Business context and reporting period
PennyMac Mortgage Investment Trust (PMT) filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2012. PMT is an externally managed mortgage REIT with two segments: investment activities, including distressed residential loans and real estate acquired through loan resolutions, and correspondent lending, which purchases newly originated loans for resale. The filing compares earnings with the corresponding 2011 periods and balance-sheet amounts with December 31, 2011.
Financial performance and position
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net investment income | $99.2 million | $42.0 million | $210.3 million | $89.5 million |
| Income before income taxes | $59.0 million | $24.9 million | $121.5 million | $51.2 million |
| Net income | $40.4 million | $20.5 million | $89.0 million | $44.8 million |
| Diluted earnings per share | $0.81 | $0.73 | $2.29 | $1.72 |
| Dividends declared per share | $0.55 | $0.50 | $1.65 | $0.92 |
- Net investment income includes investment gains and interest as well as correspondent-lending gains. Q3 mortgage-loan-acquired-for-sale gains were $49.8 million, including $36.8 million of noncash MSR value recognized on loan sales. For the nine months, those amounts were $81.2 million and $66.6 million, respectively.
- Q3 segment pretax income was $37.4 million from correspondent lending and $21.5 million from investment activities. For the nine months, the respective amounts were $59.7 million and $61.8 million; correspondent lending contributed approximately 49% of pretax income.
- Total expenses were $40.2 million in Q3 and $88.7 million for the nine months, up from $17.1 million and $38.3 million. Growth in correspondent lending drove fulfillment fees; portfolio growth and financing increased interest and servicing expenses. The filing does not provide a single consolidated operating-margin measure.
- At September 30, assets were $2.329 billion, liabilities $1.145 billion, and shareholders’ equity $1.184 billion, versus $1.386 billion, $840.0 million, and $546.0 million, respectively, at year-end 2011. Cash was $67.8 million and short-term investments $38.3 million.
- Repurchase-agreement borrowings totaled $1.041 billion at quarter-end, compared with $812.4 million across repurchase and forward-purchase borrowings at year-end 2011. The company reported that 92% of assets in the financed asset classes were pledged, with a 56% advance rate against pledged assets.
- For the nine months, operating cash flow was negative $662.2 million, investing cash flow negative $54.5 million, and financing cash flow positive $769.9 million; cash increased by $53.2 million. Operating cash use primarily reflected growth in loans held for sale and related purchase-and-sale activity.
Material changes versus comparable periods
- Q3 net income nearly doubled year over year; nine-month net income also nearly doubled, while diluted EPS increased less because weighted-average shares rose substantially.
- Correspondent-lending purchases grew to $12.0 billion for the nine months from $294.4 million in 2011; sales proceeds were $11.4 billion versus $257.7 million. Loans held for sale reached $847.6 million at quarter-end, including $194.1 million pending sale to affiliate PennyMac Loan Services (PLS).
- Assets increased 68% from December 31, 2011. PMT raised approximately $606.8 million net from common-share offerings and at-the-market sales during the first nine months; issued shares rose from 28.4 million at year-end to 58.9 million at September 30.
- PMT sold its entire MBS portfolio during Q3. It also completed settlement of its two Citigroup Global Markets Realty forward-purchase commitments during 2012; no forward-purchase assets or borrowings remained at quarter-end.
- MSRs grew materially: carrying value was $65.2 million at September 30 versus $6.0 million at year-end 2011. The company recorded $4.5 million of impairment provisions on amortized-cost MSRs in the first nine months.
Outlook, commentary, risks and unusual items
- Management described modest economic growth and improving housing indicators, and cited opportunities in distressed-loan acquisitions, correspondent lending, MSRs and warehouse financing. It said short-term liquidity was sufficient, while pursuing additional financing; no specific earnings or revenue guidance was provided.
- Most borrowings were short-term and secured, with maturities within one year. Management noted that facilities must be renewed or replaced and that margin calls can require rapid repayment or additional collateral if asset values fall. It also identified difficulty financing REO as a possible source of liquidity pressure.
- Distressed-loan performance depends on borrower cures, property values, foreclosure timing, documentation quality and servicing or resolution execution. Approximately 64% of the fair value of investment-portfolio mortgage loans was nonperforming; 83% of that portfolio originated in 2005–2007, and 69% had unpaid principal balances above current property values.
- Correspondent lending and MSRs are sensitive to interest-rate movements, refinancing and prepayments. Management hedges loan inventory and purchase commitments but does not use derivatives to hedge MSR fair-value changes. Fair-value estimates rely significantly on Level 3, unobservable inputs and could vary materially from realized outcomes.
- Related-party arrangements are significant: PCM externally manages PMT and PLS services loans and performs correspondent-lending functions. A May 2012 management-agreement amendment bases the management fee on GAAP shareholders’ equity and is expected to increase the base fee. Q3 base management fees were $3.7 million; no incentive fee was incurred.
- PMT remains a REIT and must generally distribute at least 90% of taxable income. It revoked TRS status for its operating-partnership general partner during Q3; one TRS remained. The nine-month income-tax provision was $32.5 million, up from $6.4 million.
- Subsequent events: on October 15, the maximum purchase price under a Citibank repurchase agreement was increased from $200 million to $400 million, of which $350 million was committed. PCM committed on November 5 to acquire approximately $111.5 million of mortgage loans, subject to due diligence and closing conditions. The board declared a $0.57-per-share dividend on November 7, payable November 30.
- Management reported effective disclosure controls, no material change in internal control over financial reporting, and no legal proceedings believed likely to have a material adverse effect. The filing reported no material change in risk factors from the 2011 Form 10-K.
Important facts for investors to verify
- How much of reported earnings and growth is supported by cash realization versus fair-value gains and noncash MSR recognition.
- Whether correspondent-lending volumes, sale margins and hedging results remain profitable as operations scale; Q3 hedging losses were significant within the loan-sale gain calculation.
- The quality, assumptions and sensitivity of Level 3 valuations for distressed loans, REO and MSRs, including exposure to housing prices and prepayment speeds.
- Repurchase-facility renewal terms, counterparty concentration, margin-call capacity and compliance with minimum liquidity and net-worth covenants.
- The sustainability of dividends relative to REIT taxable income, cash flows, growth funding needs and future equity issuance.
- Performance of the pending $111.5 million loan acquisition and availability of the expanded repurchase capacity disclosed after quarter-end.