PennyMac: Learning from Experience

09/30/2013 7:00 am EST


George Putnam

Editor, The Turnaround Letter

Often, in the turnaround world, we see situations where people cause a problem, learn from their mistakes, and then make a lot of money by cleaning up the problem, observes George Putnam, editor of The Turnaround Letter.

Such is the case with PennyMac (PMT), a specialty finance company that was formed in 2009 to take advantage of the turmoil in the mortgage industry, following the housing crisis of 2007-08.

Much of PennyMac's top management came out of Countrywide Financial, which many people saw as the poster child for the mortgage lending abuses that led to the housing bust.

In addition, the company's president also did a stint running the mortgage securitization business at Morgan Stanley, another major player in the 2007-08 mortgage debacle.

These experienced mortgage professionals are now directing PennyMac to profit from many of the problems that they helped cause a few years ago.

The company has been very successful at buying distressed mortgage loans at deeply discounted prices and realizing sizeable profits by restructuring the mortgages or selling the underlying properties.

While the opportunities in this line of business may be narrowing a little, there are still plenty of profitable distressed loans left to purchase.

Many banks are only now getting healthy enough to sell-off troubled assets to free-up capital. Moreover, since real estate prices are rising again, the distressed loans in PennyMac's portfolio will grow in value.

PennyMac is also developing two other promising lines of business. Many of the big banks have been getting out of the correspondent lending business because it ties up too much capital under the new Basel 3 international banking standards.

Much of that business is now going to non-banks such as PennyMac; the company is now the fifth largest player and is growing.

Management sees additional growth in related areas such as the securitization of jumbo mortgage loans, a business that is just beginning to emerge from a prolonged dormancy.

The third leg of the stool for PennyMac is mortgage servicing. This time it is the smaller players who are getting out of the business and selling their servicing portfolios because they are no longer profitable in the new environment.

This business has synergies with PennyMac's other lines, and it will grow more profitable as the company acquires scale.

PennyMac aims to reward shareholders, both through a generous dividend, and through stock-price appreciation. The unusually high dividend (10.5% yield), not only looks sustainable, but could grow if the company can execute on its strategies.

Moreover, with the stock trading at a price-to-earnings ratio of only about six, there is plenty of opportunity for price appreciation as well.

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