PennyMac Financial Services, Inc. — FY2019 Form 10-K
Reporting period: Fiscal year ended December 31, 2019. This is an annual report, not a standalone Q4 filing; quarterly figures below are unaudited. Amounts are U.S. dollars.
Business context
Pennymac is a non-bank mortgage finance and servicing company, with production, servicing and investment management segments. Its activities include originating and acquiring residential loans, servicing loans for itself and others, and managing PennyMac Mortgage Investment Trust (PMT). The company relies significantly on PMT for correspondent-loan purchases, servicing business and investment-management fees.
Financial results and key metrics
| Metric | FY2019 | FY2018 |
|---|---|---|
| Total net revenue | $1.477 billion | $984.6 million |
| Expenses | $948.0 million | $716.9 million |
| Income before taxes | $529.4 million | $267.7 million |
| Income tax provision | $136.5 million | $23.3 million |
| Net income | $393.0 million | $244.4 million |
| Diluted EPS | $4.89 | $2.59 |
| Operating cash flow | $(2.245) billion | $572.4 million |
| Investing cash flow | $148.8 million | $(322.6) million |
| Financing cash flow | $2.129 billion | $(132.0) million |
- Loan production totaled $117.6 billion in unpaid principal balance (UPB), up from $67.6 billion. Loans purchased or originated for sale were $61.5 billion; an additional $56.0 billion of conventional loans were fulfilled for PMT.
- The servicing portfolio reached $368.7 billion UPB, up from $299.3 billion; $225.8 billion was serviced under owned MSRs and $135.4 billion was subserviced for PMT.
- At year-end, total assets were $10.204 billion, liabilities $8.143 billion and stockholders’ equity $2.062 billion. Short-term debt was $4.639 billion and long-term debt $1.493 billion.
- Cash and short-term investments totaled $262.9 million. Reported Agency-eligible liquidity was $257.8 million, compared with requirements of $80.0 million for Fannie Mae/Freddie Mac and $216.1 million for Ginnie Mae; the company reported compliance.
- About 79% of assets were measured at or based on fair value; Level 3 assets represented $3.5 billion, making valuation assumptions particularly relevant.
Material changes and Q4 performance
- Revenue increased about 50% and net income about 61% year over year. Management attributed the gains chiefly to higher production volume and improved production margins amid lower interest rates and stronger mortgage demand.
- Production segment pretax income increased to $527.8 million from $87.3 million. Servicing moved to a $14.8 million pretax loss from $172.3 million of income, primarily reflecting adverse MSR and related fair-value movements.
- Net loan servicing fees declined $151.7 million to $293.7 million. A $1.006 billion net reduction in MSR fair value comprised $550.7 million from market-input changes and $455.5 million from cash-flow realization; hedging results partially offset servicing-related valuation losses.
- Expenses rose $231.0 million, including higher compensation and loan-origination costs as the business expanded. The effective tax rate rose to 25.8% from 8.7%, principally because the November 2018 reorganization made the company taxable on a greater share of earnings.
- Operating cash use reflected a $2.487 billion cash outflow related to loans held for sale. Financing provided $2.129 billion, supporting higher loan inventory and MSR investment. Year-end loans held for sale rose to $4.913 billion from $2.522 billion.
- In Q4 2019, net income was $152.7 million and diluted EPS was $1.88; income before taxes was $203.4 million. Quarterly net income rose sequentially from $121.5 million in Q3.
Outlook, risks, contingencies and unusual items
- Outlook: No numerical earnings or revenue guidance is provided. Management describes plans to expand consumer-direct and broker-direct lending, correspondent seller relationships and servicing, including organic additions and MSR purchases. In February 2020 the company acquired approximately $2.3 billion UPB of Ginnie Mae MSRs and agreed, subject to conditions, to acquire another $292 million UPB of defaulted-government-loan MSRs.
- Interest rates and fair value: Lower rates supported refinancing and production but reduced MSR values through faster expected prepayments. MSR values depend on significant unobservable assumptions; the auditor identified MSR pricing-spread and prepayment-speed assumptions as a critical audit matter.
- Funding and liquidity: The business is leveraged and depends on short-term, often annually renewed facilities. Margin calls, collateral-value declines, refinancing constraints or lender withdrawals could pressure liquidity. Year-end commitments to purchase and originate loans were $7.122 billion; contractual obligations totaled $13.664 billion. The filing states there were no off-balance-sheet arrangements or guarantees.
- Concentration and agreements: PMT-related entities generated 31% of net revenue in 2019. Several PMT management, servicing and related agreements were due to expire September 12, 2020, subject to automatic renewal; termination or unfavorable changes could materially affect operations.
- Other material risks: Dependence on Fannie Mae, Freddie Mac and Ginnie Mae; regulatory and licensing requirements; loan repurchase and indemnification exposure; servicing advances; cybersecurity and technology execution; and the planned LIBOR transition by the end of 2021. The representations-and-warranties liability was $21.4 million, against $177.6 billion UPB of loans subject to such provisions.
- Legal matters: Pending proceedings include a shareholder fiduciary-duty action concerning the 2018 reorganization, in which a motion to dismiss was denied, and a trade-secrets/contract dispute with Black Knight. Pennymac also filed a separate antitrust and unfair-competition suit against Black Knight. Management states it intends to defend the claims; ultimate outcomes are uncertain.
- Capital returns and controls: The company began quarterly common dividends in October 2019 and declared $0.12 per share for FY2019; future dividends remain discretionary. Management and the auditor concluded internal control over financial reporting was effective, and the financial-statement audit opinion was unqualified.
Important facts for investors to verify
- How much of production gains and reported earnings reflects recurring cash economics versus fair-value estimates, especially MSR marks and hedging.
- Whether production volumes and margins can be sustained if refinancing demand falls or competition compresses pricing.
- Current borrowing capacity, facility renewals and covenant headroom, collateral requirements and exposure to margin calls.
- PMT agreement renewal status and the terms of the company’s related-party production, servicing and investment-management arrangements.
- Updates on pending litigation, loan repurchase claims and MSR valuation assumptions, including the timing and impact of the LIBOR transition.
- Dividend sustainability after considering liquidity needs, regulatory capital requirements and growth-related funding.