UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
Form 10-Q
(Mark One)
For the quarterly period ended September 30, 2013
Or
For the transition period from to
Commission file number: 001-34416
PennyMac Mortgage Investment Trust
(Exact name of registrant as specified in its charter)
(State or other jurisdiction of
incorporation or organization)
(IRS Employer
Identification No.)
(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 ¨
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):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): Yes ¨ 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 6, 2013
70,453,582
PENNYMAC MORTGAGE INVESTMENT TRUST
FORM 10-Q
September 30, 2013
TABLE OF CONTENTS
Item 1.
Financial Statements (Unaudited):
Consolidated Balance Sheets
Consolidated Statements of Income
Consolidated Statements of Changes in Shareholders’ Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Observations on Current Market Opportunities
Results of Operations
Net Investment Income
Expenses
Balance Sheet Analysis
Asset Acquisitions
Investment Portfolio Composition
Cash Flows
Liquidity and Capital Resources
Off-Balance Sheet Arrangements and Aggregate Contractual Obligations
Quantitative and Qualitative Disclosures About Market Risk
Factors That May Affect Our Future Results
Item 3.
Item 4.
Controls and Procedures
Legal Proceedings
Item 1A.
Risk Factors
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults Upon Senior Securities
Mine Safety Disclosures
Item 5.
Other Information
Item 6.
Exhibits
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
PENNYMAC MORTGAGE INVESTMENT TRUST AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(in thousands, except per share data)
Cash
Short-term investments
Mortgage-backed securities at fair value
Agency debt security at fair value
Mortgage loans acquired for sale at fair value (includes $731,717 and $972,079 pledged to secure mortgage loans acquired for sale under agreements to repurchase)
Mortgage loans at fair value (includes $1,774,101 and $956,583 pledged to secure repurchase agreements)
Mortgage loans at fair value held by variable interest entity (includes $501,417 collateralized mortgage loans at fair value held by variable interest entity sold under agreement to repurchase and asset-backed secured financing at fair value)
Mortgage loans under forward purchase agreements at fair value (includes $228,086 pledged to secure borrowings under forward purchase agreements)
Derivative assets
Real estate acquired in settlement of loans (includes $67,870 and $23,834 pledged to secure real estate acquired in settlement of loans sold under agreements to repurchase)
Real estate acquired in settlement of loans under forward purchase agreements, pledged to secure forward purchase agreements
Mortgage servicing rights at lower of amortized cost or fair value
Mortgage servicing rights at fair value
Excess servicing spread purchased from PennyMac Financial Services, Inc.
Principal and interest collections receivable
Principal and interest collections receivable under forward purchase agreements
Interest receivable
Servicing advances
Due from PennyMac Financial Services, Inc.
Other assets
Total assets
Assets sold under agreements to repurchase:
Securities
Mortgage loans acquired for sale at fair value
Mortgage loans at fair value
Mortgage loans at fair value held by variable interest entity
Real estate acquired in settlement of loans
Borrowings under forward purchase agreements
Asset-backed secured financing at fair value
Exchangeable senior notes
Derivative liabilities
Accounts payable and accrued liabilities
Due to PennyMac Financial Services, Inc.
Income taxes payable
Liability for losses under representations and warranties
Total liabilities
Commitments and contingencies
Common shares of beneficial interest—authorized, 500,000,000 common shares of $0.01 par value; issued and outstanding, 70,453,326 and 58,904,456 common shares, respectively
Additional paid-in capital
Retained earnings
Total shareholders’ equity
Total liabilities and shareholders’ equity
The accompanying notes are an integral part of these consolidated financial statements.
1
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Net gain on mortgage loans acquired for sale
Loan origination fees
Net interest income:
Interest income
Interest expense
Net gain (loss) on investments:
Mortgage-backed securities
Agency debt security
Mortgage loans
Excess servicing spread
Net loan servicing fees
Results of real estate acquired in settlement of loans
Other
Net investment income
Expenses payable to
PennyMac Financial Services, Inc.:
Loan fulfillment fees
Loan servicing fees
Management fees
Professional services
Compensation
Total expenses
Income before provision for income taxes
(Benefit) provision for income taxes
Net income
Earnings per share
Basic
Diluted
Weighted-average shares outstanding
Dividends declared per share
2
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (UNAUDITED)
Balance at December 31, 2011
Share-based compensation
Cash dividends, $1.65 per share
Proceeds from offerings of common shares
Underwriting and offering costs
Balance at September 30, 2012
Balance at December 31, 2012
Cash dividends, $1.71 per share
Balance at September 30, 2013
3
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(in thousands)
Cash flows from operating activities:
Adjustments to reconcile net income to net cash used by operating activities:
Net gain on mortgage loans at fair value
Net gain on mortgage-backed securities at fair value
Accrual of unearned discounts on mortgage-backed securities at fair value and capitalization of interest and advances on mortgage loans at fair value
Net gain on mortgage loans acquired for sale at fair value
Net gain on excess servicing spread
Change in fair value of Agency debt security
Change in fair value, amortization and impairment of mortgage servicing rights
Amortization of credit facility commitment fees and debt issuance costs
Accrual of costs related to forward purchase agreements
Share-based compensation expense
Purchases of mortgage loans acquired for sale at fair value
Sales of mortgage loans acquired for sale at fair value to nonaffiliates
Sales of mortgage loans acquired for sale to PennyMac Financial Services, Inc.
Decrease (increase) in principal and interest collections receivable
(Increase) decrease in principal and interest collections receivable under forward purchase agreements
Increase in interest receivable
Decrease (increase) in due from PennyMac Financial Services, Inc.
Increase in other assets
(Decrease) increase in accounts payable and accrued liabilities
Increase (decrease) in payable to PennyMac Financial Services, Inc.
Increase in income taxes payable
Net cash used by operating activities
Cash flows from investing activities
Net increase in short-term investments
Purchase of Agency debt security
Purchase of excess servicing spread from PennyMac Financial Services, Inc.
Maturity of United States Treasury security
Purchases of mortgage-backed securities at fair value
Repayments of mortgage-backed securities at fair value
Sales of mortgage-back securities at fair value
Purchases of mortgage loans at fair value
Repayments of mortgage loans at fair value
Repayments of mortgage loans under forward purchase agreements at fair value
Purchase of real estate acquired in settlement of loans
Sales of real estate acquired in settlement of loans
Sales of real estate acquired in settlement of loans under forward purchase agreements
Purchases of mortgage servicing rights
Sales of mortgage servicing rights
Increase in margin deposits and restricted cash
Net cash used by investing activities
Cash flows from financing activities
Sales of securities under agreements to repurchase
Repurchases of securities sold under agreements to repurchase
Sales of mortgage loans acquired for sale at fair value under agreements to repurchase
Repurchase of mortgage loans acquired for sale at fair value under agreements to repurchase
Sales of mortgage loans at fair value and held by variable interest entity under agreements to repurchase
Repurchases of mortgage loans at fair value and held by variable interest entity sold under agreements to repurchase
Repayments of note payable secured by mortgage loans at fair value
Sales of real estate acquired in settlement of loans financed under agreement to repurchase
Repurchases of real estate acquired in settlement of loans financed under agreement to repurchase
Repayments of borrowings under forward purchase agreements
Proceeds from asset-backed secured financing
Payment of underwriting fees payable
Issuance of exchangeable senior notes
Payment of exchangeable senior notes issuance costs
Proceeds from issuance of common shares
Payment of common share underwriting and offering costs
Payments of dividends
Net cash provided by financing activities
Net increase in cash
Cash at beginning of period
Cash at end of period
4
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note 1—Organization and Basis of Presentation
PennyMac Mortgage Investment Trust (“PMT” or the “Company”) was organized in Maryland on May 18, 2009, and commenced operations on August 4, 2009, when it completed its initial offerings of common shares of beneficial interest (“shares”). The Company is a specialty finance company, which, through its subsidiaries (all of which are wholly-owned), invests primarily in residential mortgage loans and mortgage-related assets.
The Company operates in two segments: correspondent lending and investment activities:
Most of the loans the Company has acquired in its correspondent lending activities have been eligible for sale to government-sponsored entities such as the Federal National Mortgage Association (“Fannie Mae”) and Federal Home Loan Mortgage Corporation (“Freddie Mac”) or through government agencies such as the Government National Mortgage Association (“Ginnie Mae”). Fannie Mae, Freddie Mac and Ginnie Mae are each referred to as an “Agency” and, collectively, as the “Agencies.”
The Company is externally managed by PCM, an investment adviser registered with the Securities and Exchange Commission (the “SEC”) that specializes in and focuses on residential mortgage loans. Under the terms of a management agreement, PCM is paid a management fee with a base component and a performance incentive component. Determination of the amount of management fees is discussed in Note 3—Transactions with Related Parties.
The Company believes that it qualifies, and has elected to be taxed, as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”), beginning with its taxable period ended on December 31, 2009. To maintain its tax status as a REIT, the Company has to distribute at least 90% of its taxable income in the form of qualifying distributions to shareholders.
The Company conducts substantially all of its operations and makes substantially all of its investments through its subsidiary, PennyMac Operating Partnership, L.P. (the “Operating Partnership”), and the Operating Partnership’s subsidiaries. A subsidiary of the Company is the sole general partner, and the Company is the sole limited partner, of the Operating Partnership.
The accompanying consolidated financial statements have been prepared in compliance with accounting principles generally accepted in the United States (“U.S. GAAP”) for interim financial information and with the SEC’s instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, these financial statements and notes do not include all of the information required by U.S. GAAP for complete financial statements. The interim consolidated information should be read together with the Company’s Annual Report on Form 10-K for the year ended December 31, 2012 (the “Annual Report”).
The Company enters into various types of on- and off-balance sheet transactions with special purpose entities (SPEs), which are trusts that are established for a limited purpose. Generally, SPEs are formed in connection with securitization transactions. In a securitization transaction, the Company transfers mortgage loans on its balance sheet to an SPE, which then issues to investors various forms of interests in those assets. In a securitization transaction, the Company typically receives cash and/or interests in an SPE in exchange for the assets the Company transfers.
SPEs are generally considered variable interest entities (VIEs). A VIE is an entity having either a total equity investment that is insufficient to finance its activities without additional subordinated financial support or whose equity investors lack the ability to control the entity’s activities. Variable interests are investments or other interests that will absorb portions of a VIE’s expected losses or receive portions of the VIE’s expected residual returns.
The Company is a variable interest holder in certain VIEs. The Company consolidates the assets and liabilities of VIEs of which the Company is the primary beneficiary. The primary beneficiary is the party that has both the power to direct the activities that most significantly impact the VIE and a variable interest that could potentially be significant to the VIE. To determine whether a variable
5
interest the Company holds could potentially be significant to the VIE, the Company considers both qualitative and quantitative factors regarding the nature, size and form of its involvement with the VIE. The Company assesses whether it is the primary beneficiary of a VIE on an ongoing basis.
