Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 


 

Form 10-Q

 


 

(Mark One)

 

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2013

 

Or

 

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from              to            

 

Commission file number: 001-35916

 


 

PennyMac Financial Services, Inc.

(Exact name of registrant as specified in its charter)

 


 

Delaware

 

80-0882793

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employer
Identification No.)

 

 

 

6101 Condor Drive, Moorpark, California

 

93021

(Address of principal executive offices)

 

(Zip Code)

 

(818) 224-7442

(Registrant’s telephone number, including area code)

 


 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  x  No  ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  x  No  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one):

 

Large accelerated filer o

 

Accelerated filer o

 

 

 

Non-accelerated filer x

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): Yes  o  No  x

 

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.

 

Class

 

Outstanding at November 12, 2013

Class A Common Stock, $0.0001 par value

 

18,887,777

Class B Common Stock, $0.0001 par value

 

61

 

 

 



Table of Contents

 

PENNYMAC FINANCIAL SERVICES, INC.

 

FORM 10-Q

September 30, 2013

 

TABLE OF CONTENTS

 

 

Page

PART I. FINANCIAL INFORMATION

2

 

 

 

Item 1.

Financial Statements (Unaudited):

2

 

Consolidated Balance Sheets

2

 

Consolidated Statements of Income

3

 

Consolidated Statements of Changes in Stockholders’ Equity

4

 

Consolidated Statements of Cash Flows

5

 

Notes to Consolidated Financial Statements

6

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

51

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

76

Item 4.

Controls and Procedures

76

 

 

 

PART II. OTHER INFORMATION

77

 

 

 

Item 1.

Legal Proceedings

77

Item 1A.

Risk Factors

77

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

77

Item 3.

Defaults Upon Senior Securities

77

Item 4.

Mine Safety Disclosures

77

Item 5.

Other Information

77

Item 6.

Exhibits

78

 

1



Table of Contents

 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

PENNYMAC FINANCIAL SERVICES, INC.
CONSOLIDATED BALANCE SHEETS (UNAUDITED)

 

 

 

September 30,

 

December 31,

 

 

 

2013

 

2012

 

 

 

(in thousands, except share data)

 

ASSETS

 

 

 

 

 

Cash

 

$

56,398

 

$

12,323

 

Short-term investments at fair value

 

127,487

 

53,164

 

Mortgage loans held for sale at fair value (includes $522,031 and $438,850 pledged to secure mortgage loans sold under agreements to repurchase)

 

530,248

 

448,384

 

Servicing advances (includes $6,865 and $7,430 pledged to secure note payable)

 

105,344

 

93,152

 

Derivative assets

 

24,066

 

27,290

 

Carried Interest due from Investment Funds

 

58,134

 

47,723

 

Investment in PennyMac Mortgage Investment Trust at fair value

 

1,701

 

1,897

 

Mortgage servicing rights at lower of amortized cost or fair value (includes $216,463 and $88,587 pledged to secure note payable)

 

226,090

 

89,177

 

Mortgage servicing rights at fair value (includes $10,125 and $12,370 pledged to secure note payable)

 

26,768

 

19,798

 

Receivable from Investment Funds

 

2,541

 

3,672

 

Receivable from PennyMac Mortgage Investment Trust

 

20,030

 

16,691

 

Furniture, fixtures, equipment and building improvements, net

 

8,498

 

5,065

 

Capitalized software, net

 

743

 

795

 

Deferred tax asset

 

54,530

 

 

Other

 

11,806

 

13,032

 

Total assets

 

$

1,254,384

 

$

832,163

 

LIABILITIES

 

 

 

 

 

Mortgage loans sold under agreements to repurchase

 

$

387,883

 

$

393,534

 

Note payable

 

56,775

 

53,013

 

Excess servicing spread financing at fair value

 

2,857

 

 

Derivative liabilities

 

5,776

 

509

 

Accounts payable and accrued expenses

 

53,355

 

36,279

 

Payable to Investment Funds

 

36,424

 

36,795

 

Payable to PennyMac Mortgage Investment Trust

 

55,523

 

46,779

 

Payable to exchanged Private National Mortgage Acceptance Company, LLC unitholders under tax receivable agreement

 

58,615

 

 

Liability for losses under representations and warranties

 

7,215

 

3,504

 

Total liabilities

 

664,423

 

570,413

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

STOCKHOLDERS’ EQUITY

 

 

 

 

 

Class A Common Stock, par value $0.0001 per share, 200,000,000 shares authorized, 18,887,777 issued and outstanding at September 30, 2013

 

$

2

 

$

 

Class B Common Stock, par value $0.0001 per share, 1,000 shares authorized, 61 issued and outstanding at September 30, 2013

 

 

 

Additional paid-in capital

 

136,484

 

 

Retained earnings

 

7,990

 

 

Total PennyMac Financial Services, Inc. stockholders’ equity

 

144,476

 

 

Members’ equity related to Private National Mortgage Acceptance Company, LLC

 

 

261,750

 

Noncontrolling interest in Private National Mortgage Acceptance Company, LLC

 

445,485

 

 

Total equity

 

589,961

 

261,750

 

Total liabilities and stockholders’ equity

 

$

1,254,384

 

$

832,163

 

 

The accompanying notes are an integral part of these financial statements.

 

2



Table of Contents

 

PENNYMAC FINANCIAL SERVICES, INC.
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

 

 

 

Quarter ended
September 30,

 

Nine months ended
September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(in thousands, except per share data)

 

Revenue

 

 

 

 

 

 

 

 

 

Net gains on mortgage loans held for sale at fair value

 

$

25,949

 

$

39,760

 

$

108,560

 

$

68,487

 

Loan origination fees

 

6,280

 

2,752

 

18,260

 

5,439

 

Fulfillment fees from PennyMac Mortgage Investment Trust

 

18,327

 

17,258

 

68,625

 

31,097

 

Net servicing income:

 

 

 

 

 

 

 

 

 

Loan servicing fees

 

 

 

 

 

 

 

 

 

From non-affiliates

 

14,596

 

2,154

 

35,397

 

8,776

 

From PennyMac Mortgage Investment Trust

 

10,738

 

4,600

 

27,251

 

13,163

 

From Investment Funds

 

1,813

 

2,484

 

6,060

 

9,130

 

Mortgage servicing rebate (to) from Investment Funds

 

(362

)

135

 

(535

)

(360

)

Ancillary and other fees

 

2,777

 

1,153

 

7,700

 

3,661

 

 

 

29,562

 

10,526

 

75,873

 

34,370

 

Amortization, impairment and change in estimated fair value of mortgage servicing rights

 

(8,163

)

(4,414

)

(16,363

)

(9,024

)

Net servicing income

 

21,399

 

6,112

 

59,510

 

25,346

 

Management fees:

 

 

 

 

 

 

 

 

 

From PennyMac Mortgage Investment Trust

 

8,539

 

3,672

 

23,486

 

7,964

 

From Investment Funds

 

2,001

 

2,442

 

5,889

 

7,199

 

 

 

10,540

 

6,114

 

29,375

 

15,163

 

Carried Interest from Investment Funds

 

2,812

 

3,355

 

10,411

 

7,254

 

Net interest income (expense):

 

 

 

 

 

 

 

 

 

Interest income

 

5,093

 

1,914

 

11,310

 

4,491

 

Interest expense

 

4,156

 

2,042

 

11,686

 

4,226

 

 

 

937

 

(128

)

(376

)

265

 

Change in fair value of investment in and dividends received from PennyMac Mortgage Investment Trust

 

165

 

314

 

(68

)

630

 

Other

 

785

 

695

 

1,842

 

1,886

 

Total net revenue

 

87,194

 

76,232

 

296,139

 

155,567

 

Expenses

 

 

 

 

 

 

 

 

 

Compensation

 

35,830

 

31,856

 

113,850

 

77,756

 

Professional services

 

2,831

 

1,287

 

7,901

 

3,538

 

Loan origination

 

2,802

 

1,787

 

7,825

 

1,803

 

Technology

 

2,587

 

1,057

 

6,203

 

3,161

 

Servicing

 

1,931

 

999

 

5,072

 

2,438

 

Occupancy

 

796

 

394

 

1,883

 

1,078

 

Other

 

5,500

 

989

 

12,966

 

2,890

 

Total expenses

 

52,277

 

38,369

 

155,700

 

92,664

 

Income before provision for income taxes

 

34,917

 

37,863

 

140,439

 

62,903

 

Provision for income taxes

 

3,493

 

 

5,531

 

 

Net income

 

31,424

 

$

37,863

 

134,908

 

$

62,903

 

Less: Net income attributable to noncontrolling interest

 

26,227

 

 

 

126,918

 

 

 

Net income attributable to PennyMac Financial Services, Inc. common stockholders

 

$

5,197

 

 

 

$

7,990

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings per common share

 

 

 

 

 

 

 

 

 

Basic

 

$

0.29

 

 

 

$

0.50

 

 

 

Diluted

 

$

0.28

 

 

 

$

0.50

 

 

 

Weighted-average common shares outstanding

 

 

 

 

 

 

 

 

 

Basic

 

17,958

 

 

 

16,042

 

 

 

Diluted

 

75,876

 

 

 

75,867

 

 

 

 

The accompanying notes are an integral part of these financial statements.

 

3



Table of Contents

 

PENNYMAC FINANCIAL SERVICES, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (UNAUDITED)

 

 

 

PennyMac Financial Services, Inc. Stockholders

 

 

 

Noncontrolling interest in Private

 

 

 

 

 

Number of Shares

 

Common stock

 

Additional

 

Retained

 

Members’

 

National Mortgage Acceptance

 

 

 

 

 

Class A

 

Class B

 

Class A

 

Class B

 

paid-in capital

 

earnings

 

equity

 

Company, LLC

 

Total equity

 

 

 

(in thousands)

 

Balance at December 31, 2011

 

 

 

$

 

$

 

$

 

$

 

$

123,915

 

$

 

$

123,915

 

Capital:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Contributions

 

 

 

 

 

 

 

15,058

 

 

15,058

 

Redemptions

 

 

 

 

 

 

 

(6

)

 

(6

)

Distributions

 

 

 

 

 

 

 

(11,369

)

 

(11,369

)

Unit-based compensation expense

 

 

 

 

 

 

 

13,880

 

 

13,880

 

Net income

 

 

 

 

 

 

 

62,903

 

 

62,903

 

Balance at September 30, 2012

 

 

 

$

 

$

 

$

 

$

 

$

204,381

 

$

 

$

204,381

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2012

 

 

 

$

 

$

 

$

 

$

 

$

261,750

 

$

 

$

261,750

 

Capital:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Distributions

 

 

 

 

 

 

 

(19,623

)

 

(19,623

)

Unit-based compensation expense

 

 

 

 

 

 

 

238

 

 

238

 

Partner capital issuance costs

 

 

 

 

 

 

 

(3,745

)

 

(3,745

)

Net income

 

 

 

 

 

 

 

76,834

 

 

76,834

 

Exchange of existing member units to Class A units of Private National Mortgage Acceptance Company, LLC

 

 

 

 

 

 

 

(315,454

)

315,454

 

 

Balance post-reorganization

 

 

 

 

 

 

 

 

315,454

 

315,454

 

Issuance of common shares in initial public offering, net of issuance costs

 

12,778

 

 

1

 

 

229,999

 

 

 

 

230,000

 

Underwriting and offering costs

 

 

 

 

 

(13,290

)

 

 

(196

)

(13,486

)

Dilution assumed with IPO

 

 

 

 

 

(127,160

)

 

 

127,160

 

 

Stock-based compensation expense

 

 

 

 

 

891

 

 

 

1,265

 

2,156

 

Distributions

 

 

 

 

 

 

 

 

(3,395

)

(3,395

)

Net income

 

 

 

 

 

 

7,990

 

 

50,084

 

58,074

 

Tax related impact to exchange of Class A Units of Private National Mortgage Acceptance Company, LLC to Class A stock of PennyMac Financial Services, Inc.

 

 

 

 

 

1,158

 

 

 

 

1,158

 

Exchange of Class A units of Private National Mortgage Acceptance Company, LLC to Class A stock of PennyMac Financial Services, Inc.

 

6,110

 

 

1

 

 

44,886

 

 

 

(44,887

)

 

Balance at September 30, 2013

 

18,888

 

 

$

2

 

$

 

$

136,484

 

$

7,990

 

$

 

$

445,485

 

$

589,961

 

 

The accompanying notes are an integral part of these financial statements.

 

4



Table of Contents

 

PENNYMAC FINANCIAL SERVICES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

 

 

 

Nine months ended September 30,

 

 

 

2013

 

2012

 

 

 

(in thousands)

 

Cash flow from operating activities:

 

 

 

 

 

Net income

 

$

134,908

 

$

62,903

 

Adjustments to reconcile net income to net cash provided by (used in) operating activities:

 

 

 

 

 

Net gain on mortgage loans held for sale at fair value

 

(108,560

)

(68,487

)

Accrual of servicing rebate to Investment Funds

 

535

 

360

 

Amortization, impairment and change in fair value of mortgage servicing rights

 

16,363

 

9,024

 

Carried Interest from Investment Funds

 

(10,411

)

(7,255

)

Change in fair value of investment in common shares of PennyMac Mortgage Investment Trust

 

196

 

(506

)

Change in fair value of real estate acquired in settlement of loans

 

22

 

 

Stock and unit-based compensation expense

 

2,394

 

13,880

 

Amortization of debt issuance costs and commitment fees relating to financing facilities

 

3,714

 

1,261

 

Depreciation and amortization

 

594

 

389

 

Purchase of mortgage loans held for sale from PennyMac Mortgage Investment Trust

 

(12,429,698

)

(5,111,185

)

Originations of mortgage loans held for sale

 

(895,405

)

(304,402

)

Sale and principal payments of mortgage loans held for sale

 

13,210,810

 

5,112,530

 

Increase in servicing advances

 

(12,192

)

(12,989

)

Increase in prepaid expenses

 

(9,094

)

(3,457

)

Repurchase of real estate acquired in settlement of loans subject to representations and warranties

 

(309

)

 

Sale of real estate acquired in settlement of loans subject to representations and warranties

 

287

 

 

Decrease in receivable from Investment Funds

 

596

 

3,674

 

(Increase) decrease in receivable from PennyMac Mortgage Investment Trust

 

(1,790

)

2,528

 

Decrease (increase) in other assets

 

4,087

 

(2,962

)

Increase in accounts payable and accrued expenses

 

17,060

 

15,695

 

(Decrease) increase in payable to Investment Funds

 

(371

)

4,821

 

Increase in payable to PennyMac Mortgage Investment Trust

 

8,158

 

10,325

 

Net cash used in operating activities

 

(68,106

)

(273,853

)

 

 

 

 

 

 

Cash flow from investing activities:

 

 

 

 

 

Net (increase) decrease in short-term investment

 

(74,323

)

12,625

 

Purchase of mortgage servicing rights

 

(5,124

)

 

Sale of mortgage servicing rights

 

550

 

 

Purchase of furniture, fixtures, equipment and building improvements

 

(4,719

)

(2,495

)

Acquisition of capitalized software

 

(242

)

(379

)

Increase in margin deposits and restricted cash

 

5,349

 

(27,524

)

Net cash used in investing activities

 

(78,509

)

(17,773

)

 

 

 

 

 

 

Cash flow from financing activities:

 

 

 

 

 

Sale of loans under agreements to repurchase

 

12,225,201

 

4,924,895

 

Repurchase of loans sold under agreements to repurchase

 

(12,230,851

)

(4,641,117

)

Increase in note payable

 

3,762

 

15,433

 

Issuance of excess servicing spread financing

 

2,828

 

 

Issuance of common stock

 

230,000

 

 

Payment of common stock underwriting and offering costs

 

(13,486

)

 

Payment by noncontrolling interest of common stock issuance costs

 

(3,745

)

 

Noncontrolling interest repayments of partners’ capital contributions

 

 

15,058

 

Noncontrolling interest collection of subscriptions receivable

 

 

(6

)

Noncontrolling interest distributions

 

(23,019

)

(11,368

)

Net cash provided by financing activities

 

190,690

 

302,895

 

Net increase in cash

 

44,075

 

11,269

 

Cash at beginning of period

 

12,323

 

16,465

 

Cash at end of period

 

$

56,398

 

$

27,734

 

 

The accompanying notes are an integral part of these financial statements.

 

5



Table of Contents

 

PENNYMAC FINANCIAL SERVICES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

Note 1—Organization and Basis of Presentation

 

PennyMac Financial Services, Inc. (“PFSI” or the “Company”) was formed as a Delaware corporation on December 31, 2012. Pursuant to a reorganization, the Company became a holding corporation and its sole asset is an equity interest in Private National Mortgage Acceptance Company, LLC (“PennyMac”). The Company is the managing member of PennyMac and operates and controls all of the businesses and affairs of PennyMac subject to the consent rights of other members under certain circumstances and, through PennyMac and its subsidiaries, continues to conduct the business previously conducted by these subsidiaries.

 

PennyMac is a Delaware limited liability company which, through its subsidiaries, engages in mortgage banking and investment management activities. PennyMac’s mortgage banking activities consist of residential mortgage lending (including correspondent lending and retail lending) and loan servicing. The investment management activities and a portion of the loan servicing activities are conducted on behalf of investment vehicles that invest in residential mortgage loans and related assets. PennyMac’s primary wholly-owned subsidiaries are:

 

·                  PNMAC Capital Management, LLC (“PCM”) — a Delaware limited liability company registered with the Securities and Exchange Commission (“SEC”) as an investment adviser under the Investment Advisers Act of 1940, as amended. PCM enters into investment management agreements with entities that invest in residential mortgage loans and related assets.

 

Presently, PCM has management agreements with PennyMac Mortgage Investment Trust, a publicly held real estate investment trust (“PMT”), and three investment funds: PNMAC Mortgage Opportunity Fund, LLC and PNMAC Mortgage Opportunity Fund, L.P., (the “Master Fund”), both registered under the Investment Company Act of 1940, as amended; and PNMAC Mortgage Opportunity Fund Investors, LLC (collectively, “Investment Funds”). Together, the Investment Funds and PMT are referred to as the “Advised Entities.”

 

·                  PennyMac Loan Services, LLC (“PLS”) — a Delaware limited liability company that services portfolios of residential mortgage loans on behalf of non-affiliates or the Advised Entities, originates new prime credit quality residential mortgage loans, and engages in other mortgage banking activities for its own account and the account of PMT.

 

PLS is approved as a seller/servicer of mortgage loans by the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”) and as an issuer of securities guaranteed by the Government National Mortgage Association (“Ginnie Mae”). PLS is a licensed Federal Housing Administration Nonsupervised Title II Lender with the U.S. Department of Housing and Urban Development (“HUD”) and a lender/servicer with the Veterans Administration (“VA”) (each an “Agency” and collectively the “Agencies “).

 

·                  PNMAC Opportunity Fund Associates, LLC (“PMOFA”) — a Delaware limited liability company and the general partner of the Master Fund. PMOFA is entitled to incentive fees representing allocations of profits (“Carried Interest”) from the Master Fund.

 

Initial Public Offering and Recapitalization

 

On May 14, 2013, PFSI completed an initial public offering (“IPO”) in which it sold approximately 12.8 million shares of its Class A common stock, at a public offering price of $18.00 per share. PFSI received net proceeds of $216.8 million, after deducting net underwriting discounts and commissions, from sales of its shares in the IPO. PFSI used these net proceeds to purchase approximately 12.8 million Class A Units of PennyMac.  PFSI operates and controls all of the business and affairs and consolidates the financial results of PennyMac and its subsidiaries.  The purchase of 12.8 million Class A Units of PennyMac has been accounted for as a transfer of interests under common control. Accordingly, the accompanying consolidated financial statements reflect a reclassification of members’ equity to noncontrolling interests in the Company of $315.5 million. This amount represents the carrying value in the Company of the existing owners of PennyMac that has been purchased for the Class A Units of PennyMac.

 

6



Table of Contents

 

Before the IPO, PennyMac completed a reorganization by amending its limited liability company agreement to convert all classes of ownership interests held by its existing owners to a single class of common units. The conversion of existing interests was based on the various interests’ liquidation priorities as specified in PennyMac’s prior limited liability company agreement. In connection with that reorganization, PFSI became the sole managing member of PennyMac.

 

After the completion of the recapitalization and reorganization transactions, PennyMac is a consolidated subsidiary of the Company, accordingly, PennyMac’s consolidated financial statements are the Company’s historical financial statements. The historical consolidated financial statements of PennyMac are reflected herein based on the historical ownership interests of the existing owners of PennyMac.

 

Tax Receivable Agreement

 

As part of the IPO, PFSI entered into an Exchange Agreement with PennyMac’s existing owners whereby the existing owners may exchange their PennyMac units for PFSI stock. Before 2013, PennyMac made an election pursuant to Section 754 of the Internal Revenue Code which remains in effect. An exchange results in a special adjustment for PFSI that may increase PFSI’s tax basis of the assets of PennyMac that otherwise would not have been available. These increases in tax basis may reduce the amount of income tax that PFSI would otherwise be required to pay in the future. These increases in tax basis may also decrease gains (or increase losses) on future dispositions of certain assets to the extent tax basis is allocated to those assets.

 

PFSI entered into a tax receivable agreement with PennyMac’s existing unitholders that will provide for the payment by PFSI to PennyMac exchanged unitholders an amount equal to 85% of the amount of the benefits, if any, that PFSI is deemed to realize as a result of (i) increases in tax basis resulting from exchanges and (ii) certain other tax benefits related to PFSI entering into the tax receivable agreement, including tax benefits attributable to payments under the tax receivable agreement.

 

The term of the tax receivable agreement will continue until all such tax benefits have been utilized or expired, unless PFSI exercises its right to terminate the tax receivable agreement.  In the event of termination of the tax receivable agreement, the Company would be required to make an immediate payment equal to the present value of the anticipated future net tax benefits, which upfront payment may be made years in advance of the actual realization of such future benefits.

 

Basis of presentation

 

The Company’s unaudited consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and applicable rules and regulations of the SEC regarding interim financial reporting. The information included in this quarterly report on Form 10-Q should be read with the financial statements and accompanying notes included herein.

 

The accompanying unaudited consolidated financial statements reflect all normal recurring adjustments necessary to present fairly the financial position, results of operations, and cash flows for the interim periods, but are not necessarily indicative of the results of operations to be anticipated for the full year ending December 31, 2013.

 

Reclassification of previously presented balances

 

Net interest income:

 

           Interest expense is presented along with Interest income as a new caption of Net interest income to better reflect our results due to growth in the Company’s portfolio of interest-earning assets.  Previously, Interest expenses were included within Total expenses whereby, the balance is presented within Total net revenue during the three and nine months ended September 30, 2013 and 2012.

 

Note 2—Concentration of Risk

 

A substantial portion of the Company’s activities relate to the Advised Entities. Fees charged to these entities (comprised of management fees, loan servicing fees and loan servicing rebates, Carried Interest and fulfillment fees from PMT) totaled 50% and 45% of total net revenues for the quarters ended September 30, 2013 and 2012, respectively, and 48% for both the nine month periods ended September 30, 2013 and 2012.

 

Note 3—Significant Accounting Policies

 

The Company’s updated accounting policies are summarized below.

 

Stock-Based Compensation

 

The Company’s 2013 Equity Incentive Plan provides for awards of nonstatutory and incentive stock options (“Stock Options”), time-based restricted stock units, performance-based restricted stock units, stock appreciation rights, performance units and stock grants. The Company estimates the value of the Stock Options, time-based restricted stock units and performance-based restricted stock units awarded with reference to the value of its underlying common stock on the date of the award. Compensation costs are fixed, except for performance-based restricted stock units, at the estimated fair value as of the award date as all grantees are employees and directors of the Company or PennyMac. The Company amortizes the cost of time-based restricted stock unit awards to compensation expense over the vesting period using the graded vesting method. The Company amortizes performance-based restricted stock unit awards on a straight-line basis over the vesting period.  Expense relating to awards is included in Compensation in the consolidated statements of income.

 

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Income Taxes

 

As a result of the PennyMac recapitalization and reorganization, the Company expects to benefit from amortization and other tax deductions due to an increase in tax basis due to the exchange of PennyMac Class A units. Those deductions will be allocated to the Company and will be taken into account in reporting the Company's taxable income. The Company has entered into an agreement with the unitholders of PennyMac that will provide for the additional payment by the Company to exchanging unitholders of PennyMac equal to 85% of the amount of cash savings, if any, in U.S. federal, state and local income tax that PFSI realizes due to (i) increases in tax basis resulting from exchanges of the then-existing unitholders and (ii) certain other tax benefits related to PFSI entering into the tax receivable agreement, including tax benefits attributable to payments under the tax receivable agreement.

 

The Company is subject to federal and state income taxes.  Income taxes are provided using the asset and liability method.  Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and their respective tax bases.  Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.

 

The effect on deferred taxes of a change in tax rates is recognized as income in the period in which the change occurs.  A valuation allowance is established if, in management’s judgment, it is not more likely than not that the deferred tax asset will be realized.

 

The Company recognizes tax benefits relating to its tax positions only if, in the opinion of management, it is more likely than not that the tax position will be sustained upon examination by the appropriate taxing authority.  A tax position that meets this standard is recognized as the largest amount that is greater than 50% likely to be realized upon ultimate settlement with the appropriate taxing authority.  The Company will classify any penalties and interest as a component of provision for income taxes.

 

Note 4—Transactions with Affiliates

 

PennyMac Mortgage Investment Trust

 

Management Fees

 

Before February 1, 2013, under a management agreement, PennyMac received from PMT a base management fee. The base management fee was calculated at 1.5% per year of PMT’s shareholders’ equity. The management agreement also provided for a performance incentive fee, which was calculated at 20% per year of the amount by which PMT’s “core earnings,” on a rolling four-quarter basis and before the incentive fee, exceeded an 8% “hurdle rate” as defined in the management agreement. PennyMac did not earn a performance incentive fee before February 1, 2013.

 

Effective February 1, 2013, the management agreement was amended to provide that:

 

·                  The base management fee is calculated quarterly and is equal to the sum of (i) 1.5% per year of PMT’s shareholders’ equity up to $2 billion, (ii) 1.375% per year of shareholders’ equity in excess of $2 billion and up to $5 billion, and (iii) 1.25% per year of PMT’s shareholders’ equity in excess of $5 billion.

 

·                  The performance incentive fee is calculated at a defined annualized percentage of the amount by which PMT’s “net income,” on a rolling four-quarter basis and before deducting the incentive fee, exceeds certain levels of return on “equity.”

 

The performance incentive fee is calculated quarterly and is equal to the sum of: (a) 10% of the amount by which PMT’s net income for the quarter exceeds (i) an 8% return on equity plus the “high watermark,” up to (ii) a 12% return on PMT’s equity; plus (b) 15% of the amount by which PMT’s net income for the quarter exceeds (i) a 12% return on PMT’s equity plus the high watermark, up to (ii) a 16% return on PMT’s equity; plus (c) 20% of the amount by which PMT’s net income for the quarter exceeds a 16% return on equity plus the high watermark.

 

For the purpose of determining the amount of the performance incentive fee:

 

“Net income” is defined as net income or loss computed in accordance with U.S. GAAP and certain other non-cash charges determined after discussions between the Company and PMT’s independent trustees and approval by a majority of PMT’s independent trustees.

 

“Equity” is the weighted average of the issue price per common share of all of PMT’s public offerings, multiplied by the weighted average number of common shares outstanding (including restricted share units) in the four-quarter period.

 

The “high watermark” starts at zero and is adjusted quarterly. The quarterly adjustment reflects the amount by which the net income (stated as a percentage of return on equity) in that quarter exceeds or falls short of the lesser of 8% and the Fannie Mae Mortgage-Backed Security (“MBS”) yield (the target yield) for such quarter. If the net

 

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income is lower than the target yield, the high watermark is increased by the difference. If the net income is higher than the target yield, the high watermark is reduced by the difference. Each time a performance incentive fee is earned, the high watermark returns to zero. As a result, the threshold amounts required for the Company to earn a performance incentive fee are adjusted cumulatively based on the performance of PMT’s net income over (or under) the target yield, until the net income in excess of the target yield exceeds the then-current cumulative high watermark amount, and a performance incentive fee is earned.

 

The base management fee and the performance incentive fee are both receivable quarterly in arrears. The performance incentive fee may be paid in cash or in PMT’s common shares (subject to a limit of no more than 50% paid in common shares), at PMT’s option.

 

Following is a summary of the base management and performance incentive fees earned from PMT for the periods presented:

 

 

 

Quarter ended September 30,

 

Nine months ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(in thousands)

 

Base management fee

 

$

5,104

 

$

3,672

 

$

14,043

 

$

7,964

 

Performance incentive fee

 

3,435

 

 

9,443

 

 

 

 

$

8,539

 

$

3,672

 

$

23,486

 

$

7,964

 

 

The term of the management agreement, as amended, expires on February 1, 2017, subject to automatic renewal for additional 18-month periods, unless terminated earlier in accordance with the terms of the management agreement.

 

In the event of termination by PMT, the Company may be entitled to a termination fee in certain circumstances.  The termination fee is equal to three times the sum of (a) the average annual base management fee, and (b) the average annual (or, if the period is than 24 months, annualized) performance incentive fee earned by the Company, in each case during the 24-month period before termination.

 

Mortgage Loan Servicing

 

The Company has a loan servicing agreement with PMT. Before February 1, 2013, the servicing fee rates were based on the risk characteristics of the mortgage loans serviced and total servicing compensation was established at levels that management believed were competitive with those charged by other servicers or specialty servicers, as applicable.

 

·                  Servicing fee rates for nonperforming loans ranged between 50 and 100 basis points per year on the unpaid principal balance of the mortgage loans serviced on PMT’s behalf. PennyMac was also entitled to certain customary market-based fees and charges, including boarding and deboarding fees, liquidation and disposition fees, assumption, modification and origination fees and late charges, as well as interest on funds on deposit in custodial accounts. In the event PennyMac either effected a refinancing of a loan on PMT’s behalf and not through a third party lender and the resulting loan was readily saleable, or originated a loan to facilitate the disposition of real estate that PMT had acquired in settlement of a loan, PennyMac was entitled to receive from PMT market-based fees and compensation.

