PennyMac Financial Services, Inc. — Q1 2020 Form 10-Q
Reporting period: Quarter ended March 31, 2020. The company is a mortgage banking and investment management firm, operating through production, servicing and investment management segments. Comparative results are for Q1 2019; balance sheet comparisons are to December 31, 2019. Dollar amounts below are in U.S. dollars.
Financial performance and position
| Metric | Q1 2020 / March 31, 2020 | Comparable period / prior year-end |
|---|---|---|
| Total net revenues | $721.8 million | $247.7 million in Q1 2019 |
| Income before taxes | $414.7 million | $60.3 million in Q1 2019 |
| Net income | $306.2 million | $46.1 million in Q1 2019 |
| Diluted EPS | $3.73 | $0.58 in Q1 2019 |
| Return on average common equity | 56.0% | 11.0% in Q1 2019 |
| Net interest income | $11.1 million | $20.8 million in Q1 2019 |
| Total assets / stockholders’ equity | $10.9 billion / $2.36 billion | $10.2 billion / $2.06 billion at Dec. 31, 2019 |
| Cash and short-term investments | $880.7 million | $262.9 million at Dec. 31, 2019 |
| Debt, as presented in MD&A | $4.97 billion short-term; $1.47 billion long-term | $4.64 billion short-term; $1.49 billion long-term at Dec. 31, 2019 |
Loan servicing fees and other servicing revenue contributed to net loan servicing fees of $257.8 million, versus $80.6 million in Q1 2019. The servicing portfolio totaled $384.2 billion in unpaid principal balance (UPB), up from $368.7 billion at year-end. Mortgage servicing rights (MSRs) were valued at $2.19 billion, down from $2.93 billion at year-end. The filing describes higher production profit margins but does not provide a single overall margin percentage.
Cash flow from operating activities was negative $730.3 million, compared with negative $134.2 million in Q1 2019; investing activities provided $1.12 billion and financing activities provided $304.5 million. Cash and restricted cash increased $690.5 million to $879.0 million. The operating cash outflow primarily reflected mortgage loan inventory growth; investing inflows included $942.0 million in net settlements of MSR hedging derivatives.
Material changes versus Q1 2019 and year-end
- Net gains on loans held for sale rose to $344.3 million from $84.8 million, reflecting higher production volume and stronger gain-on-sale margins amid low rates and reduced industry capacity. Loan origination fees increased to $57.6 million from $23.9 million.
- Net servicing fees improved substantially versus Q1 2019, when MSR valuation and hedging effects produced a net loss in that component. In Q1 2020, a $1.04 billion decline in MSR fair value was largely offset by hedging results and fair-value changes in related liabilities; net servicing fair-value and hedging contribution was positive $15.9 million.
- Expenses increased to $307.1 million from $187.4 million, particularly compensation ($168.4 million versus $106.6 million) and loan origination costs ($46.0 million versus $14.5 million), alongside business growth and higher volumes.
- Net interest income fell by $9.7 million, in part because a prior repurchase-facility incentive that reduced interest expense expired in 2019, and borrowing balances and interest shortfalls increased.
- Repurchase-agreement debt rose to $4.44 billion from $4.14 billion at year-end. Cash increased as management elected to preserve liquidity amid pandemic-related uncertainty; $773.4 million of reported cash was pledged to creditors.
Outlook, risks and unusual items
- COVID-19 and forbearance: Management expects CARES Act forbearance and increased delinquencies to require substantial principal, interest, tax and insurance advances, raise servicing costs and potentially reduce servicing income. The effects depend on economic and market developments and are uncertain.
- MSR and market exposure: Lower rates, faster refinancing, servicing costs and higher market-required returns drove a 36% reduction in MSR fair value from its year-end value. The company warns hedges may not offset future changes as effectively. MSR valuations rely significantly on unobservable Level 3 inputs.
- PMT dependence: PMT accounted for 22% of Q1 2020 net revenue, compared with 31% in Q1 2019. PMT reported a $595 million net loss for the quarter. The company expects PMT base management fees to fall materially and does not expect performance incentive fees for the foreseeable future.
- Market outlook: Management cited third-party/current market forecasts of approximately $2.4 trillion in U.S. mortgage originations for 2020 and $2.2 trillion for 2021, versus an estimated $2.3 trillion for 2019. These are market estimates, not company earnings guidance.
- Liquidity and financing: The company reported compliance with financing covenants and Agency capital and liquidity requirements at March 31. However, short-term facilities, margin calls, collateral values and the potential classification of pandemic forbearances as serious delinquencies may affect liquidity and access to financing. Agencies had proposed stricter eligibility requirements.
- Subsequent financing: After quarter-end, the company established servicing-advance financing and, on April 24, increased the related committed capacity to $600 million; it also increased maximum combined Credit Suisse facility capacity to $2.25 billion. Management said facilities maturing between quarter-end and the report date had been renewed or extended.
- Contingencies: The filing discusses a pending shareholder fiduciary-duty action and Black Knight litigation, which was ordered to arbitration; Black Knight appealed. Management says it believes the claims are without merit, but outcomes cannot be assured.
- Capital returns: A $0.12 per-share dividend was declared for Q1; a further $0.12 dividend was announced May 7, payable May 28, 2020. The company repurchased 238,133 shares in March for approximately $4.1 million.
Most important facts for investors to verify
- How forbearance-related delinquencies and required servicing advances affect liquidity, servicing costs, and Agency capital and liquidity thresholds.
- Whether MSR fair values, prepayment assumptions and hedge performance stabilize, and how much of reported earnings reflects valuation changes rather than realized cash earnings.
- The renewal terms, committed availability, collateral requirements and margin-call exposure of short-term financing facilities.
- The pace of loan production and gain-on-sale margins, including whether capacity constraints and low interest rates persist.
- The degree to which lower PMT equity and losses reduce management fees and related-party revenues.
- Developments and potential exposure in the pending legal proceedings, and the effect of the proposed FHFA eligibility changes.