At present, the Company only consolidates a VIE that it established as a statutory trust for the purpose of effecting securitizations of mortgage loans. For financial reporting purposes, the underlying loans and securities owned by the consolidated VIE are shown underMortgage loans at fair value held by variable interest entity on the Company’s consolidated balance sheets. The securities issued to third parties by the consolidated VIE are shown as secured borrowings under Asset-backed secured financing on the Company’s consolidated balance sheets. The Company includes the interest income earned on the loans owned at the VIE and interest expense attributable to the asset-backed securities issued by the VIE on its consolidated income statements.
As disclosed in Note 2—Concentration of Risks, the Company also consolidates certain assets held by a third-party VIE.
Preparation of financial statements in compliance with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, and revenues and expenses during the reporting period. Actual results will likely differ from those estimates.
In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the periods ended September 30, 2013 are not necessarily indicative of the results for the year ending December 31, 2013.
Reclassification of previously presented balances
Certain prior period amounts have been reclassified to conform to the current presentation. Specifically:
Following is a summary of the reclassifications for the periods presented:
Net interest income (new caption):
Expenses:
Loan servicing fees payable to PennyMac Financial Services, Inc.
These reclassifications did not change previously reported income before provision for income taxes, tax (benefit) provision, net income, reported consolidated balance sheet amounts, including shareholders’ equity, or consolidated cash flows.
Note 2—Concentration of Risks
As discussed in Note 1—Organization and Basis of Presentation above, PMT’s operations and investing activities are centered in mortgage-related assets, a substantial portion of which are distressed at acquisition. Because of the Company’s investment strategy, many of the mortgage loans in its targeted asset class are purchased at discounts reflecting their distressed state or perceived higher risk of default, as well as a greater likelihood of collateral documentation deficiencies. Before acquiring loans or other assets, PCM validates key information provided by the sellers that is necessary to determine the value of the acquired asset.
Because of the Company’s investment focus, PMT is exposed, to a greater extent than traditional mortgage investors, to the risks that borrowers may be in economic distress and/or may have become unemployed, bankrupt or otherwise unable or unwilling to make payments when due, and to the effects of fluctuations in the residential real estate market on the performance of its investments. Factors influencing these risks include, but are not limited to:
Due to these uncertainties, there can be no assurance that risk management activities identified and executed on PMT’s behalf will prevent significant losses arising from the Company’s investments in real estate-related assets.
6
A substantial portion of the distressed loans purchased by the Company has been acquired from or through one or more subsidiaries of Citigroup Inc. The following tables present the fair value of mortgage loans and REO purchased (including purchases under forward purchase agreements) for the Company’s investment portfolio, and the portion thereof representing assets purchased from or through one or more subsidiaries of Citigroup Inc., for the periods presented:
Investment portfolio purchases:
Loans
REO
Investment portfolio purchases above through one or more subsidiaries of Citigroup Inc.:
On July 12, 2011, December 20, 2011, June 14, 2013 and June 28, 2013, the Company entered into forward purchase agreements with Citigroup Global Markets Realty Corp. (“CGM”), a subsidiary of Citigroup Inc., to purchase certain nonperforming residential mortgage loans and residential real property acquired in settlement of loans (collectively, the “CGM Assets”). The CGM Assets were acquired by CGM from unaffiliated money center banks. The commitment under the forward purchase agreement dated July 12, 2011 was settled during the quarter ended June 30, 2012. The commitment under the forward purchase agreement dated December 20, 2011 was settled during the quarter ended September 30, 2012. The commitments under the forward purchase agreements dated June 14, 2013 and June 28, 2013 have not yet been settled and have maturity dates of June 16, 2014 and June 30, 2014, respectively.
The CGM Assets are included on the Company’s consolidated balance sheet as Mortgage loans under forward purchase agreements at fair value and Real estate acquired in settlement of loans under forward purchase agreements and the related liabilities are included as Borrowings under forward purchase agreements. The CGM Assets are held by CGM within a separate trust entity deemed a VIE. The Company’s interests in the CGM Assets are deemed to be contractually segregated from all other interests in the trust. When assets are contractually segregated, they are often referred to as a “silo.” For these transactions, the silo consists of the CGM Assets and its related liability. The Company directs all of the activities that drive the economic results of the CGM Assets. All of the changes in the fair value and cash flows of the CGM Assets are attributable solely to the Company, and such cash flows can only be used to settle the related liability.
As a result of consolidating the silo, the Company’s consolidated statements of income and cash flows for the periods presented include the following amounts related to the silo:
Statement of income:
Net gain on mortgage loans
Interest income on mortgage loans
Results of REO
Statement of cash flows:
Repayments of mortgage loans
Sales of REO
The Company has no other variable interests in the trust entity or other exposure to the creditors of the trust entity that could expose the Company to loss.
7
Note 3—Transactions with Related Parties
Management Fees
Before February 1, 2013, under a management agreement, PMT paid PCM a base management fee which was calculated at 1.5% per year of shareholders’ equity. The management agreement also provided for a performance incentive. The performance incentive fee was calculated at 20% per year of the amount by which “core earnings,” on a rolling four-quarter basis and before the incentive fee, exceeded an 8% “hurdle rate” as defined in the management agreement. The Company did not pay a performance incentive fee before February 1, 2013.
Effective February 1, 2013, the management agreement was amended to provide that:
The performance incentive fee is calculated quarterly and is equal to: (a) 10% of the amount by which net income for the quarter exceeds (i) an 8% return on equity plus the high watermark, up to (ii) a 12% return on equity; plus (b) 15% of the amount by which net income for the quarter exceeds (i) a 12% return on equity plus the high watermark, up to (ii) a 16% return on equity; plus (c) 20% of the amount by which 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’s Manager and our independent trustees and after 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 MBS yield (the target yield) for such quarter. If the net 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 PMT’s Manager to earn a performance incentive fee are adjusted cumulatively based on the performance of our 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 payable 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 the Company’s option.
Following is a summary of the base management and performance incentive fees recorded by the Company for the periods presented:
Base management fee
Performance incentive fee
Total management fee incurred during the period
In the event of termination, PCM 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 PCM, in each case during the 24-month period before termination.
8
Mortgage Loan Servicing
The Company, through its Operating Partnership, has a loan servicing agreement with PLS. 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.
Effective February 1, 2013, the servicing agreement was amended to provide for servicing fees payable to PLS 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 REO. PLS also remains entitled to market-based fees and charges including boarding and deboarding, liquidation and disposition fees, assumption, modification and origination fees and late charges relating to loans it services for the Company.
Following is a summary of mortgage loan servicing fees payable to PLS for the periods presented:
Loan servicing fees to PLS:
Base
Activity-based
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.
9
Correspondent Lending
Before February 1, 2013, the Company paid PLS a fulfillment fee of 50 basis points of the unpaid principal balance of mortgage loans sold to non-affiliates where the Company 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 PLS based on the type of mortgage loan that the Company acquires. The fulfillment fee is equal to a percentage of the unpaid principal balance of mortgage loans purchased by the Company, with the addition of potential fee rate discounts applicable to the Company’s monthly purchase volume in excess of designated thresholds. PLS has also agreed to provide such services exclusively for the Company’s benefit, and PLS and its affiliates are prohibited from providing such services for any other third party.
PLS is entitled to a fulfillment fee based on the type of mortgage loan that the Company 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 sold 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 PLS 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.
At this time, the Company does not hold the Ginnie Mae approval required to issue securities guaranteed by Ginnie Mae MBS and act as a servicer. Accordingly, under the mortgage banking and warehouse services agreement, PLS currently purchases loans salable in accordance with the Ginnie Mae Mortgage-Backed Securities Guide “as is” and without recourse of any kind from the Company at our cost less an administrative fee plus accrued interest and a sourcing fee of three basis points.
In the event that the Company purchases mortgage loans with an aggregate unpaid principal balance in any month greater than $2.5 billion and less than $5 billion, PLS 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 aggregate unpaid principal balance relating to mortgage loans for which PLS collected fulfillment fees in such month. In the event the Company purchases mortgage loans with an aggregate unpaid principal balance in any month greater than $5 billion, PLS has agreed to further discount the amount of fulfillment fees by reimbursing the Company 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 aggregate unpaid principal balance relating to mortgage loans for which PLS collected fulfillment fees in such month.
In consideration for the mortgage banking services provided by PLS with respect to the Company’s acquisition of mortgage loans under PLS’s early purchase program, PLS is entitled to fees accruing (i) at a rate equal to $25,000 per year, and (ii) in the amount of $50 for each mortgage loan the Company acquires. In consideration for the warehouse services provided by PLS with respect to mortgage loans that the Company finances for its warehouse lending clients, with respect to each facility, PLS is entitled to fees accruing (i) at a rate equal to $25,000 per year, and (ii) in the amount of $50 for each mortgage loan that the Company finances thereunder. Where the Company has entered into both an early purchase agreement and a warehouse lending agreement with the same client, PLS shall only be entitled to one $25,000 per annum fee and, with respect to any mortgage loan that becomes subject to both such agreements, only one $50 per loan fee.
The term of our 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.
10
Following is a summary of correspondent lending activity between the Company and PLS for the periods presented:
Sourcing fees received
Fulfillment fees expense
Unpaid principal balance of loans fulfilled
Fair value of loans sold to PLS
At period end:
Mortgage loans included in mortgage loans acquired for sale pending sale to PLS at period end
Investment Activities
Pursuant to the terms of a MSR recapture agreement, effective February 1, 2013, if PLS refinances through its retail lending business loans for which the Company previously held the MSRs, PLS is generally required to transfer and convey to one of the Company’s wholly-owned subsidiaries without cost to the Company, the MSRs with respect to new mortgage loans originated in those refinancings (or, under certain circumstances, other mortgage loans) that have an aggregate unpaid principal balance that is not less than 30% of the aggregate 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, PLS may, at its option, wire cash to PMT in an amount equal to such fair market value in lieu of transferring such MSRs. MSR recapture amounts are shown in Note 24—Net loan servicing fees. 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.
Pursuant to a master spread acquisition and MSR servicing agreement, effective February 1, 2013, PMT may acquire from PLS the rights to receive certain excess servicing spread arising from MSRs acquired by PLS, in which case PLS generally would be required to service or subservice the related mortgage loans. The terms of each transaction under the master 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.
Other Transactions
In connection with the initial public offering of PMT’s common shares (“IPO”) on August 4, 2009, the Company entered into an agreement with PCM pursuant to which the Company agreed to reimburse PCM for the $2.9 million payment that it made to the IPO underwriters if the Company satisfied certain performance measures over a specified period of time (the “Conditional Reimbursement”). Effective February 1, 2013, the Company amended the terms of the reimbursement agreement to provide for the reimbursement of PCM of the Conditional Reimbursement if the Company is required to pay PCM 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. During the quarter and nine months ended September 30, 2013, $388,000 and $601,000 was paid to PCM, respectively.