 

·                  For mortgage loans serviced by PMT as a result of acquisitions and sales with servicing rights retained in connection with PMT’s correspondent lending business, PennyMac was entitled to base subservicing fees and other customary market-based fees and charges as described above.

 

Effective February 1, 2013, the servicing agreement was amended to provide for servicing fees payable to the Company that changed from being based on a percentage of the loan’s unpaid principal balance to fixed per-loan monthly amounts based on the delinquency, bankruptcy and/or foreclosure status of the serviced loan or the real estate acquired in settlement of loans (“REO”). The Company also remains entitled to market-based fees and charges including boarding and deboarding fees, liquidation and disposition fees, assumption, modification and origination fees and late charges relating to loans it services for PMT.

 

·                  The base servicing fees for distressed whole loans are calculated based on a monthly per-loan dollar amount, with the actual dollar amount for each loan based on the delinquency, bankruptcy and/or foreclosure status of such loan or the related underlying real estate. Presently, the base servicing fees for distressed whole loans range from $30 per month for current loans up to $125 per month for loans that are severely delinquent and in foreclosure.

 

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·                  The base servicing fees for non-distressed loans subserviced by the Company on PMT’s behalf are also calculated through a monthly per-loan dollar amount, with the actual dollar amount for each loan based on whether the mortgage loan is a fixed-rate or adjustable-rate loan. The base servicing fees for loans subserviced on PMT’s behalf are $7.50 per month for fixed-rate loans and $8.50 per month for adjustable rate mortgage loans. To the extent that these loans become delinquent, the Company is entitled to an additional servicing fee per loan falling within a range of $10 to $75 per month based on the delinquency, bankruptcy and foreclosure status of the loan or the related underlying real estate. The Company is also entitled to customary ancillary income and certain market-based fees and charges, including boarding and deboarding fees, liquidation and disposition fees, assumption, modification and origination fees.

 

·                  The Company is required to provide a range of services and activities significantly greater in scope than the services provided in connection with a customary servicing arrangement because PMT does not have any employees or infrastructure. For these services, the Company receives a supplemental fee of $25 per month for each distressed whole loan and $3.25 per month for each non-distressed subserviced loan. The Company is entitled to reimbursement for all customary, good faith reasonable and necessary out-of-pocket expenses incurred in performance of its servicing obligations.

 

·                  The Company, on behalf of PMT, currently participates in the Home Affordable Modification Program (“HAMP”) of the U.S. Department of the Treasury and U.S. Department of Housing and Urban Development (“HUD”) (and other similar mortgage loan modification programs).  HAMP establishes standard loan modification guidelines for “at risk” homeowners and provides incentive payments to certain participants, including loan servicers, for achieving modifications and successfully remaining in the program. The loan servicing agreement entitles the Company to retain any incentive payments made to it and to which it is entitled under HAMP; provided, however, that with respect to any such incentive payments paid to the Company under HAMP in connection with a mortgage loan modification for which PMT previously paid the Company a modification fee, the Company shall reimburse PMT an amount equal to the incentive payments.

 

Following is a summary of mortgage loan servicing fees earned from PMT for the periods presented:

 

 

 

Quarter ended September 30,

 

Nine months ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(in thousands)

 

Loan servicing fees:

 

 

 

 

 

 

 

 

 

Base

 

$

7,139

 

$

3,518

 

$

19,005

 

$

9,656

 

Activity-based

 

3,599

 

1,082

 

8,246

 

3,507

 

 

 

$

10,738

 

$

4,600

 

$

27,251

 

$

13,163

 

 

The term of the servicing agreement, as amended, expires on February 1, 2017, subject to automatic renewal for additional 18-month periods, unless terminated earlier in accordance with the terms of the servicing agreement.

 

Correspondent Lending

 

Before February 1, 2013, PMT paid PennyMac a fulfillment fee of 50 basis points of the unpaid principal balance of mortgage loans sold to non-affiliates where PMT is approved or licensed to sell to such non-affiliate. Effective February 1, 2013, the mortgage banking and warehouse services agreement provides for a fulfillment fee paid to the Company based on the type of mortgage loan that PMT acquires. The fulfillment fee is equal to a percentage of the unpaid principal balance of mortgage loans purchased by PMT, with the addition of potential fee rate discounts applicable to PMT’s monthly purchase volume in excess of designated thresholds. The Company has also agreed to provide such services exclusively for PMT’s benefit, and the Company and its affiliates are prohibited from providing such services for any other third party.

 

The Company is entitled to a fulfillment fee based on the type of mortgage loan that PMT acquires and equal to a percentage of the unpaid principal balance of such mortgage loan. Presently, the applicable percentages are (i) 0.50% for conventional mortgage loans, (ii) 0.88% for loans salable in accordance with the Ginnie Mae Mortgage-Backed Securities Guide, (iii) 0.80% for the U.S. Department of the Treasury and HUD’s Home Affordable Refinance Program (“HARP”) mortgage loans with a loan-to-value ratio of 105% or less, (iv) 1.20% for HARP mortgage loans with a loan-to-value ratio of greater than 105%, and (v) 0.50% for all other mortgage loans not contemplated above; provided, however, that the Company may, in its sole discretion, reduce the amount of the applicable fulfillment fee and credit the amount of such reduction to the reimbursement otherwise due as described below. This reduction may only be credited to the reimbursement applicable to the month in which the related mortgage was funded.

 

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In the event that PMT purchases mortgage loans with an unpaid principal balance in any month totaling more than $2.5 billion and less than $5 billion, the Company has agreed to discount the amount of such fulfillment fees by reimbursing PMT an amount equal to the product of (i) 0.025%, (ii) the amount of unpaid principal balance in excess of $2.5 billion and (iii) the percentage of the total unpaid principal balance relating to mortgage loans for which the Company collected fulfillment fees in such month. In the event PMT purchases mortgage loans with an total unpaid principal balance in any month greater than $5 billion, the Company has agreed to further discount the amount of fulfillment fees by reimbursing PMT an amount equal to the product of (i) 0.05%, (ii) the amount of unpaid principal balance in excess of $5 billion and (iii) the percentage of the total unpaid principal balance relating to mortgage loans for which the Company collected fulfillment fees in such month.

 

PMT does not hold the Ginnie Mae approval required to issue Ginnie Mae MBS and act as a servicer. Accordingly, under the mortgage banking and warehouse services agreement, the Company currently purchases loans salable in accordance with the Ginnie Mae Mortgage-Backed Securities Guide “as is” and without recourse of any kind to PMT at its cost less fees collected by PMT from the seller, plus accrued interest and a sourcing fee of three basis points.

 

In consideration for the mortgage banking services provided by the Company with respect to PMT’s acquisition of mortgage loans under PLS’s early purchase program, the Company is entitled to fees (i) accruing at a rate equal to $25,000 per year per early purchase facility administered by the Company, and (ii) in the amount of $50 for each mortgage loan PMT acquires. In consideration for the warehouse services provided by the Company with respect to mortgage loans that PMT finances for its warehouse lending clients, with respect to each facility, the Company is entitled to fees (i) accruing at a rate equal to $25,000 per year, and (ii) in the amount of $50 for each mortgage loan that PMT finances thereunder. Where PMT has entered into both an early purchase agreement and a warehouse lending agreement with the same client, the Company shall only be entitled to one $25,000 per year fee and, with respect to any mortgage loan that becomes subject to both such agreements, only one $50 per loan fee.

 

The term of the mortgage banking and warehouse services agreement expires on February 1, 2017, subject to automatic renewal for additional 18-month periods, unless terminated earlier in accordance with the terms of the agreement.

 

Following is a summary of correspondent lending activity between the Company and PMT for the periods presented:

 

 

 

Quarter ended September 30,

 

Nine months ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(in thousands)

 

Sourcing fees paid

 

$

1,204

 

$

747

 

$

3,563

 

$

1,448

 

Fulfillment fee revenue

 

$

18,327

 

$

17,258

 

$

68,625

 

$

31,097

 

Unpaid principal balance of loans fulfilled for PMT

 

$

3,681,771

 

$

2,488,443

 

$

12,792,482

 

$

4,828,117

 

Fair value of loans purchased from PMT

 

$

4,147,535

 

$

2,650,097

 

$

12,429,698

 

$

5,111,185

 

 

Investment Activities

 

Pursuant to the terms of a mortgage servicing rights (“MSR”) recapture agreement, as amended, if the Company refinances through its retail lending business loans for which PMT previously held the MSRs, the Company is generally required to transfer and convey to one of PMT’s wholly-owned subsidiaries, without cost to PMT, the MSRs with respect to new mortgage loans originated in those refinancings (or, under certain circumstances, other mortgage loans) that have a total unpaid principal balance that is not less than 30% of the total unpaid principal balance of all the loans so originated. Where the fair market value of the aggregate MSRs to be transferred for the applicable month is less than $200,000, the Company may, at its option, pay cash to PMT in an amount equal to such fair market value in lieu of transferring such MSRs. The MSR recapture agreement expires, unless terminated earlier in accordance with the agreement, on February 1, 2017, subject to automatic renewal for additional 18-month periods. The Company recorded MSR recapture totaling $86,000 and $586,000 for the quarter and nine months ended September 30, 2013, respectively, as a component of gain on mortgage loans held for sale.

 

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Pursuant to the terms of a master spread acquisition and MSR servicing agreement, as amended, PMT may acquire from the Company the rights to receive certain excess servicing spread arising from MSRs acquired by the Company, in which case the Company generally would be required to service or subservice the related mortgage loans. The terms of each transaction under the spread acquisition and MSR servicing agreement will be subject to the terms of such agreement as modified and supplemented by the terms of a confirmation executed in connection with such transaction.

 

Payable to Exchanged Private National Mortgage Acceptance Company, LLC Unitholders Under Tax Receivable Agreement

 

As discussed in Note 1, the Company entered into a tax receivable agreement with PennyMac’s existing unitholders on the date of the IPO that will provide for the payment by PFSI to PennyMac’s then-existing unitholders an amount equal to 85% of the amount of the benefits, if any, that PFSI is deemed to realize as a result of (i) increases in tax basis resulting from exchanges of the then-existing unitholders and (ii) certain other tax benefits related to entering into the tax receivable agreement, including tax benefits attributable to payments under the tax receivable agreement. Based on the PennyMac unitholder exchange during the period, the Company has recorded a $58.6 million liability and has not made a payment under the tax sharing agreement as of September 30, 2013.

 

Other Transactions

 

In connection with the IPO of PMT’s common shares on August 4, 2009, the Company entered into an agreement with PMT pursuant to which PMT agreed to reimburse the Company for the $2.9 million payment that it made to the underwriters in such offering (the “Conditional Reimbursement”) if PMT satisfied certain performance measures over a specified period of time. Effective February 1, 2013, PMT amended the terms of the reimbursement agreement to provide for the reimbursement to the Company of the Conditional Reimbursement if PMT is required to pay the Company performance incentive fees under the management agreement at a rate of $10 in reimbursement for every $100 of performance incentive fees earned. The reimbursement of the Conditional Reimbursement is subject to a maximum reimbursement in any particular 12-month period of $1.0 million and the maximum amount that may be reimbursed under the agreement is $2.9 million. The Company received payments from PMT totaling $388,000 and $601,000 during the quarter and nine months ended September 30, 2013, respectively.

 

In the event the termination fee is payable to the Company under the management agreement and the Company has not received the full amount of the reimbursements and payments under the reimbursement agreement, such amount will be paid in full. The term of the reimbursement agreement expires on February 1, 2019.

 

PMT reimburses the Company for other expenses, including common overhead expenses incurred on its behalf by the Company, in accordance with the terms of its management agreement. Such amounts are summarized below:

 

 

 

Quarter ended September 30,

 

Nine months ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(in thousands)

 

Reimbursement of expenses incurred on PMT’s behalf

 

$

1,934

 

$

555

 

$

3,767

 

$

2,420

 

Reimbursement of common overhead incurred by PCM and its affiliates

 

2,552

 

1,244

 

8,359

 

2,474

 

 

 

$

4,486

 

$

1,799

 

$

12,126

 

$

4,894

 

 

 

 

 

 

 

 

 

 

 

Payments and settlements during the period (1)

 

$

29,315

 

$

12,239

 

$

94,606

 

$

28,896

 

 


(1)         Payments and settlements include payments for management fees and correspondent lending activities itemized in the preceding tables and netting settlements made pursuant to master netting agreements between the Company and PMT.

 

Amounts due from PMT are summarized below as of the dates presented:

 

 

 

September 30, 2013

 

December 31, 2012

 

 

 

(in thousands)

 

Management fees

 

$

8,539

 

$

4,473

 

Servicing fees

 

5,152

 

3,670

 

Underwriting fees

 

2,131

 

2,941

 

Allocated expenses

 

4,208

 

1,132

 

Loan purchases

 

 

4,475

 

 

 

$

20,030

 

$

16,691

 

 

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The Company also holds an investment in PMT in the form of 75,000 common shares of beneficial interest as of September 30, 2013 and December 31, 2012. The shares had fair values of $1.7 million and $1.9 million as of September 30, 2013 and December 31, 2012, respectively.

 

Investment Funds

 

Amounts due from the Investment Funds are summarized below for the dates presented:

 

 

 

September 30, 2013

 

December 31, 2012

 

 

 

(in thousands)

 

Receivable from Investment Funds:

 

 

 

 

 

Loan servicing fees

 

$

47

 

$

1,052

 

Loan servicing rebate

 

(123

)

(239

)

Management fees

 

2,001

 

2,164

 

Expense reimbursements

 

616

 

695

 

 

 

$

2,541

 

$

3,672

 

Carried Interest due from Investment Funds:

 

 

 

 

 

PNMAC Mortgage Opportunity Fund, LLC

 

$

36,357

 

$

29,785

 

PNMAC Mortgage Opportunity Fund Investors, LLC

 

21,777

 

17,938

 

 

 

$

58,134

 

$

47,723

 

 

Amounts due to the Investment Funds totaling $36.4 million and $36.8 million represent amounts advanced by the Investment Funds to fund servicing advances made by the Company as of September 30, 2013 and December 31, 2012, respectively.

 

Note 5—Earnings Per Common Share

 

Basic earnings per common share is determined using net income divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per common share is determined by dividing net income attributable to common stockholders by the weighted-average of common shares outstanding, assuming all potentially dilutive common shares were issued.

 

The Company applies the treasury stock method to determine the dilutive weighted-average common shares represented by the unvested restricted stock units and the exchangeable PennyMac Class A units. The diluted earnings per share calculation assumes the exchange of these PennyMac Class A partnership units for shares of common stock. Accordingly, the numerator is also adjusted to include the earnings allocated to the PennyMac Class A units after taking into account the tax effect of such exchange.

 

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The following table summarizes the basic and diluted earnings per share calculations:

 

 

 

Quarter ended
September 30, 2013

 

Nine months ended
September 30, 2013

 

 

 

(in thousands, except per share amounts)

 

 

 

 

 

 

 

Basic earnings per share of common stock:

 

 

 

 

 

Net income attributable to common stockholders

 

$

5,197

 

$

7,990

 

Weighted-average shares outstanding

 

17,958

 

16,042

 

Basic earnings per share

 

$

0.29

 

$

0.50

 

 

 

 

 

 

 

Diluted earnings per share of common stock:

 

 

 

 

 

Net income

 

$

5,197

 

$

7,990

 

Effect of net income attributable to noncontrolling interest, net of tax

 

15,685

 

29,595

 

Diluted net income attributable to common stockholders

 

$

20,882

 

$

37,585

 

Weighted-average common stock outstanding

 

17,958

 

16,042

 

Dilutive potential exchangeable PennyMac Class A common units to common stock

 

57,888

 

59,804

 

Dilutive potential common stock—issuable under stock-based compensation plans

 

30

 

21

 

Diluted weighted-average common stock outstanding

 

75,876

 

75,867

 

Diluted earnings per share of common stock

 

$

0.28

 

$

0.50

 

 

Note 6—Loan Sales and Servicing Activities

 

The Company purchases and sells mortgage loans to the secondary mortgage market without recourse for credit losses. However, the Company maintains continuing involvement with the loans in the form of servicing arrangements and the liability under representations and warranties it makes to purchasers and insurers of the loans.

 

The following table summarizes cash flows between the Company and transferees upon sale of mortgage loans in transactions where the Company maintains continuing involvement with the mortgage loans (primarily the obligation to service the loans on behalf of the loans’ owners or owners’ agents):

 

 

 

Quarter ended September 30,

 

Nine months ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(in thousands)

 

Cash flows:

 

 

 

 

 

 

 

 

 

Sales proceeds

 

$

4,515,106

 

$

2,654,125

 

$

13,210,810

 

$

5,112,530

 

Servicing fees received

 

$

16,403

 

$

3,940

 

$

38,104

 

$

8,327

 

Net servicing advances

 

$

(717

)

$

1,009

 

$

(4,375

)

$

2,191

 

Quarter-end information:

 

 

 

 

 

 

 

 

 

Unpaid principal balance of loans outstanding at period-end

 

$

22,776,613

 

$

6,444,618

 

$

22,776,613

 

$

6,444,618

 

Loans delinquent 30-89 days

 

$

380,070

 

$

93,069

 

$

380,070

 

$

93,069

 

Loans delinquent 90 or more days or in foreclosure or bankruptcy

 

$

247,269

 

$

39,950

 

$

247,269

 

$

39,950

 

 

14



Table of Contents

 

The Company’s mortgage servicing portfolio is summarized as follows:

 

 

 

September 30, 2013

 

 

 

Servicing
rights owned

 

Contract servicing
and subservicing

 

Total
loans serviced

 

 

 

(in thousands)

 

Affiliated entities

 

$

 

$

29,555,254

 

$

29,555,254

 

Agencies

 

21,725,393

 

 

21,725,393

 

Private investors

 

1,051,220

 

50,379

 

1,101,599

 

Mortgage loans held for sale

 

490,088

 

 

490,088

 

 

 

$

23,266,701

 

$

29,605,633

 

$

52,872,334

 

Amount subserviced for the Company

 

$

42,201

 

$

554,070

 

$

596,271

 

Delinquent mortgage loans:

 

 

 

 

 

 

 

30 days

 

$

307,399

 

$

265,806

 

$

573,205

 

60 days

 

85,367

 

114,390

 

199,757

 

90 days or more

 

168,468

 

1,422,071

 

1,590,539

 

 

 

561,234

 

1,802,267

 

2,363,501

 

Loans pending foreclosure

 

69,889

 

1,611,708

 

1,681,597

 

 

 

$

631,123

 

$

3,413,975

 

$

4,045,098

 

Custodial funds managed by the Company (1)

 

$

389,267

 

$

266,285

 

$

655,552

 

 

 

 

December 31, 2012

 

 

 

Servicing
rights owned

 

Contract servicing
and subservicing

 

Total
loans serviced

 

 

 

(in thousands)

 

Affiliated entities

 

$

 

$

16,552,939

 

$

16,552,939

 

Agencies

 

9,860,284

 

 

9,860,284

 

Private investors

 

1,321,584

 

 

1,321,584

 

Mortgage loans held for sale

 

417,742

 

 

417,742

 

 

 

$

11,599,610

 

$

16,552,939

 

$

28,152,549

 

Amount subserviced for the Company

 

$

45,562

 

$

375,818

 

$

421,380

 

Delinquent mortgage loans:

 

 

 

 

 

 

 

30 days

 

$

191,884

 

$

187,653

 

$

379,537

 

60 days

 

60,886

 

122,564

 

183,450

 

90 days or more

 

112,847

 

851,851

 

964,698

 

 

 

365,617

 

1,162,068

 

1,527,685

 

Loans pending foreclosure

 

75,329

 

1,290,687

 

1,366,016

 

 

 

$

440,946

 

$

2,452,755

 

$

2,893,701

 

Custodial funds managed by the Company (1)

 

$

263,562

 

$

150,080

 

$

413,642

 

 


(1)         Borrower and investor custodial cash accounts relate to loans serviced under the servicing agreements and are not recorded on the Company’s consolidated balance sheets. The Company earns interest on custodial funds it manages on behalf of the loans’ investors, which is recorded as part of the interest income in the Company’s consolidated statements of income.

 

15



Table of Contents

 

Following is a summary of the geographical distribution of loans included in the Company’s servicing portfolio for the top five and all other states as measured by the total unpaid principal balance:

 

State

 

September 30, 2013

 

December 31, 2012

 

 

 

(in thousands)

 

California

 

$

18,952,692

 

$

10,696,508

 

Virginia

 

2,984,671

 

*

 

Texas

 

2,962,697

 

1,223,382

 

Florida

 

2,395,337

 

1,385,286

 

Colorado

 

2,109,970

 

1,299,295

 

Washington

 

*

 

1,143,849

 

All other states

 

23,466,967

 

12,404,229

 

 

 

$

52,872,334

 

$

28,152,549

 

 


*     State did not represent a top five state as of the respective date.

 

Certain of the loans serviced by the Company are subserviced on the Company’s behalf by other mortgage loan servicers. Loans are subserviced for the Company when the loans are secured by property in the State of Massachusetts where the Company is not licensed and a license is required to perform such services, or on a transitional basis for loans where the Company has obtained the rights to service the loans but servicing of the loans has not yet transferred to the Company’s servicing system.

 

Note 7—Netting of Financial Instruments

 

The Company uses derivative financial instruments to manage exposure to interest rate risk for the commitments it makes to purchase or originate mortgage loans at specified interest rates (interest rate lock commitments or “IRLCs”), its inventory of mortgage loans held for sale and MSRs. The Company has elected to net derivative asset and liability positions, and cash collateral obtained from (or posted to) its counterparties when subject to an enforceable master netting arrangement. In the event of default, all counterparties are subject to legally enforceable master netting agreements. The derivatives that are not subject to a master netting arrangement are IRLCs.

 

As of September 30, 2013 and December 31, 2012, the Company was not party to reverse repurchase agreements or securities lending transactions that are required to be disclosed in the following table.

 

16



Table of Contents

 

Offsetting of Derivative Assets

 

 

 

September 30, 2013

 

December 31, 2012

 

 

 

Gross amount
of
recognized
assets

 

Gross
amount
offset
in the
balance
sheet

 

Net
amount
of assets in
the
balance
sheet

 

Gross amount
of
recognized
assets

 

Gross
amount
offset
in the
balance
sheet

 

Net
amount
of assets
in the
balance
sheet

 

 

 

(in thousands)

 

Derivatives subject to master netting arrangements:

 

 

 

 

 

 

 

 

 

 

 

 

 

MBS put options

 

$

 

$

 

$

 

$

967

 

$

 

$

967

 

Forward purchase contracts

 

21,226

 

 

21,226

 

1,645

 

 

1,645

 

Forward sale contracts

 

505

 

 

505

 

1,818

 

 

1,818

 

Netting

 

 

(19,382

)

(19,382

)

 

(1,091

)

(1,091

)

 

 

21,731

 

(19,382

)

2,349

 

4,430

 

(1,091

)

3,339

 

Derivatives not subject to master netting arrangements - IRLCs

 

21,717

 

 

21,717

 

23,951

 

 

23,951

 

 

 

$

43,448

 

$

(19,382

)

$

24,066

 

$

28,381

 

$

(1,091

)

$

27,290

 

 

Derivative Assets, Financial Assets, and Collateral Held by Counterparty

 

The following table summarizes by significant counterparty the amount of derivative asset positions after considering master netting arrangements and financial instruments or cash pledged that do not meet the accounting guidance qualifying for setoff accounting.

 

 

 

September 30, 2013

 

December 31, 2012

 

 

 

 

 

Gross amount not offfset in
the

 

 

 

 

 

Gross amount not offset in
the

 

 

 

 

 

Net amount

 

consolidated balance sheet

 

 

 

Net amount

 

consolidated balance sheet

 

 

 

 

 

of assets
in the balance
sheet

 

Financial
instruments

 

Cash
collateral
received

 

Net
amount

 

of assets
in the balance
sheet

 

Financial
instruments

 

Cash
collateral
received

 

Net
amount

 

 

 

(in thousands)

 

Interest rate lock commitments

 

$

 

21,717

 

$

 

$

 

$

21,717

 

$

23,951

 

$

 

$

 

$

23,951

 

Nomura

 

1,036

 

 

 

1,036

 

 

 

 

 

Goldman Sachs

 

591

 

 

 

591

 

 

 

 

 

Bank of America, N.A.

 

 

 

 

 

1,782

 

 

 

1,782

 

Citibank, N.A.

 

 

 

 

 

522

 

 

 

522

 

Bank of NY Mellon

 

 

 

 

 

311

 

 

 

311

 

Wells Fargo

 

 

 

 

 

18

 

 

 

18

 

Other

 

722

 

 

 

722

 

706

 

 

 

706

 

 

 

$

 

24,066

 

$

 

$

 

$

24,066

 

$

27,290

 

$

 

$

 

$

27,290

 

 

17



Table of Contents

 

Offsetting of Derivative Liabilities and Financial Liabilities

 

Following is a summary of net derivative liabilities and assets sold under agreements to repurchase. As discussed above, all derivatives with the exception of IRLCs are subject to master netting arrangements. The assets sold under agreements to repurchase do not qualify for setoff accounting.

 

 

 

September 30, 2013

 

December 31, 2012

 

 

 

Gross
amount of
recognized
liabilities

 

Gross amount
offset
in the
consolidated
balance
sheet

 

Net
amount
of liabilities
in the
consolidated
balance
sheet

 

Gross
amount of
recognized
liabilities

 

Gross amount
offset
in the
consolidated
balance
sheet

 

Net
amount
of liabilities
in the
consolidated
balance
sheet

 

 

 

(in thousands)

 

Derivatives:

 

 

 

 

 

 

 

 

 

 

 

 

 

Subject to a master netting arrangement:

 

 

 

 

 

 

 

 

 

 

 

 

 

Forward purchase contracts

 

$

215

 

$

 

$

215

 

$

389

 

$

 

$

389

 

Forward sale contracts

 

48,069

 

 

48,069

 

1,894

 

 

1,894

 

Netting

 

 

(42,667

)

(42,667

)

 

(1,785

)

(1,785

)

 

 

48,284

 

(42,667

)

5,617

 

2,283

 

(1,785

)

498

 

Derivatives not subject to a master netting arrangement - IRLCs

 

159

 

 

159

 

11

 

 

11

 

Total derivatives

 

48,443

 

(42,667

)

5,776

 

2,294

 

(1,785

)

509

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage loans sold under agreements to repurchase

 

387,883

 

 

387,883

 

393,534

 

 

393,534

 

 

 

$

436,326

 

$

(42,667

)

$

393,659

 

$

395,828

 

$

(1,785

)

$

394,043

 

 

Derivative Liabilities, Financial Liabilities, and Collateral Held by Counterparty

 

The following table summarizes by significant counterparty the amount of derivative liabilities and assets sold under agreements to repurchase after considering master netting arrangements and financial instruments or cash pledged that does not qualify under the accounting guidance for setoff accounting. All assets sold under agreements to repurchase are secured by sufficient collateral or exceed the liability amount recorded on the consolidated balance sheets.

 

 

 

September 30, 2013

 

December 31, 2012

 

 

 

 

 

Gross amount
not offset in the
consolidated

 

 

 

 

 

Gross amount
not offset in the
consolidated

 

 

 

 

 

Net amount of

 

balance sheet

 

 

 

Net amount of

 

balance sheet

 

 

 

 

 

liabilities
in the consolidated
balance sheet

 

Financial
instruments

 

Cash
collateral
pledged

 

Net
amount

 

liabilities
in the consolidated
balance sheet

 

Financial
instruments

 

Cash
collateral
pledged

 

Net
amount

 

 

 

(in thousands)

 

Interest rate lock commitments

 

$

159

 

$

 

$

 

$

159

 

$

11

 

$

 

$

 

$

11

 

Bank of America, N.A.

 

200,074

 

(199,423

)

 

651

 

150,082

 

(150,082

)

 

 

Credit Suisse First Boston Mortgage Capital LLC

 

188,645

 

(188,460

)

 

185

 

122,443

 

(122,252

)

 

191

 

Daiwa Capital Markets

 

1,589

 

 

 

1,589

 

20

 

 

 

20

 

Morgan Stanley Bank, N.A.

 

543

 

 

 

543

 

53

 

 

 

53

 

Bank of NY Mellon

 

524

 

 

 

524

 

 

 

 

 

Citibank, N.A.

 

34

 

 

 

34

 

121,200

 

(121,200

)

 

 

Other

 

2,091

 

 

 

2,091

 

234

 

 

 

,234

 

 

 

$

393,659

 

$

(387,883

)

$

 

$

5,776

 

$

394,043

 

$

(393,534

)

$

 

$

509

 

 

18



Table of Contents

 

Note 8—Fair Value

 

The Company’s consolidated financial statements include assets and liabilities that are measured based on their estimated fair values. The application of fair value estimates may be on a recurring or nonrecurring basis depending on the accounting principles applicable to the specific asset or liability and whether management has elected to carry the item at its estimated fair value as discussed in the following paragraphs.

 

Fair Value Accounting Elections

 

Management identified all of its non-cash financial assets and its originated MSRs relating to loans with initial interest rates of more than 4.5% to be accounted for at estimated fair value so changes in fair value will be reflected in results of operations as they occur and more timely reflect the results of the Company’s performance. The Company’s financial assets subject to this election include the short-term investments and mortgage loans held for sale.

 

For originated MSRs relating to mortgage loans with initial interest rates of less than or equal to 4.5%, management has concluded that such assets present different risks to the Company than originated MSRs relating to mortgage loans with initial interest rates of more than 4.5% and therefore require a different risk management approach. Management’s risk management efforts relating to these assets are aimed at mainly moderating the effects of non-interest rate risks on fair value, such as the effect of changes in home prices on the assets’ values. Management has identified these assets for accounting using the amortization method.

 

Management’s risk management efforts in connection with MSRs relating to mortgage loans with initial interest rates of more than 4.5% are aimed at mainly moderating the effects of changes in interest rates on the assets’ values. At times during the nine months ended September 30, 2013, a portion of the IRLCs, the fair value of which typically increases when prepayment speeds increase, were used to moderate the effect of changes in fair value of MSRs, which typically decreases as prepayment speeds increase.

