PennyMac Mortgage Investment Trust — Q2 2012 Form 10-Q
Business context and reporting period
Unaudited results cover the quarter and six months ended June 30, 2012. PennyMac is an externally managed mortgage investment trust with two segments: investment activities in distressed mortgage loans, real estate acquired in settlement of loans (REO), mortgage-backed securities (MBS) and mortgage servicing rights (MSRs); and correspondent lending, which purchases newly originated loans for resale. The company elected REIT tax treatment and generally must distribute at least 90% of taxable income.
Financial results and condition
- Q2 earnings: Net investment income was $64.4 million, versus $30.2 million in Q2 2011. Expenses were $26.4 million, versus $12.2 million; pretax income was $38.0 million, versus $18.0 million; and net income was $29.6 million, versus $16.6 million. Diluted EPS was $0.79, versus $0.59. Dividends declared were $0.55 per share, versus $0.42.
- First-half earnings: Net investment income was $111.1 million, versus $47.5 million in 2011; expenses were $48.5 million, versus $21.2 million; pretax income was $62.6 million, versus $26.3 million; and net income was $48.6 million, versus $24.3 million. Diluted EPS was $1.46, versus $0.96; dividends declared were $1.10 per share, versus $0.42.
- Drivers and earnings quality: First-half correspondent lending pretax income was $22.3 million, about 32% of total pretax income. Results included substantial fair-value gains and noncash MSRs recognized on loan sales; correspondent lending generated $31.4 million of first-half loan-sale gains, including $29.9 million of MSRs. The filing does not present a single operating-margin measure.
- Balance sheet at June 30: Assets were $1.891 billion, liabilities $1.085 billion, and shareholders’ equity $805.7 million. Cash was $28.0 million and short-term investments $32.3 million. Mortgage loans at fair value were $970.0 million, loans acquired for sale $460.4 million, and REO $89.1 million.
- Debt and liquidity: Repurchase and forward-purchase borrowings totaled $1.024 billion; total liabilities were $1.085 billion. The company reported that 89% of the relevant invested asset classes were pledged, with a 67% advance rate. Financing is predominantly short-term and subject to collateral valuation and margin calls. Management said current liquidity was sufficient for short-term needs.
- Cash flow, six months: Operating cash use was $267.6 million, investing cash use $135.4 million, and financing cash provided $416.3 million; cash increased $13.4 million to $28.0 million. Operating cash use chiefly reflected growth in loans held for sale.
Material changes versus comparable periods
- Assets grew 36% from December 31, 2011, reflecting investment growth, correspondent lending expansion and equity issuance. The company raised approximately $247 million net through share offerings in the first half.
- Correspondent lending expanded sharply: first-half loan purchases were $5.37 billion, versus $74.4 million in the prior-year period; sales were $5.14 billion, versus $59.5 million.
- Investment portfolio growth lifted mortgage-loan interest income and valuation gains. Nonperforming loans were 59% of the fair value of the mortgage-loan portfolio at June 30, down from 75% at December 31, 2011; REO carrying value was $89.1 million, up from $80.6 million at year-end.
- On May 16, the management agreement was amended so the base fee uses GAAP shareholders’ equity, including unrealized and other noncash items. Management expects this to increase the fee; the incentive-fee calculation was unchanged.
Outlook, risks and unusual items
- Management described opportunities in distressed-loan acquisitions and correspondent lending, and was exploring additional financing, term funding and securitizations. No specific earnings or financial guidance was provided.
- Management cited modest economic growth, persistently high unemployment, declining mortgage rates and continued distressed-loan supply. It noted the low 30-year mortgage rate of 3.66% during Q2 and expected foreclosure activity to increase as lenders addressed operational backlogs.
- Key risks include distressed borrower performance, home-price and foreclosure outcomes, valuation uncertainty, short-term funding renewals and margin calls, interest-rate and prepayment exposure, and dependence on affiliated manager PCM and servicer PLS. Much of the mortgage portfolio is Level 3 fair value, dependent on unobservable assumptions.
- Representations-and-warranties exposure can require loan repurchases or indemnification; the recorded liability was $1.25 million. No material adverse legal proceedings were reported. Management stated disclosure controls were effective and that there were no material changes in internal control over financial reporting.
- After quarter-end, PennyMac sold its $53.2 million fair-value non-Agency MBS portfolio, recorded a $30,000 loss and repaid $47.6 million of related repo borrowings. It also entered a $100 million Barclays loan repo facility, expanded two Credit Suisse facilities, and declared a $0.55-per-share dividend payable August 31, 2012.
Important facts for investors to verify
- How much reported income and EPS depended on Level 3 fair-value gains and noncash MSR recognition, and how those estimates compare with realized cash proceeds.
- Whether correspondent lending remains profitable after hedging losses, fulfillment fees, financing costs and MSR impairment; first-half loan-sale gains included significant noncash MSRs.
- Availability and renewal terms of short-term repo funding, compliance with minimum-cash and other covenants, and sensitivity to collateral haircuts or margin calls.
- Performance and resolution timing of distressed loans and REO, including home-price assumptions, foreclosure delays and the concentration of loans with current loan-to-value ratios above 100%.
- Effects of the revised base management-fee calculation and the company’s related-party arrangements with PCM and PLS.