The reimbursement agreement also provides for the payment to the underwriters in such offering of the payment that the Company agreed to make to them at the time of the offering if the Company satisfied certain performance measures over a specified period of time. As PCM earns performance incentive fees under the management agreement, such underwriters will be paid at a rate of $20 of payments for every $100 of performance incentive fees earned by PCM. The payment to the underwriters is subject to a maximum reimbursement in any particular 12-month period of $2.0 million and the maximum amount that may be paid under the agreement is $5.9 million. During the quarter and nine months ended September 30, 2013, $776,000 and $1.2 million was paid to the underwriters, respectively.
In the event the termination fee is payable to PCM under the management agreement and PCM and the underwriters have 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.
11
The Company reimburses PCM and its affiliates for other expenses, including common overhead expenses incurred on its behalf by PCM and its affiliates, in accordance with the terms of its management agreement as summarized below:
Reimbursement of expenses incurred on PMT’s behalf
Reimbursement of common overhead incurred by PCM and its affiliates
Payments and settlements during the period(1)
Amounts due to affiliates are summarized below as of the dates presented:
Underwriting fees payable
Servicing fees
Allocated expenses
Amounts due from affiliates totaling $113,000 and $4.8 million at September 30, 2013 and December 31, 2012, respectively, represent amounts receivable pursuant to loan sales to PLS and reimbursable expenses paid on the affiliates’ behalf by the Company.
PCM’s parent company and a subsidiary of PFSI, Private National Mortgage Acceptance Company, LLC, held 75,000 of the Company’s common shares of beneficial interest at both September 30, 2013 and December 31, 2012.
Note 4—Earnings Per Share
Basic earnings per share is determined using net income divided by the weighted-average common shares outstanding during the period. Diluted earnings per share is determined by dividing net income attributable to common shareholders, which adds back to net income the interest expense, net of applicable income taxes, on exchangeable senior notes for periods presented, by the weighted-average common shares outstanding, assuming all potentially dilutive common shares were issued. In periods in which the Company records a loss, potentially dilutive common shares are excluded from the diluted loss per share calculation, as their effect on loss per share is anti-dilutive.
The Company grants restricted share units which entitle the recipients to receive dividend equivalents during the vesting period on a basis equivalent to the dividends paid to holders of common shares. For purposes of calculating earnings per share, unvested share-based compensation awards containing non-forfeitable rights to receive dividends or dividend equivalents (collectively, “dividends”) are classified as “participating securities” and are included in the basic earnings per share calculation using the two-class method. Under the two-class method, all earnings (distributed and undistributed) are allocated to each class of common shares and participating securities, based on their respective rights to receive dividends.
12
The following table summarizes the basic and diluted earnings per share calculations:
Basic earnings per share:
Effect of participating securities—share-based compensation instruments
Net income attributable to common shareholders
Basic earnings per share
Diluted earnings per share:
Interest on exchangeable senior notes, net of income taxes
Net income available to diluted shareholders
Dilutive potential common shares:
Shares issuable pursuant to conversion of exchangeable senior notes
Shares issuable under share-based compensation plan
Diluted weighted-average number of common shares outstanding
Diluted earnings per common share
Note 5—Loan Sales and Variable Interest Entities
As described in Note 1—Organization and Basis of Presentation, the Company is a variable interest holder in various SPEs. The Company has segregated its involvement with VIEs between those VIEs which are consolidated and those VIEs for which the Company does not consolidate.
Unconsolidated VIEs with Continuing Involvement
The Company purchases and sells mortgage loans into 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 liability under representations and warranties it makes to purchasers and insurers of the loans. The Company determined that it is not the primary beneficiary of the VIEs as the Company does not have the power to direct the activities that will have the most significant economic impact on the entities and/or does not hold a variable interest that could potentially be significant to the VIE.
The following table summarizes cash flows between the Company and transferees upon sale of loans in transactions where the Company maintains continuing involvement with the mortgage loans as well as unpaid principal balance information at period end:
Cash flows:
Proceeds from sales
Service fees received
Period-end information:
Unpaid principal balance of loans outstanding
Delinquencies:
30-89 days
90 or more days or in foreclosure or bankruptcy
13
Consolidated VIEs
On September 30, 2013, the Company completed a securitization transaction in which a wholly-owned SPE issued $537.0 million in offered certificates backed by fixed rate prime jumbo mortgage loans of PMT Loan Trust 2013-J1, at a 3.9% weighted yield. The Company retained $366.8 million of those certificates.
The Company evaluated the securitization trust and determined that the entity is a VIE of which one of the consolidated subsidiaries is the primary beneficiary; therefore, the Company consolidated the entity. The Company is deemed to be the primary beneficiary of the VIE because the Company is part of a related party group that has the power to direct the activities of the VIE that most significantly impact the entity’s economic performance and the Company retains the obligation to absorb losses and the right to receive benefits that are potentially significant to the VIE. The Company’s power stems from PLS, an affiliate, in its role as servicer of the mortgage loans, directing the activities of the trust that most significantly impact the trust’s economic performance. The Company’s retained subordinated and residual interest trust certificates expose the Company to potentially significant losses and potentially significant returns.
The asset-backed securities are backed by the expected cash flows from the securitized mortgage loans. Cash inflows from these mortgage loans are distributed to investors and service providers in accordance with the contractual priority of payments and, as such, most of these inflows must be directed first to service and repay the trust senior notes or certificates. After these senior obligations are settled, substantially all cash inflows will be directed to the subordinated notes until fully repaid and, thereafter, to the residual interest that the Company owns in the trust.
The Company retains interests in the securitization transaction, including senior and subordinated securities issued by the VIE and residual interests. The Company retains credit risk in the securitization because the Company’s retained interests includes the most subordinated interests in the securitized assets, which are the first to absorb credit losses on the securitized assets. The Company expects that any credit losses in the pools of securitized assets will likely be limited to the Company’s subordinated and residual retained interests. The Company has no obligation to repurchase or replace qualified securitized assets that subsequently become delinquent or are otherwise in default other than pursuant breaches of representations and warranties.
Consolidation of the VIE results in the securitization transaction being accounted for as an on-balance sheet secured financing. The securitized mortgage loans remain on the consolidated balance sheets of the Company along with the certificates issued to nonaffiliates by the VIE. The certificates are secured solely by the assets of the VIE and not by any other assets of the Company. The assets of the VIE are the only source of funds for repayment on the notes. The following table presents a summary of the assets and liabilities of the VIE. Intercompany balances have been eliminated for purposes of this presentation.
Assets and Liabilities of Consolidated VIE at September 30, 2013
Assets
Total
Liabilities
Asset-backed secured financing
Interest payable
In addition, the Company consolidates the assets and liabilities related to the CGM assets as disclosed in Note 2.
Note 6—Netting of Financial Instruments
The Company uses derivative instruments to manage exposure to interest rate risk created by the commitments it makes to correspondent lenders to purchase loans at specified interest rates, also called interest rate lock commitments (“IRLCs”), mortgage loans acquired for sale at fair value, MBS, and MSRs. All derivative financial instruments are recorded on the balance sheet at fair value. The Company has elected to net derivative asset and liability positions, and cash collateral obtained (or posted) by (or to) its counterparties when subject to a 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 did not enter into reverse repurchase agreements or securities lending transactions that are required to be disclosed in the following table.
14
Offsetting of Derivative Assets
Derivatives:
MBS put options
Forward purchase contracts
Forward sale contracts
Netting
Total derivatives, subject to a master netting arrangement
Total derivatives, not subject to a master netting arrangement
Derivative 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 netting.
Interest rate lock commitments
Bank of America, N.A.
Daiwa Capital Markets
Barclays
Citibank
Goldman Sachs
Jefferies & Co
Credit Suisse First Boston Mortgage Capital LLC
Morgan Stanley Bank, N.A.
Wells Fargo
Cantor Fitzgerald LP
15
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. Assets sold under agreements to repurchase do not qualify for offset.
Total derivatives
Total assets sold under agreements to repurchase
16
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 do not meet the accounting guidance qualifying for offset. All assets sold under agreements to repurchase have sufficient collateral or exceed the liability amount recorded on the consolidated balance sheet.
Bank of NY Mellon
Wells Fargo Bank, N.A.
Note 7—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, including short-term investments, MBS, excess servicing spread, Agency debt securities, mortgage loans, and excess servicing spread, as well as its MSRs relating to loans with initial interest rates of more than 4.5% that were acquired as a result of its correspondent lending operations, to be accounted for at estimated fair value so such changes in fair value will be reflected in income as they occur and more timely reflect the results of the Company’s performance.
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 the Company’s correspondent lending operations, management concluded that such assets present different risks to the Company than 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 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 at the lower of amortized cost or fair value.
The Company’s risk management efforts in connection with MSRs relating to mortgage loans with initial interest rates of more than 4.5% are generally aimed at moderating the effects of changes in interest rates on the assets’ values. At times during the nine-month period ended September 30, 2013, a portion of the IRLCs, the fair value of which typically increases when prepayment speeds increase, were used to mitigate the effect of changes in fair value of the servicing assets, which typically decreases as prepayment speeds increase.
For loans sold under agreements to repurchase, REO financed through agreements to repurchase and borrowings under forward purchase agreements, management has determined that historical cost accounting is more appropriate because under this method debt issuance costs are amortized over the term of the debt, thereby matching the debt issuance cost to the periods benefiting from the usage of the debt.