 

19



Table of Contents

 

Financial Statement Items Measured at Fair Value on a Recurring Basis

 

Following is a summary of financial statement items that are measured at estimated fair value on a recurring basis:

 

 

 

September 30, 2013

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

 

 

(in thousands)

 

Assets:

 

 

 

 

 

 

 

 

 

Short-term investment

 

$

127,487

 

$

 

$

 

$

127,487

 

Mortgage loans held for sale at fair value

 

 

526,063

 

4,185

 

530,248

 

Investment in PMT

 

1,701

 

 

 

1,701

 

Mortgage servicing rights at fair value

 

 

 

26,768

 

26,768

 

Derivative assets:

 

 

 

 

 

 

 

 

 

Interest rate lock commitments

 

 

 

21,717

 

21,717

 

Forward purchase contracts

 

 

21,226

 

 

21,226

 

Forward sales contracts

 

 

505

 

 

505

 

Total derivative assets before netting

 

 

21,731

 

21,717

 

43,448

 

Netting (1)

 

 

 

 

(19,382

)

Total derivative assets

 

 

21,731

 

21,717

 

24,066

 

 

 

$

129,188

 

$

547,794

 

$

52,670

 

$

710,270

 

Liabilities:

 

 

 

 

 

 

 

 

 

Excess servicing spread financing at fair value

 

$

 

$

 

$

2,857

 

$

2,857

 

Derivative liabilities:

 

 

 

 

 

 

 

 

 

Interest rate lock commitments

 

 

 

159

 

159

 

Forward purchase contracts

 

 

215

 

 

215

 

Forward sales contracts

 

 

48,069

 

 

48,069

 

Total derivative liabilities before netting

 

 

48,284

 

159

 

48,443

 

Netting (1)

 

 

 

 

(42,667

)

Total derivative liabilities

 

 

48,284

 

159

 

5,776

 

 

 

$

 

$

48,284

 

$

3,016

 

$

8,633

 

 


(1)         Derivatives are reported net of cash collateral received and paid and, to the extent that the criteria of the accounting guidance covering the offsetting of amounts related to certain contracts are met, positions with the same counterparty are netted as part of a legally enforceable master netting agreement.

 

20



Table of Contents

 

 

 

December 31, 2012

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

 

 

 

 

(in thousands)

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

Short-term investment

 

$

53,164

 

$

 

$

 

$

53,164

 

Mortgage loans held for sale at fair value

 

 

448,384

 

 

448,384

 

Investment in PMT

 

1,897

 

 

 

1,897

 

Mortgage servicing rights at fair value

 

 

 

19,798

 

19,798

 

Derivative assets:

 

 

 

 

 

 

 

 

 

Interest rate lock commitments

 

 

 

23,951

 

23,951

 

Forward purchase contracts

 

 

1,645

 

 

1,645

 

Forward sales contracts

 

 

1,818

 

 

1,818

 

MBS put options

 

 

967

 

 

967

 

Total derivative assets before netting

 

 

4,430

 

23,951

 

28,381

 

Netting (1)

 

 

 

 

(1,091

)

Total derivative assets

 

 

4,430

 

23,951

 

27,290

 

 

 

$

55,061

 

$

452,814

 

$

43,749

 

$

550,533

 

Liabilities:

 

 

 

 

 

 

 

 

 

Derivative liabilities:

 

 

 

 

 

 

 

 

 

Interest rate lock commitments

 

$

 

$

 

$

11

 

$

11

 

Forward purchase contracts

 

 

389

 

 

389

 

Forward sales contracts

 

 

1,894

 

 

1,894

 

Total derivative liabilities before netting

 

 

2,283

 

11

 

2,294

 

Netting (1)

 

 

 

 

(1,785

)

Net derivative liabilities

 

$

 

$

2,283

 

$

11

 

$

509

 

 


(1)         Derivatives are reported net of cash collateral received and paid and, to the extent that the criteria of the accounting guidance covering the setoff of amounts related to certain contracts are met, positions with the same counterparty are netted as part of a legally enforceable master netting agreement.

 

21



Table of Contents

 

As shown above, certain of the Company’s mortgage loans held for sale, MSRs at fair value, IRLCs, and excess servicing spread financing at fair value are measured using Level 3 inputs. Following is a roll forward of these items for the quarters and nine month periods ended September 30, 2013 and 2012 where Level 3 significant inputs were used on a recurring basis:

 

 

 

Quarter ended September 30, 2013

 

 

 

Mortgage
loans held
for sale

 

Mortgage servicing
rights

 

Net interest
rate lock
commitments (1)

 

Total

 

 

 

(in thousands)

 

Assets:

 

 

 

 

 

 

 

 

 

Balance, June 30, 2013

 

$

4,525

 

$

23,070

 

$

(16,210

)

$

11,385

 

Repayments

 

(436

)

 

 

(436

)

Interest rate lock commitments issued, net

 

 

 

23,788

 

23,788

 

Purchases of MSR

 

 

1,116

 

 

1,116

 

Servicing received as proceeds from sales of mortgage loans

 

 

4,157

 

 

4,157

 

Changes in fair value included in income arising from:

 

 

 

 

 

 

 

 

 

Changes in instrument-specific credit risk

 

 

 

 

 

Other factors

 

96

 

(1,575

)

10,585

 

9,106

 

 

 

96

 

(1,575

)

10,585

 

9,106

 

Transfers of interest rate lock commitments (asset) liability to mortgage loans acquired for sale

 

 

 

3,395

 

3,395

 

Balance, September 30, 2013

 

$

4,185

 

$

26,768

 

$

21,558

 

$

52,511

 

Changes in fair value recognized during the period relating to assets still held at September 30, 2013

 

$

16

 

$

(1,575

)

$

21,558

 

 

 

Accumulated changes in fair value relating to assets still held at September 30, 2013

 

$

96

 

 

 

$

21,558

 

 

 

 


(1)  For the purpose of this table, the interest rate lock asset and liability positions are shown net.

 

 

 

Excess servicing
spread financing

 

 

 

 

 

 

 

 

 

(in thousands)

 

 

 

 

 

 

 

Liability:

 

 

 

 

 

 

 

 

 

Balance, June 30, 2013

 

$

 

 

 

 

 

 

 

Initial proceeds received from financing of excess servicing spread

 

2,828

 

 

 

 

 

 

 

Changes in fair value included in income

 

29

 

 

 

 

 

 

 

Repayments

 

 

 

 

 

 

 

 

Balance, September 30, 2013

 

$

2,857

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Changes in fair value recognized during the period relating to liability still held at September 30, 2013

 

$

29

 

 

 

 

 

 

 

Accumulated changes in fair value relating to liability still held at September 30, 2013

 

$

29

 

 

 

 

 

 

 

 

22



Table of Contents

 

 

 

Quarter ended September 30, 2012

 

 

 

Mortgage servicing
rights

 

Net interest
rate lock
commitments

 

Total

 

 

 

 

 

(in thousands)

 

 

 

Balance, June 30, 2012

 

$

23,449

 

$

12,710

 

$

36,159

 

Interest rate lock commitments issued, net

 

 

48,044

 

48,044

 

Servicing received as proceeds from sales of mortgage loans

 

30

 

 

30

 

Changes in fair value included in income arising from:

 

 

 

 

 

 

 

Changes in instrument-specific credit risk

 

 

 

 

Other factors

 

(2,239

)

128

 

(2,111

)

 

 

(2,239

)

128

 

(2,111

)

Transfers of interest rate lock commitments (asset) liability to mortgage loans acquired for sale

 

 

(27,449

)

(27,449

)

Balance, September 30, 2012

 

$

21,240

 

$

33,433

 

$

54,673

 

Changes in fair value recognized during the period relating to assets still held at September 30, 2012

 

$

(2,239

)

$

33,433

 

 

 

Accumulated changes in fair value relating to assets still held at September 30, 2012

 

 

 

$

33,433

 

 

 

 

23



Table of Contents

 

 

 

Nine months ended September 30, 2013

 

 

 

Mortgage
loans held
for sale

 

Mortgage servicing
rights

 

Net interest
rate lock
commitments (1)

 

Total

 

 

 

(in thousands)

 

Assets:

 

 

 

 

 

 

 

 

 

Balance, December 31, 2012

 

$

 

$

19,798

 

$

23,940

 

$

43,738

 

Repurchases

 

5,529

 

 

 

5,529

 

Repayments

 

(1,059

)

 

 

(1,059

)

Interest rate lock commitments issued, net

 

 

 

78,722

 

78,722

 

Purchases of MSR

 

 

5,124

 

 

5,124

 

Sales of MSR

 

 

(550

)

 

(550

)

Servicing received as proceeds from sales of mortgage loans

 

 

4,177

 

 

4,177

 

Changes in fair value included in income arising from:

 

 

 

 

 

 

 

 

 

Changes in instrument-specific credit risk

 

 

 

 

 

Other factors

 

(285

)

(1,781

)

(15,289

)

(17,355

)

 

 

(285

)

(1,781

)

(15,289

)

(17,355

)

Transfers of interest rate lock commitments (asset) liability to mortgage loans acquired for sale

 

 

 

(65,815

)

(65,815

)

Balance, September 30, 2013

 

$

4,185

 

$

26,768

 

$

21,558

 

$

52,511

 

Changes in fair value recognized during the period relating to assets still held at September 30, 2013

 

$

(344

)

$

(1,781

)

$

21,558

 

 

 

Accumulated changes in fair value relating to assets still held at September 30, 2013

 

$

(285

)

 

 

$

21,558

 

 

 

 


(1)  For the purpose of this table, the interest rate lock asset and liability positions are shown net.

 

 

 

Excess servicing
spread financing

 

 

 

 

 

 

 

 

 

(in thousands)

 

 

 

 

 

 

 

Liability:

 

 

 

 

 

 

 

 

 

Balance, December 31, 2012

 

$

 

 

 

 

 

 

 

Initial proceeds received from financing of excess servicing spread

 

2,828

 

 

 

 

 

 

 

Changes in fair value included in income

 

29

 

 

 

 

 

 

 

Repayments

 

 

 

 

 

 

 

 

Balance, September 30, 2013

 

$

2,857

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Changes in fair value recognized during the period relating to liability still held at September 30, 2013

 

$

29

 

 

 

 

 

 

 

Accumulated changes in fair value relating to liability still held at September 30, 2013

 

$

29

 

 

 

 

 

 

 

 

24



Table of Contents

 

 

 

Nine months ended September 30, 2012

 

 

 

Mortgage servicing
rights

 

Net interest
rate lock commitments

 

Total

 

 

 

(in thousands)

 

Balance, December 31, 2011

 

$

25,698

 

$

7,905

 

$

33,603

 

Interest rate lock commitments issued, net

 

 

65,192

 

65,192

 

Servicing received as proceeds from sales of mortgage loans

 

772

 

 

772

 

Changes in fair value included in income arising from:

 

 

 

 

 

 

 

Changes in instrument-specific credit risk

 

 

 

 

Other factors

 

(5,230

)

 

(5,230

)

 

 

(5,230

)

 

(5,230

)

Transfers of interest rate lock commitments (asset) liability to mortgage loans acquired for sale

 

 

(39,664

)

(39,664

)

Balance, September 30, 2012

 

$

21,240

 

$

33,433

 

$

54,673

 

Changes in fair value recognized during the period relating to assets still held at September 30, 2012

 

$

(5,230

)

$

33,433

 

 

 

Accumulated changes in fair value relating to assets still held at September 30, 2012

 

 

 

$

33,433

 

 

 

 

The information used in the preceding roll forwards represents activity for any financial statement items identified as using Level 3 significant inputs at either the beginning or the end of the periods presented. The Company had no transfers in or out among the levels other than transfers of IRLCs to mortgage loans held for sale at fair value upon funding of the respective mortgage loans.

 

Gains (losses) from changes in estimated fair values included in earnings for financial statement items carried at estimated fair value as a result of management’s election of the fair value option are summarized below:

 

 

 

Quarter ended September 30, 2013

 

Quarter ended September 30, 2012

 

 

 

Change in fair value of
mortgage loans held
for sale at fair value

 

Net
servicing
income

 

Total

 

Change in fair value of
mortgage loans held
for sale at fair value

 

Net
servicing
income

 

Total

 

 

 

(in thousands)

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage loans held for sale at fair value

 

$

(6,060

)

$

 

$

(6,060

)

$

56,079

 

$

 

$

56,079

 

Mortgage servicing rights at fair value

 

 

(1,575

)

(1,575

)

 

(2,239

)

(2,239

)

 

 

$

(6,060

)

$

(1,575

)

$

(7,635

)

$

56,079

 

$

(2,239

)

$

53,840

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Excess servicing spread financing at fair value

 

$

 

$

(29

)

$

(29

)

$

 

$

 

$

 

 

 

$

 

$

(29

)

$

(29

)

$

 

$

 

$

 

 

25



Table of Contents

 

 

 

Nine months ended September 30, 2013

 

Nine months ended September 30, 2012

 

 

 

Change in fair value of
mortgage loans held
for sale at fair value

 

Net
servicing
income

 

Total

 

Change in fair value of
mortgage loans held
for sale at fair value

 

Net
servicing
income

 

Total

 

 

 

(in thousands)

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage loans held for sale at fair value

 

$

12,428

 

$

 

$

12,428

 

$

108,205

 

$

 

$

108,205

 

Mortgage servicing rights at fair value

 

 

(1,781

)

(1,781

)

 

(5,230

)

(5,230

)

 

 

$

12,428

 

$

(1,781

)

$

10,647

 

$

108,205

 

$

(5,230

)

$

102,975

 

Liabilities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Excess servicing spread financing at fair value

 

$

 

$

(29

)

$

(29

)

$

 

$

 

$

 

 

 

$

 

$

(29

)

$

(29

)

$

 

$

 

$

 

 

Following are the fair value and related principal amounts due upon maturity of assets and liabilities accounted for under the fair value option as of the dates presented:

 

 

 

September 30, 2013

 

 

 

Fair
value

 

Principal amount due
upon maturity

 

Difference

 

 

 

(in thousands)

 

Mortgage loans held for sale:

 

 

 

 

 

 

 

Current through 89 days delinquent

 

$

529,244

 

$

496,853

 

$

32,391

 

90 or more days delinquent

 

1,004

 

1,297

 

(293

)

 

 

$

530,248

 

$

498,150

 

$

32,098

 

 

 

 

December 31, 2012

 

 

 

Fair
value

 

Principal amount due
upon maturity

 

Difference

 

 

 

(in thousands)

 

Mortgage loans held for sale:

 

 

 

 

 

 

 

Current through 89 days delinquent

 

$

447,889

 

$

418,650

 

$

29,239

 

90 or more days delinquent

 

495

 

623

 

(128

)

 

 

$

448,384

 

$

419,273

 

$

29,111

 

 

Financial Statement Items Measured at Fair Value on a Nonrecurring Basis

 

Following is a summary of financial statement items that are measured at estimated fair value on a nonrecurring basis as of the dates presented:

 

 

 

September 30, 2013

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

 

 

(in thousands)

 

Mortgage servicing rights at lower of amortized cost or fair value

 

$

 

$

 

$

102,116

 

$

102,116

 

 

 

$

 

$

 

$

102,116

 

$

102,116

 

 

26



Table of Contents

 

 

 

December 31, 2012

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

 

 

(in thousands)

 

Mortgage servicing rights at lower of amortized cost or fair value

 

$

 

$

 

$

51,180

 

$

51,180

 

 

 

$

 

$

 

$

51,180

 

$

51,180

 

 

The following table summarizes the total gains (losses) on assets measured at estimated fair values on a nonrecurring basis:

 

 

 

Quarter ended September 30,

 

Nine months ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(in thousands)

 

Mortgage servicing rights at lower of amortized cost or fair value

 

$

(1,164

)

$

(1,000

)

$

(521

)

$

(1,784

)

 

 

$

(1,164

)

$

(1,000

)

$

(521

)

$

(1,784

)

 

The Company evaluates its MSRs at lower of amortized cost or fair value for impairment with reference to the assets’ fair values. For purposes of performing its MSR impairment evaluation, the Company stratifies its MSRs at lower of amortized cost or fair value based on the interest rates borne by the mortgage loans underlying the MSRs. Mortgage loans are grouped into note rate pools of 50 basis points for fixed-rate mortgage loans with note rates between 3% and 4.5% and a single pool for mortgage loans with note rates below 3%. MSRs relating to adjustable rate mortgage loans with initial interest rates of 4.5% or less are evaluated in a single pool. If the fair value of MSRs in any of the note rate pools is below the amortized cost of the MSRs for that pool reduced by any existing valuation allowance, those MSRs are impaired.

 

When MSRs are impaired, the impairment is recognized in current period income and the carrying value of the MSRs is adjusted using a valuation allowance. If the value of the MSRs subsequently increases, the increase in value is recognized in current period income only to the extent of the valuation allowance.

 

Management periodically reviews the various impairment strata to determine whether the value of the impaired MSRs in a given stratum is likely to recover. When management concludes that recovery of the value is unlikely in the foreseeable future, a write-down of the cost of the MSRs for that note rate pool to its estimated fair value is charged to the valuation allowance.

 

Fair Value of Financial Instruments Carried at Amortized Cost

 

The Company’s Cash as well as its Mortgage loans sold under agreements to repurchase, Note payable, Carried Interest due from Investment Funds, and amounts receivable from and payable to the Advised Entities are carried at amortized cost.

 

Cash is measured using “Level 1” significant inputs. The Company’s borrowings carried at amortized cost do not have active markets or observable inputs and the fair value is measured using management’s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation. The Company has classified these financial instruments as “Level 3” financial statement items as of September 30, 2013 and December 31, 2012 due to the lack of current market activity and the Company’s reliance on unobservable inputs to estimate the fair value.

 

Management has concluded that the carrying value of the Carried Interest due from Investment Funds approximates its fair value as the balance represents the amount distributable to the Company at the balance sheet date assuming liquidation of the Investment Funds. Management has concluded that the estimated fair value of the Note payable approximates the agreements’ carrying value due to the agreements’ short term and variable interest rates.

 

The Company also carries the receivable from and payable to the Advised Entities at cost. Management has concluded that the estimated fair value of such balances approximates the carrying value due to the short terms of such balances.

 

27



Table of Contents

 

Valuation Techniques and Assumptions

 

Most of the Company’s financial assets are carried at fair value with changes in fair value recognized in current period income. Certain of the Company’s financial assets and all of its MSRs are “Level 3” financial statement items which require the use of significant unobservable inputs in the estimation of the assets’ values. Unobservable inputs reflect the Company’s own assumptions about the factors that market participants use in pricing an asset or liability, and are based on the best information available under the circumstances.

 

The Company has assigned the responsibility for estimating the fair values of “Level 3” financial statement items to its Financial Analysis and Valuation group (the “FAV group”), which is responsible for valuing and monitoring the Company’s investment portfolios and maintenance of its valuation policies and procedures.

 

The FAV group reports to the Company’s senior management valuation committee, which oversees and approves the valuations. The FAV group monitors the models used for valuation of the Company’s “Level 3” financial statement items, including the models’ performance versus actual results and reports those results to the Company’s senior management valuation committee. The results developed in the FAV group’s monitoring activities may be used to calibrate subsequent projections used for valuation.

 

The FAV group is responsible for reporting to the Company’s senior management valuation committee on a monthly basis on the changes in the valuation of the portfolio, including major factors affecting the valuation and any changes in model methods and assumptions. To assess the reasonableness of its valuations, the FAV group presents an analysis of the effect on the valuation of changes to the significant inputs to the models.

 

Following is a description of the techniques and assumptions used in estimating the fair values of “Level 2” and “Level 3” fair value financial statement items:

 

Mortgage Loans Held for Sale

 

Most of the Company’s mortgage loans held for sale at fair value are salable into active markets and are therefore categorized as “Level 2” fair value financial statement items and their fair values are estimated using their quoted market or contracted price or market price equivalent.

 

Certain of the Company’s mortgage loans may become non-salable into active markets due to identification of a defect by the Company or to the repurchase of a mortgage loan with an identified defect. Because such loans are generally not salable into active mortgage markets, they are classified as “Level 3” financial statement items. The significant unobservable inputs used in the fair value measurement of the Company’s “non-salable” mortgage loans held for sale at fair value are discount rates, home price projections, voluntary prepayment speeds and default speeds. Significant changes in any of those inputs in isolation could result in a significant change to the loans’ fair value measurement. Increases in home price projections are generally accompanied by an increase in voluntary prepayment speeds.

 

The Company did not hold “Level 3” mortgage loans held for sale before 2013. Following is a quantitative summary of key inputs used in the valuation of “Level 3” mortgage loans held for sale at fair value:

 

 

 

September 30, 2013

 

 

 

Range
(Weighted average)

 

Key Inputs

 

 

 

Discount rate

 

7.8% - 13.4%

 

 

 

(9.2%)

 

Twelve-month projected housing price index change

 

6.7% - 7.3%

 

 

 

(6.8%)

 

Prepayment speed (1) 

 

2.1% - 5.6%

 

 

 

(4.8%)

 

Total prepayment speed (2) 

 

3.4% - 5.7%

 

 

 

(5.1%)

 

 


(1) Prepayment speed is measured using Life Voluntary Conditional Prepayment Rate (“CPR”).

(2) Total prepayment speed is measured using Life Total CPR.

 

Changes in fair value attributable to changes in instrument-specific credit risk are measured by the change in the respective loan’s delinquency status at period-end from the later of the beginning of the period or acquisition date.

 

28



Table of Contents

 

Derivative Financial Instruments

 

The Company categorizes IRLCs as a “Level 3” financial statement item. The Company estimates the fair value of an IRLC based on quoted Agency MBS prices, its estimate of the fair value of the MSRs it expects to receive in the sale of the loans and the probability that the mortgage loan will fund or be purchased as a percentage of the commitment it has made (the “pull-through rate”).

 

The significant unobservable inputs used in the fair value measurement of the Company’s IRLCs are the pull-through rate and the MSR component of the Company’s estimate of the value of the mortgage loans it has committed to purchase. Significant changes in the pull-through rate and the MSR component of the IRLCs, in isolation, could result in a significant change in fair value measurement. The financial effects of changes in these assumptions are generally inversely correlated as increasing interest rates have a positive effect on the fair value of the MSR component of IRLC value, but increase the pull-through rate for loans that have decreased in fair value in comparison to the agreed-upon purchase price.

 

Following is a quantitative summary of key unobservable inputs used in the valuation of IRLCs:

 

 

 

September 30, 2013

 

December 31, 2012

 

 

 

Range
(Weighted average)

 

Key Inputs

 

 

 

 

 

Pull-through rate

 

56.6% - 98.0%

 

61.6% – 98.1%

 

 

 

(78.3%)

 

(79.1%)

 

MSR value expressed as:

 

 

 

 

 

Servicing fee multiple

 

2.1 - 5.0

 

3.2 – 4.2

 

 

 

(4.0)

 

(4.0)

 

Percentage of unpaid principal balance

 

0.4% - 2.6%

 

0.6% – 2.2%

 

 

 

(1.1%)

 

(0.9%)

 

 

The Company estimates the fair value of commitments to sell loans based on quoted MBS prices. The Company estimates the fair value of the MBS options and futures it purchases and sells based on observed interest rate volatilities in the MBS market.

 

Mortgage Servicing Rights

 

MSRs are categorized as “Level 3” fair value financial statement items. The Company uses a discounted cash flow approach to estimate the fair value of MSRs. This approach consists of projecting servicing cash flows discounted at a rate that management believes market participants would use in their determinations of value. The key assumptions used in the estimation of the fair value of MSRs include prepayment rates of the underlying loans, the applicable discount rate or pricing spread, and the cost to service loans.

 

The results of the estimates of fair value of MSRs are reported to the Company’s senior management valuation committee as part of their review and approval of monthly valuation results. Changes in the fair value of MSRs are included in the consolidated statements of income under the caption Net servicing income — Amortization, impairment and change in estimated fair value of mortgage servicing rights.

 

29



Table of Contents

 

Key assumptions used in determining the fair value of MSRs at the time of initial recognition are as follows:

 

 

 

Quarter ended September 30,

 

 

 

2013

 

2012

 

 

 

Range
(Weighted average)

 

 

 

Fair
value

 

Amortized
cost

 

Fair
value

 

Amortized
cost

 

Unpaid principal balance of underlying loans

 

$315,869

 

$4,120,962

 

$4,217

 

$2,485,982

 

Weighted-average servicing fee rate (in basis points)

 

31

 

30

 

27

 

27

 

 

 

 

 

 

 

 

 

 

 

Pricing spread (1) 

 

7.4% - 13.1%

 

5.4% - 15.9%

 

7.5% - 9.9%

 

7.5% - 9.9%

 

 

 

(9.9%)

 

(8.2%)

 

(7.8%)

 

(9.8%)

 

Annual total prepayment speed (2) 

 

8.8% - 17.2%

 

8.5% - 14.7%

 

8.4% - 9.5%

 

8.4% - 9.5%

 

 

 

(9.2%)

 

(8.8%)

 

(9.2%)

 

(8.4%)

 

Life (in years)

 

3.6 – 7.0

 

2.9 – 6.9

 

6.4 – 6.7

 

6.4 – 6.7

 

 

 

(6.9)

 

(6.7)

 

(6.4)

 

(6.7)

 

Cost of servicing

 

$68 – $120

 

$68 – $120

 

$68 – $100

 

$68 – $100

 

 

 

($101)

 

($104)

 

($71)

 

($99)

 

 

 

 

Nine months ended September 30,

 

 

 

2013

 

2012

 

 

 

Range
(Weighted average)

 

 

 

Fair
value

 

Amortized
cost

 

Fair
value

 

Amortized
cost

 

Unpaid principal balance of underlying loans

 

$318,066

 

$12,350,104

 

$17,504

 

$4,811,328

 

Weighted-average servicing fee rate (in basis points)

 

31

 

29

 

28

 

27

 

 

 

 

 

 

 

 

 

 

 

Pricing spread (1) 

 

7.4% - 13.1%

 

5.4% - 15.9%

 

7.5% - 9.9%

 

7.5% - 9.9%

 

 

 

(9.9%)

 

(8.2%)

 

(8.4%)

 

(9.8%)

 

Annual total prepayment speed (2) 

 

8.8% - 17.2%

 

8.5% - 18.5%

 

7.8% - 9.5%

 

7.8% - 9.5%

 

 

 

(9.2%)

 

(8.8%)

 

(8.6%)

 

(8.3%)

 

Life (in years)

 

3.6 – 7.0

 

2.9 – 6.9

 

5.9 – 6.9

 

5.9 – 6.9

 

 

 

(6.9)

 

(6.7)

 

(6.4)

 

(6.7)

 

Cost of servicing

 

$68 – $120

 

$68 – $120

 

$68 – $100

 

$68 – $100

 

 

 

($101)

 

($102)

 

($77)

 

($99)

 

 


(1)                                 Pricing spread represents a margin that is applied to a reference interest rate’s forward rate curve to develop periodic discount rates. The Company applies a pricing spread to the United States Dollar LIBOR curve for purposes of discounting cash flows relating to MSRs acquired as proceeds from the sale of mortgage loans.

(2)                                Prepayment speed is measured using CPR.

 

Following is a quantitative summary of key inputs used in the valuation of the Company’s MSRs at period end and the effect on the estimated fair value from adverse changes in those assumptions (weighted averages are based upon unpaid principal balance):

 

30



Table of Contents

 

Purchased MSRs backed by distressed mortgage loans

 

 

 

September 30, 2013

 

December 31, 2012

 

 

 

Range
(Weighted average)

 

 

 

Fair
value

 

Amortized
cost

 

Fair
value

 

Amortized
cost

 

 

 

(Unpaid principal balance of underlying loans and effect on value amounts
in thousands)

 

Carrying value

 

$10,125

 

 

$12,370

 

 

Unpaid principal balance of underlying loans

 

$1,051,220

 

 

$1,271,478

 

 

Weighted-average note rate

 

5.88%

 

 

6.01%

 

 

Weighted-average servicing fee rate (in basis points)

 

50

 

 

50

 

 

 

 

 

 

 

 

 

 

 

 

Discount rate

 

15.3% – 15.3%

 

 

15.3% – 15.3%

 

 

 

 

(15.3%)

 

 

(15.3%)

 

 

Effect on value of 5% adverse change

 

($252)

 

 

($302)

 

 

Effect on value of 10% adverse change

 

($494)

 

 

($590)

 

 

Effect on value of 20% adverse change

 

($945)

 

 

($1,130)

 

 

 

 

 

 

 

 

 

 

 

 

Life (in years)

 

4.8 – 4.8

 

 

5.0 – 5.0

 

 

 

 

(4.8)

 

 

(5.0)

 

 

 

 

 

 

 

 

 

 

 

 

Prepayment speed (1) 

 

11.7% – 11.7%

 

 

10.7% – 10.7%

 

 

 

 

(11.7%)

 

 

(10.7%)

 

 

Effect on value of 5% adverse change

 

($252)

 

 

($273)

 

 

Effect on value of 10% adverse change

 

($492)

 

 

($529)

 

 

Effect on value of 20% adverse change

 

($951)

 

 

($1,040)

 

 

 

 

 

 

 

 

 

 

 

 

Per-loan cost of servicing

 

$250 – $250

 

 

$270 – $270

 

 

 

 

($250)

 

 

($270)

 

 

Effect on value of 5% adverse change

 

($223)

 

 

($290)

 

 

Effect on value of 10% adverse change

 

($447)

 

 

($580)

 

 

Effect on value of 20% adverse change

 

($893)

 

 

($1,159)

 

 

 


(1)                                 Prepayment speed is measured using Life Voluntary CPR.

