The filing provides no numerical earnings or production guidance. Management cited higher mortgage demand and production activity in 2019, but cautioned that results are not necessarily indicative of full-year performance.
- Management expects liquidity from business cash flows and borrowing, ESS, equity, or debt financing; it noted that future financing capacity and availability are not assured. Many facilities are short-term and subject to renewal, collateral valuation, and margin calls.
- Interest-rate and prepayment changes create material MSR valuation exposure. MSRs are Level 3 assets measured using significant unobservable assumptions; a 10% adverse change in modeled prepayment speed was estimated to reduce MSR fair value by $118.0 million at quarter-end. These sensitivities are not earnings forecasts.
- Revenue concentration with PMT was 31% of total net revenue in both Q2 and the first half of 2019. The company also identified dependence on GSEs and government programs, regulatory and compliance exposure, counterparty and repurchase risk, and operational and cybersecurity risks.
- A lender substantially curtailed incentives under a repurchase agreement during Q2; the agreement was scheduled to expire August 21, 2019 unless extended or terminated earlier. A July 2019 amendment increased a JPMorgan mortgage-loan repurchase facility’s maximum aggregate purchase price from $500 million to $1 billion.
- Commitments to purchase and fund mortgage loans totaled $4.7 billion at June 30. The company reported an ongoing shareholder fiduciary-duty class and derivative action concerning the 2018 reorganization; management stated that ordinary-course litigation was not expected to have a material adverse effect.
Important facts for investors to verify
- How much of reported earnings reflects recurring production and servicing economics versus fair-value changes, hedging, and gains recognized on loan sales?
- How sensitive are MSR values and servicing results to further rate declines, faster refinancing, and changes in valuation assumptions?
- How much of reported liquidity is unrestricted and immediately available, given pledged cash and the substantial uncommitted portion of repurchase capacity?
- Can PFSI renew or replace short-term financing facilities on acceptable terms, and manage collateral haircuts, margin calls, and the reduced lender incentives?
- How will PMT concentration, loan repurchase obligations, the shareholder litigation, and the post-reorganization tax burden affect future results?