17
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:
Assets:
Agency debt securities
Mortgage loans under forward purchase agreements at fair value
Derivative assets:
Forward sales contracts
Total derivative assets before netting
Netting(1)
Total derivative assets
Liabilities:
Derivative liabilities:
Total derivative liabilities before netting
Total derivative liabilities
18
19
The Company’s MBS, Agency debt, excess servicing spread purchased from PennyMac Financial Services, Inc., mortgage loans at fair value, mortgage loans held by VIE, mortgage loans under forward purchase agreements, MSRs, IRLCs and securities sold under agreements to repurchase were measured using Level 3 inputs on a recurring basis. The following is a summary of changes in those items for the periods presented:
Balance, June 30, 2013
Purchases
Repayments
Interest rate lock commitments issued, net
Capitalization of interest
Servicing received as proceeds from sales of mortgage loans
Changes in fair value included in income arising from:
Changes in instrument-specific credit risk
Other factors
Transfers of mortgage loans under forward agreements
Transfers of mortgage loans to REO
Transfers of mortgage loans under forward agreements to REO under forward purchase agreements
Transfers of interest rate lock commitments to mortgage loans acquired for sale
Balance, September 30, 2013
Changes in fair value recognized during the period relating to assets still held at September 30, 2013
Accumulated changes in fair value relating to assets still held at September 30, 2013
20
Balance, June 30, 2012
Sales
Addition of unpaid interest, impound advances and fees to unpaid balance of mortgage loans
Accrual of unearned discounts
Transfer of mortgage loans to REO
Transfer to mortgage loans acquired for sale
Transfer of mortgage loans under forward purchase agreements to REO under forward purchase agreements
Transfer of mortgage loans under forward purchase agreements to mortgage loans
Balance, September 30, 2012
Changes in fair value recognized during the period relating to assets still held at September 30, 2012
Accumulated changes in fair value relating to assets still held at September 30, 2012
21
Balance, December 31, 2012
Transfer of mortgage loans under forward purchase agreement to REO under forward purchase agreements
22
Balance, December 31, 2011
Transfer from mortgage loans acquired for sale
Transfer of mortgage loans under forward purchase agreements to REO under forward purchase agreement
23
Changes in fair value included in income
Repurchases
Changes in fair value recognized during the period relating to liabilities still outstanding at September 30, 2012
Following are the fair values and related principal amounts due upon maturity of mortgage loans accounted for under the fair value option (including mortgage loans acquired for sale, mortgage loans at fair value and mortgage loans under forward purchase agreements at fair value):
Mortgage loans acquired for sale:
Current through 89 days delinquent
90 or more days delinquent(1)
Mortgage loans and mortgage loans under forward purchase agreements at fair value:
Mortgage loans at fair value held by variable interest entity:
24
Following are the changes in fair value included in current period income by consolidated statement of income line item for financial statement items accounted for under the fair value option:
Securities sold under agreements to repurchase at fair value
25
26
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:
Real estate asset acquired in settlement of loans
Real estate asset acquired in settlement of loans under forward purchase agreements
Mortgage servicing assets at lower of amortized cost or fair value
The following table summarizes the total gains (losses) on assets measured at estimated fair values on a nonrecurring basis:
Real Estate Acquired in Settlement of Loans
The Company measures its investment in REO at the respective properties’ estimated fair values less cost to sell on a nonrecurring basis. The initial carrying value of the REO is established as the lesser of (a) either the fair value of the loan at the date of transfer or the purchase price of the property, as applicable, and (b) the fair value of the real estate less the estimated cost to sell as of the date of transfer. REO may be subsequently revalued due to the Company receiving greater access to the property, the property being held for an extended period or management receiving indications that the property’s value may not be supported by developing market conditions. Any subsequent change in fair value to a level that is less than or equal to the value at which the property was initially recorded is recognized in Results of real estate acquired in settlement of loans in the consolidated statements of income.
27
Mortgage Servicing Rights at Lower of Amortized Cost or Fair Value
The Company evaluates its MSRs at lower of amortized cost or fair value for impairment with reference to the assets’ fair value. 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 point ranges for fixed-rate mortgage loans with note rates between 3% and 4.5% and a single pool for 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 the 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 of value is recognized in current period earnings only to the extent of the valuation allowance for the respective stratum.
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 deems recovery of the value to be unlikely in the foreseeable future, a write-down of the cost of the MSRs for that stratum to its estimated fair value is charged to the valuation allowance.
Fair Value of Financial Instruments Carried at Amortized Cost
The Company’s cash balances as well as certain of its borrowings are carried at amortized cost.
Management has concluded that the estimated fair values of Cash, Mortgage loans acquired for sale at fair value sold under agreements to repurchase, Mortgage loans at fair value sold under agreements to repurchase, Real estate acquired in settlement of loans financed under agreements to repurchase Borrowings under forward purchase agreements and approximate the agreements’ carrying values due to the immediate realizability of cash at its carrying amount and to the borrowing agreements’ short terms and variable interest rates.
As discussed in Note 22, the Company issued Exchangeable Senior Notes, which are carried at amortized cost. The fair value of the Exchangeable Senior Notes at September 30, 2013 was $238.4 million. The fair value of the Exchangeable Senior Notes is estimated using broker indication of value. The Company has classified this financial instrument as a “Level 3” financial statement item as of September 30, 2013 due to the lack of current market activity and the reliance on the broker’s quote to estimate the instrument’s fair value.
Cash is measured using Level 1 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 due to the lack of current market activity and the Company’s reliance on unobservable inputs to estimate these instruments’ fair value.
Valuation Techniques and Assumptions
Most of the Company’s assets are carried at fair value with changes in fair value recognized in current period income. A substantial portion of those assets 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.
PCM 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 PCM’s valuation committee, which oversees and approves the valuations. The valuation committee includes the chief executive, financial, operating, credit, and asset/liability management officers of PCM. 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 valuation committee. The results developed in the FAV group’s monitoring activities are used to calibrate subsequent projections used for valuation.
The FAV group is responsible for reporting to PCM’s 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 each of the changes to the significant inputs to the models.
28
The following describes the valuation techniques and assumptions used in estimating the fair values of Level 2 and Level 3 financial statement items:
Mortgage-Backed Securities and Agency Debt Securities
MBS values are presently determined based on whether the securities are issued by one of the Agencies as discussed below:
The significant unobservable inputs used in the fair value measurement of the Company’s Agency issued debt and non-Agency MBS are discount rates, prepayment speeds, default speeds and expected future losses (or “collateral remaining loss percentage”). Significant changes in any of those inputs in isolation could result in a significant change in fair value measurement. Changes in these assumptions are not directly correlated, as they may be separately affected by changes in collateral characteristics and performance, servicer behavior, legal and regulatory actions, economic and housing market data and market sentiment.
Following is a quantitative summary of key inputs used by the FAV group to evaluate the reasonableness of the fair value of Level 3 Agency debt security:
Security Class
Key Inputs(1)
Mortgage Loans
Fair value of mortgage loans is estimated based on whether the mortgage loans are saleable into active markets:
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.
The significant unobservable inputs used in the fair value measurement of the Company’s mortgage loans at fair value and mortgage loans under forward purchase agreements at fair value are discount rate, 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.
29
Following is a quantitative summary of key inputs used in the valuation of mortgage loans at fair value:
Key Inputs
Discount rate
Twelve-month projected housing price index change
Prepayment speed(1)
Total prepayment speed(2)
Mortgage loans under forward purchase agreements
Excess Servicing Spread Purchased from PennyMac Financial Services, Inc.
The Company categorizes excess servicing spread as a “Level 3” financial statement item. The Company uses a discounted cash flow approach to estimate the fair value of excess servicing spread. The key assumptions used in the estimation of the fair value of excess servicing spread include prepayment speed and discount rate. Significant changes to those inputs in isolation could result in a significant change in the excess servicing spread fair value measurement. Changes in these key assumptions are not necessarily directly related.
Excess servicing spread is generally subject to loss in value when interest 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 value. Reductions in the value of excess servicing spread investments affect income primarily through change in fair value.
30
Interest income for excess servicing spread 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 Net gain (loss) on investments.
Following are the key inputs used in determining the fair value of excess servicing spread:
Pricing spread
Average life
Prepayment speed
Derivative Financial Instruments
The Company estimates the fair value of IRLCs 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 commitments it has made (the “pull-through rate”). The Company categorized IRLCs as a “Level 3” financial statement item.
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:
Pull-through rate
MSR value expressed as:
Servicing fee multiple
Percentage of unpaid principal balance
The Company estimates the fair value of commitments to sell loans based on quoted MBS prices. The Company estimates the fair value of the interest rate options and futures it purchases and sells based on observed interest rate volatilities in the MBS market.
REO is measured based on its fair value on a nonrecurring basis and is categorized as a “Level 3” financial statement item. Fair value of REO is estimated by using a current estimate of value from a broker’s price opinion or a full appraisal, or the price given in a current contract of sale.
REO values are reviewed by PCM’s staff appraisers when the Company obtains multiple indications of value and there is a significant discrepancy between the values received. PCM’s staff appraisers will attempt to resolve the discrepancy between the indications of value. In circumstances where the appraisers are not able to generate adequate data to support a value conclusion, the staff appraisers will order an additional appraisal to resolve the property’s value.
Mortgage Servicing Rights
MSRs are categorized as “Level 3” financial statement items. The Company uses a discounted cash flow approach to estimate the fair value of MSRs. The key assumptions used in the estimation of the fair value of MSRs include prepayment and default rates of the underlying loans, the applicable discount rate, and cost to service loans. The key assumptions used in the Company’s discounted cash flow model are based on market factors which management believes are consistent with assumptions and data used by market participants valuing similar MSRs. The results of the estimates of fair value of MSRs are reported to PCM’s valuation committee as part of their review and approval of monthly valuation results.
31
The significant unobservable inputs used in the fair value measurement of the Company’s MSRs are pricing spreads, prepayment speeds (or life) and annual per-loan cost of servicing. Significant changes to any of those inputs in isolation could result in a significant change in the MSR fair value measurement. Changes in these key assumptions are not necessarily directly related.
MSRs are 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 MSRs, thereby reducing MSR value. Reductions in the value of MSRs affect income primarily through change in fair value and impairment charges. For MSRs backed by mortgage loans with historically low interest rates, factors other than interest rates (such as housing price changes) take on increasing influence on prepayment behavior of the underlying mortgage loans.
Following are the key inputs used in determining the fair value of MSRs at the time of initial recognition:
Unpaid principal balance of underlying loans
Average servicing fee rate (in basis points)
Pricing spread(1)
Life (in years)
Annual total prepayment speed(2)
Annual per-loan cost of servicing
32
Following is a quantitative summary of key inputs used in the valuation of MSRs as of the dates presented, and the effect on the estimated fair value from adverse changes in those assumptions (weighted averages are based upon unpaid principal balance or fair value where applicable):
Carrying value
Weighted average servicing fee rate (in basis points)
Weighted average coupon rate
Effect on value of 5% adverse change
Effect on value of 10% adverse change
Effect on value of 20% adverse change
Weighted average life (in years)
Prepayment speed(2)
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.
Securities Sold Under Agreements to Repurchase
Fair value of securities sold under agreements to repurchase is based on the accrued cost of the agreements, which approximates the agreements’ fair values, due to the agreements’ short maturities.
33
Note 8—Short-Term Investments
The Company’s short-term investments are comprised of money market accounts and unrestricted balances maintained in excess of minimum required amounts as deposited with U.S. commercial banks.
Note 9—Mortgage Loans Acquired for Sale at Fair Value
Mortgage loans acquired for sale at fair value is comprised of recently originated mortgage loans purchased by the Company for resale. Following is a summary of the distribution of the Company’s mortgage loans acquired for sale at fair value:
Loan Type
Government insured or guaranteed
Conventional:
Agency-eligible
Jumbo loans
Loans pledged to secure loans sold under agreements to repurchase
The Company is not approved by Ginnie Mae as an issuer of Ginnie Mae-guaranteed securities which are backed by government-insured or guaranteed mortgage loans. As discussed in Note 3—Transactions with Related Parties, the Company transfers government insured or guaranteed mortgage loans that it purchases from correspondent lenders to PLS, which is a Ginnie Mae-approved issuer, and earns a sourcing fee of three basis points on the unpaid principal balance plus accrued interest of each such loan.
Note 10—Derivative Financial Instruments
The Company is exposed to price risk relative to its mortgage loans acquired for sale as well as to the IRLCs it issues to correspondent lenders. The Company bears price risk from the time an IRLC is issued to a correspondent lender to the time the purchased mortgage loan is sold. During this period, the Company is exposed to losses if mortgage interest rates increase, because the value of the purchase commitment or mortgage loan acquired for sale decreases.
