Sunday, January 31, 2010

PennyMac's big discount

Of all the 2009 MREIT IPO's PennyMac Mortgage Investment Trust (PMT) trades at a worst discount to book value. This creates plenty of head scratching as to if PMT is pregnant with opportunity or pregnant with something else.

Reading the S-11's gives a number of reasons not to invest in PMT beyond those concerns with the target asset class; credit impaired residential mortgage assets requiring intensive servicing.

  • The people who run this REIT, are same ones who created this mortgage crisis.
    "Certain of the officers of PennyMac who are former employees of Countrywide, including Stanford L. Kurland, our chairman and chief executive officer, who was chief operating officer of Countrywide until September 2006, have been named as defendants in lawsuits in which Countrywide and other employees and former employees of Countrywide are defendants."
  • The management fee structure is not attractive. (1.5% base + 20% xs 8%), incentive fee's in a structure with potentially high leverage (typical of RMBS/Residential investors) can be dangerious
  • The external manager has split ownership (37% Blackrock, 37% Highfields Capital, and only 26% "Management") which raises potential issues of stability and management buy in at the external manager level.
    "BlackRock and Highfields Capital, PennyMac's strategic investors, are not obligated to provide us with any assistance and could compete with us."
  • There is a built in cash leakage due to the assignment of servicing to party related to the manager yet outside the REIT: PennyMac Loan Servicing (PLS). It is so important when dealing with externally managed company's to look at all sources of potential cash leakage in favor of management. What you are trying to avoid is any sort of "gross asset" based compensation arrangement, which is very open to abuse.
  • There is an even worse conflict of interest in that PLS may earn origination fee's.
    "This may provide PLS with an incentive to refinance a greater proportion of our loans than it otherwise would and/or to refinance loans on our behalf instead of arranging the refinancings with a third party lender. It may also provide PLS with an incentive to provide financing to facilitate sales to third parties with regard to the disposition of real estate that we acquire through foreclosure."
  • The public REIT is competing with two PennyMac managed private investment funds for investment opportunities and does so without co-investment rights. These funds have roughly $300M+ in uncommitted capital.
    "No assurance can be given that PCM will act in our best interests with respect to the allocation of personnel, services and resources to our business."
  • Finally the fairly unique risk now facing holders of residential loans: a hostile court system.
    "The borrowers under sub-performing or non-performing mortgage loans may have a variety of rights to contest the enforceability of the mortgage loans and prevent or significantly delay and increase the cost of any foreclosure action, including, without limitation, allegations regarding fraud in the inducement by the original lender or broker, failure of the lender to produce the original documentation, improper recordation of the mortgage, various theories of lender liability, and relief through the U.S. Bankruptcy Code and similar state laws providing debtor relief." This sort of thing has been a real stinger, as judges have been known to vacate a mortgage over the holders inability to produce documentation, or are otherwise unsympathetic to the holders of sub-prime loans.
  • Another issue is the companies long URL: No one is ever going to remember or bother to type that into a browser.

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