PennyMac Mortgage Investment Trust — Q1 2015 Form 10-Q
Reporting period: Quarter ended March 31, 2015. Amounts below are in U.S. dollars; financial statement figures are generally in millions unless otherwise noted.
Business context
PMT is an externally managed mortgage finance trust with two main activities: correspondent production, in which it purchases and resells newly originated loans, and investments in distressed mortgage loans, real estate acquired through loan resolution (REO), mortgage-backed securities (MBS), mortgage servicing rights (MSRs), and excess servicing spread (ESS). It operates as a REIT and relies on PennyMac Financial Services, Inc. affiliates for management, servicing, and loan fulfillment.
Financial results and position
| Metric | Q1 2015 | Q1 2014 or prior period |
|---|---|---|
| Net investment income | $37.7 | $76.6 |
| Net interest income | $14.9 | $19.6 |
| Net income | $7.5 | $37.9 |
| Basic / diluted earnings per share | $0.09 / $0.09 | $0.52 / $0.50 |
| Dividends declared per share | $0.61 | $0.59 |
| Net interest margin | 1.52% | 2.40% |
| Net interest spread | 1.04% | 1.57% |
| Total assets, March 31 | $5,737.4 | $4,904.3 at Dec. 31, 2014 |
| Total liabilities / shareholders’ equity, March 31 | $4,195.3 / $1,542.2 | $3,326.1 / $1,578.2 at Dec. 31, 2014 |
| Cash / short-term investments, March 31 | $65.7 / $44.9 | $76.4 / $139.9 at Dec. 31, 2014 |
| Cash flow from operations / investing / financing | $(753.1) / $(91.3) / $833.8 | $113.3 / $(0.5) / $(128.3) |
Pre-tax loss was $3.8 million, offset by an $11.3 million income-tax benefit, producing $7.5 million of net income. The tax benefit primarily reflected increased losses at the taxable REIT subsidiary. Q1 operating cash use was attributed mainly to growth in mortgage loans acquired for sale, including MSRs received as part of loan-sale proceeds; financing inflows largely funded the expanded loan inventory and investments.
At March 31, repurchase-agreement debt was $3,563.3 million, mortgage-loan participation financing was $71.8 million, VIE financing was $162.2 million, and exchangeable notes were $250 million. The notes carry a 5.375% coupon and mature in 2020. Management reported a 2.62x leverage ratio and 97% of the relevant invested asset classes pledged, with an 81% advance rate. Repurchase facilities had $544.7 million of available capacity, including committed and uncommitted capacity.
Material changes versus Q1 2014 and year-end 2014
- Net income fell 80% year over year, principally because investment-activity pre-tax results moved from $33.1 million income to an $8.2 million loss. Correspondent-production pre-tax income increased to $4.4 million from $3.1 million.
- Investment gains fell sharply: net gain on investments was $3.4 million versus $42.6 million. Management attributed the reduction largely to smaller fair-value gains on distressed loans, slower loan resolutions, and ESS losses amid lower rates and higher expected prepayments.
- Net interest income declined $4.6 million as mortgage-loan yields fell and average repo balances and related interest expense increased. Interest expense rose to $25.7 million from $19.8 million.
- Correspondent loan purchases grew to $8.4 billion from $5.0 billion, while the quarter-end held-for-sale loan inventory rose to $1.37 billion from $344.7 million a year earlier. Management noted increased competition and margin pressure; reported gain on mortgage loans acquired for sale was nearly flat at $10.2 million.
- Total assets increased 17% from year-end, led by a $729.2 million rise in held-for-sale loans. Borrowings and liabilities also increased, while shareholders’ equity declined by $36.0 million, primarily reflecting dividends exceeding quarterly net income.
- ESS fair-value losses were $6.2 million, compared with $2.9 million a year earlier. REO was $317.5 million, and the quarter included $11.4 million of net REO valuation adjustments, partly offset by $5.6 million of sale gains.
Outlook, risks, contingencies, and unusual items
- Management cited a growing U.S. housing market and lower mortgage rates, but expected mortgage originations to remain relatively flat; its cited industry forecast for 2015 was approximately $1.3 trillion. It described correspondent production competition as increasing and distressed-loan pricing as less attractive, and said it would remain selective in new distressed-loan purchases.
- Management expects to continue financing most assets short term until longer-term financing is more available. Repo facilities are subject to renewal, collateral valuation changes, and margin calls that may require cash or additional collateral on short notice. Direct financing for MSRs and ESS was not then available, which management said could strain liquidity or constrain investment opportunities.
- Portfolio risks include distressed-borrower credit and recovery risk, home-price and foreclosure exposure, interest-rate and prepayment sensitivity, fair-value estimation uncertainty, and reliance on affiliated manager and servicer. Significant assets are Level 3 fair-value measurements using unobservable assumptions. Lower rates and faster refinancing can reduce MSR and ESS values; a hypothetical 10% decline in property values was estimated to reduce distressed-loan fair value by $144.4 million.
- Mortgage loans held at fair value included $1.62 billion of nonperforming loans; 69% of the fair value of the distressed loan portfolio was nonperforming. About 35% of investments identified by management were nonperforming assets, with less predictable cash-flow timing.
- Representations-and-warranties liability was $15.4 million, up from $14.2 million at year-end, against $35.6 billion of loans subject to those obligations. Management warned that repurchase activity and losses may increase as loans season; estimates depend on defaults, loss severity, and recoveries from correspondent sellers.
- No material litigation or off-balance-sheet arrangements were reported, and management said disclosure controls were effective. No material risk-factor changes from the 2014 Form 10-K were reported.
- After quarter-end, PMT completed a $136 million ESS purchase on May 1 relating to PLS’s acquisition of a $15 billion Agency MSR portfolio. Separately, PLS signed an April 28 letter of intent to acquire a $9.3 billion MSR portfolio, with PMT intending to buy approximately $74 million of related ESS, subject to definitive agreements, due diligence, approvals, and closing conditions. On April 30, PMT also arranged financing of up to $150 million for ESS through PLS; the related CSFB financing increase was supported by a PMT guarantee.
Most important facts for investors to verify
- Whether the sharp year-over-year decline in investment gains and earnings reflects temporary valuation and resolution timing or a sustained change in distressed-asset returns.
- How sensitive Level 3 loan, MSR, and ESS valuations are to home prices, discount rates, prepayments, and loan-resolution assumptions.
- Liquidity under higher collateral haircuts or margin calls, including renewal and availability of short-term facilities and the consequences of uncommitted capacity.
- The economics, funding, and guarantee exposure associated with the post-quarter ESS purchases and the proposed MSR-related transaction.
- Trends in repurchase and indemnification claims, recoveries from correspondent sellers, and adequacy of the $15.4 million representations-and-warranties reserve.
- The sustainability of the $0.61 quarterly dividend relative to cash realizations, taxable income, and the REIT distribution requirement.