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Bloomberg, June 18, 2009 column


Hedge Fund Instant IPO Tests the New Complacency: Jonathan Weil


Commentary by Jonathan Weil

June 18 (Bloomberg) -- The near-collapse of the financial system was supposed to have reminded the world about the hazards of chasing short-term gains at the expense of long-term stability. Another lesson we keep relearning is that investors’ memories are short.

Look no further than the prospectus filed May 22 by PennyMac Mortgage Investment Trust, which was created only four days earlier. It has no operating history and no independent directors. As of May 19, its assets consisted of $1,000 in cash.

Eleven of PennyMac’s 14 senior managers are veterans of Countrywide Financial Corp., including Chief Executive Stanford Kurland, Countrywide’s chief operating officer until September 2006. PennyMac plans to hold its initial public offering this summer, assuming the Securities and Exchange Commission lets it.

Complacency is back in the financial markets. And sometimes it’s hard to tell what is more unnerving -- mass smugness or staring into the abyss. If your idea of economic recovery calls for reinflating old bubbles so we can rise from their wreckage, then PennyMac’s emergence is a welcome sign. The flip side is that throwing caution to the wind may be making a comeback.

PennyMac is a hedge fund dressed up as a real estate investment trust. It hopes to raise $750 million and buy junk- grade home loans and mortgage-backed securities on the cheap, through government bailout programs and agencies such as the Federal Deposit Insurance Corp. Located just a 10-minute drive on Ventura Highway from Countrywide’s old headquarters in Calabasas, California, it lists BlackRock Inc. and Highfields Capital Investments LLC as investors, in addition to its own officers.

Layers of Fees

So far, not so bad. Sure, there’s the unseemly image of Countrywide retreads trying to profit from a housing bust they helped create. The biggest risk for investors, though, may arise from the way PennyMac plans to pay its top executives.

PennyMac’s officers all are employees of a separate company, called PCM, or one of its affiliates. PCM -- owned by the same investors that started PennyMac -- will manage PennyMac and collect an annual base fee equal to 1.5 percent of the company’s shareholder equity. It’s also entitled to a quarterly incentive fee equal to 20 percent of some weird, nonstandard profitability calculation.

A third company owned by the same investors will collect money for servicing PennyMac’s loans, including percentage fees based on the loans’ unpaid principal amounts. There would be other fees for these other companies, too. In each case, PennyMac said in its prospectus, the fees “were not negotiated at arm’s length.” You can’t say they didn’t warn you.

‘Short-Term’ Emphasis

Even if PennyMac loses money, the management company still could get its base fee. As for the incentive fees, the prospectus said these “may lead PCM to place undue emphasis on the maximization of short-term net income at the expense of other criteria, such as preservation of capital, maintaining sufficient liquidity and/or management of market risk, in order to achieve higher incentive compensation.”

After all, who cares about preserving capital for shareholders when you’ve got management’s pay to protect?

The emphasis on short-term incentives was a big reason Countrywide and Merrill Lynch & Co. got in trouble. PennyMac’s IPO will be managed in part by Merrill Lynch, now owned by Bank of America Corp., which also now owns Countrywide and almost half of BlackRock. (The connections seem to never end.)

Warning Investors

The prospectus says other conflicts of interest in PennyMac’s relationship with PCM “could result in decisions that are not in the best interests of our shareholders.” PCM, which stands for PNMAC Capital Management LLC, and its owners also may receive shares in PennyMac at the IPO price should it go public.

PCM already runs two separate investment funds it started last August, using a similar strategy. As of March 31, one fund had invested $152.9 million and seen its holdings decline in value by $7.1 million, according to a quarterly report filed with the SEC. The other had invested $155.8 million and was down about $9 million. The valuations are only estimates, because the funds’ holdings are almost all illiquid.

PennyMac filed its prospectus about two weeks before the SEC accused three of Countrywide’s former top executives of securities fraud -- including former CEO Angelo Mozilo, though not Kurland or anyone else at PennyMac. PennyMac officials declined to comment, saying they can’t talk while the company’s SEC registration is pending.

Wall Street’s Climate

Don’t get me wrong. I realize many investors will see PennyMac’s fundraising as a healthy sign that the economy could be turning a corner. Still, a lot of us prudent folks wish we could return to an investment climate where stigmas matter, and startups have to show profits before big Wall Street banks will help take them public.

It’s not so much PennyMac and its prospects that should give us pause. It’s all the other fly-by-nights that a PennyMac IPO might inspire. If this puppy can get on a national stock exchange, we could be off to the races again. Too much of that, so fast, may not be such a good thing.

(Jonathan Weil is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: Jonathan Weil in New York at

Last Updated: June 18, 2009 00:01 EDT





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