PMT: A Different Style mREIT Now At An Attractive Entry-Point

Oct.12.11 | About: PennyMac Mortgage (PMT)

PennyMac Mortgage Investment Trust (NYSE:PMT) is the publicly traded REIT portion of Private National Mortgage Acceptance Co LLC. (PennyMac). There are several elements that differentiate PMT from other mortgage REITs (mREIT), but despite these differences the stock price has been beaten down alongside other mREITs and provides an attractive buying opportunity.

The first differentiator is that PennyMac is made up of much more than just the REIT. The company manages independent funds for institutional clients and has an integrated loan servicing division. This structure provides some major competitive advantages for PennyMac, leading to stronger performance of the REIT.

The second differentiator is PMT’s aversion to debt. The company has a much lower leverage ratio than other mREITs and much less reliance on short term funding and the spread between short and long term rates.

Structure

Institutional involvement is a great strength of PMT. PennyMac is owned by BlackRock (NYSE:BLK), Highbridge Capital, and management which includes former Countrywide CFO/COO Stanford Kurland. The REIT is about 72% institutionally owned with the top 10 institutions owning almost 50%. Add to this an unreported amount of institutional, separately-managed accounts and you can see that a number of large institutions have a strong vested interest in seeing PennyMac succeed.

The institutions provide technical and financial expertise that should allow PennyMac’s investments, including the REIT, to outperform. BlackRock got its start providing analytics for distressed assets at GE Capital (NYSE:GE) and has since built a world premier analytics platform. Over $10 trillion in assets is managed on BlackRock’s platforms and the BlackRock Solutions division has made a name for itself providing distressed debt analysis including a recent project for the Central Bank of Ireland.

The second major strength of PennyMac’s structure is its integrated loan servicing divisions. Because the company purchases loans at distressed prices--generally 50-70 cents per dollar of full loan value--there is room for modifications without having to write down assets or take losses. The loan servicing division provides the infrastructure to implement those mortgage modifications.

Unlike most banks whose loan divisions are built on origination and a “sell and forget” model, PennyMac is built to handle the complexities of modifications and do so in large volume. This allows the company to efficiently and effectively take loans off of bank balance sheets, modify them, and ensure the highest possible rate of return.

click to enlarge
PennyMac Structure with Institutional FoundersClick to enlarge

Leverage

Unlike many of its counterparties, PennyMac does not rely on debt, especially the short term funding market, to finance its book. The REIT carries no long term debt, has $800 million in cash and short term receivables, and just $348 million in current liabilities as of the end of Q2. This insulates the company from short term swings in interest rates which are a major risk for other mREITs, especially as the European debt crisis continues to evolve.

Company

Cash & Short term

Current Liabilities

LT Debt

Debt/Capital Ratio

PMT

$800

$348

$0

0%

NLY

$402

$84,431

$600

85.05%

CIM

$16

$4,646

$2,151

65.37%

MFA

$503

$9,046

$0

76.42%

Click to enlarge

All numbers from TD Ameritrade as of most recent quarter.

This lack of leverage should also reduce the impact that Operation Twist has on PMT. Leveraged mREITs make money off the spread between the short-term rates at which they raise cash and the long-term rates they receive from the mortgages. Twist, which is designed to lower long-term rates while raising short-term rates, will squeeze that spread. Because it has no short-term debt, PMT doesn’t have to worry about increased borrowing costs.

In addition, PMT should be less impacted by the reduction in long-term rates from Twist because of the types of mortgages they hold. A majority are underwater and none of them are agency-backed. This reduces the likelihood that the loans will be able to be refinanced even if there is a government-backed refi program, thus reducing prepayment risk for PMT.

Currently trading at .83X book with no debt and a yield of 12.75%, PMT is a lower risk mREIT that can provide a big boost to your portfolio’s yield as well as some room for capital appreciation as markets normalize.

Disclosure:
I have no positions in any stocks mentioned, but may initiate a long position in PMT over the next 72 hours.

Additional disclosure: I was previously employed by Blackrock Solutions through their internship program. I did not have access to any of PennyMac’s financial records and have no knowledge of material non-public information.