The Company engages in interest rate risk management activities in an effort to reduce the variability of earnings caused by changes in 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 and inventory of mortgage loans acquired for sale.
The Company is also exposed to risk relative to the fair value of its MSRs. The Company is exposed to loss in value of its MSRs when interest rates decrease. Beginning in the fourth quarter of 2012, the Company included MSRs in its hedging activities, and did so for a portion of 2013.
During the third quarter of 2013, the Company entered into Eurodollar futures, which settle daily, to economically hedge net fair value changes of a portion of fixed-rate mortgage loans at fair value held by variable interest entity and MBS securities at fair value and the related variable LIBOR
34
rate repurchase agreement liabilities. The Company uses the Eurodollar futures with the intention of moderating the risk of rising market rates that will result in unfavorable changes in the value of the Company’s fixed-rate assets and economic performance of its variable LIBOR rate repurchase agreement liabilities.
The Company does not use derivative financial instruments for purposes other than in support of its risk management activities. The Company records all derivative financial instruments at fair value and records changes in fair value in current period income.
The Company had the following derivative assets and liabilities and related margin deposits recorded within the Derivative assets and Derivative liabilities on the consolidated balance sheets:
Instrument
Derivatives not designated as hedging instruments:
Free-standing derivatives (economic hedges):
MBS call options
Eurodollar futures
Treasury futures
Options on Eurodollar futures
Total derivative instruments before netting
Margin deposits with derivatives counterparties
The following table summarizes the notional amount activity for derivative contracts used to hedge the Company’s IRLCs and inventory of mortgage loans acquired for sale:
Period/Instrument
Quarter ended September 30, 2013
Nine months ended September 30, 2013
35
Quarter ended September 30, 2012
Nine months ended September 30, 2012
The Company recorded net gains (losses) on derivative financial instruments used to hedge the Company’s IRLCs and inventory of mortgage loans totaling $3.1 million and $(46.1) million for the quarters ended September 30, 2013 and 2012, respectively. The Company recorded net gains (losses) on derivative financial instruments used to hedge the Company’s IRLCs and inventory of mortgage loans totaling $143.2 million and $(62.5) million for the nine months ended September 30, 2013 and 2012, respectively. Derivative gains and losses are included in Net gains on mortgage loans acquired for sale in the Company’s consolidated statements of income.
The Company recorded net losses on derivative financial instruments used as economic hedges of MSRs totaling $0 and $2.0 million for the quarter and nine months ended September 30, 2013. The derivative losses are included in Net loan servicing fees in the Company’s consolidated statements of income. The Company had no similar economic hedges in place for the quarter and nine months ended September 30, 2012.
The following table summarizes the notional of amount activity for derivative contracts used to hedge the Company’s investment activities related to its MBS securities and mortgage loans at fair value held by variable interest entity:
The Company recorded net losses on derivative financial instruments used to hedge the net change in fair value of fixed-rate assets and its variable LIBOR rate repurchase agreement liabilities. The Company recorded net losses on derivative financial instruments used as economic hedges of $12.1 million for the quarter ended September 30, 2013. The derivative losses are included in Net gain on mortgage loans acquired for sale and Net gain on mortgage-backed securities in the Company’s consolidated statements of income. The Company had no similar economic hedges in place for the quarter and nine months ended September 30, 2012.
36
Note 11—Mortgage Loans at Fair Value
Mortgage loans at fair value are comprised of mortgage loans that are not acquired for sale and may be sold at a later date pursuant to a management determination that such a sale represents the most advantageous liquidation strategy for the identified loan.
Following is a summary of the distribution of the Company’s mortgage loans at fair value:
Nonperforming loans
Performing loans:
Fixed
ARM/hybrid
Interest rate step-up
Balloon
Mortgage loans at fair value pledged to secure borrowings at period end:
Sales of loans under agreements to repurchase
Mortgage loans held in a consolidated subsidiary whose stock is pledged to secure financings of such loans
Following is a summary of certain concentrations of credit risk in the portfolio of mortgage loans at fair value:
Portion of mortgage loans originated between 2005 and 2007
Percentage of fair value of mortgage loans with unpaid-principal-balance-to-current-property-value in excess of 100%
Percentage of mortgage loans secured by California real estate
Additional states contributing 5% or more of mortgage loans
Florida
New Jersey
Note 12— Mortgage loans at fair value held by variable interest entity
Following is a summary of the distribution of the Company’s mortgage loans at fair value held by variable interest entity:
Jumbo Fixed
37
Following is a summary of certain concentrations of credit risk in the portfolio of mortgage loans at fair value held by variable interest entity:
California
Washington
Texas
Virginia
Note 13—Mortgage Loans Under Forward Purchase Agreements at Fair Value
Mortgage loans under forward purchase agreements at fair value are comprised of mortgage loans not acquired for resale. Such loans may be sold at a later date pursuant to a management determination that such a sale represents the most advantageous liquidation strategy for the identified loan. Following is a summary of the distribution of the Company’s mortgage loans under forward purchase agreements at fair value:
Following is a summary of certain concentrations of credit risk in the portfolio of mortgage loans under forward purchase agreements at fair value:
Percentage of fair value of mortgage loans with unpaid-principal-balance-to current-property-value in excess of 100%
At September 30, 2013, the entire balance of mortgage loans under forward purchase agreements was subject to borrowings under forward purchase agreements.
38
Note 14—Real Estate Acquired in Settlement of Loans
Following is a summary of the activity in REO for the periods presented:
Balance at beginning of period
Transfers from mortgage loans at fair value and advances
Transfers from REO under forward purchase agreements
Results of REO:
Valuation adjustments, net
Gain on sale, net
Sale proceeds
Balance at period end
REO pledged to secure agreements to repurchase
REO held in a consolidated subsidiary whose stock is pledged to secure financings of such properties
Note 15—Real Estate Acquired in Settlement of Loans Under Forward Purchase Agreements
Following is a summary of the activity in REO under forward purchase agreements for the periods presented:
Transfers from (to) mortgage loans under forward purchase agreements at fair value and servicing advances
Transfers to REO
Results of REO under forward purchase agreements:
(Loss) gain on sale, net
At September 30, 2013, the entire balance of real estate acquired in settlement of loans under forward purchase agreements was held under forward purchase agreements.
39
Note 16—Mortgage Servicing Rights
Carried at Fair Value:
Following is a summary of MSRs carried at fair value for the periods presented:
Additions:
MSRs resulting from loan sales
Total additions
Change in fair value:
Due to changes in valuation inputs or assumptions used in valuation model(1)
Other changes in fair value(2)
Carried at Lower of Amortized Cost or Fair Value:
Following is a summary of MSRs carried at amortized cost for the periods presented:
Mortgage Servicing Rights:
Amortization
Application of valuation allowance to write down MSRs with other-than temporary impairment
Balance before valuation allowance at period end
Valuation Allowance for Impairment of Mortgage Servicing Rights:
(Additions) Reversals
Mortgage Servicing Rights, net
Estimated fair value of MSRs at period end
40
The following table summarizes the Company’s estimate of amortization of its existing MSRs carried at amortized cost. 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. Therefore, the following estimates will change in a manner and amount not presently determinable by management.
12-month period ending September 30,
2014
2015
2016
2017
2018
Thereafter
Servicing fees relating to MSRs are recorded in Net loan servicing fees on the consolidated statements of income and are summarized below for the periods presented:
Contractual servicing fees
Note 17—Securities Sold Under Agreements to Repurchase at Fair Value
Following is a summary of financial information relating to securities sold under agreements to repurchase at fair value as of and for the periods presented:
Period end:
Balance
Weighted-average interest rate
Fair value of securities securing agreements to repurchase
During the period:
Average balance of securities sold under agreements to repurchase
Total interest expense
Maximum daily amount outstanding
41
The amount at risk (the fair value of the assets pledged plus the related margin deposit, less the amount advanced by the counterparty and interest payable) relating to the Company’s securities sold under agreements to repurchase is summarized by counterparty below as of September 30, 2013:
Counterparty
Daiwa
Note 18—Mortgage Loans Acquired for Sale Sold Under Agreements to Repurchase
Following is a summary of financial information relating to mortgage loans acquired for sale sold under agreements to repurchase:
Unused amount(1)
Fair value of mortgage loans acquired for sale securing agreements to repurchase
Weighted-average interest rate(2)
Average balance of loans sold under agreements to repurchase
Following is a summary of maturities of outstanding advances under repurchase agreements by maturity date:
Remaining maturity at September 30, 2013
Within 30 days
Over 30 to 90 days
Over 90 days to 180 days
Over 180 days to 1 year
Weighted average maturity (in months)
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. The Company had $3.0 million and $4.1 million on deposit with its loan repurchase agreement counterparties at September 30, 2013 and December 31, 2012, respectively. Margin deposits are included in Other assets in the consolidated balance sheets.
42
The amount at risk (the fair value of the assets pledged plus the related margin deposit, less the amount advanced by the counterparty and interest payable) relating to the Company’s mortgage loans acquired for sale sold under agreements to repurchase is summarized by counterparty below as of September 30, 2013:
Note 19—Mortgage Loans at Fair Value Sold Under Agreements to Repurchase
Following is a summary of financial information relating to mortgage loans and mortgage loans at fair value held by variable interest entity sold under agreements to repurchase:
Fair value of mortgage loans at fair value and REO securing agreements to repurchase
Following is a summary of maturities of repurchase agreements by maturity date:
Remaining Maturity at September 30, 2013
43
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 loans securing those agreements decreases. The Company had no margin deposits as of September 30, 2013 and as of December 31, 2012, the Company had $379,000 on deposit with its loan repurchase agreement counterparties. Margin deposits are included in Other assets in the consolidated balance sheets.
The amount at risk (the fair value of the assets pledged plus the related margin deposit, less the amount advanced by the counterparty and interest payable) relating to the Company’s mortgage loans at fair value sold under agreements to repurchase is summarized by counterparty below as of September 30, 2013:
Citibank, N.A.
Note 20—Real Estate Acquired in Settlement of Loans Financed Under Agreements to Repurchase
Following is a summary of financial information relating to REO financed under agreements to repurchase:
Fair value of loans and REO held in a consolidated subsidiary whose stock is pledged to secure agreements to repurchase
Average balance of REO sold under agreements to repurchase
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 REOs decreases. The Company had no margin deposits as of September 30, 2013 and December 31, 2012.
44
The amount at risk (the fair value of the assets pledged plus the related margin deposit, less the amount advanced by the counterparty and interest payable) relating to the Company’s REO held in a consolidated subsidiary, whose stock is pledged to secure agreements to repurchase is summarized by counterparty below as of September 30, 2013:
Note 21—Asset-backed secured financing
Following is a summary of financial information relating to the asset-backed secured financing:
Average balance
Note 22—Exchangeable Senior Notes
On April 30, 2013, PennyMac Corp. (“PMC”) issued in a private offering $250 million aggregate principal amount of its Exchangeable Senior Notes due 2020 (the “Notes”). The Notes bear interest at a rate of 5.375% per year, payable semiannually. The exchange rate initially equals 33.5149 common shares per $1,000 principal amount of the Notes (equivalent to an initial exchange price of approximately $29.84 per common share). The exchange rate is subject to adjustment upon the occurrence of certain events, but will not be adjusted for any accrued and unpaid interest. The Notes will mature May 1, 2020, unless repurchased or exchanged in accordance with their terms before such date.
