PennyMac Financial Services, Inc. — Q3 2019 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2019. The unaudited statements consolidate PennyMac Financial Services and its subsidiaries. Unless stated otherwise, figures below are in millions of dollars. The balance sheet compares September 30, 2019 with December 31, 2018; income and cash flow comparisons are year over year.
Business context and results
PennyMac is a mortgage-focused financial services company with production, servicing, and investment management segments. Its business includes originating and acquiring residential mortgage loans, servicing loans, and managing investments for PennyMac Mortgage Investment Trust (PMT). PMT is a significant affiliate and business counterparty.
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Total net revenue | $436.3 | $250.9 | $987.0 | $733.4 |
| Income before taxes | $166.2 | $61.7 | $326.1 | $209.4 |
| Net income | $121.5 | $56.2 | $240.3 | $191.5 |
| Net income attributable to PFSI common stockholders | $121.5 | $14.5 | $240.3 | $48.9 |
| Diluted earnings per share | $1.51 | $0.57 | $3.01 | $1.94 |
| Net interest income | $27.1 | $22.2 | $65.8 | $50.5 |
| Net loan servicing fees | $66.2 | $109.7 | $205.9 | $340.2 |
For Q3, loan-sale gains were $235.7 million, compared with $56.9 million a year earlier. Loan origination fees were $49.4 million and PMT fulfillment fees were $45.1 million. Expenses rose to $270.2 million from $189.2 million, including higher compensation and loan origination costs. The filing attributes stronger production revenue to higher volume and improved margins. Production pretax income increased to $179.3 million from $25.7 million; servicing recorded a pretax loss of $18.1 million, versus income of $33.6 million.
Financial position, cash flow, and liquidity
- Assets and equity: Total assets were $9.30 billion, up from $7.48 billion at year-end 2018; stockholders’ equity was $1.91 billion, up from $1.65 billion.
- Cash and liquidity: Cash was $201.3 million and short-term investments were $90.7 million. Management stated that liquidity was sufficient for current needs. Available repurchase-agreement borrowing capacity was $1.30 billion, largely uncommitted; the company also reported $150 million unused under its revolving credit facility.
- Debt and funding: Balance-sheet borrowings included $3.54 billion under repurchase agreements, $514.6 million under loan participation agreements, and $1.29 billion in notes payable. Other financing included $183.1 million of excess servicing spread financing and $23.9 million of capital lease obligations. Most repurchase and participation funding is short-term and collateralized.
- Cash flow, nine months: Operating activities used $1.69 billion, primarily reflecting growth in mortgage-loan inventory. Investing activities provided $169.4 million, including derivative settlements, partly offset by MSR purchases and increased margin deposits. Financing activities provided $1.57 billion. Cash and restricted cash increased $45.8 million to $201.7 million.
- Operating scale: The servicing portfolio was $348.5 billion in unpaid principal balance, up from $299.3 billion at December 31, 2018. Commitments to purchase and fund mortgage loans were $8.3 billion at quarter-end.
- Capital and agency requirements: The filing reports actual capital and liquidity above the stated Fannie Mae, Freddie Mac, and Ginnie Mae requirements. Management also stated the company was in compliance with borrowing covenants.
Material changes and unusual items
- Total net revenue rose 74% in Q3 and 35% for the first nine months year over year. Pretax income increased to $166.2 million in Q3 and $326.1 million year to date.
- Servicing fees declined despite portfolio growth. Lower interest rates drove substantial fair-value losses on mortgage servicing rights (MSRs) and servicing liabilities; hedging gains partly offset these losses. Net MSR/servicing-liability fair-value changes, net of hedging and excess servicing spread effects, reduced servicing results by $158.7 million in Q3 and $436.7 million for the nine months.
- Effective tax rates increased to 26.9% for Q3 and 26.3% year to date, from 9.0% and 8.6%, respectively, primarily because the November 2018 reorganization made income formerly attributable to noncontrolling interests taxable at PFSI. The reorganization also makes common-stockholder income and per-share comparisons with 2018 less directly comparable.
- The company adopted lease accounting in January 2019, recognizing operating lease right-of-use assets and liabilities; the adoption did not affect reported income or cash flows.
- A repurchase agreement that had provided financing incentives expired August 21, 2019. Those incentives were lower in 2019 than in the comparable 2018 periods.
- On October 31, 2019, the board declared a new quarterly cash dividend of $0.12 per common share, payable November 29 to shareholders of record November 15. No dividend was declared in the reported 2019 quarter.
Outlook, risks, and contingencies
The filing provides no specific financial guidance. Management cited higher production volume and improved margins, but emphasized that results depend on mortgage-market conditions and interest rates. The company’s MSRs and other fair-value positions are sensitive to prepayment speeds, discount rates, and servicing costs; a sensitivity analysis is not an earnings forecast. Key risks include rate volatility, refinancing and prepayment activity, funding availability and margin calls, dependence on GSEs and government programs, regulatory and licensing requirements, loan repurchase or indemnification claims, counterparty performance, and reliance on PMT. PMT-related revenue represented 32% of Q3 net revenue, compared with 25% a year earlier.
Loan-sale representations and warranties remain a contingent exposure: the liability was $20.0 million at September 30, while the unpaid principal balance of loans subject to those provisions was $166.5 billion. The company reported a putative shareholder and derivative lawsuit challenging the 2018 reorganization; a motion to dismiss was pending. Management did not expect the resolution of legal matters to have a material adverse effect. The filing reported no material changes to previously disclosed risk factors and no off-balance-sheet arrangements.
Management concluded disclosure controls were effective. During the quarter, the company substantially completed implementation of an internally developed loan-servicing system and updated related financial reporting controls; it said monitoring and testing continue.
Important facts for investors to verify
- How much of reported production profit reflects recurring cash economics versus noncash fair-value gains on loans, MSRs, and related hedges?
- Whether servicing economics recover or remain pressured by prepayments, MSR valuation changes, servicing costs, and hedge performance.
- The renewal, availability, collateral terms, and margin-call exposure of short-term funding facilities, particularly the largely uncommitted repurchase capacity.
- The sustainability of production volume, margins, and PMT-related fees, and the implications of PMT’s share of revenue.
- Progress testing the new servicing-system controls, developments in the reorganization litigation, and the cash and capital effects of the newly declared dividend.