PMC Capital PMC
December 20, 2002 - 12:24pm EST by
david101
2002 2003
Price: 4.12 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 49 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

PMC lends to the limited-service hospitality industry, primarily in the South and Southwest. They do a combination of in-house and government programs (SBA, 504, etc). Up until 2001, most of their loans were fixed rates and they got creamed this year by prepayments. Normally, PMC has about $105 million in loan receivables and it dropped to $72 million as of September. Interest income fell and that has resulted in a drop of the quarterly dividend to $0.12 and caused the shares to plummet. PMC has responded by switching to variable, LIBOR-based, loans, and they have seen a pick-up in new deals that should have their capital redeployed by 1st or 2nd Quarter 2003.

PMC is a business development company that operates as a regulated investment company, and its earnings receive favorable tax treatment as long as they pay out 90% of their net operating income as a dividend. It currently trades at a 11.5% yield, which is slightly below its historical range between 12% and 14%. They operate in a mature market niche, and NAV has been fairly stable at around $6/share since 1998.

Once their capital is reinvested into new loans and interest rates rise, they should be able to support a $0.20 quarterly dividend, and that would result in a share price around $6.70. Management has indicated that they had $40 million in loan commitments as of 9/30/02, and they expect to originate $50-$60 million in 2003.

Most of their borrowings are matched to their loans. Their securitizations through 2002 have all been at fixed rates, backed by fixed rate loans. Now that they are originating variable rate loans, the 2003 securitization will be variable rate. There is some interest rate sensitivity, but not much, related to fixed rate debentures sold to the SBA.

PMC is controlled by the Rosemore family, which owns 19% of the common stock; total shares outstanding are 11.8 million. The patriarch, Dr. Frederic Rosemore is chairman and treasurer, while sons Lance and Andrew serve as CEO and COO, respectively. Martha Greenberg, daughter of Frederic and sister to Lance and Andrew, serves as a director. They have a personal stake in seeing PMC's fortunes improve. However, there is no institutional following and it trades on the AMEX.

Net asset value as of 9/30/02 is $6.09. An obvious question is why not liquidate the portfolio, given the disparity to current market price? Excluding what the Rosemores might think, there are several reasons to continue operations. Interest rates and prepayments have caused a temporary trough in earnings, and the cash flow, especially via dividends, should increase going forward. Another reason not to liquidate is that they would be flooding a niche segment near a market low for their loans. They will realize more from holding onto the loans.

In terms of prepayments, PMC instituted a prepayment penalty on the loans that they originated back in 1997. The SBA instituted prepayment penalty fees in 2001 of 5% within 1 year, 3% within 2 years and 1% within 3 years, but that did not help PMC's earlier securitizations. Up to 1998, half of the loans that PMC originated were SBA, whereas SBA lending now only represents 15% of loan originations. Factoring in a rising interest rate environment, and prepayments will stabilize.

One negative is that PMC uses off-balance sheet securitizations to raise money. Their 2000 pool has had problems, but in general, their assumptions have been okay. The biggest problem has been prepayments, which is the most critical assumption in GOS, and not many people would have predicted today's abnormally low rates. I should note that while any gain on sale hits GAAP earnings, they do not affect NOI, from which dividend distribution is calculated, until any gains/losses are actually realized when the pools are finalized. However, PMC does recognize income from the securitizations related to the residual tranches that they hold. Unlike some companies that use GOS accounting, PMC is fairly open about their assumptions. In their SEC filings, PMC discloses the following from their 2002 pool:

Principal amount of sold loans $ 43,218
Structured Notes issued $ 38,897
Funding of reserve $ 1,729
Interest rate on the Structured Notes 6.67%
Structured Notes rating(1) "Aaa" (as rated by Moody's)
Weighted average interest rate on loans 9.53%
Weighted average remaining life of loans(2) 5.05 years
Aggregate losses assumed(3) 2.71%
Prepayment rate assumption(4) 9.00%
Discount rate assumptions(5) 8.2% to 12.9%
Net gain recorded $ 1,463
Value of Retained Interests $ 8,772

I should also note that PMC's management is the same management at a publicly traded REIT, PMC Commercial Trust (symbol = PCC). PMC receives advisory income for loan referrals to PCC, and PMC also receives servicing fees, as they service all the loans for PCC and for all the pools. Between PCC, PMC and the pools, they manage about $500 million in loans. I did ask management about whether PCC was cherry picking the loans, and they said that their underwriters submit their deals to the investment committee, who then decides whether to accept the deal, and then to which company it should be placed. Generally, they place the larger deals with PCC, while PMC tends to handle the SBA and SBA-like loans.

Catalyst

1. Earnings, and hence dividends, will rise as their capital is redeployed into new variable-rate loans.

2. As dividends increase, stock price will rise accordingly, approximately following a 12% to 14% yield.

3. Rising interest rates.
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