The Notes are fully and unconditionally guaranteed by the Company and are exchangeable for the Company’s common shares at any time until the close of business on the second scheduled trading day immediately preceding the maturity date.
The net proceeds from the Notes were used to fund the business and investment activities of the Company, including the acquisition of distressed mortgage loans or other investments; the funding of the continued growth of its correspondent lending business, including the purchase of jumbo loans; the repayment of other indebtedness; and general corporate purposes.
45
Following is financial information relating to the Notes:
Interest expense(1)
Note 23—Borrowings under Forward Purchase Agreements
Following is a summary of financial information relating to borrowings under forward purchase agreements:
Fair value of underlying loans and REO
Note 24—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 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.
46
Following is a summary of the Company’s Liability for losses under representations and warranties in the consolidated balance sheets for the periods presented:
Balance, beginning of period
Provisions for losses
Incurred losses
Balance, end of period
Following is a summary of the Company’s repurchase activity for the periods presented:
Unpaid balance of mortgage loans repurchased
Unpaid principal balance of repurchased mortgage loans repurchased by correspondent lenders
Unpaid balance of mortgage loans subject to pending claims for repurchase
Unpaid principal balance of mortgage loans subject to representations and warranties
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 25—Commitments and Contingencies
Litigation
From time to time, the Company may be involved in various proceedings, claims and legal actions arising in the ordinary course of business. As of September 30, 2013, the Company was not involved in any such proceedings, claims or legal actions that in management’s view would reasonably be likely to have a material adverse effect on the Company.
Mortgage Loan Commitments
The following table summarizes the Company’s outstanding contractual loan commitments:
Commitments to purchase mortgage loans:
Correspondent lending
Other mortgage loans
Note 26—Shareholders’ Equity
On August 13, 2013, the Company issued and sold 11,300,000 common shares in an underwritten public offering and received $249.4 million of proceeds, after estimated offering expenses. Proceeds from the issuance of these shares were used to fund the Company’s business and investment activities, including the acquisition of distressed mortgage loans and other investments; the funding of its correspondent lending business, including the purchase of jumbo loans; the repayment of indebtedness; and for general corporate purposes.
47
At September 30, 2013, the Company had approximately $197.5 million available for issuance under its ATM Equity Offering Sales AgreementSM. The Company has not sold any common shares under the ATM Equity OfferingSM Sales Agreement during the nine months ended September 30, 2013.
As more fully described in the Company’s Annual Report, certain of the underwriting costs incurred in the Company’s IPO were paid on PMT’s behalf by PCM and a portion of the underwriting discount was deferred by agreement with the underwriters of the offering. On February 1, 2013, the Company entered into an Amended and Restated Underwriting Fee Reimbursement Agreement (“Reimbursement Agreement”), by and among the Company, the Operating Partnership and PCM. The Reimbursement Agreement provides that, to the extent the Company is required to pay PCM performance incentive fees under the management agreement, the Company will reimburse PCM for underwriting costs it paid on the offering date at a rate of $10 in reimbursement for every $100 of performance incentive fees earned. The 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. During the quarter and nine months ended September 30, 2013, $388,000 and $601,000 was paid to PCM, respectively.
The Reimbursement Agreement also provides for the payment to the IPO underwriters of the amount that the Company agreed to make to them at the time of the IPO if the Company satisfied certain performance measures over a specified period of time. As PCM earns performance incentive fees under the management agreement, the IPO underwriters will be paid at a rate of $20 of payments for every $100 of performance incentive fees earned by PCM. The payment to the underwriters is subject to a maximum reimbursement in any particular 12-month period of $2.0 million and the maximum amount that may be paid under the agreement is $5.9 million. During the quarter and nine months ended September 30, 2013, $776,000 and $1.2 million was paid to the underwriters, respectively. The reimbursement agreement expires on February 1, 2019. Management has concluded that these amounts are likely to be paid and has recognized a liability for reimbursement to PCM and payment of the underwriting discount as a reduction of additional paid-in capital.
Note 27—Net Gain on Mortgage Loans Acquired For Sale
Net gain on mortgage loans acquired for sale is summarized below:
Cash gain (loss):
Sales proceeds
Hedging activities
Non cash gain:
Receipt of MSRs in loan sale transactions
Provision for losses relating to representations and warranties provided in loan sales
Change in fair value relating to loans and hedging derivatives held at period-end:
IRLCs
Hedging derivatives
48
Note 28—Net Interest Income
Net interest income is summarized for the periods presented below:
Interest income:
Assets sold under agreements to repurchase
Note payable secured by mortgage loans at fair value
Net interest income
Note 29—Net Loan Servicing Fees
Net loan servicing fees is summarized for the periods presented below:
Servicing fees(1)
MSR recapture fee receivable from PLS
Effect of MSRs:
(Provision for) reversal of impairment of MSRs carried at lower of amortized cost or fair value
Change in fair value of MSRs carried at fair value
Losses on hedging derivatives
Note 30—Share-Based Compensation Plans
The Company has adopted an equity incentive plan which provides for the issuance of equity based awards, including share options, restricted shares, restricted share units, unrestricted common share awards, LTIP units (a special class of partnership interests in the Operating Partnership) and other awards based on PMT’s shares that may be made by the Company directly to its officers and trustees, and the members, officers, trustees, directors and employees of PCM, PLS, or their affiliates and to PCM, PLS and other entities that provide services to PMT and the employees of such other entities. The equity incentive plan is administered by the Company’s compensation committee, pursuant to authority delegated by the board of trustees, which has the authority to make awards to the eligible participants referenced above, and to determine what form the awards will take, and the terms and conditions of the awards.
49
The Company’s equity incentive plan allows for grants of equity-based awards up to an aggregate of 8% of PMT’s issued and outstanding shares on a diluted basis at the time of the award.
The shares underlying award grants will again be available for award under the equity incentive plan if:
Restricted share units have been awarded to trustees and officers of the Company and to employees of PCM and PLS at no cost to the grantees. Such awards generally vest over a one- to four-year period. Each share option awarded under the equity incentive plan will have a term of no longer than ten years, and will have an exercise price that is no less than 100% of the fair value of the Company’s shares on the date of grant of the award.
The Company’s estimate of value included assumed grantee forfeiture rates of 15% per year, except for certain of PMT’s officers and its board of trustees, for which no turnover was assumed.
The table below summarizes restricted share unit activity and compensation expense for the periods presented:
Number of units:
Outstanding at beginning of period
Granted
Vested
Canceled
Outstanding at end of period
Weighted Average Grant Date Fair Value:
Expired or canceled
Compensation expense recorded during the period
Units available for future awards(1)
Unamortized compensation cost
As of September 30, 2013, 603,188 restricted share units with a weighted average grant date fair value of $22.80 per share unit are expected to vest over their average remaining vesting period of 30 months. The grant date fair values of share unit awards are based on the market value of the Company’s stock at the date of grant.
Note 31—Income Taxes
The Company has elected to be taxed as a REIT for U.S. federal income tax purposes under Sections 856 through 860 of the Internal Revenue Code. Therefore, PMT generally will not be subject to corporate federal or state income tax to the extent that qualifying distributions are made to shareholders and the Company meets REIT requirements including certain asset, income, distribution and share ownership tests. The Company believes that it has met the distribution requirements, as it has declared dividends sufficient to distribute substantially all of its taxable income. Taxable income will generally differ from net income. The primary differences between net income and the REIT taxable income (before deduction for qualifying distributions) are the taxable income of the taxable REIT subsidiary (“TRS”) after tax adjustments related to MSRs and the method of determining the income or loss related to valuation of the mortgage loans owned by the qualified REIT subsidiary (“QRS”).
50
In general, cash dividends declared by the Company will be considered ordinary income to the shareholders for income tax purposes. Some portion of the dividends may be characterized as capital gain distributions or a return of capital.
The Company had elected to treat two of its subsidiaries as TRSs. In the quarter ended September 30, 2012, the Company revoked the election to treat its wholly owned subsidiary that is the sole general partner of the Operating Partnership as a TRS. As a result, beginning September 1, 2012, one subsidiary, PMC, is treated as a TRS. Income from a TRS is only included as a component of REIT taxable income to the extent that the TRS makes dividend distributions of income to the REIT. No such dividend distributions have been made to date. A TRS is subject to corporate federal and state income tax. Accordingly, a provision for income taxes for PMC and, for the periods for which TRS treatment had been elected, the sole general partner of the Operating Partnership is included in the Consolidated Statements of Income.
The Company files U.S. federal and state income tax returns for both the REIT and TRSs. These federal income tax returns for 2010 and forward are subject to examination. The Company’s primary state income tax return for 2009 and forward are subject to examination. No returns are currently under examination.
The following table details the Company’s income tax expense (benefit) which relates primarily to the TRSs for the periods presented:
Current (benefit) expense:
Federal
State
Total current expense
Deferred (benefit) expense:
Total deferred expense
Total (benefit) provision for income taxes
The provision for deferred income taxes for the quarters ended September 30, 2013 and September 30, 2012 primarily relates to MSRs the Company received pursuant to sales of mortgage loans with servicing rights retained and net operating loss carryforward as detailed below.
51
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 rate for the periods presented:
Federal income tax expense at statutory tax rate
Effect of non-taxable REIT income
State income taxes, net of federal benefit
Valuation allowance
Provision for income taxes
52
The Company’s components of the provision for deferred income taxes are as follows:
Real estate valuation loss
Mortgage servicing rights
Net operating loss carryforward
Total provision for deferred income taxes
The components of income taxes payable are as follows:
Taxes currently receivable
Deferred income taxes payable
The tax effects of temporary differences that gave rise to deferred income tax assets and liabilities are presented below:
Deferred income tax assets:
REO valuation loss
Gross deferred tax assets
Deferred income tax liabilities:
Gross deferred tax liabilities
Net deferred income tax liability
The net deferred income tax liability is recorded in Income taxes payable in the consolidated balance sheets as of September 30, 2013 and December 31, 2012.
The Company recorded a deferred tax asset of $34.8 million during the nine months ended September 30, 2013, reflecting the benefit of net operating loss carryforwards that generally expire 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 32—Segments and Related Information
The Company has two business segments: correspondent lending and investment activities.
53
Financial highlights by operating segment are summarized below:
Revenues:
External
Net gain on investments
Loan fulfillment, Servicing and Management fees payable to PennyMac Financial Services, Inc.
Pre-tax income
Total assets at period end
Pre-tax net income
54
Loan fulfillment, Servicing and Management fees payable to PennyMac Financial Services, Inc
The accounting policies of the reportable segments are the same as those described in Note 3—Significant Accounting Policies to the Company’s Annual Report.
