PennyMac Mortgage Investment Trust — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. Amounts below are in U.S. dollars; financial-statement figures are generally in millions unless otherwise stated. PMT is an externally managed mortgage investment trust with correspondent production and investment activities.
Financial performance and position
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net investment income | $47.6 | $69.8 | $99.8 | $107.4 |
| Expenses | $55.8 | $44.7 | $96.9 | $86.2 |
| Pre-tax income (loss) | $(8.2) | $25.1 | $2.9 | $21.3 |
| Tax benefit | $2.9 | $3.0 | $6.3 | $14.3 |
| Net income (loss) | $(5.3) | $28.1 | $9.2 | $35.6 |
| Diluted EPS | $(0.08) | $0.36 | $0.12 | $0.46 |
| Dividend declared per share | $0.47 | $0.61 | $0.94 | $1.22 |
| Net interest income | $15.2 | $15.6 | $37.5 | $30.5 |
| Net interest margin | 1.37% | 1.39% | 1.73% | 1.40% |
- Net gain on mortgage loans acquired for sale was $24.2 million in Q2 and $39.3 million for the six months, up from $11.2 million and $21.3 million, respectively. Net mortgage servicing fees were $15.7 million and $31.2 million, compared with $13.0 million and $21.0 million.
- Net investment results turned to a loss of $15.5 million in Q2 and $19.4 million for the six months, versus gains of $22.6 million and $26.1 million in the prior-year periods. Q2 included a $15.8 million ESS valuation loss; six-month ESS losses were $33.5 million.
- At June 30, total assets were $5.77 billion, total liabilities $4.41 billion, and shareholders’ equity $1.36 billion, compared with $5.83 billion, $4.33 billion, and $1.50 billion at year-end 2015. Book value per share was $20.09, versus $20.28.
- Cash was $95.7 million and short-term investments $16.9 million. Repurchase-agreement debt was $3.28 billion; total borrowings shown in the balance-sheet analysis were approximately $4.26 billion. The company reported a 3.13x leverage ratio (borrowings divided by period-end equity) and 97% of the relevant invested assets pledged.
- Cash increased $37.6 million over the six months. Operating activities used $178.4 million, investing activities provided $315.2 million, and financing activities used $99.2 million. Operating cash use was substantially lower than the $1.66 billion use in the prior-year period, largely reflecting slower growth in mortgage-loan inventory.
- Repurchase facilities had $1.38 billion of stated available capacity at quarter-end ($488.9 million committed and $895.2 million uncommitted). Management said liquidity was sufficient for current needs. The filing also reports $1.66 billion of mortgage-loan purchase commitments, primarily due within one year.
Material changes and management commentary
- Earnings mix shifted. Correspondent production pre-tax income increased to $16.4 million in Q2 and $27.3 million for the six months, from $5.2 million and $9.7 million. Investment activities moved from pre-tax income of $19.9 million and $11.6 million to losses of $24.6 million and $24.5 million.
- Management attributed investment weakness primarily to lower ESS values as falling mortgage rates increased expected prepayments, and lower expected cash flows from distressed loans due to longer liquidation periods, higher collection costs, and lower expected home-price appreciation. MBS gains and CRT gains partly offset these effects.
- Correspondent loan purchases increased to $15.3 billion in Q2 and $25.5 billion for the six months, from $12.5 billion and $20.8 billion. Management cited a favorable rate environment and growth in its correspondent seller network. It also noted higher margins and a larger customer base.
- PMT purchased no distressed mortgage loans in the first half of 2016, compared with $242.0 million in the first half of 2015; liquidation, payoff, paydown, and sale proceeds from mortgage loans and REO were $594.0 million. Management described a transition from distressed whole loans toward correspondent-related CRT and MSR investments.
- In February 2016, PLS reacquired PMT’s Fannie Mae and Freddie Mac ESS covered by terminated spread acquisition agreements. PMT recorded $59.0 million of ESS sales in the first half. The ESS balance declined to $294.6 million from $412.4 million at year-end.
- PMT deposited $192.7 million in cash for CRT agreements during the first half; the UPB subject to credit-guarantee obligations rose to $9.0 billion from $4.5 billion. No CRT loss payments were reported for the period.
- All Federal Home Loan Bank advances were repaid by June 30 after a rule change required termination of the captive-insurance subsidiary’s membership and barred additional advances.
- PMT repurchased 6.3 million shares for $82.8 million in the first half under an authorization increased to $200 million. The remaining authorization was approximately $100.8 million at June 30.
Outlook, risks, and unusual items
- No company-specific earnings or dividend guidance was provided. Management cited industry forecasts averaging $1.8 trillion of U.S. mortgage originations for 2016, described as somewhat above 2015, and said it saw long-term opportunity in CRT and MSRs. These are market observations, not PMT guidance.
- Management expects to rely mainly on investment liquidations, business cash flows, borrowings, and potentially additional equity to fund activity. Most financing is short-term; facilities may need renewal or replacement, and margin calls may require cash or additional collateral. Availability of financing for MSRs and ESS is limited and could constrain liquidity or investment capacity.
- Interest-rate, prepayment, housing-price, borrower-credit, foreclosure-timing, and collateral risks are significant. Much of reported income comes from fair-value estimates and other non-cash items: these represented 77% of net investment income in Q2 and 82% for the six months. Level 3 valuations rely on unobservable assumptions, and actual realization may differ materially.
- MSR impairment was a notable item: the six-month impairment provision was $40.9 million, and the valuation allowance on amortized-cost MSRs increased to $51.8 million from $10.9 million at year-end. The quarter also included a $23.2 million impairment provision.
- Representation-and-warranty exposure remained: the related liability was $19.3 million against $46.3 billion UPB of loans subject to representations and warranties. Management cautioned that future repurchase losses and liability adjustments are uncertain; the first half included a $1.7 million reduction to previously recorded liabilities due to revised estimates.
- REIT qualification requires distribution of at least 90% of taxable income, limiting retained capital. The company also depends substantially on its external manager and servicer, PFSI affiliates; related-party fees, funding, servicing, and ESS arrangements are material.
- Management reported no litigation expected to have a material adverse effect, no material changes to previously disclosed risk factors, and effective disclosure controls. No material change in internal control over financial reporting was reported.
Important facts for investors to verify
- How much of future earnings and distributable cash is supported by realized cash flows versus fair-value changes, capitalized loan interest, and MSR recognition?
- Whether ESS and MSR valuations, including prepayment assumptions and impairment allowances, remain supportable as interest rates and refinancing activity change.
- Repurchase-facility renewals, committed versus uncommitted capacity, margin-call requirements, and compliance with cash, net-worth, leverage, and Agency liquidity covenants.
- Whether correspondent production margins and volumes can offset continued weakness or volatility in investment activities, and how much capital CRT and MSR growth requires.
- Performance and liquidation timelines for distressed loans and REO, including foreclosure costs, collateral values, and concentration in selected states.
- Future representation-and-warranty claims and recoveries from correspondent sellers, and the effect of share repurchases and dividends on book value and liquidity.