PennyMac Mortgage Investment Trust — Q2 2011 Form 10-Q
Business context and reporting period. Specialty finance REIT investing primarily in residential mortgage loans and related assets, including distressed loans acquired at discounts. The filing covers the quarter and six months ended June 30, 2011; financial statements are unaudited. The company is externally managed by an affiliate and relies substantially on an affiliated servicer.
Financial performance and position
- Q2 results: Net investment income was $30.2 million, up from $13.9 million in Q2 2010. Net income was $16.6 million versus $8.2 million; diluted EPS was $0.59 versus $0.48.
- First-half results: Net investment income was $47.5 million versus $17.8 million; net income was $24.3 million versus $9.4 million. Diluted EPS was $0.96 versus $0.55.
- Earnings composition: Q2 net gains on investments were $22.1 million, including $18.4 million of mortgage-loan valuation changes; mortgage-backed securities recorded an $873,000 loss. Management cited a $7.4 million gain related to improved collectibility of government-insured loan claims. Fair-value estimates are materially based on Level 3 inputs.
- Costs and returns: Q2 total expenses rose to $12.2 million from $3.9 million, including $3.0 million interest expense and $3.3 million servicing fees. Mortgage-loan interest yield was 4.63% for Q2; aggregate interest yield on investments was 4.26%. A conventional operating margin is not presented.
- Balance sheet at June 30: Total assets were $883.5 million, up from $589.1 million at year-end 2010; shareholders’ equity was $522.9 million. Mortgage loans at fair value were $657.2 million and real estate acquired in settlement of loans was $48.9 million. Book value per share was $18.82.
- Debt and liquidity: Repurchase and related financing totaled approximately $341.0 million: $262.2 million against loans, $71.0 million against securities, and $7.8 million against real estate. Cash was $2.3 million and short-term investments $38.6 million. Management said liquidity was sufficient for near-term needs, while noting financing is short-term and subject to renewal, covenants, and margin calls.
- Cash flow, first half: Operating activities used $41.3 million and investing activities used $271.2 million; financing provided $269.5 million. Cash declined $43.1 million to $2.3 million, principally as funds were deployed into investments.
- Distributions and capital: The company issued about 10.9 million shares in a February offering and over-allotment, generating about $188.4 million net, and received about $0.5 million from its controlled equity offering in Q2. First-half distributions declared were $0.42 per share and paid were $0.84 per share. On August 2, the board declared a further $0.50 per share, payable August 31.
Material changes versus comparable periods
- Results increased substantially year over year, driven by a larger loan portfolio, leverage, and higher investment gains. Average investment balances grew sharply; gains also included significant fair-value movements rather than only recurring interest income.
- Assets grew 50% from December 31, 2010, funded by equity issuance and additional borrowing. Mortgage loans at fair value increased to $657.2 million from $364.3 million.
- Portfolio risk remained concentrated in distressed assets: about 74% of mortgage-loan fair value was nonperforming, and approximately 72% of the portfolio’s estimated fair value had loan balances exceeding current property values.
- Approximately 90% of investments in mortgage loans, MBS, and real estate were financed at June 30, compared with 24% at year-end 2010.
- Q2 2011 shareholder distributions were $0.42 per share; none were reported for the comparable 2010 period.
Outlook, risks, contingencies, and unusual items
- Management anticipated uneven portfolio growth because distressed-loan opportunities, financing availability, and capital-raising timing are unpredictable. It identified potential long-term financing, securitizations, repurchase facilities, and equity offerings as funding sources, without assurance of success.
- After quarter-end, PMT agreed to acquire a pool of assets with approximately $348 million unpaid principal balance for an initial price of about $177.5 million, potentially rising to $180.6 million. Settlement depends on obtaining additional capital; the filing reports a $6.1 million purchase completed by the report date and cautions that the remaining transaction may not settle.
- Key risks include distressed-borrower credit losses, falling home values, lengthy foreclosure and modification processes, illiquid assets and Level 3 valuations, reliance on a concentrated seller, affiliated manager and servicer relationships, refinancing and counterparty risk, and repo margin calls. The company noted challenging housing and economic conditions.
- REIT status requires compliance with tax and distribution tests; the company generally plans to distribute at least 90% of taxable income. Tax expense primarily relates to taxable REIT subsidiaries, and management expected its effective rate to be volatile.
- There were no material changes to previously reported risk factors, no legal proceedings identified as likely to have a material adverse effect, and management concluded disclosure controls were effective.
Important facts for investors to verify
- How much reported earnings depends on Level 3 valuation gains, especially the government-insured loan claim valuation and other recovery assumptions.
- Whether cash and qualifying liquid resources satisfy repo covenant minimums, given reported cash of $2.3 million and stated minimum unrestricted cash requirements; the filing text does not clearly reconcile these figures.
- The renewal, maturity, collateral, and margin-call terms of short-term financing, and the impact of any collateral-value decline or lender withdrawal.
- Whether the remaining CGM asset purchase closes, its final price and funding source, and the status of the separate $126.7 million pending loan commitments.
- Progress in resolving nonperforming loans, foreclosure timelines, collateral documentation, realized recoveries, and the sustainability of distributions relative to cash generation.