PennyMac Mortgage Investment Trust (PMT)

[eastunder]

Buy This Undervalued mREIT
By Adnan Khan - April 26, 2013

http://beta.fool.com/equityfinancials/2013/04/26/buy-this-mreit-undervalued-mreit/32748/?source=eogyholnk0000001


PennyMac Mortgage Investment (NYSE: PMT) reported better than expected first quarter earnings on April 23. The remainder of this article will review the latest earnings of PennyMac Mortgage and see whether its closest peers can benefit from the strength in their results.

Financials

A quick look at the latest financial disclosures of the company reveals that its reported earnings per share of $0.9 was $0.06 ahead of the consensus mean expectation. Further, the bottom line was 8% ahead of the prior quarter’s earnings per share. This is despite the fact that the company generated revenues (net investment income) of $119.1 million, down 5% compared to the linked quarter.

During the quarter, PennyMac Mortgage reported total expenses of $63 million, which increased 6% over the linked quarter. The increase was attributed to 62% and 13% sequential increases in loan servicing expense and interest expense, partially offset by a decline in loan fulfillment fees. Compensation expense remained relatively flat over the quarter.

As a result, the company posted a net income figure of $53.3 million at the end of the first quarter, compared to net income of $49.2 million at the end of the fourth quarter of the prior year. This is a sequential increase of 8%.

Segmental Analysis

PennyMac Mortgage Investment Trust operates as a debt REIT in the US financial sector and for the purpose of reporting the company has classified its business into the following two business segments; Investment Activities and Correspondent Lending.

Within the Correspondent Lending business segment, PennyMac acquires newly originated loans from mortgage lenders, sells them to an Agency or a third party, or pools them into MBS to be securitized while retaining its mortgage servicing rights. The pre-tax income attributable to this business segment was $8.9 million for the first quarter.

Under the Investment Activities business segment, the company invests in distressed mortgage assets, most of which are purchased at a discount to their par values, reflecting their higher risk of default. Investment Lending remains the largest contributor to the company’s entire pre-tax income. The business segment earned $50.3 million in pre-tax income, which is 90% of the entire first quarter’s pre-tax income.

Competition

Since PennyMac is majorly invested in non-Agency mortgage related securities, its closest peers include Newcastle Investment (NYSE: NCT) and Nationstar Mortgage Holdings (NYSE: NSM). Newcastle Investment actively manages a portfolio of real estate securities, loans, excess mortgage servicing rights, and other real estate related assets for which none of the government Agencies guarantee the principal and interest payments. The company’s investment in real estate securities is spread across residential and commercial security types, providing the company sufficient diversification. The company has a market cap of $2.76 billion and offers a dividend yield of 8%. Newcastle is scheduled to release its first quarter performance on May 3, 2013.

Nationstar Mortgage Holdings has a market cap of over $3.09 billion and a well diversified investment portfolio. The company engages in servicing of private label residential mortgage loans besides originating and securitizing single family mortgage loans to government sponsored entities. Given Nationstar’s continued capacity to originated HARP loans, I believe it is among the only two mortgage REITs that will benefit the most from the 2-year extension of HARP. The extension will allow continued elevated levels of originations and wider GOS margins than the broader market given the pay-ups of HARP. Nationstar is scheduled to report its first quarter performance on May 7.

Valuations

Since the book values of financial stocks are marked to market frequently, they are considered to trade in proximity to their book values. Therefore, for the purpose of relative valuation, I am using a comparison of price to book value multiples.

PennyMac Mortgage is currently trading at a 15% premium to its book value. This is compared to an 86% premium for Newcastle Investment, while Nationstar is trading at a 4 times its book value. Therefore, it appears PennyMac is the most attractively valued stock within the non-Agency mREIT sector.

Conclusion

I am bullish on PennyMac Mortgage Investment. The stock has demonstrated strong performance during the prevailing ultra-low interest rate environment. Further, it offers attractive relative valuations. I believe PennyMac’s peers will also report strong first quarter results. Besides, I believe Nationstar presents an excellent opportunity as it will benefit the most from the HARP extension.