 

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Table of Contents

 

All other MSRs

 

 

 

September 30, 2013

 

December 31, 2012

 

 

 

Range
(Weighted average)

 

 

 

Fair
value

 

Amortized
cost

 

Fair
value

 

Amortized
cost

 

 

 

(Unpaid principal balance of underlying loans and
effect on value amounts in thousands)

 

Carrying value

 

$16,643

 

$226,090

 

$7,428

 

$89,177

 

Unpaid principal balance of underlying loans

 

$1,700,612

 

$20,024,781

 

$1,166,765

 

$8,730,686

 

Weighted-average note rate

 

4.68%

 

3.57%

 

5.22%

 

3.65%

 

Weighted-average servicing fee rate (in basis points)

 

27

 

28

 

26

 

28

 

Pricing spread (1)

 

6.4% – 17.5%

 

5.4% – 15.9%

 

7.5% – 19.5%

 

7.5% – 16.5%

 

 

 

(8.9%)

 

(7.6%)

 

(10.6%)

 

(9.8%)

 

Effect on value of 5% adverse change

 

($303)

 

($4,833)

 

($113)

 

($1,814)

 

Effect on value of 10% adverse change

 

($596)

 

($9,488)

 

($222)

 

($3,562)

 

Effect on value of 20% adverse change

 

($1,153)

 

($18,303)

 

($430)

 

($6,870)

 

 

 

 

 

 

 

 

 

 

 

Average life (in years)

 

0.2 – 14.4

 

2.6 – 6.9

 

0.2 – 14.4

 

2.5 – 6.9

 

 

 

(6.6)

 

(6.7)

 

(5.0)

 

(6.6)

 

Prepayment speed (2) 

 

8.7% – 72.8%

 

8.5% – 16.0%

 

9.0% – 84.2%

 

8.7% – 28.3%

 

 

 

(10.6%)

 

(9.0%)

 

(19.2%)

 

(9.2%)

 

Effect on value of 5% adverse change

 

($376)

 

($4,696)

 

($238)

 

($1,751)

 

Effect on value of 10% adverse change

 

($738)

 

($9,238)

 

($462)

 

($3,446)

 

Effect on value of 20% adverse change

 

($1,423)

 

($17,891)

 

($877)

 

($6,674)

 

 

 

 

 

 

 

 

 

 

 

Per-loan cost of servicing

 

$68 – $120

 

$68 – $120

 

$68 – $140

 

$68 – $140

 

 

 

($77)

 

($102)

 

($76)

 

($99)

 

Effect on value of 5% adverse change

 

($150)

 

($2,383)

 

($77)

 

($963)

 

Effect on value of 10% adverse change

 

($300)

 

($4,766)

 

($153)

 

($1,926)

 

Effect on value of 20% adverse change

 

($601)

 

($9,531)

 

($307)

 

($3,852)

 

 


(1)         Pricing spread represents a margin that is applied to a reference interest rate’s forward curve to develop periodic discount rates. The Company applies a pricing spread to the United States Dollar LIBOR curve for purposes of discounting cash flows relating to MSRs acquired as proceeds from the sale of mortgage loans and purchased MSRs not backed by pools of distressed mortgage loans.

(2)         Prepayment speed is measured using CPR.

 

The preceding sensitivity analyses are limited in that they were performed at a particular point in time; only contemplate the movements in the indicated variables; do not incorporate changes in the variables in relation to other variables; are subject to the accuracy of various models and assumptions used; and do not incorporate other factors that would affect the Company’s overall financial performance in such scenarios, including operational adjustments made by management to account for changing circumstances. For these reasons, the preceding estimates should not be viewed as an earnings forecast.

 

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Table of Contents

 

Excess Servicing Spread Financing at Fair Value

 

The Company categorizes excess servicing spread financing as a “Level 3” financial statement item. The Company uses a discounted cash flow approach to estimate the fair value of excess servicing spread financing. The key assumptions used in the fair value estimate of excess servicing spread financing include pricing spread, average life, and prepayment speed. Significant changes to any of those inputs in isolation could result in a significant change in the excess servicing spread financing fair value measurement. Changes in these key assumptions are not necessarily directly related.

 

Excess servicing spread is generally subject to loss in value when mortgage rates decrease. Decreasing mortgage rates normally encourage increased mortgage refinancing activity. Increased refinancing activity reduces the life of the loans underlying the excess servicing spread, thereby reducing excess servicing spread financing’s value. Reductions in the value of excess servicing spread financing affect income primarily through change in fair value.

 

Interest expense for excess servicing spread financing is accrued using the interest method based upon the expected income from the excess servicing spread through the expected life of the underlying mortgages. Changes to expected cash flows result in a change in fair value which is recorded in Amortization, impairment and change in estimated fair value of mortgage servicing rights.

 

Following are the key inputs used in determining the fair value of excess servicing spread financing at the time of initial recognition:

 

 

 

September 30, 2013

 

December 31, 2012

 

Key Inputs

 

 

 

 

 

Pricing spread

 

6.80

%

 

Average life

 

6.7

 

 

Prepayment speed

 

9.1

%

 

 

Note 9—Mortgage Loans Held for Sale at Fair Value

 

Mortgage loans held for sale at fair value include the following:

 

 

 

September 30, 2013

 

December 31, 2012

 

 

 

(in thousands)

 

Conforming

 

$

57,651

 

$

50,003

 

Government-insured or guaranteed

 

468,412

 

398,381

 

Repurchased mortgage loans

 

4,185

 

 

 

 

$

530,248

 

$

448,384

 

 

 

 

 

 

 

Fair value of mortgage loans pledged to secure mortgage loans sold under agreements to repurchase

 

$

522,031

 

$

438,850

 

 

Note 10—Derivative Instruments

 

The Company is exposed to price risk relative to its mortgage loans held for sale as well as to its IRLCs. The Company bears price risk from the time an IRLC is made to PMT or a loan applicant to the time the mortgage loan is sold. The Company is exposed to loss in value of its IRLCs and mortgage loans held for sale when mortgage rates increase. The Company is also exposed to loss in value of its MSRs when interest rates decrease.

 

The Company engages in interest rate risk management activities in an effort to reduce the variability of earnings caused by changes in market interest rates. To manage this price risk resulting from interest rate risk, the Company uses derivative financial instruments acquired with the intention of moderating the risk that changes in market interest rates will result in unfavorable changes in the value of the Company’s IRLCs, inventory of mortgage loans held for sale and MSRs. The Company does not use derivative financial instruments for purposes other than in support of its risk management activities.

 

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Table of Contents

 

The Company had the following derivative financial instruments recorded on its consolidated balance sheets:

 

 

 

September 30, 2013

 

December 31, 2012

 

 

 

 

 

Fair value

 

 

 

Fair value

 

Instrument

 

Notional
amount

 

Derivative
assets

 

Derivative
liabilities

 

Notional
amount

 

Derivative
assets

 

Derivative
liabilities

 

 

 

(in thousands)

 

Derivatives not designated as hedging instruments

 

 

 

 

 

 

 

 

 

 

 

 

 

Free-standing derivatives:

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate lock commitments

 

1,163,531

 

$

21,717

 

$

159

 

1,576,174

 

$

23,951

 

$

11

 

Forward purchase contracts

 

1,580,434

 

21,226

 

215

 

1,021,981

 

1,645

 

389

 

Forward sales contracts

 

3,086,889

 

505

 

48,069

 

2,621,948

 

1,818

 

1,894

 

MBS put options

 

 

 

 

500,000

 

967

 

 

Total derivatives before netting

 

 

 

43,448

 

48,443

 

 

 

28,381

 

2,294

 

Netting

 

 

 

(19,382

)

(42,667

)

 

 

(1,091

)

(1,785

)

 

 

 

 

$

24,066

 

$

5,776

 

 

 

$

27,290

 

$

509

 

 

The following table summarizes the activity for derivative contracts used to hedge the Company’s IRLCs and inventory of mortgage loans held for sale at notional value:

 

Period/Instrument

 

Balance
beginning
of period

 

Additions

 

Dispositions/
expirations

 

Balance
end
of period

 

 

 

(in thousands)

 

Quarter ended September 30, 2013

 

 

 

 

 

 

 

 

 

Forward purchase contracts

 

2,071,590

 

13,386,366

 

(13,877,522

)

1,580,434

 

Forward sales contracts

 

4,226,940

 

18,727,428

 

(19,867,479

)

3,086,889

 

MBS call options

 

625,000

 

300,000

 

(925,000

)

 

MBS put options

 

260,000

 

50,000

 

(310,000

)

 

 

Period/Instrument

 

Balance
beginning
of period

 

Additions

 

Dispositions/
expirations

 

Balance
end
of period

 

 

 

(in thousands)

 

Quarter ended September 30, 2012

 

 

 

 

 

 

 

 

 

Forward purchase contracts

 

545,175

 

5,707,334

 

(5,351,309

)

901,200

 

Forward sales contracts

 

1,522,674

 

8,324,782

 

(7,336,268

)

2,511,188

 

MBS call options

 

5,000

 

5,000

 

(10,000

)

 

MBS put options

 

210,000

 

512,000

 

(387,000

)

335,000

 

 

Period/Instrument

 

Balance
beginning
of period

 

Additions

 

Dispositions/
expirations

 

Balance
end
of period

 

 

 

(in thousands)

 

Nine months ended September 30, 2013

 

 

 

 

 

 

 

 

 

Forward purchase contracts

 

1,021,981

 

35,012,198

 

(34,453,745

)

1,580,434

 

Forward sales contracts

 

2,621,948

 

51,199,986

 

(50,735,045

)

3,086,889

 

MBS call options

 

 

2,100,000

 

(2,100,000

)

 

MBS put options

 

500,000

 

2,210,000

 

(2,710,000

)

 

 

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Table of Contents

 

Period/Instrument

 

Balance
beginning
of period

 

Additions

 

Dispositions/
expirations

 

Balance
end
of period

 

 

 

(in thousands)

 

Nine months ended September 30, 2012

 

 

 

 

 

 

 

 

 

Forward purchase contracts

 

130,900

 

10,197,428

 

(9,427,128

)

901,200

 

Forward sales contracts

 

510,569

 

16,424,121

 

(14,423,502

)

2,511,188

 

MBS call options

 

3,000

 

168,000

 

(171,000

)

 

MBS put options

 

29,000

 

885,000

 

(579,000

)

335,000

 

 

The Company recorded net losses on derivative financial instruments used to hedge the Company’s IRLCs and mortgage loans held for sale at fair value totaling $4.6 million and $39.0 million for the quarters ended September 30, 2013 and September 30, 2012, respectively. The Company recorded net gains on derivative financial instruments totaling $101.9 million for the nine months ended September 30, 2013 and net losses totaling $64.5 million for the nine months ended September 30, 2012. Derivative gains and losses are included in Net gains on mortgage loans held for sale at fair value in the Company’s consolidated statements of income.

 

The Company did not record any net gains or losses on derivative financial instruments used as economic hedges of MSRs for the quarter ended September 30, 2013.  The Company recorded net losses on derivative financial instruments used as economic hedges of MSRs totaling $1.3 million for the nine months ended September 30, 2013.  The derivative losses are included in Amortization, impairment and change in estimated fair value of mortgage servicing rights in the Company’s consolidated statements of income.

 

Note 11—Mortgage Servicing Rights

 

Carried at Fair Value:

 

The activity in MSRs carried at fair value is as follows:

 

 

 

Quarter ended September 30,

 

Nine months ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(in thousands)

 

Balance at beginning of period

 

$

23,070

 

$

23,449

 

$

19,798

 

$

25,698

 

Additions:

 

 

 

 

 

 

 

 

 

Servicing resulting from MSR purchases

 

1,116

 

 

5,124

 

 

Servicing resulting from loan sales

 

4,157

 

30

 

4,177

 

772

 

Sales

 

 

 

(550

)

 

Change in fair value:

 

 

 

 

 

 

 

 

 

Due to changes in valuation inputs or assumptions used in valuation model (1)

 

(635

)

(882

)

1,233

 

(1,218

)

Other changes in fair value (2) 

 

(940

)

(1,357

)

(3,014

)

(4,012

)

Total change in fair value

 

(1,575

)

(2,239

)

(1,781

)

(5,230

)

Balance at end of period

 

$

26,768

 

$

21,240

 

$

26,768

 

$

21,240

 

 


(1)                                                Principally reflects changes in discount rates and prepayment speed assumptions, primarily due to changes in interest rates.

(2)                                                Represents changes due to realization of cash flows.

 

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Table of Contents

 

Carried at Lower of Amortized Cost or Fair Value:

 

The activity in MSRs carried at the lower of amortized cost or fair value is summarized below:

 

 

 

Quarter ended September 30,

 

Nine months ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(in thousands)

 

Amortized cost:

 

 

 

 

 

 

 

 

 

Balance at beginning of period

 

$

179,003

 

$

30,305

 

$

92,155

 

$

6,496

 

Additions:

 

 

 

 

 

 

 

 

 

Servicing resulting from loan sales

 

55,981

 

25,590

 

150,175

 

50,234

 

Amortization

 

(5,367

)

(1,127

)

(12,713

)

(1,962

)

Application of valuation allowance to write down MSRs with other-than-temporary impairment

 

 

 

 

 

Balance at end of period

 

229,617

 

54,768

 

229,617

 

54,768

 

 

 

 

 

 

 

 

 

 

 

Valuation allowance for impairment of MSRs:

 

 

 

 

 

 

 

 

 

Balance at beginning of period

 

(2,335

)

(854

)

(2,978

)

(70

)

Additions

 

(1,192

)

(1,000

)

(549

)

(1,784

)

Application of valuation allowance to write down MSRs with other-than-temporary impairment

 

 

 

 

 

Balance at end of period

 

(3,527

)

(1,854

)

(3,527

)

(1,854

)

MSRs, net

 

$

226,090

 

$

52,914

 

$

226,090

 

$

52,914

 

Estimated fair value of MSRs at end of period

 

$

239,326

 

$

53,419

 

$

239,326

 

$

53,419

 

 

The following table summarizes the Company’s estimate of future amortization of its existing MSRs. This projection was developed using the assumptions made by management in its September 30, 2013 valuation of MSRs. The assumptions underlying the following estimate will change as market conditions and portfolio composition and behavior change, causing both actual and projected amortization levels to change over time.

 

 

 

Estimated MSR

 

12-month period ending September 30,

 

amortization

 

 

 

(in thousands)

 

2014

 

$

22,633

 

2015

 

21,637

 

2016

 

20,658

 

2017

 

19,910

 

2018

 

18,859

 

Thereafter

 

125,920

 

Total

 

$

229,617

 

 

Servicing fees relating to MSRs are recorded in Net servicing income—Loan servicing fees—From non-affiliates on the consolidated statements of income; late charges, ancillary and other fees are recorded in Net servicing income—Loan servicing fees—Ancillary and other fees on the consolidated statements of income and are summarized below:

 

 

 

Quarter ended September 30,

 

Nine months ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(in thousands)

 

Contractual servicing fees

 

$

14,596

 

$

2,154

 

$

35,397

 

$

8,776

 

Late charges

 

527

 

209

 

1,336

 

682

 

Ancillary and other fees

 

140

 

72

 

374

 

194

 

 

 

$

15,263

 

$

2,435

 

$

37,107

 

$

9,652

 

 

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Table of Contents

 

Note 12—Carried Interest Due from Investment Funds

 

The activity in the Company’s Carried Interest due from Investment Funds is summarized as follows:

 

 

 

Quarter ended September 30,

 

Nine months ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(in thousands)

 

Balance at beginning of period

 

$

55,322

 

$

41,149

 

$

47,723

 

$

37,250

 

Carried Interest recognized during the period

 

2,812

 

3,355

 

10,411

 

7,254

 

Proceeds received during the period

 

 

 

 

 

Balance at end of period

 

$

58,134

 

$

44,504

 

$

58,134

 

$

44,504

 

 

The amount of the Carried Interest received by the Company depends on the Investment Funds’ future performance. As a result, the amount of Carried Interest recorded by the Company at period end is subject to adjustment based on future results of the Investment Funds and may be reduced in future periods. However, the Company is not required to pay guaranteed returns to the Investment Funds and the amount of Carried Interest will only be reduced to the extent of amounts previously recognized.

 

Management expects the Carried Interest to be collected by the Company when the Investment Funds liquidate. The investment period for the Investment Funds ended on December 31, 2011. The Investment Funds will continue in existence through December 31, 2016, subject to three one-year extensions by PCM at its discretion as specified in the limited liability company and limited partnership agreements that govern the Investment Funds.

 

Note 13—Investment in PennyMac Mortgage Investment Trust at Fair Value

 

Following is a summary of Change in fair value of investment in and dividends received from PennyMac Mortgage Investment Trust:

 

 

 

Quarter ended September 30,

 

Nine months ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(in thousands)

 

Dividends

 

$

43

 

$

41

 

$

128

 

$

124

 

Change in fair value

 

122

 

273

 

(196

)

506

 

 

 

$

165

 

$

314

 

$

(68

)

$

630

 

 

 

 

 

 

 

 

 

 

 

Fair value of PMT shares at period end

 

$

1,701

 

$

1,753

 

$

1,701

 

$

1,753

 

 

Note 14—Borrowings

 

As of September 30, 2013, the Company maintained four borrowing facilities: three facilities that provide for sales of mortgage loans under agreements to repurchase; and one note payable secured by MSRs and servicing advances made relating to loans in the Company’s loan servicing portfolio.

 

Mortgage Loans Sold Under Agreement to Repurchase

 

The borrowing facilities secured by mortgage loans held for sale are in the form of loan sale and repurchase agreements. Eligible loans are sold under advance rates based on the loan type. Interest is charged at a rate based on the buyer’s overnight cost-of funds rate for one agreement and based on LIBOR for the other two agreements. Loans sold under these agreements may be re-pledged by the lenders.

 

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Table of Contents

 

Financial data pertaining to mortgage loans sold under agreements to repurchase are as follows:

 

 

 

Quarter ended September 30,

 

Nine months ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(dollar amounts in thousands)

 

Period end:

 

 

 

 

 

 

 

 

 

Balance

 

$

387,883

 

$

361,478

 

$

387,883

 

$

361,478

 

Unused amount (1)

 

$

612,117

 

$

88,522

 

$

612,117

 

$

88,522

 

Weighted-average interest rate

 

1.82

%

2.38

%

1.82

%

2.38

%

Fair value of loans securing agreements to repurchase

 

$

522,031

 

$

408,415

 

$

522,031

 

$

408,415

 

During the period:

 

 

 

 

 

 

 

 

 

Average balance of loans sold under agreements to repurchase

 

$

373,386

 

$

219,047

 

$

354,125

 

$

146,425

 

Weighted-average interest rate (2)

 

1.89

%

2.23

%

2.02

%

2.18

%

Total interest expense

 

$

2,920

 

$

1,682

 

$

8,251

 

$

3,583

 

Maximum daily amount outstanding

 

$

588,494

 

$

361,588

 

$

623,523

 

$

361,588

 

 


(1)         The amount the Company is able to borrow under loan repurchase agreements is tied to the fair value of unencumbered mortgage loans eligible to secure those agreements and the Company’s ability to fund the agreements’ margin requirements relating to the mortgage loans sold.

(2)         Excludes the effect of amortization of commitment fees totaling $1.1 million and $423,000 for the quarters ended September 30, 2013 and September 30, 2012, respectively, and $2.8 million and $1.1 million for the nine months ended September 30, 2013 and September 30, 2012, respectively.

 

Following is a summary of maturities of outstanding advances under repurchase agreements by maturity date:

 

Remaining maturity at September 30, 2013

 

Balance

 

 

 

(in thousands)

 

Within 30 days

 

$

423

 

Over 30 to 90 days

 

387,460

 

Over 90 days to 180 days

 

 

Over 180 days to 1 year

 

 

 

 

$

387,883

 

Weighted-average maturity (in months)

 

2.6

 

 

The amount at risk (the fair value of the assets pledged plus the related margin deposit, less the amount advanced by the counterparty and accrued interest) relating to the Company’s mortgage loans held for sale sold under agreements to repurchase is summarized by counterparty below as of September 30, 2013:

 

Counterparty

 

Amount at risk

 

Weighted-average
maturity of advances under
repurchase agreement

 

Facility maturity

 

 

 

(in thousands)

 

 

 

 

 

Bank of America, N.A.

 

$

45,516

 

December 16, 2013

 

January 2, 2014

 

Credit Suisse First Boston Mortgage Capital LLC

 

$

89,917

 

December 18, 2013

 

(1)

 

 


(1) The earlier to occur of October 31, 2014 or the rolling maturity date that is 364 days from any particular date of determination.

 

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The Company is subject to margin calls during the period the agreements are outstanding and therefore may be required to repay a portion of the borrowings before the respective agreements mature if the value (as determined by the applicable lender) of the mortgage loans securing those agreements decreases. As of September 30, 2013, the Company had $1.5 million on deposit with its mortgage loan repurchase agreement counterparties. Such amounts are included in Other assets on the consolidated balance sheets.

 

Excess Servicing Spread Financing

 

In August 2013, the Company acquired MSRs on a pool of agency residential mortgage loans. In connection with such acquisition, the Company, in September 2013, sold to PMT the right to receive the excess cash flow generated from the related mortgage loans after receipt of a fixed base servicing fee per loan. The Company retained all ancillary income associated with servicing the loans and the fixed base servicing fee. The Company continues to be the servicer of the loan pool and provides all servicing and advancing functions. PMT has no prior or continuing involvement with the loans. The Company accounts for the transaction as a financing and the total proceeds received was $2.8 million.

 

The carrying amount of the financing was $2.9 million at September 30, 2013.

 

Note Payable

 

The note payable is summarized below:

 

 

 

September 30, 2013

 

December 31, 2012

 

 

 

(in thousands)

 

Period end:

 

 

 

 

 

Note payable secured by:

 

 

 

 

 

Servicing advances

 

$

3,823

 

$

4,905

 

MSRs

 

52,952

 

48,108

 

 

 

$

56,775

 

$

53,013

 

Assets pledged to secure note:

 

 

 

 

 

Servicing advances

 

$

6,865

 

$

7,430

 

MSRs

 

$

226,588

 

$

100,957

 

 

The note payable matures on the earlier to occur of October 31, 2014 or the rolling maturity date that is 364 days from any particular date of determination. Interest is charged at a rate based on the lender’s overnight cost of funds. The note payable is secured by servicing advances and MSRs relating to certain loans in the Company’s servicing portfolio, and provides for advance rates ranging from 50% to 85% of the amount of the servicing advances or the carrying value of the MSR pledged, up to a maximum of $17 million in the case of servicing advances and $100 million in the case of MSRs.

 

The borrowing facilities contain various covenants, including financial covenants governing the Company’s net worth, debt-to-equity ratio, profitability and liquidity. Management believes the Company was in compliance with these requirements as of September 30, 2013.

 

Note 15—Liability for Losses Under Representations and Warranties

 

The Company’s agreements with Fannie Mae and Freddie Mac include representations and warranties related to the loans the Company sells to those Agencies. The representations and warranties require adherence to Agency origination and underwriting guidelines, including but not limited to the validity of the lien securing the loan, property eligibility, borrower credit, income and asset requirements, and compliance with applicable federal, state and local law.

 

In the event of a breach of its representations and warranties, the Company may be required to either repurchase the mortgage loans with the identified defects or indemnify the investor or insurer. In such cases, the Company bears any subsequent credit loss on the mortgage loans. The Company’s credit loss may be reduced by any recourse it has to correspondent lenders that, in turn, had sold such mortgage loans to the Company and breached similar or other representations and warranties. In such event, the Company has the right to seek a recovery of related repurchase losses from the correspondent lender.

 

The Company records a provision for losses relating to the representations and warranties it makes as part of its loan sale transactions. The method used to estimate the liability for representations and warranties is a function of estimated future defaults, loan repurchase rates, the potential severity of loss in the event of defaults and, for loans purchased from correspondent lenders, the probability of reimbursement by the correspondent lenders. The Company establishes a liability at the time loans are sold and continually updates its liability estimate.

 

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Table of Contents

 

Following is a summary of the Company’s liability for representations and warranties:

 

 

 

Quarter ended September 30,

 

Nine months ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(in thousands)

 

Balance at beginning of period

 

$

6,185

 

$

1,387

 

$

3,504

 

$

449

 

Provisions for losses on loans sold

 

1,069

 

918

 

3,766

 

1,856

 

Incurred losses

 

(39

)

 

(55

)

 

Balance at end of period

 

$

7,215

 

$

2,305

 

$

7,215

 

$

2,305

 

Unpaid principal balance of mortgage loans subject to representations and warranties

 

$

20,428,213

 

$

6,444,618

 

$

20,428,213

 

$

6,444,618

 

 

Following is a summary of the Company’s repurchase activity:

 

 

 

Quarter ended September 30,

 

Nine months ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(in thousands)

 

During the period:

 

 

 

 

 

 

 

 

 

Unpaid balance of mortgage loans repurchased

 

$

1,973

 

$

 

$

6,840

 

$

 

Unpaid principal balance of mortgage loans put to correspondent lenders

 

$

357

 

$

 

$

1,410

 

$

 

At period end:

 

 

 

 

 

 

 

 

 

Unpaid principal balance of mortgage loans subject to pending claims for repurchase

 

$

1,249

 

$

3,459

 

$

1,249

 

$

3,459

 

 

The Company’s representations and warranties are generally not subject to stated limits of exposure. However, management believes that the current unpaid principal balance of loans sold by the Company to date represents the maximum exposure to repurchases related to representations and warranties.

 

The level of the liability for representations and warranties is difficult to estimate and requires considerable management judgment. The level of mortgage loan repurchase losses is dependent on economic factors, investor demand strategies, and other external conditions that will change over the lives of the underlying loans. However, management believes the amount and range of reasonably possible losses in relation to the recorded liability is not material to the Company’s financial condition or results of operations.

 

Note 16—Income Taxes

 

The Company files U.S. federal and state corporate income tax returns for PFSI and partnership return for PennyMac. Before the IPO, the Company did not have a provision for income taxes as PennyMac is a pass-through taxable entity. PFSI’s tax returns are subject to examination for 2012 and forward.  In March 2013, the IRS concluded its audit of the partnership return of PennyMac and its subsidiaries for the tax year ended December 31, 2010 and proposed no changes to the return as originally filed. No returns are currently under examination. PennyMac’s federal partnership returns are subject to examination for 2011 and forward.  PennyMac’s primary state tax return is generally subject to examination for 2009 and forward.

 

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Table of Contents

 

The following table details the Company’s income tax expense (benefit).

 

 

 

Quarter ended
September 30, 2013

 

Nine months ended
September 30, 2013

 

 

 

(in thousands)

 

Current expense:

 

 

 

 

 

Federal

 

$

 

$

 

State

 

 

 

Total current expense

 

 

 

Deferred expense:

 

 

 

 

 

Federal

 

2,823

 

4,339

 

State

 

670

 

1,192

 

Total deferred expense

 

3,493

 

5,531

 

Total provision for income taxes

 

$

3,493

 

$

5,531

 

 

The provision for deferred income taxes for the quarter and nine months ended September 30, 2013 primarily relates to its investment in PennyMac partially offset by a net operating loss carryforward.  The portion attributable to its investment in PennyMac primarily relates to MSRs that PennyMac received pursuant to sales of mortgage loans held for sale at fair value and Carried Interest from the Investment Funds.

 

The following table is a reconciliation of the Company’s provision for income taxes at statutory rates to the provision for income taxes at the Company’s effective tax rate:

 

 

 

Quarter ended
September 30, 2013

 

Nine months ended
September 30, 2013

 

Federal income tax statutory rate

 

35.0

%

35.0

%

Less: Rate attributable to non-controlling members

 

(26.3

)%

(31.6

)%

State income taxes, net of federal benefit

 

1.2

%

0.6

%

Other

 

0.0

%

0.0

%

Valuation allowance

 

0.0

%

0.0

%

Effective tax rate

 

9.9

%

4.0

%

 

The components of the Company’s provision for deferred income taxes are as follows:

 

 

 

Quarter ended
September 30, 2013

 

Nine months ended
September 30, 2013

 

 

 

(in thousands)

 

Investment in PennyMac

 

$

5,491

 

$

7,762

 

Net operating loss carryforward

 

(1,998

)

(2,231

)

Other

 

 

 

Valuation allowance

 

 

 

Total provision for deferred income taxes

 

$

3,493

 

$

5,531

 

 

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Table of Contents

 

The components of Deferred tax asset are as follows:

 

 

 

September 30, 2013

 

 

 

(in thousands)

 

Taxes currently receivable

 

$

7

 

Deferred income tax asset, net

 

54,523

 

Deferred tax asset

 

$

54,530

 

 

The tax effects of temporary differences that gave rise to deferred income tax assets and liabilities are presented below:

 

 

 

September 30, 2013

 

 

 

(in thousands)

 

Deferred income tax assets:

 

 

 

Investment in PennyMac

 

$

52,292

 

Net operating loss carryforward

 

$

2,231

 

Other

 

 

Gross deferred tax assets

 

54,523

 

Deferred income tax liabilities:

 

 

 

Other

 

 

Gross deferred tax liabilities

 

 

Net deferred income tax asset

 

$

54,523

 

 

The Company’s deferred income tax is recorded in Deferred tax asset in the consolidated balance sheets as of September 30, 2013.  There was no income tax asset or liability as of December 31, 2012 since PennyMac is a pass-through taxable entity and PFSI had no activity in 2012.  Increases in deferred tax assets are primarily due to the increase in the Company’s ownership of PennyMac as a result of a member exchanging its PennyMac Class A units for PFSI stock.  As existing members exchange their units, the Company records a deferred tax asset related to PennyMac’s election pursuant to Section 754 of the Internal Revenue Code.  The investment in PennyMac deferred tax asset is reflected net of the investment in PennyMac deferred tax liabilities primarily related to deferred income from MSRs and accrued Carried Interest from the Investment Funds.

 

The Company’s net operating loss carryforward of $2.2 million generally expires in 2033.

 

At September 30, 2013 and December 31, 2012, the Company had no unrecognized tax benefits and does not anticipate any increase in unrecognized tax benefits. Should the accrual of any interest or penalties relative to unrecognized tax benefits be necessary, it is the Company’s policy to record such accruals in the Company’s income tax accounts. No such accruals existed at September 30, 2013 and December 31, 2012.

 

Note 17—Stockholders’ Equity

 

During the quarter ended September 30, 2013, a PennyMac unitholder exchanged 6,110,000 Class A Units for PFSI Class A common stock. The impact of the exchange reduced the percentage of the Noncontrolling interest in Private National Mortgage Acceptance Company, LLC from 83.16% to 75.11%.

