Pennymac Mortgage Investment Trust — FY2011 Form 10-K
Reporting period: Fiscal year ended December 31, 2011. This is an annual filing, not a standalone Q4 report; fourth-quarter figures below are from the filing’s unaudited quarterly data. Amounts are in U.S. dollars.
Business context
Pennymac is an externally managed mortgage investment trust focused on residential mortgage assets. Its investment portfolio emphasizes distressed loans, including nonperforming loans, and real estate acquired through foreclosure. It also expanded correspondent lending, purchasing newly originated loans for resale or transfer and retaining some mortgage servicing rights. PNMAC Capital Management manages the trust, and affiliate PennyMac Loan Services primarily services its loans.
Financial performance and position
| Metric | FY2011 | FY2010 |
|---|---|---|
| Net investment income | $128.6 million | $44.1 million |
| Net income | $64.4 million | $24.5 million |
| Diluted earnings per share | $2.41 | $1.44 |
| Total expenses | $56.1 million | $17.0 million |
| Interest income | $36.1 million | $14.6 million |
- FY2011 earnings included $82.6 million of net gains on investments and $7.6 million of correspondent-loan gains. The filing attributes much of the improvement to portfolio growth and fair-value gains; these gains are not equivalent to recurring cash income.
- At December 31, 2011, total assets were $1.386 billion, total liabilities $840.0 million, and shareholders’ equity $546.0 million. Book value was $19.22 per share, versus $19.01 a year earlier.
- Borrowings totaled $812.4 million, chiefly under repurchase agreements and forward purchase agreements. Cash was $14.6 million, short-term investments $30.3 million, and a $50.0 million Treasury security matured January 19, 2012.
- Operating cash flow was negative $275.1 million and investing cash flow negative $277.8 million; financing provided $522.1 million. Cash declined $30.9 million to $14.6 million.
- Management reported a 4.35% annualized interest yield on average investment assets and a 3.74% borrowing cost. The filing does not present a conventional operating margin measure.
- Correspondent lending purchases totaled $1.319 billion in FY2011, including $1.0 billion in Q4; year-end inventory was $232.0 million. The segment generated $7.3 million of pretax income for the year.
- At year-end, the investment portfolio included $825.6 million of distressed mortgage loans, $103.5 million of REO, $72.8 million of MBS and $6.0 million of MSRs. About 75% of the fair value of the mortgage-loan investment portfolio was nonperforming.
Fourth-quarter results and changes from the prior year
- Q4 2011 net investment income was $39.1 million, net income $19.6 million and diluted EPS $0.70, compared with Q4 2010 net investment income of $13.6 million, net income of $7.3 million and diluted EPS of $0.43.
- Assets increased 135% year over year to $1.386 billion, while borrowings increased to $812.4 million from $248.6 million. Equity rose to $546.0 million from $319.9 million, aided by a 2011 public offering that generated approximately $188.4 million net and additional at-the-market issuance.
- The company substantially increased correspondent lending from $30.1 million of purchases in 2010 to $1.319 billion in 2011. Distressed mortgage-loan purchases rose to $647.6 million from $417.2 million.
- Interest expense rose to $16.9 million from $0.8 million, and servicing fees to $14.2 million from $3.0 million, reflecting higher portfolio balances and leverage.
- MBS fair-value losses were $2.8 million in 2011, versus gains of $0.2 million in 2010; management cited market concerns and a higher discount rate for subprime MBS. Mortgage-loan gains increased substantially, supported by valuation changes, payoffs and loan resolution activity.
Outlook, risks and unusual items
- Management expects investment growth to be uneven and says the supply of distressed loans may recede as conditions improve. It is expanding correspondent lending and evaluating other mortgage-related opportunities. No quantified earnings or return guidance is provided.
- The company stated that current liquidity was sufficient for short-term needs, but all known contractual obligations at year-end matured within one year. Repurchase financing is short-term, collateralized and subject to margin calls; the company depends on renewals or replacement financing.
- Significant risks include distressed-loan credit losses, falling home prices, delays in foreclosure and liquidation, interest-rate and prepayment volatility, fair-value estimation uncertainty, leverage and counterparty risk, and dependence on affiliated manager and servicer. About $575.5 million of 2011 distressed-asset purchases came from or through Citigroup subsidiaries; Citigroup also provided financing.
- Related-party arrangements include management fees of 1.5% annually of defined shareholders’ equity and a potential incentive fee of 20% of core earnings above an 8% hurdle. The filing notes the agreements were not negotiated at arm’s length. Performance incentive fees were zero in 2011.
- The trust intends to distribute at least 90% of taxable income to maintain REIT status, but has no minimum dividend commitment. FY2011 declared dividends were $1.42 per share; the board declared a $0.55-per-share dividend in February 2012.
- Management and Deloitte reported effective internal controls; Deloitte gave an unqualified opinion on the financial statements. No material legal proceedings were reported. A trustee resigned effective March 7, 2012.
- Fair-value gains materially influenced earnings, and many mortgage assets rely on Level 3 estimates using unobservable inputs. The filing cautions that estimates may differ from realizable values. FY2011 also included $10.3 million of net REO valuation adjustments, partly offset by sale gains.
Important facts for investors to verify
- How much of reported earnings reflects realized cash proceeds versus unrealized fair-value gains, and whether those gains persist.
- Performance, resolution progress and collateral values for the nonperforming-loan portfolio and REO, including foreclosure timelines and redefaults.
- Renewal, extension and refinancing of short-term facilities; covenant headroom, margin-call capacity and the ability to settle forward purchase commitments.
- Concentration in Citigroup-sourced assets and financing, and the economic terms and allocation of investment opportunities involving affiliates.
- Correspondent lending profitability after hedging, financing, servicing and representation-and-warranty costs, as well as growth in repurchase exposure.
- REIT qualification, taxable income and distribution requirements, including the distinction between GAAP net income and cash available for dividends.