IPO Preview: Provident Mortgage Capital Associates

Feb.29.12 | About: Provident Mortgage (PMCA)

Based in Burlingame, California, Provident Mortgage Capital Associates (PMCA) scheduled a $125 million with market capitalization of $131 million at a price range mid-point of $15, for Thursday, March 1, 2011 PMCA is one of six IPOs scheduled for this week (see our IPO calendar). Notice that Yelp! is scheduled for Friday.

SUMMARY
PMCA, a REIT (a mortgage-oriented real estate investment trust), that intends to purchase mortgages originated by its Parent, Provident. The focus over time is to move assets into jumbo loans mortgages.

This IPO seems to be a sweetheart deal to set up a extra revenue stream for Provident Funding Associates shareholders.

There is no dividend payout objective, so PMCA is saying 'trust us', which is difficult to do in the current economic environment.

CONCLUSION
PMCA wants to sell 100% of the company on the IPO (including a current private placement, see 'use of proceeds' below) to maximize revenue streams for its parent, Provident Funding Associates.

It seems prudent to give PMCA a chance to see what kind of returns it can generate, then compare results with similar REITS. In other words, pass on this IPO.

BUSINESS
PMCA is a newly formed real estate finance company that will acquire residential mortgage loans, including primarily Jumbo loans, residential mortgage-backed securities and other mortgage-related assets.

PMCA will be externally managed and advised by its Manager, an affiliate of Provident Funding Associates.

ABOUT PROVIDENT FUNDING ASSOCIATES
For the nine months ended September 30, 2011, according to Inside Mortgage Finance, Provident was the largest wholesale mortgage originator, representing mortgage loans sourced and submitted to Provident by independent mortgage brokers on behalf of borrowers, the third largest non-bank mortgage originator and the ninth largest mortgage originator in the United States, in each case in terms of loans funded directly to the borrower, with $13.8 billion in origination volume.

In the nine months ended September 30, 2011, Provident's origination volume totaled $14.9 billion. Provident's business philosophy has been built around leveraging proprietary technology to create a standardized loan experience with a "no exceptions" mindset, which requires strict adherence to policies and procedures and does not allow for any transactions to be conducted outside of specified parameters.

This approach, according to PMCA, has enabled Provident to maintain a low cost structure, which in turn allows it to offer its loan products at attractive prices in the marketplace. In return for lower prices in the marketplace, Provident attracts high quality mortgage loans.

An indication of the high quality of these products is that, for the nine months ended September 30, 2011, the average FICO score of Provident's originated mortgage loans was 773 and the average loan-to-value ratio at origination was 62%.

Another indication of this quality is evidenced by the loss experience related to breaches of representations and warranties of 8.4 basis points, or bps (0.084%) on the approximately $208 billion of loans originated by Provident from 2001 through September 30, 2011.

Additionally, as of September 30, 2011, Provident's $51.5 billion mortgage servicing portfolio had a rate of delinquencies 30 days or greater or in foreclosure of 2.41% based on the total dollar volume of loans serviced, which Provident believes compares favorably to the rate reported by Inside Mortgage Finance Large Servicer Delinquency Index of 10.70%.

DIVIDENDS
"We generally intend over time to pay quarterly dividends in an amount equal to our taxable income."

BASE MANAGEMENT FEES
PMCA will pay its Manager a base management fee under the management agreement, calculated and payable quarterly in arrears, equal to 1.5% per annum of stockholders' equity.

Each of PMCA's officers and non-independent directors is also an employee of the Manager and/or one of its affiliates.

INCENTIVE FEE
PMCA will pay a quarterly incentive fee to our Manager in an amount equal to 20.0% of the dollar amount by which Core Earnings for the most recently completed fiscal quarter, or the Current Quarter, before the incentive fee received in relation to such fiscal quarter exceeds a quarterly hurdle (as described below).

Quarterly Hurdle: The product of (1) the weighted average of the issue price per share of common stock in all of our offerings multiplied by the weighted average number of shares of common stock outstanding during the Current Quarter and (2) 8%, or the Hurdle, expressed on a quarterly basis.

TERMINATION FEE
The termination fee is equal to three times the sum of (1) the average annual base management fee and (2) the average annual incentive fee earned by the Manager during the prior 24-month period immediately preceding the date of termination, calculated as of the end of the most recently completed fiscal quarter prior to the date of termination.

Upon termination of the management agreement, the restricted shares of common stock issued to the Manager in respect of any incentive fee shall vest immediately to the extent such shares have not already vested.

CONFLICTS
Provident will not purchase any loan, RMBS or MSRs (and/or participation interests in MSRs) from any other fund or investment vehicle managed or advised by Provident or one of its affiliates, unless such loan, security or right is first offered to PMCA.

Currently, two such affiliates of Provident are Provident Mortgage Trust, Inc., or PMT, a private REIT that invests in Agency RMBS, Non-Agency RMBS, IO Strips and mortgage loans (primarily fixed-rate home equity term loans), 85% of the outstanding common stock of which is owned by Craig Pica, the Chairman of the board of directors, and CFSB, which is 89% owned by Craig Pica.

ASSET ACQUISITION STRATEGY
PMCA's asset acquisition strategy will focus on acquiring a diversified portfolio of residential mortgage loans, RMBS and other mortgage-related assets that appropriately balances the risk and reward opportunities PMCA's Manager observes in the marketplace.

Given the current state of the mortgage market, which is heavily dominated by the origination and securitization of conforming mortgage loans, PMCS expects to initially focus on acquiring primarily Agency RMBS and, to a lesser extent, Jumbo loans.

Given PMCA's long-term view that the market for non-conforming residential mortgage loans including, in particular, Jumbo loans, will grow, PMCA expects its portfolio to become increasingly focused on this asset class over time.

USE OF PROCEEDS
PMCA expects to net $120 million from its IPO.

In addition, PMCA expects that it will sell shares of common stock to Provident and its affiliates, including Craig Pica, the Chairman of the board of directors, and certain other members of our senior management team, in a separate private placement, at the initial public offering price per share, for a minimum aggregate investment of 4.5% of the gross proceeds of this offering, excluding the underwriters' over-allotment option, up to $5.625 million, resulting in aggregate net proceeds of $125.6 million

Upon completion of this offering and the concurrent private placement, PMCA will apply substantially all of the net proceeds of this offering, the concurrent private placement and borrowings under repurchase agreements to acquire an initial portfolio of assets from Provident and its affiliates consisting primarily of shorter duration Agency RMBS and IO Strips.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: Provident Mortgage Capital Associates (PMCA) expects to price Wednesday evening for trading Thursday, PMCA is the focus ticker.