Market Overview

Is the American Housing Market Still Underwater?


US retail mortgages may be one of the scariest assets at this point in time. Apart from Italian or Greek bonds, owning securities back by retail mortgages is harrowing for investors across the globe. Although the brunt of the damage occurred a few years ago, the stigma and uncertainty related to mortgages and retail loans still exists.

As we now know, mortgage lenders decreased their screening standards and essentially gave loans to everyone that walked in the doors. At this point in time, is there anyone who retains responsibility in the housing market? One interesting real estate investment trust is the PennyMac Mortgage Investment Trust (NYSE: PMT). Despite having a small market capitalization of about $475 million, PennyMac may have certain characteristics that appease investors.

Over the last several quarters, it appears that management has been able to invest in mortgages pretty well. Starting in 2010, the company has been consistently profitable, managing to increase revenues each quarter. Operating expenses have also increased, but it has not become a detriment to the company's operating income. Non-operating expenses have not crippled the company either, and in the end, net income has progressively increased. In the third quarter, the REIT's performance beat analyst expectations and posted a record high net income of $21 million.

The REIT's cash situation appears to be a very different story from its statement of operations. While the fund has been increasing net income over time, changes in working capital have killed cash flow from operations. One interesting line item is the net gain on mortgage loans, which lost about $66 million over 2011. This essentially means that investments in mortgage loans have been floundering, and have done much worse in 2011 than in 2010, when the loss from this line item was about $19 million. Average working capital accounts also negatively affected cash flow, whether it was receivables or payables.

Cash flow from investing activities have been negative, but this is expected for a fund, which actively makes additions to its short-term and long-term portfolios. One interesting thing to note is that PennyMac is not making any sales in its investment portfolios. It appears to be actively accumulating investments, however. This may or may not be a sign of strength or weakness in the company. It could be possible that management still thinks that mortgages are undervalued and are trying to accumulate as much as possible for a huge future payoff.

Cash flows from financing activities shows that management has been significantly tapping into the debt capital markets to sustain its activities. For example, in the last quarter itself, the REIT issued a total of about $1.6 billion in debt. However, it has been able to keep up in debt repayments, paying back about $1.45 billion in the same quarter. Management has also opted to issue common stock over the last few quarters. Cumulatively, the company has lost about $33 million in cash in the last quarter, which is not necessarily a good thing for investment funds.

As a result of the company's business model, the balance sheet has a small amount of line items. It's assets are essentially tied to its real estate investments, and based on how cash has been used over the last several quarters, it is clear that these assets have been increasing significantly. Short-term debt has also increased significantly, along with paid-in capital. All these trends are expected based on how management has been using its cash in its business' operations.

PennyMac Mortgage Investment Trust appears to be a growing fund that is actively purchasing retail mortgages and related securities. While the company has not liquidated many investments yet, it appears to have a great amount of confidence in American retail housing. However, certain factors like its borrowing capacity may be of concern to some investors.

PennyMac Mortgage Investment Trust is currently trading at $17.12, down 6.01% for the year.

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