PennyMac Lender Returns to Roots With Planned IPO

Kurland When former top executives from Countrywide Financial Corp. started PennyMac Financial Services Inc. in 2008, they seized upon what was then one of the hottest trends in finance: buying up distressed mortgages. But now, officials at the Moorpark company are taking the firm back to its origins. The firm filed a prospectus this month for an initial public offering on the New York Stock Exchange, aiming to raise $288 million to expand its lending operations, including direct-to-consumer origination and correspondent lending, which involves selling loans originated by the firm to other banks. Company officials did not comment, citing a mandatory quiet period following its Securities and Exchange Commission filing, but they have publicly indicated PennyMac is positioning itself for growth in originating prime loans as the housing market rebounds. “In the initial years of our operation … we identified distressed investing as an attractive opportunity and we raised and deployed capital through a series of successful transactions,” the company said in its filing. “As the mortgage market presented opportunities in new loan production and servicing, we expanded our management and capabilities to profitably capitalize on these businesses as well.” The five-year-old company was built on its publicly-traded real estate investment trust, PennyMac Mortgage Investment Trust, which reported $138 million in profit last year and $1.2 billion in book equity as of Sept. 30. The REIT acquires mortgages from lenders looking to clear their books of the distressed assets, but the parent also has slowly built its own business to include direct lending – mostly through a direct-to-consumer Internet model. Despite its profitability, PennyMac has drawn critical scrutiny for its ties to Countrywide Financial Corp., a leading sub-prime lender that was purchased by Bank of America Corp. in 2008 amid the financial crisis. The deal ultimately strapped the Charlotte, N.C. bank with tens of billions of dollars in bad loans. Countrywide co-founder and Chief Executive Angelo Mozilo took most of the heat, paying a $22.5 million penalty in 2010 to settle SEC allegations over the company’s risky loan practices. But PennyMac’s Chairman and Chief Executive Stanley Kirkland had played a big role in its growth too as Mozilo’s chief lieutenant until he left in 2006. What’s more, half a dozen other officials at PennyMac also came from Countrywide. Chief Operating Officer David Spector spent 16 years at Countrywide. Chief Financial Officer Anne McCallion was in the same position at Countrywide when it was acquired by Bank of America. But the company is now spinning those experiences into a positive. In its prospectus, the company addressed the past and its possible impact on PennyMac’s offering. The company said its management team’s “extensive experience managing all aspects of the residential mortgage business through a variety of credit cycles and market conditions” will be a benefit to the firm. It also said it benefits from its ability to originate loans backed by government-sponsored lender Fannie Mae and Freddie Mac, as well as the Federal Housing Administration. But in its risks disclosures, PennyMac notes that it “cannot assure you that any existing or future investigations, litigation or negative publicity involving Countrywide Financial Corp. will not generate negative publicity or media attention for us or adversely impact us.” The company faces other challenges. It is structured so that most of its revenue flows through the REIT, and analysts say the new arrangement with the parent company will pull from the REIT’s profits. PennyMac Financial is the parent company of Private National Mortgage Acceptance Co., which acts as the investment manager of the REIT, while another subsidiary, PennyMac Loan Services, generates revenue by taking a fee from the REIT for the loans it services. The loan services unit also conducts correspondent loan business in which it originates loans that it then sells wholesale to banks and other non-bank lenders, taking a fee for the sale. Bose George, senior mortgage REIT analyst for New York investment banking firm Keefe, Bruyette & Woods, wrote in a note following the filing that the new fee structure that comes as part of the IPO may impact the REIT’s bottom line. The REIT will now pay higher fees to the managing arm of PennyMac for servicing loans, chipping away at the REIT profits. While the analyst maintained PMT’s price target, he cut his earnings estimate on the news. “We are trimming our forward estimates to reflect the new management agreement offset by higher income reflecting the strong earnings from the distressed portfolio in the fourth quarter,” he wrote. PennyMac is pushing ahead with its plans. The company, which got its start with financial backing from New York investment firms BlackRock Inc. and HC Partners, reported sharply rising profits and revenue in its prospectus released earlier this month. Through the first nine months of last year, it earned $60.4 million on revenue of $157 million, up from net income of $11.5 million on revenue of $60.4 million in the same period a year earlier. Earlier this year, the firm expanded its reach by opening its only retail branch in Pasadena. Last year, it opened a Tampa, Fla. facility to support its growing correspondent lending operations. And it has aggressively sought new business through its online advertising and direct-to-consumer business model, in addition to increasing its portfolio of mortgages through acquisition. The company also intends to maintain its distressed portfolio, which it believes will remain strong throughout the year. “Distressed whole loan investments are also expected to increase, and they remain a key investment strategy,” said Kurland during an earnings call to discuss the REIT’s fourth quarter earnings. “We see new participants entering the market looking to sell legacy assets in order to clean up their balance sheets and free up capital.” Despite the steady growth of the REIT, however, the IPO is not guaranteed to raise the capital PennyMac wants. Underwritten by Citigroup, Bank of America Merrill Lynch, Credit Suisse, and Goldman Sachs & Co., the earnings target is far below the target set for the PennyMac REIT in 2008. In 2008, when the REIT went public as PMT, the firm expected to raise as much as $750 million with 20 million shares priced at $20 each. It raised less than half that, with 16 million shares raising $320 million. Kurland however, expressed optimism in the diversification strategy during the earnings call. “(PennyMac) … is in an excellent position to capitalize on these opportunities and we remain optimistic regarding the U.S. residential mortgage market and our ability to grow as it evolves,” he said.