 

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Table of Contents

 

Note 18—Net Gain on Mortgage Loans Held for Sale

 

Net gain on mortgage loans held for sale at fair value is summarized below:

 

 

 

Quarter ended September 30,

 

Nine months ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(in thousands)

 

Cash (loss) gain:

 

 

 

 

 

 

 

 

 

Sales proceeds

 

$

(93,725

)

$

26,676

 

$

(148,866

)

$

49,695

 

Hedging activities

 

88,789

 

(19,574

)

128,670

 

(40,276

)

 

 

(4,936

)

7,102

 

(20,196

)

9,419

 

Non-cash gain:

 

 

 

 

 

 

 

 

 

Receipt of MSRs in loan sale transactions

 

60,137

 

25,620

 

154,352

 

51,006

 

MSR recapture payable to affiliate

 

(86

)

 

(586

)

 

Provision for losses relating to representations and warranties provided in loan sales

 

(1,069

)

(918

)

(3,766

)

(1,856

)

Change in fair value relating to loans and hedging derivatives held at period end:

 

 

 

 

 

 

 

 

 

IRLCs

 

37,768

 

20,723

 

(2,382

)

25,528

 

Mortgage loans

 

27,510

 

6,693

 

7,876

 

8,636

 

Hedging derivatives

 

(93,375

)

(19,460

)

(26,738

)

(24,246

)

 

 

$

25,949

 

$

39,760

 

$

108,560

 

$

68,487

 

 

Note 19—Net Interest Income (Expense)

 

Net interest income (expense) is summarized for the periods presented below:

 

 

 

Quarter ended
September 30,

 

Nine months ended
September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(in thousands)

 

Interest income:

 

 

 

 

 

 

 

 

 

Short-term investments

 

$

432

 

$

11

 

$

635

 

$

54

 

Mortgage loans at fair value

 

4,661

 

1,903

 

10,675

 

4,437

 

 

 

5,093

 

1,914

 

11,310

 

4,491

 

Interest expense:

 

 

 

 

 

 

 

 

 

Assets sold under agreements to repurchase

 

2,920

 

1,682

 

8,251

 

3,583

 

Note payable

 

681

 

281

 

2,326

 

645

 

Other

 

555

 

79

 

1,109

 

(2

)

 

 

4,156

 

2,042

 

11,686

 

4,226

 

Net interest income (expense)

 

$

937

 

$

(128

)

$

(376

)

$

265

 

 

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Table of Contents

 

Note 20—Stock-Based Compensation

 

The Company’s 2013 Equity Incentive Plan provides for grants of stock options, time-based and performance-based restricted stock units (“RSUs”), stock appreciation rights, performance units and stock grants.  As of September 30, 2013, the Company has 120.2 million units available for future awards.  The Company estimates the cost of the stock options, time-based restricted stock units and performance-based restricted stock units awarded with reference to the fair value of PFSI’s underlying common stock on the date of the award.  The Company amortizes the cost of previously granted stock-based awards to compensation expense over the vesting period using the graded vesting method. Compensation costs are fixed, except for the performance-based restricted stock units, at the grant’s estimated fair value on the grant date as all grantees are employees and directors of the Company. Expense relating to awards is included in Compensation in the consolidated statements of income.

 

Following is a summary of the stock-based compensation expense by instrument awarded for the periods presented:

 

 

 

Quarter ended September 30,

 

Nine months ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(in thousands)

 

Stock options

 

$

593

 

$

 

$

791

 

$

 

Performance-based RSUs

 

464

 

 

746

 

 

Time-based RSUs

 

330

 

 

395

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

1,387

 

$

 

$

1,932

 

$

 

 

Stock Options

 

The Stock Option award agreements provide for the award of Stock Options to purchase the optioned common stock. In general, and except as otherwise provided by the agreement, one-third of the optioned common stock will vest in a lump sum on each of the first, second, and third anniversaries of the grant date, subject to the recipient’s continued service through each anniversary. Each Stock Option will have a term of ten years from the date of grant but will expire (1) immediately upon termination of the holder’s employment or other association with the Company for cause, (2) one year after the holder’s employment or other association is terminated due to death or disability and (3) three months after the holder’s employment or other association is terminated for any other reason.

 

The fair value of each Stock Option award is estimated on the date of grant using a variant of the Black Scholes model based on the assumptions noted in the following table:

 

 

 

Quarter ended
September 30, 2013

 

Nine months  ended
September 30, 2013

 

Expected volatility (1)

 

 

45%

 

Expected dividends

 

 

0%

 

Risk-free rate

 

 

0.03% - 2.30%

 

Annualized grantee forfeiture rate

 

 

6.2% - 19.2%

 

 


(1) Based on historical volatilities of comparable companies’ common stock.

 

The Company uses its historical data to estimate employee departure behavior used in the option-pricing model; groups of employees (executives and non-executives) that have similar historical behavior are considered separately for valuation purposes. The expected term of common stock options granted is derived from the option pricing model and represents the period of time that common stock options granted are expected to be outstanding. The risk-free rate for periods within the contractual term of the common stock option is based on the U.S. Treasury yield curve in effect at the time of grant.

 

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Table of Contents

 

The table below summarizes stock option award activity and compensation expense for the periods presented:

 

 

 

Quarter ended
September 30, 2013

 

Nine months ended
September 30, 2013

 

Number of Stock Options

 

 

 

 

 

Outstanding at beginning of period

 

423,407

 

 

Granted

 

 

423,407

 

Exercised

 

 

 

Expired or canceled

 

253

 

253

 

Outstanding at end of period

 

423,154

 

423,154

 

Weighted-average exercise price:

 

 

 

 

 

Outstanding at beginning of period

 

$

21.03

 

$

 

Granted

 

 

21.03

 

Exercised

 

 

 

Expired or canceled

 

21.03

 

21.03

 

Outstanding at end of period

 

$

21.03

 

$

21.03

 

Exercisable at end of period

 

 

 

Available for future grant

 

 

 

Weighted-average remaining contractual term (in years):

 

 

 

 

 

Outstanding at end of period

 

9.7

 

 

Exercisable at end of period

 

 

 

Aggregate intrinsic value:

 

 

 

 

 

Outstanding at end of period

 

$

 

$

 

Exercisable at end of period

 

$

 

$

 

 

Time-Based RSUs

 

The RSU grant agreements provide for the award of time-based RSUs, for each RSU, entitling the award recipient to one share of the Company’s Class A common stock. One-third of all time-based RSUs vest in a lump sum on each of the first, second, and third anniversaries of the vesting commencement date, subject to the recipient’s continued service through each anniversary.

 

Compensation cost relating to time-based RSUs is based on the fair value of PFSI’s common stock and the number of shares expected to vest. For purposes of estimating the cost of the time-based RSUs granted, management assumes turnover rates of 6.2% - 19.2% per year based on the grantees’ employee classification. Compensation cost relating to time-based RSUs is amortized to expense using the graded vesting method and is included in the Compensation expense on the accompanying consolidated statements of income.

 

Following is a summary of time-based RSU activity for the periods presented:

 

 

 

Quarter ended
September 30, 2013

 

Nine months ended
September 30, 2013

 

Number of units

 

 

 

 

 

Outstanding at beginning of period

 

70,826

 

 

Granted

 

27,407

 

98,233

 

Vested

 

 

 

Expired or canceled

 

126

 

126

 

Outstanding at end of period

 

98,107

 

98,107

 

Weighted-average grant date fair value:

 

 

 

 

 

Outstanding at beginning of period

 

$

17.51

 

$

 

Granted

 

$

19.37

 

$

18.03

 

Vested

 

$

 

$

 

Expired or canceled

 

$

17.51

 

$

17.51

 

Outstanding at end of period

 

$

18.03

 

$

18.03

 

Compensation expense recorded during the period (in thousands)

 

$

330

 

$

395

 

Period end:

 

 

 

 

 

Unamortized compensation cost (in thousands)

 

$

979

 

 

 

 

Performance-Based RSUs

 

The performance-based RSUs provide for the issuance of shares of PFSI Class A common stock based equally on the attainment of earnings per share and total shareholder return goals and are adjusted for grantee performance ratings. The performance period for these grants is from June 13, 2013 through December 31, 2015. The grantees’ satisfaction of the performance goals will be established by review of a committee of PFSI’s board of directors. Shares vested under these grants will be issued to the grantees no later than March 15, 2016.

 

The performance-based RSUs contain both performance goals (attainment of earnings per share) and market goals (total shareholder return). The Company separately accounts for the performance and market goals when recognizing compensation expense relating to performance-based RSUs.

 

The fair value of the market goal component of the performance-based RSUs is measured using a variant of the Black-Scholes model. Key inputs are the expected volatility of the Company’s Class A common stock, the risk-free interest rate and expected grantee forfeiture rates.

 

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Table of Contents

 

Following are the inputs for grants made for the periods presented:

 

Input

 

Quarter ended 
September 30, 2013

 

Nine months ended
September 30, 2013

 

Expected volatility

 

 

45%

 

Expected dividends

 

 

0%

 

Risk-free interest rate

 

 

0.3%-2.3%

 

Annualized grantee forfeiture rate

 

 

6.2%-19.2%

 

 

The fair value of the performance goal component of the performance-based RSUs is measured based on the fair value of the Company’s common shares at the grant date, management’s estimate of to what extent the performance goal will be met and the number of shares to be forfeited during the vesting period. The cost of the performance-based RSUs is amortized to Compensation expense using the straight line method over the performance period.

 

Following is a summary of performance-based RSU activity for the periods presented:

 

 

 

Quarter ended
September 30, 2013

 

Nine months ended
September 30, 2013

 

Number of units

 

 

 

 

 

Outstanding at beginning of period

 

499,364

 

 

Granted

 

 

499,364

 

Vested

 

 

 

Expired or canceled

 

253

 

253

 

Outstanding at end of period

 

499,111

 

499,111

 

Weighted-average grant date fair value:

 

 

 

 

 

Outstanding at beginning of period

 

$

11.58

 

$

 

Granted

 

$

 

$

11.58

 

Vested

 

$

 

$

 

Expired or canceled

 

$

11.58

 

$

11.58

 

Outstanding at end of period

 

$

11.58

 

$

11.58

 

Compensation expense recorded during the period (in thousands)

 

$

464

 

$

746

 

Period end:

 

 

 

 

 

Unamortized compensation cost (in thousands)

 

$

3,816

 

 

 

 

Note 21—Supplemental Cash Flow Information

 

 

 

Nine months ended September 30,

 

 

 

2013

 

2012

 

 

 

(in thousands)

 

Cash paid for interest

 

$

11,110

 

$

3,506

 

Cash paid for income taxes

 

$

7

 

$

 

Non-cash investing activity:

 

 

 

 

 

Receipt of MSRs created in loan sales activities

 

$

154,352

 

$

51,006

 

 

Note 22—Regulatory Net Worth and Agency Capital Requirements

 

The Company, through PLS, is required to maintain specified levels of equity to remain a seller/servicer in good standing with the Agencies. Such equity requirements generally are tied to the size of the Company’s loan servicing portfolio or loan origination volume.

 

The Agencies’ capital requirements, the calculations of which are specified by each Agency, are summarized below:

 

 

 

September 30, 2013

 

December 31, 2012

 

Requirement - company subject to requirement

 

Net worth (1)

 

Required

 

Net worth (1)

 

Required

 

 

 

(in thousands)

 

Fannie Mae - PLS

 

$

273,445

 

$

54,546

 

$

172,843

 

$

35,947

 

Freddie Mac - PLS

 

$

273,798

 

$

53,751

 

$

173,273

 

$

27,119

 

Ginnie Mae:

 

 

 

 

 

 

 

 

 

Issuer — PLS

 

$

260,032

 

$

45,625

 

$

152,782

 

$

23,886

 

Issuer’s parent — PennyMac

 

$

554,841

 

$

50,188

 

$

227,560

 

$

26,275

 

HUD - PLS

 

$

260,032

 

$

195,891

 

$

152,782

 

$

1,000

 

 


(1)                                 Calculated in compliance with the respective Agency’s requirements.

 

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Table of Contents

 

Noncompliance with the respective agencies’ capital requirements can result in the respective Agency taking various remedial actions up to and including removing PennyMac’s ability to sell loans to and service loans on behalf of the respective Agency. Management believes that PennyMac and PLS had Agency capital in excess of the respective Agencies’ requirements at September 30, 2013.

 

Note 23—Commitments and Contingencies

 

Litigation

 

The business of the Company involves the collection of numerous accounts, as well as the validity of liens and compliance with various state and federal lending and servicing laws. Accordingly, the Company may be involved in proceedings, claims, and legal actions arising in the ordinary course of business. As of September 30, 2013, the Company was not involved in any legal proceedings, claims, or actions in management’s view would be reasonably likely to have a material adverse effect on the Company.

 

Commitments to Fund and Sell Mortgage Loans

 

 

 

September 30, 2013

 

 

 

(in thousands)

 

Commitments to purchase mortgage loans from PMT

 

$

1,022,670

 

Commitments to fund mortgage loans

 

140,861

 

 

 

$

1,163,531

 

Commitments to sell mortgage loans

 

$

3,086,889

 

 

Note 24—Segments and Related Information

 

The Company has two operating segments: mortgage banking and investment management.

 

The mortgage banking segment represents the Company’s operations aimed at originating, purchasing, selling and servicing newly originated mortgage loans and servicing mortgage loans sourced and managed by the investment management segment, including executing the loan resolution strategy identified by the investment management segment relating to distressed mortgage loans.

 

The investment management segment represents the activities of the Company’s investment manager, which include sourcing, performing diligence, bidding and completion of asset acquisitions and managing the acquired assets for the Advised Entities.

 

The investment management segment presently focuses on managing investments in distressed mortgage assets, which include mortgage loans that are either in default or are perceived to be at higher risk of default. The investment management segment then seeks to maximize the value of the mortgage loans on behalf of investors through the direction of effective “high touch” servicing by the mortgage banking segment. “High touch” servicing is based on significant levels of borrower outreach and contact, and the ability to implement long-term, sustainable loan modification and restructuring programs that address borrowers’ ability and willingness to pay their mortgage loans. Where this is not possible, the investment management segment seeks to effect property resolution in a timely, orderly and economically efficient manner for the investor.

 

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Financial highlights by operating segment are as follows:

 

 

 

Quarter ended September 30, 2013

 

 

 

Mortgage
banking

 

Investment
management

 

Total

 

 

 

(in thousands)

 

Revenues:

 

 

 

 

 

 

 

Net gains on mortgage loans held for sale at fair value

 

$

25,949

 

$

 

$

25,949

 

Loan origination fees

 

6,280

 

 

6,280

 

Fulfillment fees from PMT

 

18,327

 

 

18,327

 

Net servicing income

 

21,399

 

 

21,399

 

Management fees

 

 

10,540

 

10,540

 

Carried Interest from Investment Funds

 

 

2,812

 

2,812

 

Net interest income:

 

 

 

 

 

 

 

Interest income

 

5,089

 

4

 

5,093

 

Interest expense

 

(4,156

)

 

(4,156

)

 

 

933

 

4

 

937

 

Other

 

(22

)

972

 

950

 

 

 

72,866

 

14,328

 

87,194

 

Expenses:

 

 

 

 

 

 

 

Compensation

 

33,969

 

1,861

 

35,830

 

Other

 

16,240

 

207

 

16,447

 

 

 

50,209

 

2,068

 

52,277

 

Income before provision for income taxes

 

$

22,657

 

$

12,260

 

$

34,917

 

Segment assets at period end

 

$

1,208,156

 

$

46,228

 

$

1,254,384

 

 

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Quarter ended September 30, 2012

 

 

 

Mortgage
banking

 

Investment
management

 

Total

 

 

 

(in thousands)

 

Revenues:

 

 

 

 

 

 

 

Net gains on mortgage loans held for sale at fair value

 

$

39,760

 

$

 

$

39,760

 

Loan origination fees

 

2,752

 

 

2,752

 

Fulfillment fees from PMT

 

17,258

 

 

17,258

 

Net servicing income

 

6,112

 

 

6,112

 

Management fees

 

 

6,114

 

6,114

 

Carried Interest from Investment Funds

 

 

3,355

 

3,355

 

Net interest income (expense):

 

 

 

 

 

 

 

Interest income

 

1,913

 

1

 

1,914

 

Interest expense

 

(2,042

)

 

(2,042

)

 

 

(129

)

1

 

(128

)

Other

 

1

 

1,008

 

1,009

 

 

 

65,754

 

10,478

 

76,232

 

Expenses:

 

 

 

 

 

 

 

Compensation

 

29,089

 

2,767

 

31,856

 

Other

 

6,375

 

138

 

6,513

 

 

 

35,464

 

2,905

 

38,369

 

Income before provision for income taxes

 

$

30,290

 

$

7,573

 

$

37,863

 

Segment assets at period end

 

$

709,733

 

$

17,529

 

$

727,262

 

 

 

 

Nine months ended September 30, 2013

 

 

 

Mortgage
banking

 

Investment
management

 

Total

 

 

 

(in thousands)

 

Revenues:

 

 

 

 

 

 

 

Net gains on mortgage loans held for sale at fair value

 

$

108,560

 

$

 

$

108,560

 

Loan origination fees

 

18,260

 

 

18,260

 

Fulfillment fees from PMT

 

68,625

 

 

68,625

 

Net servicing income

 

59,510

 

 

59,510

 

Management fees

 

 

29,375

 

29,375

 

Carried Interest from Investment Funds

 

 

10,411

 

10,411

 

Net interest income (expense):

 

 

 

 

 

 

 

Interest income

 

11,296

 

14

 

11,310

 

Interest expense

 

(11,686

)

 

(11,686

)

 

 

(390

)

14

 

(376

)

Other

 

(22

)

1,796

 

1,774

 

 

 

254,543

 

41,596

 

296,139

 

Expenses:

 

 

 

 

 

 

 

Compensation

 

106,584

 

7,266

 

113,850

 

Other

 

41,354

 

496

 

41,850

 

 

 

147,938

 

7,762

 

155,700

 

Income before provision for income taxes

 

$

106,605

 

$

33,834

 

$

140,439

 

Segment assets at period end

 

$

1,208,156

 

$

46,228

 

$

1,254,384

 

 

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Table of Contents

 

 

 

Nine months ended September 30, 2012

 

 

 

Mortgage
banking

 

Investment
management

 

Total

 

 

 

(in thousands)

 

Revenues:

 

 

 

 

 

 

 

Net gains on mortgage loans held for sale at fair value

 

$

68,487

 

$

 

$

68,487

 

Loan origination fees

 

5,439

 

 

5,439

 

Fulfillment fees from PMT

 

31,097

 

 

31,097

 

Net servicing income

 

25,346

 

 

25,346

 

Management fees

 

 

15,163

 

15,163

 

Carried Interest from Investment Funds

 

 

7,255

 

7,255

 

Net interest income:

 

 

 

 

 

 

 

Interest income

 

4,488

 

3

 

4,491

 

Interest expense

 

(4,226

)

 

(4,226

)

 

 

262

 

3

 

265

 

Other

 

1

 

2,514

 

2,515

 

 

 

130,632

 

24,935

 

155,567

 

Expenses:

 

 

 

 

 

 

 

Compensation

 

71,541

 

6,214

 

77,755

 

Other

 

14,443

 

466

 

14,909

 

 

 

85,984

 

6,680

 

92,664

 

Income before provision for income taxes

 

$

44,648

 

$

18,255

 

$

62,903

 

Segment assets at period end

 

$

709,733

 

$

17,529

 

$

727,262

 

 

Note 25—Subsequent Events

 

Management has evaluated all events and transactions through the date the Company issued these consolidated financial statements. During this period:

 

·            On November 1, 2013, the Company, through PLS, acquired $10.3 billion in UPB of Fannie Mae MSRs from a third party, with a $62 million co-investment by PMT in the excess servicing spread associated with this MSR portfolio.

 

·            On November 11, 2013, the Company, through PLS, entered into a purchase agreement with a third party to purchase $10.8 billion in UPB of Ginnie Mae MSRs.  The Company expects to enter into an agreement with PMT providing for approximately $86 million of co-investment in the excess servicing spread associated with this MSR portfolio.  The MSR acquisition by PLS and PMT’s co-investment in the excess servicing spread are subject to the negotiation and execution of definitive documentation, continuing due diligence and customary closing conditions and approvals. There can be no assurance that the committed amounts will ultimately be acquired or that the transactions will be completed at all.

 

·            On October 1, 2013, the Company filed with the SEC a registration statement on Form S-1, which registers the resale from time to time by certain stockholders of up to 43,973,679 shares of the Company’s Class A common stock, of which 37,863,679 shares are issuable upon the exchange of Class A Units, and 6,110,000 shares are currently held by one of the stockholders.  The registration statement was declared effective by the SEC on October 28, 2013.

 

·            All agreements to repurchase assets that matured between September 30, 2013 and the date of this Report were extended or renewed.

 

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Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Cautionary Statement Regarding Forward-Looking Statements

 

The following discussion and analysis of financial condition and results of operations should be read in conjunction with the consolidated financial statements and the related notes of PennyMac Financial Services, Inc. included within this Quarterly Report on Form 10-Q.

 

Statements contained in this Quarterly Report on Form 10-Q may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve known and unknown risks, uncertainties and other factors, which may cause actual results to be materially different from those expressed or implied in such statements. You can identify these forward-looking statements by words such as “may,” “will,” “should,” “expect,” “anticipate,” “believe,” “estimate,” “intend,” “plan” and other similar expressions. You should consider our forward-looking statements in light of a number of factors, including those described in “Factors that May Affect Our Future Results” and the risks discussed under the heading “Risk Factors” in the Company’s final prospectus included as part of its Registration Statement on Form S-1, as amended (SEC File No. 333-186495) (the “Registration Statement”), and in Part II, Item 1A., Risk Factors, of this Quarterly Report on Form 10-Q, as well as its consolidated financial statements, related notes, and the other financial information appearing elsewhere in this Quarterly Report on Form 10-Q and its other filings with the United States Securities and Exchange Commission (“SEC”). The forward-looking statements contained in this Quarterly Report on Form 10-Q are made as of the date hereof and the Company assumes no obligation to update or supplement any forward-looking statements.

 

Overview

 

The following discussion and analysis provides information that we believe is relevant to an assessment and understanding of our consolidated results of operations and financial condition. Unless the context indicates otherwise, references in this Quarterly Report on Form 10-Q to the words “we,” “us,” “our” and the “Company” refer to PennyMac Financial Services, Inc. (“PFSI”).

 

Initial Public Offering and Recapitalization

 

On May 14, 2013, we completed an initial public offering (“IPO”) in which we sold approximately 12.8 million shares of Class A Common Stock par value $0.0001 per share (“Class A Common Stock”) for cash consideration of $16.875 per share (net of underwriting discounts). With the net proceeds from the IPO, we bought Class A Units of Private National Mortgage Acceptance Company, LLC (“PennyMac”) and became its sole managing member. We operate and control all of the business and affairs and consolidate the financial results of PennyMac.

 

Before the completion of the IPO, the limited liability company agreement of PennyMac was amended and restated to, among other things, change its capital structure by converting the different classes of interests held by its existing unitholders into Class A Units. PennyMac and its existing unitholders also entered into an exchange agreement under which (subject to the terms of the exchange agreement) they have the right to exchange their Class A Units for shares of our Class A Common Stock on a one-for-one basis, subject to customary conversion rate adjustments for stock splits, stock dividends, reclassifications and certain other transactions that would cause the number of outstanding shares of Class A Common Stock to be different than the number of Class A Units that PFSI owns.

 

Before 2013, PennyMac made an election pursuant to Section 754 of the Internal Revenue Code which remains in effect. An exchange results in a special adjustment for PFSI that may increase PFSI’s tax basis in the assets of PennyMac that otherwise would not have been available.  These increases in tax basis may reduce the amount of tax that PFSI would otherwise be required to pay in the future and result in increases in investment in PennyMac deferred tax assets net of investment in PennyMac deferred tax liabilities.

 

As part of the IPO, we entered into a tax receivable agreement with the then-existing unitholders of PennyMac that provides for payment to such owners of 85% of the tax benefits, if any, that we are deemed to realize under certain circumstances as a result of (i) increases in tax basis resulting from exchanges of Class A Units and (ii) certain other tax benefits related to our tax receivable agreement, including tax benefits attributable to payments under the tax receivable agreement.

 

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Our Company

 

We are a specialty financial services firm with a comprehensive mortgage platform and integrated business focused on the production and servicing of U.S. residential mortgage loans and the management of investments related to the U.S. residential mortgage market. We believe that our operating capabilities, specialized expertise, access to long-term investment capital, and our management’s deep experience across all aspects of the mortgage business will allow us to profitably grow these activities and capitalize on other related opportunities as they arise in the future.

 

PennyMac was founded in 2008 by members of its executive leadership team and two strategic partners, BlackRock Mortgage Ventures, LLC, together with its affiliates, and HC Partners LLC, formerly known as Highfields Capital Investments LLC, together with its affiliates.

 

We conduct our business in two segments: mortgage banking and investment management. Our principal mortgage banking subsidiary, PennyMac Loan Services, LLC, (“PLS”), is a non-bank producer and servicer of mortgage loans in the United States.  Our principal investment management subsidiary, PNMAC Capital Management, LLC, (“PCM”), is an SEC registered investment adviser. PCM manages PennyMac Mortgage Investment Trust (“PMT”), a mortgage real estate investment trust, listed on the New York Stock Exchange. PCM also manages PNMAC Mortgage Opportunity Fund, LLC and PNMAC Mortgage Opportunity Fund, LP, both registered under the Investment Company Act of 1940, as amended, and PNMAC Mortgage Opportunity Fund Investors, LLC. We refer to these funds collectively as our “Investment Funds” and, together with PMT, as our “Advised Entities.”

 

Mortgage Banking

 

Our mortgage banking segment is comprised of three primary businesses: correspondent lending, retail lending, and loan servicing.

 

·                  Correspondent Lending. Our correspondent lending business manages, on behalf of PMT and for our own account, the acquisition of newly originated, prime credit quality, first-lien residential mortgage loans that have been underwritten to investor guidelines. PMT acquires, from approved correspondent sellers, newly originated loans, primarily “conventional” residential mortgage loans guaranteed by the Agencies. For conventional loans, we perform fulfillment activities for PMT and earn a fulfillment fee for each loan purchased by PMT. In the case of government-insured loans, we purchase them from PMT at PMT’s cost plus a sourcing fee and fulfill them for our own account.

 

·                  Retail Lending. Our retail lending business originates new prime credit quality, first-lien residential conventional and government-insured mortgage loans on a national basis to allow customers to purchase or refinance their homes. We conduct this business through a consumer direct model, which relies on the Internet and call center-based staff to acquire and interact with customers across the country. We do not have a “brick and mortar” branch network and have been developing our consumer direct operations with call centers strategically positioned across the United States.

 

·                  Loan Servicing. Our loan servicing business performs loan administration, collection and default activities, including the collection and remittance of loan payments; response to customer inquiries; accounting for principal and interest; holding custodial (impound) funds for the payment of property taxes and insurance premiums; counseling delinquent mortgagors; and supervising foreclosures and property dispositions. We service a diverse portfolio of loans both as the owner of MSRs and on behalf of other MSR or mortgage owners. We provide prime servicing for conventional and government-insured loans, as well as special servicing for distressed loans that have been acquired as investments by our Advised Entities, and loans in “private-label” MBS securities, which are securities issued by institutions that are not affiliated with any Agency.

 

During the quarter and nine months ended September 30, 2013, we managed PMT’s acquisition of approximately $8.0 billion and $25.2 billion, respectively, in unpaid principal balance of newly originated, prime credit quality, first-lien residential mortgage loans.  We purchased, for our own account, approximately $4.0 billion and $12.0 billion in unpaid principal balance of government-insured loans from PMT during the quarter and nine month period ended September 30, 2013. We also originated $282.5 million and $892.3 million in unpaid principal balance of residential mortgage loans through our retail channel during the quarter and nine month period ended September 30, 2013. During the quarter and nine months ended September 30, 2013, we increased our portfolio of loans that we serviced or subserviced from approximately $28.2 billion at December 31, 2012 to approximately $52.9 billion at September 30, 2013.

 

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During the quarter and nine months ended September 30, 2012, we managed PMT’s acquisition of approximately $6.3 billion and $11.5 billion, respectively, in unpaid principal balance of newly originated, prime credit quality, first-lien residential mortgage loans. We purchased for our account approximately $2.6 billion and $5.0 billion, respectively, in unpaid principal balance of government-insured loans from PMT. We also originated $147.5 million and $302.6 million, respectively, in unpaid principal balance of residential mortgage loans through our retail channel during the quarter and nine months ended September 30, 2012, and increased our portfolio of loans that we serviced or subserviced from approximately $7.7 billion at December 31, 2011 to approximately $18.6 billion at September 30, 2012.

 

Investment Management

 

We are an investment manager through our indirect wholly-owned subsidiary, PCM. PCM currently manages PMT and the Investment Funds, which had combined net assets of approximately $2.1 billion as of September 30, 2013. For these activities, we earn management fees as a percentage of net assets and incentive compensation based on investment performance.

 

Observations on Current Market Opportunities

 

Our business is affected by macroeconomic conditions in the United States, including economic growth, unemployment rates, the residential housing market and interest rate levels and expectations. The U.S. economy continues its pattern of modest growth as reflected in recent economic data. During the third quarter of 2013, real U.S. gross domestic product expanded at an annual rate of 2.8% compared to revised 2.5% and 2.8% annual rates for the second quarter of 2013 and third quarter of 2012, respectively. Modest economic growth continued to affect unemployment rates during the second quarter of 2013. The national unemployment rate was 7.2% at September 30, 2013 and compares to a revised seasonally adjusted rate of 7.8% at September 30, 2012 and 7.6% at June 30, 2013. Delinquency rates on residential real estate loans remain elevated compared to historical rates. As reported by the Federal Reserve, during the second quarter of 2013, the delinquency rate on residential real estate loans held by commercial banks was 9.4%, a reduction from 10.6% during the second quarter of 2012.

 

Residential real estate activity appears to be improving. The seasonally adjusted annual rate of existing home sales for September 2013 was 10.7% higher than for September 2012 and the national median existing home price for all housing types was $199,200, an 11.7% increase from September 2012. On a national level, foreclosure filings during the third quarter of 2013 decreased by 27% as compared to the third quarter of 2012. Foreclosure activity across the country is expected to remain above historical average levels through the remainder of 2013 and beyond.

