Pennymac Mortgage Investment Trust quarterly report, Q3 FY2017

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Business context and reporting period

PennyMac Mortgage Investment Trust (PMT) is an externally managed specialty finance company investing primarily in residential mortgage assets. Its activities include correspondent loan production, credit-sensitive investments, and interest-rate-sensitive investments such as mortgage servicing rights (MSRs), excess servicing spread (ESS), and mortgage-backed securities (MBS). This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2017; income comparisons are against the corresponding 2016 periods, and balance-sheet comparisons are against December 31, 2016.

Financial performance and position

  • Third-quarter results: Net investment income was $75.8 million versus $103.3 million a year earlier. Net income was $19.4 million versus $35.4 million; net income attributable to common shareholders was $13.3 million, or $0.20 per basic and diluted share, compared with $35.4 million and $0.52 basic/$0.49 diluted per share. Common dividends declared were $0.47 per share.
  • Nine-month results: Net investment income was $224.2 million versus $203.2 million; net income was $76.9 million versus $44.6 million. Net income attributable to common shareholders was $67.9 million, or $1.01 basic and $0.98 diluted per share, compared with $44.6 million and $0.63 per share. Dividends declared were $1.41 per common share.
  • Income drivers: Q3 2017 included $18.0 million of gain on loans acquired for sale, $13.8 million of net investment gains, $21.9 million of net servicing fees, and $11.3 million of net interest income. For nine months, the respective amounts were $54.3 million, $58.1 million, $49.3 million, and $36.2 million.
  • Margins and returns: Net interest margin was 0.93% in Q3 2017 versus 0.48% in Q3 2016; nine-month margin was 1.02% versus 1.58%. Net interest spread was 0.61% and 1.19% for the respective quarters, and 0.79% and 1.27% for the nine-month periods. Annualized return on average common equity was 4.0% for Q3 2017 versus 10.4%, and 6.9% for the first nine months versus 4.2%.
  • Cash flow: For the first nine months, operating cash flow was $283.1 million (versus use of $791.7 million), investing cash flow was $415.5 million (versus $168.2 million provided), and financing cash flow was a use of $633.6 million (versus $704.4 million provided). Cash increased $65.0 million to $99.5 million.
  • Balance sheet and liquidity: Total assets were $5.785 billion, down from $6.358 billion at year-end; total liabilities were $4.174 billion and shareholders’ equity was $1.611 billion. Cash and short-term investments totaled $105.2 million. Repurchase-agreement liabilities were $3.203 billion; the filing reports $3.802 billion in secured borrowings and a 2.52x leverage ratio, down from 3.58x. Repurchase facilities had approximately $2.690 billion of available capacity, including $457.1 million committed and $2.233 billion uncommitted. Management stated liquidity was sufficient for current needs.
  • Portfolio and capital: MSRs totaled $790.3 million, MBS $1.037 billion, distressed mortgage loans and REO $1.201 billion, and CRT-related deposits and derivatives $602.6 million. PMT issued $310 million of preferred shares in 2017, with initial fixed dividend rates of 8.125% for Series A and 8.00% for Series B. Book value per common share was $19.74 versus $20.26 at year-end.

Material changes versus comparable periods

  • Q3 net income declined year over year, primarily because lower correspondent-production profit margins reduced gains on loans acquired for sale; that gain fell to $18.0 million from $43.9 million. Loan sales were $18.5 billion versus $19.2 billion, and management cited higher mortgage rates and increased price competition as pressures on demand and margins.
  • Nine-month net income increased, mainly reflecting stronger CRT gains and smaller ESS losses. Net investment gains were $58.1 million versus a $5.1 million loss, including CRT gains of $66.6 million versus $22.1 million. ESS losses narrowed to $10.9 million from $36.3 million.
  • Net interest income fell to $11.3 million for Q3 from $17.8 million, and to $36.2 million for nine months from $55.3 million. Management attributed the decline to the shrinking distressed-loan portfolio and increased financing of MSRs and CRT investments; funding costs also rose.
  • Assets contracted by $572.5 million from year-end, mainly due to lower held-for-sale and distressed loan balances and lower REO, partly offset by growth in MBS, MSRs, and CRT deposits. Distressed mortgage loans and REO declined from $1.629 billion to $1.201 billion.
  • The company changed its segment reporting during 2017 to distinguish credit-sensitive, interest-rate-sensitive, and corporate activities; comparative segment data were restated.

Outlook, commentary, risks, and unusual items

  • No specific earnings or dividend guidance was provided. Management said investment growth will depend in part on access to additional financing and equity capital and described continued use of short-term secured funding, with longer-term financing sought where available.
  • Management assessed the effects of 2017 hurricanes on affected loans and collateral. It expected temporary increases in delinquency-related servicing costs and CRT losses, but did not expect significant negative effects on future earnings.
  • Noncash items were 118% of net investment income in Q3 and 113% for the nine months. Loan-sale gains include the estimated fair value of retained MSRs; fair-value changes and capitalized interest mean reported income does not necessarily equate to current cash generation.
  • Key risks include interest-rate, prepayment, credit, real-estate valuation, financing-renewal and margin-call risks; concentrated distressed-loan exposures; dependence on affiliated manager and servicer PFSI/PLS; and potential repurchase or indemnification claims on sold loans. The company reported $10.0 million of representation-and-warranty liabilities against $67.2 billion of loans subject to representations and warranties.
  • On October 27, 2017, PMT committed to sell approximately $324 million UPB of distressed-portfolio loans, subject to definitive documentation, due diligence, and customary conditions; completion is not assured. Management reported no legal proceedings expected to have a material adverse effect and no material changes to the risk factors in its 2016 Form 10-K.
  • PMT reported effective disclosure controls and no material change in internal control over financial reporting during the period. Agency seller/servicer capital and liquidity requirements were met at September 30, 2017.

Most important facts for investors to verify

  • Whether correspondent-production margins recover, given the Q3 decline in loan-sale gains and management’s comments on rates and competition.
  • How much reported investment income converts to cash, particularly given the high share of noncash valuation items and MSRs recognized in loan sales.
  • Performance and valuation assumptions for CRT assets, distressed loans, MSRs, and ESS, including the effects of prepayments, interest rates, home prices, and hurricane-related delinquencies.
  • Availability and renewal terms of short-term financing, exposure to margin calls, and the distinction between committed and uncommitted borrowing capacity.
  • Progress and realized proceeds from the proposed $324 million UPB loan sale, and the development of representation-and-warranty claims and losses.
  • The cost and dividend obligations of the newly issued preferred shares and the sustainability of common dividends in relation to cash generation and REIT distribution requirements.