In the year or so since PennyMac Financial Services Inc. has gone public, the firm has reported solid growth in both revenue and profit, all while diversifying its business model to meet market conditions. You’d think that would be enough to get investors excited by the Moorpark company, which originates and services U.S. residential mortgage loans. Instead, its share price is down about 15 percent since its initial public offering at $18 a share last May. So what’s the problem? Take your pick, starting with investor suspicion over its origins, an uneven recovery for residential real estate and a confusing business model. PennyMac Financial is the sister company of PennyMac Mortgage Investment Trust, which went public in 2009 to buy distressed mortgage assets at the bottom of the financial crisis. Both firms were founded and are headed by Stanford Kurland, the former president of Countrywide Financial, the poster child for housing boom excess. “The trust is just a legal piece of paper. All the work is done at the financial services firm. You couldn’t come up with a more confusing company,” said Paul Miller, managing director at FBR Capital Markets in New York. Still, even if complicated, the financial services firm has some big money backing, with founding investments by asset management giant BlackRock Inc. in New York and Highfields Capital Management LP in Boston. The two firms and company management collectively own more than 70 percent of the company. It’s also the third largest correspondent mortgage lender in the United States, only behind megabanks Wells Fargo & Co. in San Francisco and JPMorgan Chase & Co. in New York. Correspondent lenders fund mortgages originated by smaller third parties, and often sell the loans in securitized packages. Its reached such heights quickly, and that’s reflected in its earnings. Last month, the financial services firm reported net income of $8 million (38 cents a share) on revenue of $106 million for its first quarter, meeting profit and beating revenue forecasts. Complex relationship Perhaps the biggest challenge for investors is getting their hands around the operation. Both companies operate out of the same 142,000-square-foot office at 6101 Condor Drive in Moorpark. The companies employ about 1,500 in total, but no breakdown is available. The trust, founded in 2009 a year after the financial services firm, was established to buy distressed whole loans, some of which it acquires from its sister firm. The trust also buys loans from other parties and takes part in correspondent lending. All of the loans the company acquires are then pooled for sale. Financial Services was founded in partnership with BlackRock and Highfields. But the two PennyMac’s have several overlapping business endeavors, including investing in distressed mortgage loans. And over time, the financial services firm began working in refinancing and even originating mortgages online. Through the companies’ complex relationship, the trust actually holds the mortgages and it pays the financial services firm a “servicing fee.” The trust reported net income of $37.9 million (50 cents a share) in the first quarter , compared with $53.3 million (90 cents) in the same period a year earlier. Kurland said in the earnings report the fall in income was due to reduction in the company’s correspondent lending business and lower gains in the distressed whole loan portfolio. But since it operates as a real estate investment trust, it is required to pay out 90 percent of taxable income to investors through dividends. Over the last two years, the quarterly dividend has hovered around 50 cents a share. The trust, with a market cap of about $1.6 billion, hit an all-time high in January 2013 at $28.73 a share. But it now trades at less than $22 a share. Financial services also enjoyed success last year, with shares hitting $22.45 on May 21, as interest in the new public company was strong. But the stock has underwhelmed since, not crossing the $19 barrier since last summer. Its high for the year was $18.68 in March, barely over its IPO price. Despite the stock trouble, Nikolas Karas, managing director at Santa Monica boutique investment bank Cappello Global LLC, said investors should be more interested in the companies, given their management. “They rose in the midst of the crisis and took advantage of that market, buying and selling distressed mortgages. Since then, they seem like they’ve adapted well to the changing market,” he said. “They look to be well positioned and should be an interesting company to watch.” Market struggles The problem for the financial services firm is likely the housing recovery, which has been uneven at beset. What’s more, it’s widely expected interest rates will rise, slowing sales. “I don’t think it’s the healthiest time for residential home mortgages,” said Emil Khodorkovsky, chief executive of Forbix Capital Corp., a real estate financing firm in Sherman Oaks. “Volume will slow down on the home loan side because of the rates, and everyone knows that.” Miller from FBR Capital agrees. “Nobody is going to buy a mortgage bank in this cycle,” he said. “The market is running away from anything related to mortgage banks. We think the industry is in for another rough quarter or two at least.” The financial services firm seems to be aware of the challenges as it has shifted attention from loan origination. In the first quarter, its fastest growing business line was loan servicing, which rose 43 percent from the fourth quarter to $40 million. In fact, servicing made up 42 percent of the company’s revenue in the first quarter, with loan origination making up 33 percent. Most of the loans serviced by the financial services firm are home mortgages guaranteed mostly by the Federal Housing Administration and the Veterans Administration. Miller said loan servicing is a highly lucrative industry at the moment, and PennyMac can still increase its stake in that market though it’s unlikely to change investor sentiment. “Their servicing book is growing rapidly and they want that to become a big part of the business,” he said. “But no one cares. They’re still seen as a mortgage bank.” Eric Beardsley, an analyst at Goldman Sachs in New York initiated coverage of the financial services firm earlier this month with a price target of $19. However, he has a far more positive outlook on the stock, arguing it is far smaller than competitors, giving it a lot more room to grow. “We believe this stock is significantly undervalued,” he wrote in a note to investors this month. Still, both PennyMac companies continue to face a perception problem. The financial crisis left many investors wary of mortgage lenders and both firms are peppered with former top Countrywide executives beyond Kurland. But Khodorkovsky discounts such talk and lauds Kurland’s experience. “It’s about efficiency,” he said. “This guy grew Countrywide and he can do it again.”