 

Thirty-year fixed rate mortgage interest rates ranged from a high of 4.49% to a low of 4.37% during the third quarter of 2013 (Source: the Federal Home Loan Mortgage Corporation’s Weekly Primary Mortgage Market Survey). During the first nine months of 2013, mortgage interest rates have ranged from a high of 4.58% to a low of 3.34%. During the third quarter of 2012, interest rates for the thirty-year fixed rate mortgage ranged from a high of 3.66% to a low of 3.40%.

 

Changes in fixed rate residential mortgage loan interest rates generally follow changes in long-term U.S. Treasury yields. Toward the end of the second quarter, an increase in these treasury yields led to an increase in mortgage loan interest rates. As a result of this increase in mortgage loan interest rates, market volumes for mortgage originations have declined led by a reduction in refinance activity.

 

Mortgage lenders originated an estimated $460 billion of home loans during the third quarter of 2013, down 18.6 percent from the second quarter of the year. That brought year-to-date volume for the origination market to slightly less than $1.6 trillion, up 3.9 percent from the pace set during the first nine months of 2012 (Source: Inside Mortgage Finance). However, mortgage originations are forecast to decline, with current industry estimates for the fourth quarter of 2013 totaling $280 billion (Source: average of Fannie Mae, Freddie Mac and Mortgage Bankers Association forecasts).

 

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In our capacity as an investment manager, we continue to see substantial volumes of distressed residential mortgage loan sales (sales of loan pools that consist of either nonperforming loans, troubled but performing loans or a combination thereof) offered for sale by a limited number of sellers. During the third quarter of 2013, we reviewed 25 mortgage loan pools with unpaid principal balances totaling approximately $7.3 billion. This compares to our review of 23 mortgage loan pools with unpaid principal balances totaling approximately $3.8 billion during the third quarter of 2012. We managed the acquisition, on behalf of PMT, of distressed mortgage loans with fair values totaling $822 million during the third quarter of 2013 compared to $151 million during the third quarter of 2012.

 

In recent periods, we have seen increased competition from new and existing market participants in both our correspondent lending and retail lending businesses, as well as reductions in the overall level of refinancing activity. We believe that this change in supply and demand within the marketplace has been driving lower production margins in recent periods, which is reflected in our results of operations in our gains on mortgage loans held for sale. Although margins on gains from mortgage loans held for sale benefitted from wider secondary spreads (the difference between interest rates charged to borrowers and yields on mortgage-backed securities in the secondary market) in 2012, margins narrowed in subsequent quarters and we expect them to continue to normalize toward their long-term averages in 2013 and 2014.

 

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Results of Operations

 

Our results of operations are summarized below for the periods presented:

 

 

 

Quarter ended September 30,

 

Nine months ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(in thousands)

 

Revenue

 

 

 

 

 

 

 

 

 

Net gains on mortgage loans held for sale at fair value

 

$

25,949

 

$

39,760

 

$

108,560

 

$

68,487

 

Loan origination fees

 

6,280

 

2,752

 

18,260

 

5,439

 

Fulfillment fees from PennyMac Mortgage Investment Trust

 

18,327

 

17,258

 

68,625

 

31,097

 

Net servicing income

 

21,399

 

6,112

 

59,510

 

25,346

 

Management fees

 

10,540

 

6,114

 

29,375

 

15,163

 

Carried Interest from Investment Funds

 

2,812

 

3,355

 

10,411

 

7,254

 

Net interest income

 

937

 

(128

)

(376

)

265

 

Change in fair value of investment in and dividends received from PennyMac Mortgage Investment Trust

 

165

 

314

 

(68

)

630

 

Other

 

785

 

695

 

1,842

 

1,886

 

Total revenue

 

87,194

 

76,232

 

296,139

 

155,567

 

Total expenses

 

52,277

 

38,369

 

155,700

 

92,664

 

Provision for income taxes

 

3,493

 

 

5,531

 

 

Net income

 

$

31,424

 

$

37,863

 

$

134,908

 

$

62,903

 

 

 

 

 

 

 

 

 

 

 

Pre-tax income by segment:

 

 

 

 

 

 

 

 

 

Mortgage Banking

 

$

22,657

 

$

30,290

 

$

106,605

 

$

44,648

 

Investment Management

 

12,260

 

7,573

 

33,834

 

18,255

 

 

 

$

34,917

 

$

37,863

 

$

140,439

 

$

62,903

 

During the period:

 

 

 

 

 

 

 

 

 

Mortgage loans purchased and originated for sale:

 

 

 

 

 

 

 

 

 

Government-insured or guaranteed loans acquired from PMT at fair value

 

$

4,147,535

 

$

2,650,097

 

$

12,429,698

 

$

5,111,185

 

Retail production at fair value

 

282,440

 

149,006

 

895,405

 

304,402

 

 

 

$

4,429,975

 

$

2,799,103

 

$

13,325,103

 

$

5,415,587

 

Unpaid principal balance of mortgage loans fulfilled for PMT

 

$

3,681,771

 

$

2,488,443

 

$

12,792,482

 

$

4,828,117

 

At period end:

 

 

 

 

 

 

 

 

 

Unpaid principal balance of mortgage loan servicing portfolio

 

 

 

 

 

 

 

 

 

Mortgage loans held for sale

 

$

490,088

 

$

376,717

 

$

490,088

 

$

376,717

 

MSRs owned

 

22,776,613

 

8,286,075

 

22,776,613

 

8,286,075

 

Subserviced

 

29,605,633

 

10,313,879

 

29,605,633

 

10,313,879

 

 

 

$

52,872,334

 

$

18,976,671

 

$

52,872,334

 

$

18,976,671

 

Net assets of Advised Entities

 

 

 

 

 

 

 

 

 

PennyMac Mortgage Investment Trust

 

$

1,494,765

 

$

1,184,203

 

$

1,494,765

 

$

1,184,203

 

Investment Funds

 

556,013

 

575,850

 

556,013

 

575,850

 

 

 

$

2,050,778

 

$

1,760,053

 

$

2,050,778

 

$

1,760,053

 

 

Comparison of the quarters and nine months ended September 30, 2013 and 2012

 

Net income decreased by approximately $6.4 million or 17% and increased $72.0 million or 114% for the quarter and nine months ended September 30, 2013, respectively, when compared to the same periods in 2012.

 

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The decrease in net income from the quarter ended September 30, 2012 to the quarter ended September 30, 2013 is due to the contraction in the mortgage origination market and the resulting increased price competition, which had a negative effect on our margins during the quarter ended September 30, 2013. While our mortgage loan origination volume increased $1.6 billion or 58%, increased price competition in the mortgage market during the quarter ended September 30, 2013 caused a reduction in our net gain on mortgage loans held for sale at fair value of $13.8 million or 35%.

 

The increase in net income for the nine months ended September 30, 2013 as compared to the nine months ended September 30, 2012, primarily reflects growth in the Company’s mortgage banking operations. Loan purchase and origination volume increased by approximately $7.9 billion or 146% in the nine months ended September 30, 2013 as compared to the nine months ended September 30, 2012 and the Company’s loan servicing portfolio was approximately $52.9 billion at September 30, 2013, an increase of $33.9 billion or 179% from September 30, 2012. This growth was supplemented by growth in the Company’s investment management segment due to an increase of $14.2 million or 94% in management fees for the nine months ended September 30, 2013, compared to the nine months ended September 30, 2012. These revenue increases were partly offset by increases in expenses of approximately $63.0 million or 68%, during the nine month periods ended September 30, 2013 as compared to the comparable periods in 2012. We incurred these increases in expenses to accommodate the Company’s growth.

 

Net gains on mortgage loans held for sale at fair value

 

During the quarter and nine months ended September 30, 2013, we recognized net gains on mortgage loans held for sale at fair value totaling $25.9 million and $108.6 million, respectively. This compares to net gains on mortgage loans held for sale at fair value totaling $39.8 million and $68.5 million, respectively, during the quarter and nine months ended September 30, 2012.

 

The decrease in net gains on mortgage loans held for sale at fair value from the quarter ended September 30, 2012 to the quarter ended September 30, 2013 is due to the effect of increasing price competition in the mortgage market, which had a negative effect on our margins during the quarter ended September 30, 2013. The net gain for the quarters ended September 30, 2013 and 2012 included $60.1 million and $25.6 million, respectively, in fair value of MSRs received as part of proceeds on sales.

 

The increase in net gains on mortgage loans held for sale at fair value for the nine months ended September 30, 2013 as compared to the nine months ended September 30, 2012, was due to growth in the volume of mortgage loans that we purchased and originated and subsequently sold during 2013 as compared to 2012. The net gains for the nine months ended September 30, 2013 included $154.4 million in fair value of MSRs received as part of proceeds on sales. The net gains for the nine months ended September 30, 2012 included $51.0 million in fair value of MSRs received as part of proceeds on sales.

 

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We recognized gains on mortgage loans held for sale as summarized below:

 

 

 

Quarter ended September 30,

 

Nine months ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(in thousands)

 

Cash (loss) gain:

 

 

 

 

 

 

 

 

 

Sales proceeds

 

$

(93,725

)

$

26,676

 

$

(148,866

)

$

49,695

 

Hedging activities

 

88,789

 

(19,574

)

128,670

 

(40,276

)

 

 

(4,936

)

7,102

 

(20,196

)

9,419

 

Non-cash gain:

 

 

 

 

 

 

 

 

 

Receipt of MSRs in loan sale transactions

 

60,137

 

25,620

 

154,352

 

51,006

 

MSR recapture payable to affiliate

 

(86

)

 

(586

)

 

Provision for losses relating to representations and warranties provided in loan sales

 

(1,069

)

(918

)

(3,766

)

(1,856

)

Change in fair value relating to mortgage loans and hedging derivatives held for sale at period end:

 

 

 

 

 

 

 

 

 

IRLCs

 

37,768

 

20,723

 

(2,382

)

25,528

 

Mortgage loans

 

27,510

 

6,693

 

7,876

 

8,636

 

Hedging derivatives

 

(93,375

)

(19,460

)

(26,738

)

(24,246

)

 

 

$

25,949

 

$

39,760

 

$

108,560

 

$

68,487

 

During the period:

 

 

 

 

 

 

 

 

 

 

 

 

 

Unpaid principal balance of loans sold

 

$

4,442,944

 

$

2,490,174

 

$

12,679,436

 

$

4,834,492

 

Interest rate lock commitments issued, net of cancellations

 

$

3,699,970

 

$

2,274,847

 

$

12,280,205

 

$

3,539,763

 

At period end:

 

 

 

 

 

 

 

 

 

Fair value of mortgage loans held for sale

 

$

530,248

 

$

410,071

 

$

530,248

 

$

410,071

 

Commitments to fund and purchase mortgage loans

 

$

1,163,531

 

$

1,470,590

 

$

1,163,531

 

$

1,470,590

 

 

 

 

 

 

 

 

 

 

 

Increase (decrease) in gains on mortgage loans held for sale at fair value due to:

 

 

 

 

 

 

 

 

 

Change in IRLCs fair value

 

$

17,045

 

$

19,324

 

$

27,910

 

$

24,428

 

Volume of loans sold

 

7,532

 

17,981

 

68,494

 

41,143

 

Gain margin

 

(38,388

)

112

 

(512

)

(979

)

Total change

 

$

(13,811

)

$

37,417

 

$

95,892

 

$

64,592

 

 

We recognize a substantial portion of our gain on mortgage loans held for sale at fair value before we fund or purchase the loan. In the course of our correspondent and retail lending activities, we make contractual commitments to PMT and to mortgage loan applicants to purchase or fund mortgage loans at specified terms. We call these commitments interest rate lock commitments (“IRLCs”). We recognize the value of IRLCs at the time we make a commitment to PMT or the borrower.

 

We estimate the fair value of an IRLC based on quoted Agency MBS prices, our estimate of the fair value of the MSRs we expect to receive in the sale of the loans and the probability that the mortgage loan will fund or be purchased as a percentage of the commitment we have made (the “pull-through rate”). We update our estimates of the value of the IRLCs as the mortgage loans move through the purchase or loan process for changes in our estimate of the probability the loan will fund and for changes in interest rates.

 

An active, observable market for IRLCs does not exist. Therefore, we estimate the fair value of IRLCs using methods and assumptions we believe that market participants use in pricing IRLCs. The significant unobservable inputs used in the fair value measurement of the Company’s IRLCs are the pull-through rate and the MSR component of the Company’s estimate of the value of the mortgage loans we have committed to purchase. Significant changes in the pull-through rate and the MSR component of the IRLCs, in isolation, could result in a significant change in fair value measurement. The financial effects of changes in these assumptions are generally inversely correlated as increasing interest rates have a positive effect on the fair value of the MSR component of IRLC value, but rising interest rates increase the pull-through rate for loans that have decreased in fair value in comparison to the agreed-upon purchase price.

 

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Following is a quantitative summary of key unobservable inputs we used in the valuation of IRLCs as of the dates presented:

 

 

 

September 30, 2013

 

December 31, 2012

 

 

 

Range
(Weighted average)

 

Key Inputs

 

 

 

 

 

Pull-through rate

 

56.6% - 98.0%

 

61.6% — 98.1%

 

 

 

(78.3%)

 

(79.1%)

 

MSR value expressed as:

 

 

 

 

 

Servicing fee multiple

 

2.1 - 5.0

 

3.2 — 4.2

 

 

 

(4.0)

 

(4.0)

 

Percentage of unpaid principal balance

 

0.4% - 2.6%

 

0.6% — 2.2%

 

 

 

(1.1%)

 

(0.9%)

 

 

MSRs represent the value of a contract that obligates us to service mortgage loans on behalf of the purchaser of the loan in exchange for servicing fees and the right to collect certain ancillary income from the borrower. We recognize MSRs at our estimate of the fair value of the contract to service the loans. As discussed in Net loan servicing income, below, how much of the MSR we realize in cash depends on how our initial estimates of the future cash flows accruing to the MSRs are realized.

 

As economic fundamentals influence the loans we sell with servicing rights retained, our estimate of the fair value of MSRs will also change. As a result, we will record changes in fair value as a component of Net loan servicing income for the MSRs we carry at fair value and we may recognize changes in fair value relating to our MSRs carried at the lower of amortized cost or fair value depending on the relationship of the asset’s fair value to its carrying value at the measurement date.

 

Following are the key inputs used in determining the fair value of MSRs at the time of initial recognition:

 

 

 

Quarter ended September 30,

 

 

 

2013

 

2012

 

 

 

Range
(Weighted average)

 

 

 

Amortized
cost

 

Fair
value

 

Amortized
cost

 

Fair
value

 

Unpaid principal balance of underlying loans

 

$4,120,962

 

$315,869

 

$2,485,982

 

$4,217

 

Weighted-average servicing fee rate (in basis points)

 

30

 

31

 

27

 

27

 

 

 

 

 

 

 

 

 

 

 

Pricing spread (1) 

 

5.4% - 15.9%

 

7.4% - 13.1%

 

7.5% - 9.9%

 

7.5% - 9.9%

 

 

 

(8.2%)

 

(9.9%)

 

(9.8%)

 

(7.8%)

 

Annual total prepayment speed (2) 

 

8.5% - 14.7%

 

8.8% - 17.2%

 

8.4% - 9.5%

 

8.4% - 9.5%

 

 

 

(8.8%)

 

(9.2%)

 

(8.4%)

 

(9.2%)

 

Life (in years)

 

2.9 — 6.9

 

3.6 — 7.0

 

6.4 — 6.7

 

6.4 — 6.7

 

 

 

(6.7)

 

(6.9)

 

(6.7)

 

(6.4)

 

Cost of servicing

 

$68 — $120

 

$68 — $120

 

$68 — $100

 

$68 — $100

 

 

 

$(104)

 

$(101)

 

$(99)

 

$(71)

 

 

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Nine months ended September 30,

 

 

 

2013

 

2012

 

 

 

Range
(Weighted average)

 

 

 

Amortized
cost

 

Fair
value

 

Amortized
cost

 

Fair
value

 

Unpaid principal balance of underlying loans

 

$12,350,104

 

$318,066

 

$4,811,328

 

$17,504

 

Weighted-average servicing fee rate (in basis points)

 

29

 

31

 

27

 

28

 

 

 

 

 

 

 

 

 

 

 

Pricing spread (1) 

 

5.4% - 15.9%

 

7.4% - 13.1%

 

7.5% - 9.9%

 

7.5% - 9.9%

 

 

 

(8.2%)

 

(9.9%)

 

(9.8%)

 

(8.4%)

 

Annual total prepayment speed (2) 

 

8.5% - 18.5%

 

8.8% - 17.2%

 

7.8% - 9.5%

 

7.8% - 9.5%

 

 

 

(8.8%)

 

(9.2%)

 

(8.3%)

 

(8.6%)

 

Life (in years)

 

2.9 – 6.9

 

3.6 – 7.0

 

5.9 – 6.9

 

5.9 – 6.9

 

 

 

(6.7)

 

(6.9)

 

(6.7)

 

(6.4)

 

Cost of servicing

 

$68 – $120

 

$68 – $120

 

$68 – $100

 

$68 – $100

 

 

 

$(102)

 

$(101)

 

$(99)

 

$(77)

 

 


(1)                  Pricing spread represents a margin that is applied to a reference interest rate’s forward rate curve to develop periodic discount rates. The Company applies a pricing spread to the United States Dollar LIBOR curve for purposes of discounting cash flows relating to MSRs acquired as proceeds from the sale of mortgage loans.

(2)                  Annual total prepayment speed is measured using CPR.

 

We also provide for our estimate of the future losses that we may be required to incur as a result of our breach of representations and warranties provided to the purchasers of the loans we sold. Our agreements with the Agencies include representations and warranties related to the loans we sell to the Agencies. The representations and warranties require adherence to Agency origination and underwriting guidelines, including but not limited to the validity of the lien securing the loan, property eligibility, borrower credit, income and asset requirements, and compliance with applicable federal, state and local law.

 

In the event of a breach of our representations and warranties, we may be required to either repurchase the mortgage loans with the identified defects or indemnify the investor or insurer. In such cases, we bear any subsequent credit loss on the mortgage loans. Our credit loss may be reduced by any recourse we have to correspondent lenders that sold such mortgage loans and breached similar or other representations and warranties. In such event, we have the right to seek a recovery of related repurchase losses from that correspondent lender.

 

We evaluate the adequacy of the balance of our recorded liability for losses under representations and warranties based on our loss experience and our assessment of future losses to be incurred relating to loans we have previously sold and which remain outstanding at the balance sheet date. The method used to estimate the liability for representations and warranties is a function of the representations and warranties given and considers a combination of factors, including, but not limited to, estimated future defaults and loan repurchase rates and the potential severity of loss in the event of defaults and the probability of reimbursement by the correspondent loan seller. We establish a liability at the time loans are sold and periodically update our liability estimate.

 

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Following is a summary of our Liability for losses under representations and warranties in the consolidated balance sheets:

 

 

 

Quarter ended September 30,

 

Nine months ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(in thousands)

 

Balance at beginning of period

 

$

6,185

 

$

1,387

 

$

3,504

 

$

449

 

Provisions for losses on loans sold

 

1,069

 

918

 

3,766

 

1,856

 

Incurred losses

 

(39

)

 

(55

)

 

Balance at end of period

 

$

7,215

 

$

2,305

 

$

7,215

 

$

2,305

 

Unpaid principal balance of mortgage loans subject to representations and warranties

 

$

20,428,213

 

$

6,444,618

 

$

20,428,213

 

$

6,444,618

 

 

Following is a summary of the repurchase activity and unpaid balance of mortgage loans subject to representations and warranties:

 

 

 

Quarter ended September 30,

 

Nine months ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(in thousands)

 

During the period:

 

 

 

 

 

 

 

 

 

Unpaid balance of mortgage loans repurchased

 

$

1,973

 

$

 

$

6,840

 

$

 

Unpaid principal balance of mortgage loans put to correspondent lenders

 

$

357

 

$

 

$

1,410

 

$

 

At period end:

 

 

 

 

 

 

 

 

 

Unpaid principal balance of mortgage loans subject to pending claims for repurchase

 

$

1,249

 

$

3,459

 

$

1,249

 

$

3,459

 

 

During the quarter and nine months ended September 30, 2013, we repurchased mortgage loans with unpaid balances totaling $2.0 million and $6.8 million, respectively, and charged $39,000 and $55,000, respectively, in incurred losses relating to these repurchases against our liability for representations and warranties. As the outstanding balance of loans we purchase and sell subject to representations and warranties increases and the loans sold season, we expect the level of repurchase activity to increase. As economic fundamentals change and as investor and Agency evaluation of their loss mitigation strategies, including claims under representations and warranties, change, the level of repurchase activity and ensuing losses will change, which may be material to us.

 

The level of the liability for losses under representations and warranties is difficult to estimate and requires considerable management judgment. The level of mortgage loan repurchase losses is dependent on economic factors, investor demand strategies, and other external conditions that may change over the lives of the underlying loans. Our representations and warranties are generally not subject to stated limits of exposure. However, we believe that the current unpaid principal balance of loans sold by us to date represents the maximum exposure to repurchases related to representations and warranties. We believe the amount and range of reasonably possible losses in relation to the recorded liability is not material to our financial condition or results of operations.

 

Our hedging activities relating to correspondent and retail lending primarily involve forward sales of our inventory and IRLCs as well as purchases of options to sell and options to purchase MBS.

 

Other loan production-related revenues

 

Loan origination fees increased $3.5 million and $12.8 million, respectively, in the quarter and nine months ended September 30, 2013 compared to the same periods in 2012. The increase was due to growth in the volume of loans produced.

 

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Loan fulfillment fees from PMT represent fees we collect for services we perform on behalf of PMT in connection with its acquisition, packaging and sale of mortgage loans.  The loan fulfillment fees are calculated as a percentage of the unpaid principal balance of the mortgage loans we fulfill for PMT.  Summarized below are our fulfillment fees for the periods presented:

 

 

 

Quarter ended September 30,

 

Nine months ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(in thousands)

 

Fulfillment fee revenue

 

$

18,327

 

$

17,258

 

$

68,625

 

$

31,097

 

Unpaid principal balance of loans fulfilled

 

$

3,681,771

 

$

2,488,443

 

$

12,792,482

 

$

4,828,117

 

 

The increase of $1.1 million and $37.5 million, respectively, in fulfillment fees during the quarter and nine months ended September 30, 2013 compared to the same periods in 2012 is due to the continuing growth in the volume of Agency-eligible and jumbo mortgage loans PMT purchased in its correspondent lending activities.

 

Net servicing income

 

Our net servicing income is summarized before for the periods presented

 

 

 

Quarter ended
September 30,

 

Nine months ended
September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(in thousands, except share data)

 

Net servicing income:

 

 

 

 

 

 

 

 

 

Loan servicing fees

 

 

 

 

 

 

 

 

 

From non-affiliates

 

$

14,596

 

$

2,154

 

$

35,397

 

$

8,776

 

From PennyMac Mortgage Investment Trust

 

10,738

 

4,600

 

27,251

 

13,163

 

From Investment Funds

 

1,813

 

2,484

 

6,060

 

9,130

 

Mortgage servicing rebate from (to) Investment Funds

 

(362

)

135

 

(535

)

(360

)

Ancillary and other fees

 

2,777

 

1,153

 

7,700

 

3,661

 

 

 

29,562

 

10,526

 

75,873

 

34,370

 

Amortization, impairment and change in estimated fair value of mortgage servicing rights

 

(8,163

)

(4,414

)

(16,363

)

(9,024

)

Net servicing income

 

$

21,399

 

$

6,112

 

$

59,510

 

$

25,346

 

 

Following is a summary of our loan servicing portfolio as of the dates presented:

 

 

 

September 30,
2013

 

December 31,
2012

 

 

 

(in thousands)

 

Loans serviced at period end:

 

 

 

 

 

Prime servicing:

 

 

 

 

 

Subserviced for our Advised Entities

 

$

24,540,141

 

$

12,920,209

 

Owned MSRs—Originated

 

20,024,781

 

8,992,602

 

Owned MSRs—Acquisitions

 

1,700,612

 

990,461

 

Mortgage loans held for sale

 

490,088

 

417,742

 

Total prime servicing

 

46,755,622

 

23,321,014

 

Special servicing:

 

 

 

 

 

Subserviced for our Advised Entities

 

5,015,113

 

3,559,893

 

Subserviced for non-affiliates

 

50,379

 

 

Owned MSRs—Acquisitions

 

1,051,220

 

1,271,642

 

Total special servicing

 

6,116,712

 

4,831,535

 

Total loans serviced

 

$

52,872,334

 

$

28,152,549

 

 

Total loan servicing fees increased $19.0 million and $41.5 million, respectively, in the quarter and nine months ended September 30, 2013 compared to the same periods in 2012. The increase in the quarter and nine months ended September 30, 2013 was due to an increase of $12.4 million and $26.6 million, respectively, in loan servicing fees from non-affiliates due to growth in our portfolio of loans serviced as a result of our ongoing sales of mortgage loans with servicing rights retained; an increase of $6.1 million and $14.1 million, respectively, in loan servicing fees from PMT due to growth in the volume of loans we service and subservice for PMT; and an increase of $1.6 million and $4.0 million, respectively, in ancillary fees due to growth in the portfolios of mortgage loans serviced, partially offset by a decrease in loan servicing fees net of mortgage servicing rebate from the Investment Funds of $398,000 and $3.2 million, respectively. This decrease was due to the decrease in the principal balance in the Investment Funds’ mortgage loan portfolios as these portfolios liquidate following the end of the related commitment periods on December 31, 2011.

 

Amortization, impairment and change in estimated fair value of mortgage servicing rights are summarized below for the periods presented:

 

 

 

Quarter ended September 30,

 

Nine months ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(in thousands)

 

MSRs carried at lower of amortized cost or fair value:

 

 

 

 

 

 

 

 

 

Amortization

 

$

5,367

 

$

1,127

 

$

12,713

 

$

1,962

 

Recognition of impairment

 

1,192

 

1,000

 

549

 

1,784

 

Hedging losses

 

 

48

 

1,291

 

48

 

 

 

6,559

 

2,175

 

14,553

 

3,794

 

MSRs carried at fair value:

 

 

 

 

 

 

 

 

 

Change in fair value

 

1,575

 

2,239

 

1,781

 

5,230

 

Change in fair value of excess spread financing

 

29

 

 

29

 

 

 

 

1,604

 

2,239

 

1,810

 

5,230

 

Total amortization, impairment and change in fair value

 

$

8,163

 

$

4,414

 

$

16,363

 

$

9,024

 

 

Amortization, impairment and change in estimated fair value of mortgage servicing rights increased $3.8 million from $4.4 million to $8.2 million from the quarter ended September 30, 2012 to the quarter ended September 30, 2013 and increased $7.4 million from $9.0 million to $16.4 million from the nine months ended September 30, 2012 to the nine months ended September 30, 2013. The increase in amortization, impairment and change in estimated fair value during the quarter and nine months ended September 30, 2013 as compared to the quarter and nine months ended September 30, 2012 was due primarily to growth in our investment in MSRs between 2012 and 2013, which caused an increase in amortization of the asset.

 

Amortization, impairment and changes in fair value of MSRs have a significant effect on net servicing income, driven primarily by our monthly re-estimation of the fair value of MSRs. As our investment in MSRs grows, we expect that the effect of amortization, impairment and changes in fair value will have an increasing influence on our net income. The fair value of MSRs is difficult to determine because MSRs are not actively traded in standalone markets. Considerable judgment is required to estimate the fair values of these assets and the exercise of such judgment can significantly affect our income.

 

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Our MSR valuation process combines the use of a discounted cash flow model and analysis of current market data to arrive at an estimate of fair value at each balance sheet date. The cash flow and prepayment assumptions used in our discounted cash flow model are based on market factors and include the historical performance of our MSRs, which we believe are consistent with assumptions and data used by market participants valuing similar MSRs.

 

The key assumptions used in the valuation of MSRs include mortgage prepayment and default rates of the underlying loans, the applicable discount rate, and cost to service loans. These variables can, and generally do, change from period to period as market conditions change. Therefore our estimate of the fair value of MSRs changes from period to period. Our valuation committee reviews and approves the fair value estimates of our MSRs.

 

We account for MSRs at either our estimate of the asset’s estimated fair value with changes in fair value recorded in current period income or using the amortization method with the MSRs carried at the lower of amortized cost or estimated fair value based on whether we believe the underlying mortgages are sensitive to prepayments resulting from changing market interest rates. We have identified an initial mortgage interest rate of 4.5% for MSRs originated through our lending activities as the threshold for whether such mortgage loans are sensitive to changes in interest rates:

 

·                  Our risk management efforts in connection with MSRs relating to mortgage loans originated through our lending activities with initial interest rates of more than 4.5% are aimed at moderating the effects of changes in interest rates on the assets’ values.

 

·                  For MSRs relating to mortgage loans with initial interest rates of less than or equal to 4.5% that were acquired as a result of our lending activities, we have concluded that such assets present different risks than MSRs relating to mortgage loans with initial interest rates of more than 4.5% and therefore require a different risk management approach. Our risk management efforts relating to these assets are aimed at moderating the effects of non-interest rate risks on fair value, such as the effect of changes in home prices on the assets’ values. We have identified these assets for accounting using the amortization method.

