PennyMac Mortgage Investment Trust — Q3 2019 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2019. PMT is a specialty finance company investing in residential mortgage assets, including mortgage servicing rights (MSRs), credit risk transfer (CRT) investments, mortgage-backed securities (MBS), and loans acquired for sale. Amounts below are in U.S. dollars; financial statement amounts are generally in millions unless stated otherwise.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Net investment income | $130.8 | $108.5 | $333.8 | $267.2 |
| Expenses | $82.6 | $56.8 | $202.4 | $135.4 |
| Pretax income | $48.1 | $51.7 | $131.4 | $131.8 |
| Net income | $70.0 | $46.6 | $167.8 | $111.2 |
| Net income attributable to common shareholders | $63.8 | $40.3 | $149.1 | $92.5 |
| Basic / diluted earnings per common share | $0.75 / $0.71 | $0.66 / $0.62 | $2.00 / $1.90 | $1.51 / $1.44 |
| Common dividend declared per share | $0.47 | $0.47 | $1.41 | $1.41 |
| Net interest income | $3.6 | $15.7 | $17.8 | $34.2 |
PMT does not present a conventional consolidated revenue subtotal; net investment income is the filing’s principal operating-income measure. Q3 net interest margin was 0.08% and net interest spread was negative 0.06%, versus 1.15% and 1.08% a year earlier. For the nine months, these were 0.33% and 0.18%, compared with 0.96% and 0.85%.
Balance sheet, funding, and cash flow
- At September 30, total assets were $10.745 billion, total liabilities $8.525 billion, and shareholders’ equity $2.220 billion. Assets increased 38% from December 31, 2018, principally reflecting growth in loans acquired for sale and CRT-related deposits.
- Cash was $113.7 million and short-term investments were $74.9 million. Borrowings were approximately $8.360 billion; PMT’s reported borrowings-to-equity leverage ratio was 3.77, versus 3.89 at year-end 2018. Repurchase-agreement debt was $6.355 billion, and notes payable were $1.361 billion.
- Repurchase financing was largely short-term and subject to collateral valuation and margin calls. The filing reported $140.5 million of committed and $1.926 billion of uncommitted repurchase borrowing capacity at quarter-end; availability depends on eligible collateral and ability to meet margin requirements.
- For the first nine months, operating cash flow was negative $2.332 billion, investing cash flow negative $370.4 million, and financing cash flow positive $2.756 billion. Cash increased $53.8 million to $113.7 million. The operating outflow largely reflected growth in loans held for sale.
- PMT raised approximately $510.2 million net in three underwritten common-share offerings and $104.6 million net through its at-the-market program during the nine months. Common shares outstanding were 90.35 million at quarter-end and 90.98 million at October 31, 2019.
Material changes versus comparable periods
- Q3 net income increased despite pretax income declining $3.5 million; the principal difference was a $21.9 million income tax benefit in 2019 versus a $5.1 million tax provision in Q3 2018. Management attributed the tax benefit primarily to an MSR fair-value impairment in the taxable REIT subsidiary.
- Lower mortgage rates supported higher MBS gains, CRT gains, correspondent production volume, and loan-sale income, but also increased refinancing expectations and reduced MSR and excess servicing spread values. Q3 net loan servicing fees fell to $5.2 million from $44.4 million; for the nine months they were negative $79.5 million versus positive $128.1 million.
- Q3 net gains on investments were $45.8 million, up from $9.7 million, while net gains on loans acquired for sale rose to $49.3 million from $24.8 million. Correspondent loan sales totaled $32.3 billion in Q3, compared with $17.8 billion.
- PMT substantially liquidated its distressed-loan portfolio: its fair value declined to $15.4 million from $117.7 million at year-end 2018. REO was $79.2 million, down from $85.7 million at year-end; PMT also committed to liquidate real estate held for investment.
- MSR fair-value changes, net of hedging results, reduced Q3 income by $79.7 million and nine-month income by $303.8 million. These marks are noncash and materially affected reported earnings.
Outlook, commentary, and risks
- No specific earnings or financial guidance is provided. Management’s stated objective is long-term risk-adjusted returns, primarily through dividends and secondarily through capital appreciation. Management said future portfolio growth is expected to depend in part on raising additional equity capital and continuing to obtain financing.
- PMT held $2.044 billion of deposits securing CRT arrangements and had $847.3 million face amount of commitments to purchase CRT securities. CRT exposures are sensitive to borrower defaults, loss severity, home prices, and valuation assumptions. Management reported $3.4 million of CRT loss settlements for the first nine months.
- Interest-rate and prepayment movements are important risks. A 10% adverse change in MSR prepayment assumptions was estimated to reduce MSR fair value by $64.3 million; management cautioned that sensitivities are model-based and are not earnings forecasts. Much of the portfolio is valued using Level 3, unobservable inputs.
- Common earnings include substantial noncash items: these represented 106% of net investment income in Q3 and 64% for the nine months. Loan-sale gains include estimated fair values for MSRs and CRT commitments, which may differ from cash realized over time.
- Short-term funding, collateral values, margin calls, covenant requirements, and refinancing of facilities are liquidity risks. A $250 million exchangeable note is due May 2020. Subsequent to quarter-end, PMT issued $375 million of secured term notes in October 2019; the filing says agreements maturing before filing were extended or renewed.
- Related-party dependence is significant: PMT is externally managed by an affiliate and relies on PennyMac Loan Services for fulfillment and servicing. Management fees, servicing charges, and other affiliate transactions should be monitored.
- PMT reported no material legal proceedings and no material changes to the risk factors in its 2018 Form 10-K. Its representation-and-warranty liability was $7.7 million against $109.1 billion of loans subject to representations and warranties; management noted future repurchase activity and losses could increase.
- PLS implemented a new internally developed servicing system during the quarter. PMT redesigned certain controls and stated disclosure controls were effective, while noting it would continue testing the new controls.
Important facts for investors to verify
- Whether recurring cash earnings and dividends are supported by realized cash flows, given the high share of noncash income and volatile MSR marks.
- Current financing availability, collateral haircuts, margin-call exposure, covenant headroom, and refinancing plans for short-term debt.
- How MSR, CRT, and other Level 3 valuations respond to continued changes in rates, prepayments, credit spreads, home prices, and defaults.
- The effect of common-share issuance and potential further equity raising on per-share earnings, book value, and dividend coverage.
- Whether correspondent production gains and CRT returns remain resilient as loan volumes, margins, and interest-rate conditions change.
- Developments in representation-and-warranty claims, servicing-system control testing, and affiliate service arrangements.