55
Note 33—Supplemental Cash Flow Information
Cash paid for interest
Income tax (refund) payment
Non-cash investing activities:
Transfer of mortgage loans acquired for sale at fair value to mortgage loans at fair value held by variable interest entity
Transfer of mortgage loans acquired for sale to mortgage loans at fair value
Purchase of mortgage loans financed through forward purchase agreements
Transfer of mortgage loans under forward purchase agreements to mortgage loans, at fair value
Receipt of MSRs as proceeds from sales of loans
Purchase of REO financed through forward purchase agreements
Transfer of REO under forward purchase agreements to REO
Non-cash financing activities:
Transfer of note payable secured by mortgage loans to mortgage loans sold under agreements to repurchase
Transfer of mortgage loans at fair value financed through agreements to repurchase to REO financed under agreements to repurchase
Note 34—Regulatory Net Worth Requirement
PMC is a seller-servicer for Fannie Mae and Freddie Mac. To retain its status as an approved seller-servicer, PMC is required to meet Fannie Mae’s and Freddie Mac’s capital standards, which require PMC to maintain a minimum net worth of $2.5 million for both Agencies. Management believes PMC complies with Fannie Mae’s and Freddie Mac’s net worth requirement as of September 30, 2013.
Note 35—Subsequent Events
Management has evaluated all events and transactions through the date the Company issued these consolidated financial statements. During this period:
56
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
We are a specialty finance company that invests primarily in residential mortgage loans and mortgage-related assets. Our objective is to provide attractive risk-adjusted returns to our investors over the long-term, principally through dividends and secondarily through capital appreciation. We intend to achieve this objective largely by investing in distressed mortgage assets and acquiring, pooling and selling newly originated prime credit quality residential mortgage loans (“correspondent lending”).
Changes in the mortgage market have significantly reduced the outlets for sales of newly originated mortgage loans by mortgage lenders who have traditionally sold their loans to larger mortgage companies and banks who, in turn, sold those loans to Agencies and other investors or into securitizations. We believe that these changes are due in part to banks’ anticipation of regulatory changes to loan and securitization-related capital requirements, along with a focus on retail lending; and that the changes provide us with the opportunity to act as a link between loan originators and the Agency and securitization markets.
During the quarter and the nine months ended September 30, 2013, we purchased loans with fair values totaling $8.2 billion and $26.0 billion, respectively, in furtherance of our correspondent lending business. To the extent that we purchase loans that are insured by the U.S. Department of Housing and Urban Development (“HUD”), through the Federal Housing Administration (“FHA”) or insured or guaranteed by the Veterans Administration, we and PLS have agreed that PLS will fulfill and purchase such loans, as PLS is a Ginnie Mae approved issuer and servicer and we are not. This arrangement has enabled us to compete with other correspondent lenders that purchase both government and conventional loans. We receive a sourcing fee from PLS of three basis points on the unpaid principal balance of each loan that we sell to PLS under such arrangement, and earn interest income on the loan for the time period we hold the loan prior to the sale to PLS. We received sourcing fees totaling $1.2 million and $3.6 million relating to $4.1 billion and $12.4 billion of fair value loans we sold to PLS for the quarter and nine months ended September 30, 2013, respectively, compared to $747,000 and $1.4 million relating to $2.7 billion and $5.1 billion of loans at fair value that we sold to PLS for the quarter and nine months ended September 30, 2012, respectively.
We invest in distressed mortgage loans through direct acquisitions of mortgage loan portfolios from institutions such as banks and mortgage companies. A substantial portion of the nonperforming loans we have purchased has been acquired from or through one or more subsidiaries of Citigroup Inc.
We seek to maximize the value of the distressed mortgage loans that we acquire using means that are appropriate for the particular loan, including both proprietary and nonproprietary loan modification programs, special servicing and other initiatives focused on avoiding foreclosure, when possible. When we are unable to effect a cure for a mortgage delinquency, our objective is to effect timely acquisition and/or liquidation of the property securing the loan through the use, in part, of short sales and deed-in-lieu of foreclosure programs. During the quarter and nine months ended September 30, 2013, we acquired distressed mortgage loans with fair values totaling $581.0 million and $1.0 billion, respectively, and we received proceeds from liquidation, payoffs and sales from our portfolio of distressed mortgage loans and REO totaling $102.3 million and $300.1 million, respectively.
We supplement these activities through participation in other mortgage-related activities, which are in various states of analysis, planning or implementation, including:
We are externally managed by PCM, an investment adviser that specializes in and focuses on, residential mortgage loans. Most of our mortgage loan portfolio is serviced by PLS, an affiliate of PCM.
57
We conduct substantially all of our operations, and make substantially all of our investments, through our Operating Partnership and its subsidiaries. We are the sole limited partner and one of our subsidiaries is the sole general partner of our Operating Partnership.
We believe that we qualify to be taxed as a REIT. We believe that we will not be subject to federal income tax on that portion of our income that is distributed to shareholders as long as we meet certain asset, income and share ownership tests. If we fail to qualify as a REIT, and do not qualify for certain statutory relief provisions, our profits will be subject to income taxes and we may be precluded from qualifying as a REIT for the four tax years following the year we lose our REIT qualification. A portion of our activities, including our correspondent lending business, is conducted in a taxable REIT subsidiary (“TRS”), which is subject to corporate federal and state income taxes. Accordingly, we have made a provision for income taxes with respect to the operations of our TRS. We expect that the effective rate for the provision for income taxes may be volatile in future periods. Our goal is to manage the business to take full advantage of the tax benefits afforded to us as a REIT.
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. Towards 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 pushed year-to-date production volume to slightly less than $1.6 trillion, and put the market 3.9 percent ahead of 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).
The potential market opportunity in non-agency jumbo mortgage loans continues to be significant. In the first nine months of 2013, prime jumbo MBS issuance surpassed the total for all of 2012, with securitizations totaling $12.3 billion in unpaid principal balance. The depth of investor demand for non-agency MBS is limited as evidenced by weaker pricing for securitizations issued in the third quarter. We believe that the Federal Housing Finance Agency (“FHFA”) will execute upon its stated goal to reduce the role of Fannie Mae and Freddie Mac in mortgage finance over time, and part of that goal will be to reduce agency conforming limits to pre-crisis levels beginning sometime in 2014. This would open a significant portion of the jumbo market to non-agency securitization and move the market one step closer to normalization. During the nine months ended September 30, 2013, we produced approximately $190 million in unpaid principal balance of jumbo loans and acquired $393 million in unpaid principal balance of jumbo loans on a bulk basis, compared to $11 million in unpaid principal balance of jumbo loans produced during all of 2012.
Our Manager continues 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, our Manager reviewed 25 mortgage loan pools with unpaid principal balances totaling approximately $7.3 billion. This compares to our Manager’s review of 23 mortgage loan pools with unpaid principal balances totaling approximately $3.8 billion during the third quarter of 2012. We acquired 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 our correspondent lending business, 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) early in the fourth quarter of 2012, margins narrowed in subsequent quarters and we expect them to continue to normalize toward their long-term averages in 2013 and 2014.
58
The following is a summary of our key performance measures for the periods presented:
Pre-tax income by segment:
Investment activities
Intersegment elimination and other
Earnings per share:
Dividends per share:
Declared
Paid
Correspondent lending:
Purchases of mortgage loans for sale
Proceeds from sales of mortgage loans acquired for sale:
Cash:
Sales to nonaffiliated investors
Sales of government-insured and guaranteed loans to PLS
MSRs
Investment activities:
Distressed mortgage loans and REO:
Cash proceeds from liquidation activities
MBS:
Cash proceeds from repayment and sales
Share prices during the period:
High
Low
At period end
Book value per share
During the quarter and nine months ended September 30, 2013, we recorded net income of $39.7 million and $147.5 million, or $0.57 and $2.29 per diluted share, respectively. Our net income for the quarter and nine months ended September 30, 2013 reflects net gains on our investments in financial instruments totaling $60.1 million and $244.6 million (comprised of net gain on investments and net gain on mortgage loans acquired for sale), including $41.9 million and $136.2 million of valuation gains on mortgage loans at fair value and mortgage loans under forward purchase agreements at fair value. These gains were supplemented by $15.8 million and $34.1 million of net interest income. During the quarter and nine months ended September 30, 2013, we purchased $8.2 billion and $26.0 billion, respectively, in fair value of newly originated mortgage loans. We recognized gains on such loans totaling approximately $11.0 million and $84.57 million, respectively. At September 30, 2013, we held mortgage loans acquired for sale with fair values totaling $737.1 million, including $273.0 million that were pending sale to PLS.
59
During the quarter and nine months ended September 30, 2012, we recorded net income of $40.4 million and $89.0 million, or $0.81 and $2.29 per diluted share, respectively. Our net income for the quarter and nine months ended September 30, 2012 reflects net gains on our investments in financial instruments (comprised of net gain on investments and net gain on mortgage loans acquired for sale) totaling $75.9 million and $146.8 million, including $22.9 million and $50.1 million of valuation gains on MBS and mortgage loans excluding mortgage loans acquired for sale, supplemented by $11.4 million and $30.5 million of net interest income, respectively. During the quarter and nine months ended September 30, 2012, we purchased $6.6 billion and $12.0 billion, respectively, in fair value of newly originated mortgage loans. We recognized gains on such loans totaling approximately $49.8 million and $81.2 million, respectively. At September 30, 2012, we held mortgage loans acquired for sale with fair values totaling $847.6 million, including $194.1 million pending sale to PLS.
Our net income decreased during the quarter ended September 30, 2013 due to decreased gains on mortgage loans held for sale. Our net income increased for the nine months ended September 30, 2013 as compared to the nine months ended September 30, 2012 due to growth in both our correspondent lending and investment activities segments. During the quarter and nine months ended September 30, 2013, we sold $4.2 billion and $13.2 billion in fair value of mortgage loans to nonaffiliates and issued $6.7 billion and $24.8 billion of IRLCs, an increase of $356 million or 6% and $13.3 billion or 116%, respectively, from the quarter and nine months ended September 30, 2012. During the quarter ended September 30, 2013, rising interest rates negatively impacted our net gain on mortgage loans acquired for sale margins. As a result, although we sold more loans during the quarter ended September 30, 2013 as compared to the quarter ended September 30, 2012, our net gain on loans acquired for sale decreased by $38.8 million or 78%.
For the nine months ended September 30, 2013 as compared to the nine months ended September 30, 2012, our net gain on mortgage loans acquired for sale increased by $3.5 million or 4%. In our investment activities, our average investment portfolio was approximately $1.8 billion and $1.4 billion during the quarter and nine months ended September 30, 2013, an increase of $805.7 million or 79% and $476.3 million or 49% from the quarter and nine months ended September 30, 2012. We recognized interest income and net gain on investments totaling approximately $84.4 million and $238.9 million during the quarter and nine months ended September 30, 2013, a increase of $38.6 million or 84% for the quarter ended September 30, 2013 as compared to the quarter ended September 30, 2012, and an increase of $121.2 million or 103% from the nine months ended September 30, 2012.