 

Our MSRs are summarized by the basis on which we account for the assets below as of the dates presented:

 

Basis of Accounting

 

September 30, 2013

 

December 31, 2012

 

 

 

(in thousands)

 

Fair value

 

$

26,768

 

$

19,798

 

Lower of amortized cost or fair value:

 

 

 

 

 

Amortized cost

 

$

229,617

 

$

92,155

 

Valuation allowance

 

(3,527

)

(2,978

)

Carrying value

 

$

226,090

 

$

89,177

 

Fair value

 

$

239,326

 

$

91,028

 

 

 

 

 

 

 

Total MSR:

 

 

 

 

 

Carrying value

 

$

252,858

 

$

108,975

 

Fair value

 

$

266,094

 

$

110,826

 

Unpaid balance of mortgage loans underlying MSRs

 

$

22,776,613

 

$

11,254,705

 

Average servicing fee rate (in basis points)

 

 

 

 

 

Amortized cost

 

28

 

28

 

Fair value

 

27

 

26

 

Fair value special servicing

 

50

 

50

 

 

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Key assumptions used in determining the fair value of MSRs as of the dates presented are as follows:

 

Purchased MSRs backed by distressed mortgage loans

 

 

 

September 30, 2013

 

December 31, 2012

 

 

 

Range
(Weighted average)

 

 

 

Fair
value

 

Amortized
cost

 

Fair
value

 

Amortized
cost

 

 

 

(Unpaid principal balance of underlying loans and effect on value amounts
in thousands)

 

Carrying value

 

$10,125

 

 

$12,370

 

 

Unpaid principal balance of underlying loans

 

$1,051,220

 

 

$1,271,478

 

 

Weighted-average note rate

 

5.88%

 

 

6.01%

 

 

Weighted-average servicing fee rate (in basis points)

 

50

 

 

50

 

 

 

 

 

 

 

 

 

 

 

 

Discount rate

 

15.3% – 15.3%

 

 

15.3% – 15.3%

 

 

 

 

(15.3%)

 

 

(15.3%)

 

 

 

 

 

 

 

 

 

 

 

 

Average life (in years)

 

4.8

 

 

5.0

 

 

Prepayment speed (1) 

 

11.7% – 11.7%

 

 

10.7% – 10.7%

 

 

 

 

(11.7%)

 

 

(10.7%)

 

 

 

 

 

 

 

 

 

 

 

 

Per-loan cost of servicing

 

$250 – $250

 

 

$270 – $270

 

 

 

 

$(250)

 

 

$(270)

 

 

 


(1)                                 Prepayment speed is measured using CPR.

 

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All other MSRs

 

 

 

September 30, 2013

 

December 31, 2012

 

 

 

Range
(Weighted average)

 

 

 

Fair
value

 

Amortized
cost

 

Fair
value

 

Amortized
cost

 

 

 

(Unpaid principal balance of underlying loans and
effect on value amounts in thousands)

 

Carrying value

 

$16,643

 

$226,090

 

$7,428

 

$89,177

 

Unpaid principal balance of underlying loans

 

$1,700,612

 

$20,024,781

 

$1,166,765

 

$8,730,686

 

Weighted-average note rate

 

4.68%

 

3.57%

 

5.22%

 

3.65%

 

Weighted-average servicing fee rate (in basis points)

 

27

 

28

 

26

 

28

 

Pricing spread (1)

 

6.4% – 17.5%

 

5.4% – 15.9%

 

7.5% – 19.5%

 

7.5% – 16.5%

 

 

 

(8.9%)

 

(7.6%)

 

(10.6%)

 

(9.8%)

 

 

 

 

 

 

 

 

 

 

 

Average life (in years)

 

0.2 – 14.4

 

2.6 – 6.9

 

0.2 – 14.4

 

2.5 – 6.9

 

 

 

(6.6)

 

(6.7)

 

(5.0)

 

(6.6)

 

Prepayment speed (2) 

 

8.7% – 72.8%

 

8.5% – 16.0%

 

9.0% – 84.2%

 

8.7% – 28.3%

 

 

 

(10.6%)

 

(9.0%)

 

(19.2%)

 

(9.2%)

 

 

 

 

 

 

 

 

 

 

 

Per-loan cost of servicing

 

$68 – $120

 

$68 – $120

 

$68 – $140

 

$68 – $140

 

 

 

$(77)

 

$(102)

 

$(76)

 

$(99)

 

 


(1)         Pricing spread represents a margin that is applied to a reference interest rate’s forward curve to develop periodic discount rates. The Company applies a pricing spread to the United States Dollar LIBOR curve for purposes of discounting cash flows relating to MSRs acquired as proceeds from the sale of loans and purchased MSRs not backed by pools of distressed mortgage loans.

(2)         Prepayment speed is measured using CPR.

 

Significant changes to any of the key assumptions shown above in isolation could result in a significant change in the MSR fair value measurement. Changes in these key assumptions are not necessarily directly related. The sensitivity analyses, under Quantitative and Qualitative Disclosures about Market Risk in this document, are limited in that they were performed as of a particular point in time, only contemplate the movements in the indicated variables, do not incorporate changes in the variables in relation to other variables, are subject to the accuracy of various models and inputs used, and do not take into account other factors that would affect our overall financial performance in such scenarios, including operational adjustments made by the Manager to account for changing circumstances. For these reasons, the sensitivity tables in the following pages should not be viewed as earnings forecasts.

 

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Management fees and Carried Interest

 

Management fees and Carried Interest are summarized below for the periods presented:

 

 

 

Quarter ended September 30,

 

Nine months ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(in thousands)

 

Management Fees:

 

 

 

 

 

 

 

 

 

PennyMac Mortgage Investment Trust:

 

 

 

 

 

 

 

 

 

Base management fee

 

$

5,104

 

$

3,672

 

$

14,043

 

$

7,964

 

Performance incentive fee

 

3,435

 

 

9,443

 

 

 

 

8,539

 

3,672

 

23,486

 

7,964

 

Investment Funds

 

2,001

 

2,442

 

5,889

 

7,199

 

 

 

$

10,540

 

$

6,114

 

$

29,375

 

$

15,163

 

 

 

 

 

 

 

 

 

 

 

Carried Interest

 

$

2,812

 

$

3,355

 

$

10,411

 

$

7,254

 

Total management fees and carried interest

 

$

13,352

 

$

9,469

 

$

39,786

 

$

22,417

 

 

 

 

 

 

 

 

 

 

 

Net assets of Advised Entities:

 

 

 

 

 

 

 

 

 

PennyMac Mortgage Investment Trust

 

$

1,494,765

 

$

1,184,203

 

$

1,494,765

 

$

1,184,203

 

Investment Funds

 

556,013

 

575,850

 

556,013

 

575,850

 

 

 

$

2,050,778

 

$

1,760,053

 

$

2,050,778

 

$

1,760,053

 

 

Management fees from PMT increased $4.9 million and $15.5 million, respectively, in the quarter and nine months ended September 30, 2013 compared to the same periods in 2012. The increase was due primarily to:

 

·            Base management fees increased due to an increase in PMT’s shareholders’ equity upon which its management fee is based by $310.6 million or 26% from September 30, 2012 through September 30, 2013.

 

·            We recognized incentive fees of $3.4 million and $9.4 million for the quarter and nine months ended September 30, 2013, respectively. These fees were not recognized during 2012. We recognized performance incentive fees during 2013 as a result of the amendment to our management agreement with PMT effective February 1, 2013, which changed the basis on which profitability is measured for incentive fee purposes. Under the amended agreement, profitability is primarily based on net income determined in compliance with U.S. GAAP. Previously, the agreement based profitability on U.S. GAAP net income generally excluding non-cash gains and losses.

 

Partially offsetting the increases in management fees from PMT, management fees from the Investment Funds decreased $441,000 and $1.3 million, respectively, in the quarter and nine months ended September 30, 2013 compared to the same periods in 2012. The decrease was due to decreases in the Investment Funds’ net asset values as a result of continued distributions to the Funds’ investors following the end of the Investment Funds’ commitment periods at December 31, 2011, which reduced the investment base on which the management fees are computed.

 

Carried Interest from Investment Funds decreased $543,000 from $3.4 million for the quarter ended September 30, 2012 to $2.8 million for the quarter ended September 30, 2013. The decrease was due to decreases in the Investment Funds’ net asset values as a result of continued distributions to the Funds’ investors following the end of the Investment Funds’ commitment periods at December 31, 2011, which reduced the investment base on which the Carried Interest returns is computed. Carried Interest from Investment Funds increased $3.2 million from $7.3 million for the nine months ended September 30, 2012 to $10.4 million for the nine months ended September 30, 2013. The increase was primarily due to valuation gains in the Investment Funds’ loan portfolios as a result of increases in demand for distressed mortgage loans, improvements in the value of the loans as they proceed through the resolution process and continuing increases in collateral valuations for the properties underlying the Funds’ loans.

 

Other revenues

 

Net interest income increased $1.1 million from ($128,000) for the quarter ended September 30, 2012, to $937,000 for the quarter ended September 30, 2013 due to the increase in our average inventory of mortgage loans held for sale as a result of the growth in our loan production activities, and primarily relates to the interest that we earned on mortgage loans net of interest paid on our financing facilities during the period for which we held the loans pending sale.  Net interest income decreased $641,000 from $265,000 for the nine months ended September 30, 2012 to ($376,000) for the nine months ended September 30, 2013 due to interest expense financing our non-interest earning assets exceeding net interest income on our interest earning assets.

 

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The results of our holdings of common shares of PMT, which is included in Changes in fair value of investment in, and dividends received from PMT are summarized below:

 

 

 

Quarter ended September 30,

 

Nine months ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(in thousands)

 

Dividends

 

$

43

 

$

41

 

$

128

 

$

124

 

Change in fair value

 

122

 

273

 

(196

)

506

 

 

 

$

165

 

$

314

 

$

(68

)

$

630

 

 

 

 

 

 

 

 

 

 

 

Fair value of PMT shares at period end

 

$

1,701

 

$

1,753

 

$

1,701

 

$

1,753

 

 

Change in fair value of investment in and dividends received from PMT decreased $149,000 and $698,000, respectively, in the quarter and nine months ended September 30, 2013 compared to the same periods in 2012.  The decreases were primarily due to decreases in the fair value of our investment in common shares of PMT as of September 30, 2013 as compared to the appreciation in value of our investment in common shares of PMT during 2012. During the periods ended September 30, 2013 and 2012, we held 75,000 common shares of PMT.

 

Expenses

 

Our compensation expense is summarized below for the periods presented:

 

 

 

Quarter ended September 30,

 

Nine months ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(in thousands)

 

Salaries and wages

 

$

26,722

 

$

16,320

 

$

74,970

 

$

41,269

 

Incentive compensation

 

2,945

 

7,645

 

22,649

 

14,690

 

Taxes and benefits

 

3,825

 

2,298

 

11,937

 

5,964

 

Stock and unit-based compensation

 

2,338

 

5,593

 

4,294

 

15,833

 

 

 

$

35,830

 

$

31,856

 

$

113,850

 

$

77,756

 

 

 

 

 

 

 

 

 

 

 

Average headcount

 

1,402

 

800

 

1,324

 

649

 

Period-end headcount

 

1,329

 

850

 

1,329

 

850

 

 

Compensation expense increased $4.0 million from $31.9 million for the quarter ended September 30, 2012 to $35.8 million for the quarter ended September 30, 2013 and increased $36.1 million from $77.8 million for the nine months ended September 30, 2012 to $113.9 million for the nine months ended September 30, 2013. The increase in compensation expense was due to the development of and growth in our mortgage banking segment as well as growth in the level of assets managed and serviced for PMT, partially offset by decreases in unit-based compensation relating to PennyMac Class A units awards. The increase in compensation expense in the quarter ended September 30, 2013 was further offset by reduced accruals for cash-based incentive compensation. We expect stock-based compensation to increase in future quarters as a result of equity-based grants made on June 13, 2013. However, based on current outstanding equity award grants we do not expect to incur stock-based compensation expense at the level recorded during 2012.

 

Professional services expense increased $1.5 million and $4.4 million, respectively, in the quarter and nine months ended September 30, 2013 compared to the same periods in 2012. The increase was due to growth in the size of our operations.

 

Loan origination expense increased $1.0 million from $1.8 million for the quarter ended September 30, 2012 to $2.8 million for the quarter ended September 30, 2013 and increased $6.0 million from $1.8 million for the nine months ended September 30, 2012 to $7.8 million for the nine months ended September 30, 2013. The increase was due to growth in our loan origination volume and to changes in our fee structure which resulted in many of our fees being charged to correspondent lenders on an other-than pass-through basis. As a result of this change in structure, we recognized both the fee income and expense during 2013 as compared to “passing through” these items on a net basis during 2012.

 

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Technology expense increased $1.5 million and $3.0 million, respectively, in the quarter and nine months ended September 30, 2013 compared to the same periods in 2012. The increase was due to growth in the size of our operations.

 

Servicing expense increased $932,000 and $2.6 million, respectively, in the quarter and nine months ended September 30, 2013 compared to the same periods in 2012. The increase was due to growth in our mortgage servicing portfolio.

 

Occupancy expense increased $402,000 and $805,000, respectively, in the quarter and nine months ended September 30, 2013 compared to the same periods in 2012. The increase was primarily due to growth in the size of our operations.

 

Other expense increased $4.5 million and $10.1 million, respectively, in the quarter and nine months ended September 30, 2013 compared to the same periods in 2012. The increase was due to growth in the size of our operations.

 

Expenses Allocated to PMT

 

PMT reimburses us for other expenses, including common overhead expenses incurred on its behalf by us, in accordance with the terms of our management agreement.  The expense amounts presented in our income statement are net of these allocations.  Expense amounts allocated to PMT during the periods ended September 30, 2013 and 2012 are summarized below:

 

 

 

Quarter ended September 30,

 

Nine months ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(in thousands)

 

Technology

 

$

891

 

$

310

 

$

2,814

 

$

568

 

Occupancy

 

558

 

414

 

1,658

 

897

 

Depreciation and amortization

 

349

 

178

 

986

 

365

 

Other

 

729

 

342

 

2,335

 

645

 

Total expenses

 

$

2,527

 

$

1,244

 

$

7,793

 

$

2,475

 

 

The amount of total expenses that we allocated to PMT increased $1.3 million from $1.2 million in the quarter ended September 30, 2012 to $2.5 million for the quarter ended September 30, 2013 and increased $5.3 million from $2.5 million for the nine months ended September 30, 2012 to $7.8 million for the nine months ended September 30, 2013. The increase was due to growth in our overhead expenses, resulting in a larger portion of our overhead expenses being allocated to PMT.

 

Provision for Income Taxes

 

For the quarter and nine months ended September 30, 2013, our effective tax rates were 9.9% and 4.0%, respectively. The difference between our effective tax rate and the statutory rate is primarily due to the allocation of earnings to the noncontrolling interest unitholders. As the noncontrolling unitholders convert their ownership units into our shares, we expect an increase in allocated earnings that will be subject to corporate federal and state statutory tax rates.

 

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Table of Contents

 

Balance Sheet Analysis

 

Following is a summary of key balance sheet items as of the dates presented:

 

 

 

September 30, 2013

 

December 31, 2012

 

 

 

(in thousands)

 

ASSETS

 

 

 

 

 

Cash and short-term investments

 

$

183,885

 

$

65,487

 

Mortgage loans held for sale at fair value

 

530,248

 

448,384

 

Servicing advances

 

105,344

 

93,152

 

Receivable from affiliates

 

22,571

 

20,363

 

Carried Interest due from Investment Funds

 

58,134

 

47,723

 

Mortgage servicing rights

 

252,858

 

108,975

 

Other assets

 

101,344

 

48,079

 

Total assets

 

$

1,254,384

 

$

832,163

 

 

 

 

 

 

 

LIABILITIES

 

 

 

 

 

Borrowings

 

$

444,658

 

$

446,547

 

Payable to affiliates

 

94,804

 

83,574

 

Other liabilities

 

124,961

 

40,292

 

Total liabilities

 

664,423

 

570,413

 

EQUITY

 

589,961

 

261,750

 

Total liabilities and equity

 

$

1,254,384

 

$

832,163

 

 

Total assets increased $422.2 million from $832.2 million at December 31, 2012 to $1.3 billion at September 30, 2013. The increase was primarily due to an increase of $143.9 million in MSRs and an increase of $81.9 million in mortgage loans held for sale at fair value, both due to growth in our correspondent lending operations. Our cash and short-term investment balances increased by $118.4 million reflecting the proceeds from our IPO partially offset by our use of the IPO proceeds to pay down our repurchase agreement borrowings which reduced the percentage of our assets being financed.

 

Total liabilities increased by $94.0 million from $570.4 million as of December 31, 2012 to $664.4 million as of September 30, 2013. The increase was primarily attributable to an increase in liabilities relating to a tax receivable agreement with PennyMac’s partners of $58.6 million, which resulted from one exchange of PennyMac Class A units to shares of PFSI stock.

 

Cash Flows

 

Comparison of Quarters ended September 30, 2013 and 2012

 

Our cash flows resulted in a net increase in cash of $44.1 million during the nine months ended September 30, 2013 as compared to the nine months ended September 30, 2012. The positive cash flows arose primarily due to our initial public offering during the period. Cash used in operating activities totaled $68.2 million during the nine months ended September 30, 2013. The cash used in operating activities were primarily due to growth of our mortgage loans held for sale portfolio as origination and purchases of loans exceeded loan sales.

 

Net cash used in investing activities was $78.5 million during the nine months ended September 30, 2013. This use of cash reflects an increase in short-term investments due to the liquidity provided by the IPO.

 

Net cash provided by financing activities was $190.8 million during the nine months ended September 30, 2013. Cash provided by financing activities was primarily due to the IPO which raised $212.3 million net of underwriting and offering costs.

 

Liquidity and Capital Resources

 

Our liquidity reflects our ability to meet our current obligations (including our operating expenses and, when applicable, the retirement of, and margin calls relating to, our debt, and margin calls relating to hedges on our commitments to purchase or originate mortgage loans), fund new originations and purchases, and make investments as we identify them. We expect our primary sources of liquidity to be through cash flows from business activities, earnings on our investments and proceeds from borrowings and/or additional equity offerings. We believe that our liquidity is sufficient to meet our current liquidity needs.

 

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Our current leverage strategy is to finance our assets where we believe such borrowing is prudent and appropriate. Our borrowing activities are in the form of sales of mortgage loans under agreements to repurchase, and a note payable secured by mortgage servicing rights and servicing advances.

 

Our repurchase agreements represent the sales of mortgage loans together with agreements for us to buy back the mortgage loans at a later date. During the nine months ended September 30, 2013, the average balance outstanding under agreements to repurchase mortgage loans totaled $354.1 million, and the maximum daily amount outstanding under such agreements totaled $623.5 million. During the nine months ended September 30, 2012, the average balance outstanding under agreements to repurchase mortgage loans totaled $146.4 million, and the maximum daily amount outstanding under such agreements totaled $361.6 million.

 

The difference between the maximum and average daily amounts outstanding was due to increases in the sizes and utilization of our existing facilities, all in support of the growth in our mortgage loan production, investments and correspondent lending activities.

 

All of our borrowings discussed above have short-term maturities. The transactions relating to mortgage loans under agreements to repurchase mature between January 2, 2014 and the earlier to occur of October 31, 2014 or the rolling maturity date that is 364 days from any particular date of determination and provide for the repurchase from major financial institution counterparties based on the estimated fair value of the mortgage loans sold. Our note payable secured by mortgage servicing rights and loan servicing advances at fair value has a maturity date that is the earlier to occur of October 31, 2014 or the rolling maturity date that is 364 days from any particular date of determination.

 

PLS’s debt financing agreements require it to comply with various financial covenants. The most significant financial covenants currently include the following:

 

·                  positive net income during each calendar quarter;

 

·                  a minimum in unrestricted cash and cash equivalents of $20 million;

 

·                  a minimum tangible net worth of $90 million;

 

·                  a maximum ratio of total liabilities to tangible net worth of 10:1; and

 

·                  at least one other warehouse or repurchase facility that finances amounts and assets similar to those being financed under our existing debt financing agreements.

 

Although these financial covenants limit the amount of indebtedness that we may incur and affect our liquidity through minimum cash reserve requirements, we believe that these covenants currently provide us with sufficient flexibility to successfully operate our business and obtain the financing necessary to achieve that purpose.

 

With respect to servicing that we perform for the Advised Entities, we are also subject to certain covenants under their respective debt agreements. These covenants are similar to those above, with the additional covenant that we must maintain a minimum servicing portfolio of $5 billion in UPB.

 

Our debt financing agreements also contain margin call provisions that, upon notice from the applicable lender at its option, require us to transfer cash or, in some instances, additional assets in an amount sufficient to eliminate any margin deficit. A margin deficit will generally result from any decline in the market value (as determined by the applicable lender) of the assets subject to the related financing agreement. Upon notice from the applicable lender, we will generally be required to satisfy the margin call on the day of such notice or within one business day thereafter, depending on the timing of the notice.

 

We continue to explore a variety of additional means of financing our continued growth, including debt financing through bank warehouse lines of credit and additional repurchase agreements. However, there can be no assurance as to how much additional financing capacity such efforts will produce, what form the financing will take or whether such efforts will be successful.

 

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Off-Balance Sheet Arrangements and Aggregate Contractual Obligations

 

Off-Balance Sheet Arrangements and Guarantees

 

As of September 30, 2013, we have not entered into any off-balance sheet arrangements or guarantees.

 

Contractual Obligations

 

As of September 30, 2013, we had on-balance sheet contractual obligations of $387.9 million to finance assets under agreements to repurchase with maturities between July 25, 2013 and the earlier to occur of October 31, 2014 or the rolling maturity date that is 364 days from any particular date of determination. We also had a contractual obligation of $56.8 million relating to a note payable secured by mortgage servicing rights and loan servicing advances at fair value and with a maturity date that is the earlier to occur of October 31, 2014 or the rolling maturity date that is 364 days from any particular date of determination. We also lease our primary office facilities under an agreement that expires on February 28, 2017 and we license certain software to support our loan servicing operations.

 

Payment obligations under these agreements are summarized below:

 

 

 

Payments due by period

 

Contractual Obligations

 

Total

 

Less than
1 year

 

1 - 3
years

 

3 - 5
years

 

More
than
5 years

 

 

 

(in thousands)

 

Commitments to purchase mortgage loans from PMT

 

$

1,022,670

 

$

1,022,670

 

$

 

$

 

$

 

Commitments to fund mortgage loans

 

140,861

 

140,861

 

 

 

 

Commitments to sell mortgage loans

 

3,086,889

 

3,086,889

 

 

 

 

Loans sold under agreements to repurchase

 

387,883

 

387,883

 

 

 

 

Note payable

 

56,775

 

56,775

 

 

 

 

Payable to Private National Mortgage Acceptance Company, LLC partner under tax receivable agreement

 

58,615

 

 

11,916

 

9,959

 

36,740

 

Software licenses (1)

 

7,710

 

3,855

 

3,855

 

 

 

Office leases

 

13,132

 

3,584

 

7,829

 

1,719

 

 

Total

 

$

4,774,535

 

$

4,702,517

 

$

23,600

 

$

11,678

 

$

36,740

 

 


(1)                                 Software licenses include both volume and activity-based fees that are dependent on the number of loans serviced during each period and include a base fee of approximately $452,000 per year. Estimated payments for software licenses above are based on the number of loans currently serviced by us, which totaled approximately 226,000 at September 30, 2013. Future amounts due may significantly fluctuate based on changes in the number of loans serviced by us. For the quarter ended September 30, 2013, software license fees totaled $2.8 million. All figures contained in this footnote are in actual amounts and not in thousands (in contrast to the table above).

 

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The amount at risk (the fair value of the assets pledged plus the related margin deposit, less the amount advanced by the counterparty and accrued interest) relating to our assets sold under agreements to repurchase is summarized by counterparty below as of September 30, 2013:

 

Counterparty

 

Amount at risk

 

Weighted-average
maturity of advances under
repurchase agreement

 

Facility Maturity

 

 

 

(in thousands)

 

 

 

 

 

Bank of America, N.A.

 

$

45,516

 

December 16, 2013

 

January 2, 2014

 

Credit Suisse First Boston Mortgage Capital LLC

 

$

89,917

 

December 18, 2013

 

(1)

 

 


(1)         The earlier to occur of October 31, 2014 or the rolling maturity date that is 364 days from any particular date of determination.

 

Debt Obligations

 

As described further above in “Liquidity and Capital Resources,” we currently finance certain of our assets through borrowings with major financial institution counterparties in the form of sales of mortgage loans under agreements to repurchase, and a note payable secured by mortgage servicing rights and loan servicing advances. The borrower under each of these facilities is PLS, and all obligations thereunder are guaranteed by Private National Mortgage Acceptance Company, LLC.

 

Under the terms of these agreements, PLS is required to comply with certain financial covenants, as described further above in “Liquidity and Capital Resources,” and various non-financial covenants customary for transactions of this nature. As of September 30, 2013, we were in compliance in all material respects with these covenants.

 

The agreements also contain margin call provisions that, upon notice from the applicable lender, require us to transfer cash or, in some instances, additional assets in an amount sufficient to eliminate any margin deficit. Upon notice from the applicable lender, we will generally be required to satisfy the margin call on the day of such notice or within one business day thereafter, depending on the timing of the notice.

 

In addition, the agreements contain events of default (subject to certain materiality thresholds and grace periods), including payment defaults, breaches of covenants and/or certain representations and warranties, cross-defaults, guarantor defaults, servicer termination events and defaults, material adverse changes, bankruptcy or insolvency proceedings and other events of default customary for these types of transactions. The remedies for such events of default are also customary for these types of transactions and include the acceleration of the principal amount outstanding under the agreements and the liquidation by our lenders of the mortgage loans or other collateral then subject to the agreements.

 

All of PLS’s borrowings discussed above have short-term maturities that expire as follows:

 

Counterparty (1)

 

Outstanding
Indebtedness (2)

 

Committed
Amount

 

Maturity Date

 

 

 

(in thousands)

 

 

 

Bank of America, N.A.

 

$

199,423

 

$

300,000

 

January 2, 2014

 

Citibank, N.A.

 

$

 

$

150,000

 

July 24, 2014

 

Credit Suisse First Boston Mortgage Capital LLC

 

$

188,460

 

$

300,000

 

(3)

 

Credit Suisse First Boston Mortgage Capital LLC

 

$

56,775

 

$

117,000

 

(3)

 

 


(1)         The borrowings with Bank of America, N.A., Citibank, N.A. and Credit Suisse First Boston Mortgage Capital LLC (with a committed amount of $300 million) are in the form of sales of mortgage loans under agreements to repurchase. The borrowing with Credit Suisse First Boston Mortgage Capital LLC (with a committed amount of $117 million) is in the form of a note payable secured by mortgage servicing rights and servicing advances.

 

(2)         Represents outstanding indebtedness reduced by cash collateral as of September 30, 2013.

 

(3)      The earlier to occur of October 31, 2014 or the rolling maturity date that is 364 days from any particular date of determination.

 

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Quantitative and Qualitative Disclosures about Market Risk

 

Market risk is the exposure to loss resulting from changes in interest rates, foreign currency exchange rates, commodity prices, equity prices, real estate values and other market-based risks. The primary market risks that we are exposed to are interest rate risk, credit risk, prepayment risk, inflation risk and market value risk.

 

Credit Risk

 

We are subject to credit risk in connection with our loan sales activities. Our loan sales are generally made with contractual representations and warranties, which, if breached, can require us to repurchase the mortgage loan or reimburse the investor for any losses incurred because of that breach. These breaches are generally evidenced when the borrower defaults on a loan. The amount of our liability for losses due to representations and warranties to the loans’ investors is not limited. However, we believe that the current unpaid principal balance of loans sold by us to date represents the maximum exposure to repurchases related to representations and warranties. We include a provision for potential losses due to recourse as part of our recognition of loan sales, based initially on our estimate of the fair value of such obligation. We review our loss experience relating to representations and warranties and adjust our liability estimate when necessary. We believe that residual loan credit quality is primarily determined by the borrowers’ credit profiles and loan characteristics.

 

In the event of developments affecting the credit performance of loans we have sold subject to representations and warranties, such as a significant increase in unemployment or a significant deterioration in real estate values in markets where properties securing mortgage loans we purchase are located, defaults could increase and result in credit losses arising from claims under our representations and warranties, which could materially and adversely affect our business, financial condition and results of operations.

 

Interest Rate Risk

 

Interest rate risk is highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations, and other factors beyond our control. Changes in interest rates affect both the fair value of, and interest income we earn from, our mortgage-related investments. This effect is most pronounced with fixed-rate mortgage assets. In general, rising interest rates negatively affect the fair value of our interest rate lock agreements and inventory of mortgage loans held for sale.

 

Our operating results will depend, in part, on differences between the income from our investments and our financing costs. Presently our debt financing is based on a floating rate of interest calculated on a fixed spread over the relevant index, as determined by the particular financing arrangement.

 

We engage in interest rate risk management activities in an effort to reduce the variability of income caused by changes in interest rates. To manage this price risk resulting from interest rate risk, we use derivative financial instruments acquired with the intention of moderating the risk that changes in market interest rates will result in unfavorable changes in the value of our interest rate lock commitments and inventory of mortgage loans held for sale. We do not use derivative financial instruments for purposes other than in support of our risk management activities.

 

Prepayment Risk

 

To the extent that the actual prepayment rate on the mortgage loans underlying our MSRs differs from what we projected when we initially recognized the MSRs and when we measured fair value as of the end of each reporting period, the carrying value of our investment in MSRs will be affected. In general, a decline in the principal balances of the loans underlying our MSRs or an increase in prepayment expectations will accelerate the amortization and may result in impairments of our MSRs accounted for using the amortization method and decrease our estimates of the fair value of both the MSRs accounted for using the amortization method and those accounted for using the fair value method, thereby reducing net servicing income.

 

Inflation Risk

 

Virtually all of our assets and liabilities are interest rate sensitive in nature. As a result, interest rates and other factors will influence our performance more than inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates. Furthermore, our consolidated financial statements are prepared in accordance with GAAP and any distributions that PennyMac may make to its members will be determined by us as the managing member of PennyMac based primarily on our taxable income and, in each case, our activities and balance sheet are measured with reference to historical cost and/or fair value without considering inflation.

 

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Market Value Risk

 

Our mortgage loans held for sale are reported at their estimated fair values. The fair value of these assets fluctuates primarily due to changes in interest rates.

 

The following sensitivity analyses are limited in that they were (i) performed at a particular point in time, (ii) only contemplate certain movements in interest rates, (iii) do not incorporate changes in interest rate volatility or changes in the relationship of one interest rate index to another, (iv) are subject to the accuracy of various models and assumptions used, including prepayment forecasts and discount rates, and (v) do not incorporate other factors that would affect our overall financial performance in such scenarios, including operational adjustments made by management to account for changing circumstances. For these reasons, the following estimates should not be viewed as an earnings forecast.

