PennyMac Mortgage Investment Trust — Q3 2016 Form 10-Q
Business context and period. Specialty finance REIT investing in residential mortgage assets, with correspondent loan production and investment activities. This unaudited report covers the quarter and nine months ended September 30, 2016; balance-sheet comparisons are with December 31, 2015. Dollar figures below are in millions unless stated otherwise.
Financial performance and condition
| Metric | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Net investment income | $103.3 | $90.8 | $203.2 | $198.2 |
| Net interest income | $17.8 | $23.7 | $55.3 | $54.2 |
| Net income | $35.4 | $38.8 | $44.6 | $74.4 |
| Diluted earnings per share | $0.49 | $0.49 | $0.63 | $0.95 |
| Dividends declared per share | $0.47 | $0.47 | $1.41 | $1.69 |
- Q3 pre-tax income was $45.0 million; income tax expense was $9.6 million. Nine-month pre-tax income was $47.9 million and tax expense was $3.3 million. The effective tax rate was 21.3% for Q3 and 6.8% year to date.
- Net interest margin was 1.56% in Q3 versus 1.77% a year earlier; nine-month margin was 1.67% versus 1.54%. Net interest spread was 1.59% and 1.56%, respectively, for those periods.
- At September 30, assets were $6.619 billion, liabilities $5.264 billion and shareholders’ equity $1.355 billion. Cash was $139.1 million and short-term investments $33.4 million. Book value was $20.21 per share, versus $20.28 at year-end 2015.
- Repurchase-agreement borrowings were $4.041 billion; mortgage loan participation and sale agreements added $88.5 million. Other borrowings included $384.4 million of VIE asset-backed financing, $196.1 million of notes payable, $245.8 million of exchangeable notes and a $150 million related-party note. FHLB advances were fully repaid. Leverage, defined as borrowings divided by equity, was 3.77x, versus 2.81x at year-end.
- Net cash used in operations for the first nine months was $791.7 million; investing activities provided $168.2 million and financing activities provided $704.4 million. Cash increased $81.0 million to $139.1 million. Operating cash use primarily reflected growth in loans held for sale.
Material changes versus comparable periods
- Q3 net income declined 9% year over year; nine-month net income fell 40%. Investment-activities pre-tax income was $13.6 million in Q3 versus $34.9 million a year earlier, and a $10.8 million loss year to date versus $46.5 million of income in 2015.
- Management attributed weaker investment results chiefly to ESS and distressed-loan fair-value losses, reflecting higher expected prepayments on underlying MSRs, longer liquidation timelines, increased collection costs and lower-than-expected home-price appreciation. Nine-month net investment gains/losses shifted from a $51.0 million gain to a $5.1 million loss.
- Correspondent production improved: loan purchases were $19.8 billion in Q3 and $45.3 billion for nine months, up from $15.1 billion and $35.9 billion. Gains on loans acquired for sale rose to $43.9 million and $83.1 million, respectively, supported by higher volume and margins.
- Assets grew to $6.619 billion from $5.827 billion at year-end. Loans held for sale rose to $2.043 billion from $1.284 billion; MBS increased to $708.9 million from $322.5 million; distressed mortgage loans fell to $1.957 billion from $2.556 billion; and ESS declined to $280.4 million from $412.4 million.
- The company repurchased 7.0 million shares for $93.4 million during the first nine months, reducing shares outstanding. Total repurchases under its $200 million authorization were 8.1 million shares for $109.8 million through September 30.
Outlook, commentary and risks
- No company-specific earnings or dividend guidance is provided. Management said it is shifting from distressed whole-loan investing toward correspondent-related CRT and MSR investments, while continuing to manage and liquidate its existing distressed portfolio. It cited opportunity in GSE credit-risk transfers; the jumbo securitization market remained limited and pricing inconsistent.
- Management stated liquidity was sufficient for current needs. However, the business depends on short-term secured financing, facility renewals and access to additional capital. Repurchase agreements are subject to margin calls; 98% of invested assets in the cited financed asset classes were pledged. Total contractual obligations were $7.807 billion, including $2.431 billion of commitments to purchase loans.
- Fair-value estimates are significant and include substantial Level 3 assets. Non-cash items represented 106% of Q3 and 95% of nine-month net investment income, so reported earnings did not equate to cash generation. MSR impairment provisions were $44.3 million year to date, and ESS fair-value losses were $36.3 million.
- Key risks include interest-rate and prepayment changes, housing values, distressed-loan resolution and foreclosure timing, counterparty and funding availability, representations-and-warranties repurchases, and reliance on affiliated manager and servicer PFSI/PLS. Management reported no material change to the 2015 Form 10-K risk factors, no litigation expected to have a material adverse effect, and effective disclosure controls.
- Subsequent events: repurchase capacity was expanded or extended through amendments and new facilities; a $200 million JPMorgan facility included $50 million committed capacity. The company also agreed to sell $172 million UPB of performing loans, expected to settle in December 2016, subject to due diligence and closing conditions.
Important facts for investors to verify
- How much reported income is recurring and cash-based versus fair-value changes, retained MSRs and capitalized interest on modified loans.
- Whether short-term funding facilities renew on acceptable terms, and the company’s exposure to margin calls, collateral haircuts and refinancing concentration.
- Actual distressed-loan recoveries, liquidation times and expenses compared with valuation assumptions, including property values and prepayment expectations.
- Performance and capital usage of CRT agreements, including $427.7 million of deposits securing them and $12.2 billion UPB subject to credit-guarantee obligations.
- Whether the announced loan sale closes and how share repurchases and dividends affect book value, liquidity and leverage.