 

Mortgage Servicing Rights

 

The following tables summarize the estimated change in fair value of MSRs accounted for using the amortization method as of September 30, 2013, given several shifts in pricing spreads, prepayment speed and annual per-loan cost of servicing:

 

Pricing spread shift in %

 

-20%

 

-10%

 

-5%

 

+5%

 

+10%

 

+20%

 

 

 

(dollar amounts in thousands)

 

Fair value

 

$

260,632

 

$

249,562

 

$

244,345

 

$

234,493

 

$

229,837

 

$

221,023

 

Change in fair value:

 

 

 

 

 

 

 

 

 

 

 

 

 

$

 

$

21,306

 

$

10,236

 

$

5,020

 

$

(4,833

)

$

(9,488

)

$

(18,303

)

%

 

8.90

%

4.28

%

2.10

%

-2.02

%

-3.96

%

-7.65

%

 

Prepayment speed shift in %

 

-20%

 

-10%

 

-5%

 

+5%

 

+10%

 

+20%

 

 

 

(dollar amounts in thousands)

 

Fair value

 

$

259,797

 

$

249,207

 

$

244,182

 

$

234,630

 

$

230,088

 

$

221,435

 

Change in fair value:

 

 

 

 

 

 

 

 

 

 

 

 

 

$

 

$

20,472

 

$

9,881

 

$

4,856

 

$

(4,696

)

$

(9,238

)

$

(17,891

)

%

 

8.55

%

4.13

%

2.03

%

-1.96

%

-3.86

%

-7.48

%

 

Per-loan servicing cost shift in %

 

-20%

 

-10%

 

-5%

 

+5%

 

+10%

 

+20%

 

 

 

(dollar amounts in thousands)

 

Fair value

 

$

248,857

 

$

244,091

 

$

241,709

 

$

236,943

 

$

234,560

 

$

229,794

 

Change in fair value:

 

 

 

 

 

 

 

 

 

 

 

 

 

$

 

$

9,531

 

$

4,766

 

$

2,383

 

$

(2,383

)

$

(4,766

)

$

(9,531

)

%

 

3.98

%

1.99

%

1.00

%

-1.00

%

-1.99

%

-3.98

%

 

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The following tables summarize the estimated change in fair value of MSRs accounted for using the fair value method as of September 30, 2013, given several shifts in pricing spreads, prepayment speed and annual per-loan cost of servicing:

 

Pricing spread shift in %

 

-20%

 

-10%

 

-5%

 

+5%

 

+10%

 

+20%

 

 

 

(dollar amounts in thousands)

 

Fair value

 

$

17,971

 

$

17,283

 

$

16,957

 

$

16,339

 

$

16,046

 

$

15,490

 

Change in fair value:

 

 

 

 

 

 

 

 

 

 

 

 

 

$

 

$

1,329

 

$

640

 

$

314

 

$

(303

)

$

(596

)

$

(1,153

)

%

 

7.99

%

3.85

%

1.89

%

-1.82

%

-3.58

%

-6.93

%

 

Prepayment speed shift in %

 

-20%

 

-10%

 

-5%

 

+5%

 

+10%

 

+20%

 

 

 

(dollar amounts in thousands)

 

Fair value

 

$

18,303

 

$

17,440

 

$

17,033

 

$

16,266

 

$

15,904

 

$

15,219

 

Change in fair value:

 

 

 

 

 

 

 

 

 

 

 

 

 

$

 

$

1,660

 

$

797

 

$

391

 

$

(376

)

$

(738

)

$

(1,423

)

%

 

9.98

%

4.79

%

2.35

%

-2.26

%

-4.44

%

-8.55

%

 

Per-loan servicing cost shift in %

 

-20%

 

-10%

 

-5%

 

+5%

 

+10%

 

+20%

 

 

 

(dollar amounts in thousands)

 

Fair value

 

$

17,244

 

$

16,943

 

$

16,793

 

$

16,492

 

$

16,342

 

$

16,042

 

Change in fair value:

 

 

 

 

 

 

 

 

 

 

 

 

 

$

 

$

601

 

$

300

 

$

150

 

$

(150

)

$

(300

)

$

(601

)

%

 

3.61

%

1.81

%

0.90

%

-0.90

%

-1.81

%

-3.61

%

 

The following tables summarize the estimated change in fair value of purchased MSRs backed by distressed mortgage loans accounted for using the fair value method as of September 30, 2013, given several shifts in pricing spreads, prepayment speed and annual per-loan cost of servicing:

 

Pricing spread shift in %

 

-20%

 

-10%

 

-5%

 

+5%

 

+10%

 

+20%

 

 

 

(dollar amounts in thousands)

 

Fair value

 

$

11,266

 

$

10,667

 

$

10,390

 

$

9,873

 

$

9,631

 

$

9,180

 

Change in fair value:

 

 

 

 

 

 

 

 

 

 

 

 

 

$

 

$

1,141

 

$

542

 

$

265

 

$

(252

)

$

(494

)

$

(945

)

%

 

11.27

%

5.36

%

2.61

%

-2.49

%

-4.88

%

-9.33

%

 

Prepayment speed shift in %

 

-20%

 

-10%

 

-5%

 

+5%

 

+10%

 

+20%

 

 

 

(dollar amounts in thousands)

 

Fair value

 

$

11,188

 

$

10,640

 

$

10,377

 

$

9,873

 

$

9,633

 

$

9,174

 

Change in fair value:

 

 

 

 

 

 

 

 

 

 

 

 

 

$

 

$

1,063

 

$

515

 

$

252

 

$

(252

)

$

(492

)

$

(951

)

%

 

10.50

%

5.08

%

2.49

%

-2.48

%

-4.86

%

-9.40

%

 

Per-loan servicing cost shift in %

 

-20%

 

-10%

 

-5%

 

+5%

 

+10%

 

+20%

 

 

 

(dollar amounts in thousands)

 

Fair value

 

$

11,018

 

$

10,572

 

$

10,348

 

$

9,902

 

$

9,678

 

$

9,232

 

Change in fair value:

 

 

 

 

 

 

 

 

 

 

 

 

 

$

 

$

893

 

$

447

 

$

223

 

$

(223

)

$

(447

)

$

(893

)

%

 

8.82

%

4.41

%

2.21

%

-2.21

%

-4.41

%

-8.82

%

 

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Factors That May Affect Our Future Results

 

This Report contains certain forward-looking statements that are subject to various risks and uncertainties. Forward-looking statements are generally identifiable by use of forward-looking terminology such as “may,” “will,” “should,” “potential,” “intend,” “expect,” “seek,” “anticipate,” “estimate,” “approximately,” “believe,” “could,” “project,” “predict,” “continue,” “plan” or other similar words or expressions. Forward-looking statements are based on certain assumptions, discuss future expectations, describe future plans and strategies, contain financial and operating projections or state other forward-looking information. Examples of forward-looking statements include the following:

 

·                  Projections of our revenues, income, earnings per share, capital structure or other financial items;

 

·                  Descriptions of our plans or objectives for future operations, products or services;

 

·                  Forecasts of our future economic performance, interest rates, profit margins and our share of future markets; and

 

·                  Descriptions of assumptions underlying or relating to any of the foregoing expectations regarding the timing of generating any revenues.

 

Our ability to predict results or the actual effect of future events, actions, plans or strategies is inherently uncertain. Although we believe that the expectations reflected in such forward-looking statements are based on reasonable assumptions, our actual results and performance could differ materially from those set forth in the forward-looking statements. There are a number of factors, many of which are beyond our control that could cause actual results to differ significantly from management’s expectations. Some of these factors are discussed below.

 

You should not place undue reliance on any forward-looking statement and should consider the following uncertainties and risks, as well as the risks and uncertainties discussed elsewhere in this Report and as set forth in Item IA. of Part II hereof and the section entitled “Risk Factors” in our final prospectus filed pursuant to Rule 424(b)(4) on May 8, 2013 with the SEC in connection with our initial public offering.

 

Factors that could cause actual results to differ materially from historical results or those anticipated include, but are not limited to:

 

·                  The continually changing federal, state and local laws and regulations applicable to the highly regulated industry in which we operate;

 

·                  Lawsuits or governmental actions if we do not comply with the laws and regulations applicable to our businesses;

 

·                  The creation of the Consumer Financial Protection Bureau, or CFPB, its recently issued and future rules and the enforcement thereof by the CFPB;

 

·                  Changes in existing U.S. government-sponsored entities, their current roles or their guarantees or guidelines;

 

·                  Changes to government mortgage modification programs;

 

·                  The licensing and operational requirements of states and other jurisdictions applicable to our businesses, to which our bank competitors are not subject;

 

·                  Foreclosure delays and changes in foreclosure practices;

 

·                  Certain banking regulations that may limit our business activities;

 

·                  Changes in macroeconomic and U.S. residential real estate market conditions;

 

·                  Difficulties inherent in growing loan production volume;

 

·                  Difficulties inherent in adjusting the size of our operations to reflect changes in business levels;

 

·                  Changes in prevailing interest rates;

 

·                  Increases in loan delinquencies and defaults;

 

·                  Our reliance on PMT as a significant source of financing for, and revenue related to, our correspondent lending business;

 

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Table of Contents

 

·                  Any required additional capital and liquidity to support business growth that may not be available on acceptable terms, if at all;

 

·                  Our obligation to indemnify third-party purchasers or repurchase loans if loans that we originate, acquire or assist in the fulfillment of, fail to meet certain criteria or characteristics or under other circumstances;

 

·                  Our obligation to indemnify PMT and the Investment Funds if our services fail to meet certain criteria or characteristics or under other circumstances;

 

·                  Decreases in the historical returns on the assets that we select and manage for our clients, and our resulting management and incentive fees;

 

·                  The extensive amount of regulation applicable to our investment management segment;

 

·                  Conflicts of interest in allocating our services and investment opportunities among ourselves and our Advised Entities;

 

·                  The potential damage to our reputation and adverse impact to our business resulting from the ongoing negative publicity focused on Countrywide Financial Corporation, given the former association of certain of our officers with that entity; and

 

·                  Our recent rapid growth.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

In response to this Item, the information set forth on pages 72 to 74 of this Report is incorporated herein by reference.

 

Item 4. Controls and Procedures

 

Disclosure Controls and Procedures

 

Under the supervision and with the participation of management, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures as required by Rules 13a-15 and 15d-15 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) as of September 30, 2013. Based upon our evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective, as of September 30, 2013, to provide reasonable assurance that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the applicable rules and forms, and that it is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.  No matter how well a control system is designed and operated, it can provide only reasonable, not absolute, assurance that it will detect or uncover control issues and instances of fraud, if any, within the Company to disclose material information otherwise required to be set forth in our periodic reports.

 

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Table of Contents

 

PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings

 

From time to time, we may be involved in various legal proceedings, claims and actions arising in the ordinary course of business. As of September 30, 2013, we were not involved in any such legal proceedings, claims or actions that management believes would be reasonably likely to have a material adverse effect on us.

 

Item 1A. Risk Factors

 

There are no material changes from the risk factors set forth in our final prospectus dated October 28, 2013 included as part of our Registration Statement on Form S-1, as amended (SEC File No. 333-191522).

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

Effective July 15, 2013, the Company received a Notice of Election of Exchange from a unitholder related to the exchange of 6,110,000 Class A units for an equivalent number of shares of the Company’s Class A Common Stock.  In connection with delivering the Notice of Election of Exchange, the unitholder surrendered its Class A units to the Company for cancellation and was issued 6,110,000 unregistered shares of Class A Common Stock that qualified for exemption under Section 4(2) of the Securities Act of 1933, as amended.

 

Item 3. Defaults Upon Senior Securities

 

None

 

Item 4. Mine Safety Disclosures

 

Not applicable

 

Item 5. Other Information

 

None

 

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Table of Contents

 

Item 6. Exhibits

 

Exhibit

 

 

Number

 

Exhibit Description

3.1

 

Amended and Restated Certificate of Incorporation of PennyMac Financial Services, Inc. (incorporated by reference to Exhibit 3.1 of the Registrant’s Current Report on Form 8-K as filed with the SEC on May 14, 2013).

3.2

 

Amended and Restated Bylaws of PennyMac Financial Services, Inc. (incorporated by reference to Exhibit 3.1 of the Registrant’s Current Report on Form 8-K as filed with the SEC on August 19, 2013).

4.1

 

Specimen Class A Common Stock Certificate (incorporated by reference to Exhibit 4.1 of the Registrant’s

 

 

Amendment No. 4 to Form S-1 Registration Statement as filed with the SEC on April 29, 2013).

10.1

 

Fourth Amended and Restated Limited Liability Company Agreement of Private National Mortgage Acceptance Company, LLC, dated as of May 8, 2013 (incorporated by reference to Exhibit 10.1 of the Registrant’s Current Report on Form 8-K as filed with the SEC on May 14, 2013).

10.2

 

Exchange Agreement, dated as of May 8, 2013, between PennyMac Financial Services, Inc. and Private National Mortgage Acceptance Company, LLC and the Company Unitholders (incorporated by reference to Exhibit 10.2 of the Registrant’s Current Report on Form 8-K as filed with the SEC on May 14, 2013).

10.3

 

Tax Receivable Agreement, dated as of May 8, 2013, between PennyMac Financial Services, Inc. Private National Mortgage Acceptance Company, LLC and each of the Members (incorporated by reference to Exhibit 10.3 of the Registrant’s Current Report on Form 8-K as filed with the SEC on May 14, 2013).

10.4

 

Registration Rights Agreement, dated as of May 8, 2013, between PennyMac Financial Services, Inc. and the Holders (incorporated by reference to Exhibit 10.4 of the Registrant’s Current Report on Form 8-K as filed with the SEC on May 14, 2013).

10.5

 

Stockholder Agreement, dated as of May 8, 2013, between PennyMac Financial Services, Inc. and BlackRock Mortgage Ventures, LLC (incorporated by reference to Exhibit 10.5 of the Registrant’s Current Report on Form 8-K as filed with the SEC on May 14, 2013).

10.6

 

Stockholder Agreement, dated as of May 8, 2013, between PennyMac Financial Services, Inc. and HC Partners LLC (incorporated by reference to Exhibit 10.6 of the Registrant’s Current Report on Form 8-K as filed with the SEC on May 14, 2013).

10.7

PennyMac Financial Services, Inc. 2013 Equity Incentive Plan (incorporated by reference to Exhibit 99.1 of the Registrant’s Current Report on Form 8-K as filed with the SEC on May 14, 2013).

10.8

PennyMac Financial Services, Inc. 2013 Equity Incentive Plan Form of Restricted Stock Unit Award Agreement for Non-Employee Directors (incorporated by reference to Exhibit 10.1 of the Registrant’s Current Report on Form 8-K as filed with the SEC on May 16, 2013).

10.9

PennyMac Financial Services, Inc. 2013 Equity Incentive Plan Form of Restricted Stock Unit Award Agreement for Executive Officers (incorporated by reference to Exhibit 10.2 of the Registrant’s Current Report on Form 8-K as filed with the SEC on June 17, 2013).

10.10

PennyMac Financial Services, Inc. 2013 Equity Incentive Plan Form of Restricted Stock Unit Award Agreement for Other Eligible Participants (incorporated by reference to Exhibit 10.3 of the Registrant’s Current Report on Form 8-K as filed with the SEC on June 17, 2013).

10.11

PennyMac Financial Services, Inc. 2013 Equity Incentive Plan Form of Stock Option Award Agreement (incorporated by reference to Exhibit 10.1 of the Registrant’s Current Report on Form 8-K as filed with the SEC on June 17, 2013).

10.12

Form of PennyMac Financial Services, Inc. Indemnification Agreement (incorporated by reference to Exhibit 10.8 of the Registrant’s Amendment No. 2 to Form S-1 Registration Statement as filed with the SEC on April 5, 2013).

10.13

Employment Agreement, dated as of April 20, 2013, by and among Private National Mortgage Acceptance Company, LLC, PennyMac Financial Services, Inc. and Stanford L. Kurland (incorporated by reference to Exhibit 10.34 of the Registrant’s Amendment No. 3 to Form S-1 Registration Statement as filed with the SEC on April 22, 2013).

10.14

Employment Agreement, dated as of April 20, 2013, by and among Private National Mortgage Acceptance Company, LLC, PennyMac Financial Services, Inc. and David A. Spector (incorporated by reference to Exhibit 10.35 of the Registrant’s Amendment No. 3 to Form S-1 Registration Statement as filed with the SEC on April 22, 2013).

10.15

 

Mortgage Banking and Warehouse Services Agreement, effective as of February 1, 2013, by and between PennyMac Loan Services, LLC and PennyMac Corp. (incorporated by reference to Exhibit 10.9 of the Registrant’s Form S-1 Registration Statement as filed with the SEC on February 7, 2013).

10.16

 

Amendment No. 1 to Mortgage Banking and Warehouse Services Agreement, dated as of March 1, 2013, by and between PennyMac Loan Services LLC and PennyMac Corp. (incorporated by reference to Exhibit 10.31 of the Registrant’s Amendment No. 1 to Form S-1 Registration Statement as filed with the SEC on March 26, 2013).

 

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Exhibit
Number

 

Exhibit Description

10.17

 

Amendment No. 2 to Mortgage Banking and Warehouse Services Agreement, dated as of August 14, 2013, by and between PennyMac Loan Services, LLC and PennyMac Corp. (incorporated by reference to Exhibit 1.1 of the Registrant’s Current Report on Form 8-K as filed with the SEC on August 19, 2013).

10.18

 

Amended and Restated Flow Servicing Agreement, dated as of February 1, 2013, by and between PennyMac Loan Services, LLC and PennyMac Operating Partnership, L.P. (incorporated by reference to Exhibit 10.10 of the Registrant’s Form S-1 Registration Statement as filed with the SEC on February 7, 2013).

10.19

 

Second Amended and Restated Flow Servicing Agreement, dated as of March 1, 2013, by and between PennyMac Operating Partnership, L.P. and PennyMac Loan Services, LLC (incorporated by reference to Exhibit 10.30 of the Registrant’s Amendment No. 1 to Form S-1 Registration Statement as filed with the SEC on March 26, 2013).

10.20

 

MSR Recapture Agreement, effective as of February 1, 2013, by and between PennyMac Loan Services, LLC and PennyMac Corp. (incorporated by reference to Exhibit 10.11 of the Registrant’s Form S-1 Registration Statement as filed with the SEC on February 7, 2013).

10.21

 

Amendment No. 1 to MSR Recapture Agreement, dated as of August 1, 2013, by and between PennyMac Loan Services, LLC and PennyMac Corp. (incorporated by reference to Exhibit 10.21 of the Registrant’s Form S-1 Registration Statement as filed with the SEC on October 1, 2013).

10.22

 

Amended and Restated Management Agreement, dated as of February 1, 2013, by and among PennyMac Mortgage Investment Trust, PennyMac Operating Partnership, L.P. and PNMAC Capital Management, LLC (incorporated by reference to Exhibit 10.12 of the Registrant’s Form S-1 Registration Statement as filed with the SEC on February 7, 2013).

10.23

 

Amended and Restated Underwriting Fee Reimbursement Agreement, dated as of February 1, 2013, by and among PennyMac Mortgage Investment Trust, PennyMac Operating Partnership, L.P. and PNMAC Capital Management, LLC (incorporated by reference to Exhibit 10.13 of the Registrant’s Form S-1 Registration Statement as filed with the SEC on February 7, 2013).

10.24

 

Master Spread Acquisition and MSR Servicing Agreement, by and between PennyMac Loan Services, LLC and PennyMac Operating Partnership, L.P., dated as of February 1, 2013 (incorporated by reference to Exhibit 10.26 of the Registrant’s Form S-1 Registration Statement as filed with the SEC on February 7, 2013).

10.25

 

Amendment No. 1 to Master Spread Acquisition and MSR Servicing Agreement, by and between PennyMac Loan Services, LLC and PennyMac Operating Partnership, L.P., dated as of September 30, 2013 (incorporated by reference to Exhibit 10.25 of the Registrant’s Form S-1/A Registration Statement as filed with the SEC on October 22, 2013).

10.26

 

Confidentiality Agreement, by and between PennyMac Mortgage Investment Trust and PNMAC Capital Management, LLC, dated as of February 6, 2013 (incorporated by reference to Exhibit 10.28 of the Registrant’s Form S-1 Registration Statement as filed with the SEC on February 7, 2013).

10.27

 

Amended and Restated Confidentiality Agreement, dated as of March 1, 2013, by and between PennyMac Mortgage Investment Trust and Private National Mortgage Acceptance Company, LLC (incorporated by reference to Exhibit 10.29 of the Registrant’s Amendment No. 1 to Form S-1 Registration Statement as filed with the SEC on March 26, 2013).

10.28

 

Amended and Restated Flow Servicing Agreement, by and between PNMAC Mortgage Co., LLC and PennyMac Loan Services, LLC, dated August 1, 2010 (incorporated by reference to Exhibit 10.14 of the Registrant’s Amendment No. 1 to Form S-1 Registration Statement as filed with the SEC on March 26, 2013).

10.29

 

Second Amended and Restated Flow Servicing Agreement, dated as of August 1, 2008, as amended effective as of January 1, 2012, by and between PNMAC Mortgage Opportunity Fund Investors, LLC and PennyMac Loan Services, LLC (incorporated by reference to Exhibit 10.15 of the Registrant’s Form S-1 Registration Statement as filed with the SEC on February 7, 2013).

10.30

 

Amended and Restated Flow Servicing Agreement, dated as of August 1, 2010, by and between PNMAC Mortgage Opportunity Fund, LP and PennyMac Loan Services, LLC (incorporated by reference to Exhibit 10.27 of the Registrant’s Amendment No. 1 to Form S-1 Registration Statement as filed with the SEC on March 26, 2013).

 

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Exhibit

 

 

Number

 

Exhibit Description

10.31

 

Investment Management Agreement, as amended and restated May 26, 2011, by and between PNMAC Mortgage Opportunity Fund, L.P. and PNMAC Capital Management, LLC (incorporated by reference to Exhibit 10.16 of the Registrant’s Form S-1 Registration Statement as filed with the SEC on February 7, 2013).

10.32

 

Investment Management Agreement, dated as of August 1, 2008, between PNMAC Mortgage Opportunity Fund Investors, LLC and PNMAC Capital Management, LLC (incorporated by reference to Exhibit 10.17 of the Registrant’s Form S-1 Registration Statement as filed with the SEC on February 7, 2013).

10.33

 

Master Repurchase Agreement, dated as of March 17, 2011, by and among Bank of America, N.A., PennyMac Loan Services, LLC and Private National Mortgage Acceptance Company, LLC (incorporated by reference to Exhibit 10.18 of the Registrant’s Form S-1 Registration Statement as filed with the SEC on February 7, 2013).

10.34

 

Amendment No. 1 to Master Repurchase Agreement, dated as of July 21, 2011, by and among Bank of America, N.A., PennyMac Loan Services, LLC and Private National Mortgage Acceptance Company, LLC (incorporated by reference to Exhibits 10.19 of the Registrant’s Amendment No. 3 to Form S-1 Registration Statement as filed with the SEC on April 22, 2013).

10.35

 

Amendment No. 2 to Master Repurchase Agreement, dated as of March 23, 2012, by and among Bank of America, N.A., PennyMac Loan Services, LLC and Private National Mortgage Acceptance Company, LLC (incorporated by reference to Exhibits 10.19 of the Registrant’s Amendment No. 3 to Form S-1 Registration Statement as filed with the SEC on April 22, 2013).

10.36

 

Amendment No. 3 to Master Repurchase Agreement, dated as of August 28, 2012, by and among Bank of America, N.A., PennyMac Loan Services, LLC and Private National Mortgage Acceptance Company, LLC (incorporated by reference to Exhibits 10.19 of the Registrant’s Amendment No. 3 to Form S-1 Registration Statement as filed with the SEC on April 22, 2013).

10.37

 

Amendment No. 4 to Master Repurchase Agreement, dated as of January 3, 2013, by and among Bank of America, N.A., PennyMac Loan Services, LLC and Private National Mortgage Acceptance Company, LLC (incorporated by reference to Exhibits 10.19 of the Registrant’s Amendment No. 3 to Form S-1 Registration Statement as filed with the SEC on April 22, 2013).

10.38

 

Amendment No. 5 to Master Repurchase Agreement, dated as of March 28, 2013, by and among Bank of America, N.A., PennyMac Loan Services, LLC and Private National Mortgage Acceptance Company, LLC (incorporated by reference to Exhibits 10.19 of the Registrant’s Amendment No. 3 to Form S-1 Registration Statement as filed with the SEC on April 22, 2013).

10.39

 

Master Repurchase Agreement, dated as of June 26, 2012, by and between PennyMac Loan Services, LLC and Citibank, N.A. (incorporated by reference to Exhibit 10.20 of the Registrant’s Form S-1 Registration Statement as filed with the SEC on February 7, 2013).

10.40

 

Amendment Number One to the Master Repurchase Agreement, dated as of December 31, 2012, by and between PennyMac Loan Services, LLC and Citibank, N.A. (incorporated by reference to Exhibit 10.21 of the Registrant’s Form S-1 Registration Statement as filed with the SEC on February 7, 2013).

10.41

 

Amendment Number Two to the Master Repurchase Agreement, dated April 17, 2013, by and between PennyMac Loan Services, LLC and Citibank, N.A. (incorporated by reference to Exhibit 10.40 of the Registrant’s Form S-1 Registration Statement as filed with the SEC on October 1, 2013).

10.42

 

Amendment Number Three to the Master Repurchase Agreement, dated June 25, 2013, by and between PennyMac Loan Services, LLC and Citibank, N.A. (incorporated by reference to Exhibit 10.41 of the Registrant’s Form S-1 Registration Statement as filed with the SEC on October 1, 2013).

10.43

 

Amendment Number Four to the Master Repurchase Agreement, dated July 25, by and between PennyMac Loan Services, LLC and Citibank, N.A. (incorporated by reference to Exhibit 10.42 of the Registrant’s Form S-1 Registration Statement as filed with the SEC on October 1, 2013).

10.44

 

Second Amended and Restated Loan and Security Agreement, dated as of March 27, 2012, between Credit Suisse First Boston Mortgage Capital LLC, PennyMac Loan Services, LLC and Private National Mortgage Acceptance Company, LLC (incorporated by reference to Exhibit 10.22 of the Registrant’s Form S-1 Registration Statement as filed with the SEC on February 7, 2013).

10.45

 

Amendment No. 1 to Second Amended and Restated Loan and Security Agreement, dated as of December 12, 2012, among Credit Suisse First Boston Mortgage Capital LLC, PennyMac Loan Services, LLC and Private National Mortgage Acceptance Company, LLC (incorporated by reference to Exhibit 10.23 of the Registrant’s Amendment No. 3 to Form S-1 Registration Statement as filed with the SEC on April 22, 2013).

10.46

 

Amendment No. 2 to Second Amended and Restated Loan and Security Agreement, dated as of March 22, 2013, among Credit Suisse First Boston Mortgage Capital LLC, PennyMac Loan Services, LLC and Private National Mortgage Acceptance Company, LLC (incorporated by reference to Exhibit 10.23 of the Registrant’s Amendment No. 3 to Form S-1 Registration Statement as filed with the SEC on April 22, 2013).

 

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Exhibit

 

 

Number

 

Exhibit Description

10.47

 

Amended and Restated Master Repurchase Agreement, dated as of May 3, 2013, by and among Credit Suisse First Boston Mortgage Capital LLC, PennyMac Loan Services, LLC and Private National Mortgage Acceptance Company, LLC (incorporated by reference to Exhibit 10.36 of the Registrant’s Amendment No. 5 to Form S-1 Registration Statement as filed with the SEC on May 7, 2013).

10.48

 

Amendment No. 1 to Amended and Restated Master Repurchase Agreement, dated as of September 5, 2013, by and among Credit Suisse First Boston Mortgage Capital LLC, PennyMac Loan Services, LLC and Private National Mortgage Acceptance Company, LLC (incorporated by reference to Exhibit 10.47 of the Registrant’s Form S-1 Registration Statement as filed with the SEC on October 1, 2013).

10.49

 

Master Repurchase Agreement, dated as of July 2, 2013, by and between PennyMac Loan Services, LLC and Morgan Stanley Bank, N.A. (incorporated by reference to Exhibit 1.1 of the Registrant’s Current Report on Form 8-K as filed with the SEC on July 8, 2013).

10.50

 

Amendment Number One to the Master Repurchase Agreement, dated as of August 26, 2013, by and between PennyMac Loan Services, LLC and Morgan Stanley Bank, N.A. (incorporated by reference to Exhibit 10.49 of the Registrant’s Form S-1 Registration Statement as filed with the SEC on October 1, 2013).

10.51

 

Guaranty Agreement, dated as of July 2, 2013, by Private National Mortgage Acceptance Company, LLC in favor of Morgan Stanley Bank, N.A. (incorporated by reference to Exhibit 1.2 of the Registrant’s Current Report on Form 8-K as filed with the SEC on July 8, 2013).

31.1

 

Certification of Stanford L. Kurland pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2

 

Certification of Anne D. McCallion pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1

*

Certification of Stanford L. Kurland pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2

*

Certification of Anne D. McCallion pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101

**

Interactive Data Files Pursuant to Rule 405 of Regulation S-T: (i) the Consolidated Balance Sheets as of September 30, 2013 and December 31, 2012, (ii) the Consolidated Statements of Income for the quarters ended September 30, 2013 and 2012, (iii) the Consolidated Statements of Changes in Members’ Equity for the quarters ended September 30, 2013 and 2012, (iv) the Consolidated Statements of Cash Flows for the quarters ended September 30, 2013 and 2012 and (v) the Notes to the Consolidated Financial Statements.

 


*

The certifications attached hereto as Exhibits 32.1 and 32.2 are furnished to the SEC pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not be deemed filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, nor shall it be deemed incorporated by reference in any filing under the Securities Act of 1933, except as shall be expressly set forth by specific reference in such filing.

**

Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Section 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and are not otherwise subject to liability under those sections.

Indicates management contract or compensatory plan or arrangement.

 

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

PENNYMAC FINANCIAL SERVICES, INC.

 

(Registrant)

 

 

 

 

Dated: November 14, 2013

By:

/S/ STANFORD L. KURLAND

 

 

Stanford L. Kurland

 

 

Chairman of the Board and Chief Executive Officer

 

 

 

Dated: November 14, 2013

By:

/S/ ANNE D. MCCALLION

 

 

Anne D. McCallion

 

 

Chief Financial Officer

 

82