During the quarter and nine months ended September 30, 2013, we recorded net investment income of $86.1 million and $309.4 million, respectively, comprised primarily of net gain on mortgage loans acquired for sale of $11.0 million and $84.7 million and net gain on investments of $49.1 million and $159.9 million, respectively, supplemented by $15.8 million and $34.1 million of net interest income, $4.6 million and $14.8 million of loan origination fees and $6.7 million and $20.6 million of net loan servicing fees, partially offset by $2.3 million and $7.5 million of losses from results of REO, respectively. This compares to net investment income of $90.9 million and $188.6 million recognized during the quarter and nine months ended September 30, 2012, comprised primarily of net gain on mortgage loans acquired for sale of $49.8 million and $81.2 million and net gain on investments of $26.1 million and $65.5 million, respectively, supplemented by $11.4 million and $30.5 million of net interest income and $1.3 million and $7.6 million from results of REO, partially offset by negative net loan servicing income of $511,000 and $1.2 million, respectively.
60
Net investment income includes noncash fair value adjustments. Because we have elected to record our mortgage loan investments (which include mortgage loans at fair value, and our mortgage loans at fair value under forward purchase agreements and mortgage loans held in a variable interest entity at fair value) at fair value, a substantial portion of the income we record with respect to such loans results from changes in fair value. Net investment income also includes noncash fair value adjustments related to mortgage loans acquired for sale at fair value, IRLCs, forward purchase and sale contracts and MBS put and call options. The fair value adjustments related to our mortgage loan investments are included in “Net gain (loss) on investments—Mortgage loans.” The fair value adjustments related to mortgage loans acquired for sale at fair value, IRLCs, forward purchase and sale contracts and MBS put and call options are included in “Net gain on mortgage loans acquired for sale.” The amounts of fair value adjustments included for the periods indicated are as follows:
Net gain or loss on investments—mortgage loans
Mortgage loans acquired for sale
Cash is generated when mortgage loan investments are monetized through payoffs or sales, when payment of principal and interest occur on such loans, generally after they are modified, or when the property securing a mortgage loan that has been settled through acquisition of the property has been sold. We receive proceeds on the sale of mortgage loans acquired for sale that include both cash and our estimate of the value of MSRs and we recognize a liability for potential losses relating to representations and warranties created in the loan sales transactions. Cash flows relating to hedging instruments are generally produced when the instruments mature or when we effectively cancel the transactions through an offsetting trade.
During the quarter and nine months ended September 30, 2013, we received proceeds from liquidation of mortgage loan investments and REO of $102.3 million and $300.1 million, respectively. For these liquidations, we had recorded $12.9 million and $32.8 million, respectively, of accumulated valuation gains during the period we held the assets and recorded additional gains of $8.8 million and $31.1 million, respectively, when the assets were liquidated.
During the quarter and nine months ended September 30, 2012, we received proceeds from liquidations of mortgage loan investments of $82.9 million and $256.7 million, respectively. For these liquidations, we had recorded $4.7 million and $13.7 million, respectively, of accumulated valuation gains during the period we held the assets and recorded additional gains of $8.8 million and $31.8 million, respectively, when the assets were liquidated.
The growth in net investment income during the nine months ended September 30, 2013, as compared to the nine months ended September 30, 2012, primarily reflects the growth in the distressed loan portfolio. The decrease in net investment income during the quarter ended September 30, 2013 as compared to the quarter ended September 30, 2012, is due to a reduction in gain on mortgage loans acquired for sale owing to margins during the quarter ended September 30, 2013. This reduction is partially offset by increases in gains on investments, reflecting growth in our portfolio of mortgage loan investments and debt securities.
Net Gain on Mortgage Loans Acquired for Sale
During the quarter and nine months ended September 30, 2013, we recorded a net gain on mortgage loans acquired for sale of $11.0 million and $84.7 million, respectively, which included approximately $49.0 million and $156.2 million, respectively, in fair value of MSRs received as part of the proceeds from our correspondent lending loan sales.
During the quarter and nine months ended September 30, 2012, we recorded a net gain on mortgage loans acquired for sale of $49.8 million and $81.2 million, respectively, which included approximately $36.8 million and $66.6 million, respectively, in fair value of MSRs received as part of the proceeds from our correspondent lending sales.
61
Our gains on mortgage loans acquired for sale are summarized below:
Increase (decrease) in gain on mortgage loans acquired for sale due to:
Change in IRLCs fair value
Volume of loans sold
Gain margin
Total change
Our gain on mortgage loans acquired for sale includes both cash and non-cash elements. We receive proceeds on sale that include both cash and our estimate of the value of MSRs and we recognize a liability for potential losses relating to representations and warranties created in the loan sales transactions.
The change in our cash gain on mortgage loans acquired for sale from the quarter ended September 30, 2012 to the quarter ended September 30, 2013 reflects the cash losses based on prevailing market conditions during the respective periods, which was offset by settlements of hedging transactions entered into to hedge our IRLCs and mortgage loan inventory. During the quarter and nine months ended September 30, 2012, mortgage interest rates were generally decreasing, resulting in larger cash gains. During the quarter and nine months ended September 30, 2013, mortgage interest rates were generally increasing, resulting in reduced cash gains. In addition, during the quarter and nine months ended September 30, 2013, pricing margins were compressed as compared to the quarter ended September 30, 2012, due to increasing competition in the market for mortgage loans.
We recognize a substantial portion of our gain on mortgage loans held for sale at fair value before we purchase the loan. In the course of our correspondent lending activities, we make contractual commitments to correspondent lenders to purchase loans at specified terms. We call these commitments IRLCs. We recognize the value of IRLCs at the time we make the commitment to the correspondent lender.
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. 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 be purchased as a percentage of the commitment we have made (the “pull-through rate”). Changes in our estimate of the probability the loan will fund and changes in interest rates are updated as the mortgage loans move through the purchase process and may result in changes in the estimates of the value of the IRLCs. Such changes are reflected in the change in fair value of IRLCs in our gain on mortgage loans acquired for sale.
The significant unobservable inputs we use in the fair value measurement of our IRLCs are the pull-through rate and the MSR component of our 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 increase the pull-through rate for loans that have decreased in fair value in comparison to the agreed-upon purchase price.
62
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 initially at our estimate of the fair value of the contract to service the loans. As discussed in Net loan servicing fees, 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 influencing the loans we sell with servicing rights retained change, 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 fees 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.
63
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, in turn, had sold such mortgage loans to us 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 originator.
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 the probability of reimbursement by the correspondent loan seller. We establish a liability at the time loans are sold and review our liability estimate on a periodic basis.
64
Following is a summary of our liability for representations and warranties in the consolidated balance sheets:
Following is a summary of the repurchase activity and unpaid balance of mortgage loans subject to representations and warranties:
During the quarter and nine months ended September 30, 2013, we repurchased mortgage loans with unpaid balances totaling $5.7 and $6.9 million respectively, and incurred no losses relating to such repurchases. However, 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 recourse liability is difficult to estimate and requires considerable management judgment. The level of mortgage loan repurchase losses is dependent on economic factors, investor loss mitigation 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 lending primarily involve forward sales of our IRLCs and mortgage loans acquired for sale as well as purchases of options to sell and options to purchase MBS.
65
Following is a summary of the notional activity in our hedging derivatives for our investment activities related to our IRLCs and inventory of mortgage loans acquire for sale for the periods presented:
Loan Origination Fees
Loan origination fees represent fees we charge correspondent lenders relating to our purchase of loans from those lenders. The fees are charged to the correspondent lenders based on a fee schedule, whereby we charge standardized rates. The increase in fees during 2013 compared to 2012 is due to a change in production volume.
Net Gain (Loss) on Investments
During the quarter and nine months ended September 30, 2013, we recognized net gains on MBS, Agency debt security, mortgage loans and excess servicing spread totaling $49.1 million and $159.9 million, respectively. This compares to recognized net gains on investments totaling $26.1 million and $65.5 million during the quarter and nine months ended September 30, 2012, respectively. The increase for the quarter and nine months ended September 30, 2013 as compared to the same prior periods is primarily due to valuation gains in our portfolio of mortgage loans, including mortgage loans under forward purchase agreements, reflecting continuing improvements in the performance of the residential real estate market. This appreciation was compounded by growth in our average investment in mortgage loans at fair value. The average portfolio balance of mortgage investments increased $805.7 million or 79%, and $476.3 million or 49%, respectively, during the quarter and nine months ended September 30, 2013 as compared to the same prior periods.
66
Net gains on mortgage loans at fair value and mortgage loans under forward purchase agreements at fair value are summarized below for the periods presented:
Valuation changes:
Performing loans
Payoffs
Because we have elected to record our mortgage loans and mortgage loans under forward purchase agreements at fair value, a substantial portion of the income we record with respect to such loans results from changes in fair value. Valuation changes amounted to $41.9 million and $22.9 million in the quarters ended September 30, 2013 and 2012, respectively, and $136.3 million and $50.1 million in the nine months ended September 30, 2013 and 2012, respectively.
The valuation losses on performing loans for the quarter ended September 30, 2013 reflects the effects of capitalization of delinquent interest on loans we modify. When we capitalize interest in a loan modification, we increase the carrying value of the loan. However, the modification does not result in an immediate increase in the loan’s fair value. As a result, the interest income we recognize is offset by a valuation loss. During the quarter and nine months ended September 30, 2013, we capitalized interest totaling $13.2 million and $25.0 million, respectively. The valuation gains for the performing loans for the nine months ended September 30, 2013 and for the nonperforming loans for the quarter and nine months ended September 30, 2013 were due to observed market demand for distressed mortgage loans, continuing improvement in the residential real estate market and changes in the value of the loans as they move through the resolution process.
Cash is generated when mortgage loans and mortgage loans under forward purchase agreements are monetized through payoffs or sales, when payments of principal and interest occur on such loans, generally after they are modified, or when the property securing a mortgage loan that has been settled through acquisition of the property has been sold. During the quarters ended September 30, 2013 and 2012, we received proceeds from liquidation of mortgage loans and REO of $102.3 million and $82.9 million; and during the nine month periods ended September 30, 2013 and 2012, we received proceeds from liquidation of mortgage loans and REO totaling $300.1 million and $256.7 million, respectively. For these liquidations, we had recorded accumulated gains on the liquidated assets during the period we held those assets totaling $12.9 million and $4.6 million for the quarters ended September 30, 2013 and 2012, respectively, and $32.8 million and $13.7 million for the nine month periods ended September 30, 2013 and 2012, respectively, and we recorded additional gains of $8.9 million and $8.8 million for the quarters ended September 30, 2013 and 2012, and $31.0 million and $31.5 million for the nine month periods ended September 30, 2013 and 2012, respectively, when the assets were liquidated.
During the quarters ended September 30, 2013 and 2012, we recognized gains on mortgage loan payoffs as summarized below:
Number of loans
Unpaid principal balance
Gain recognized at payoff
The increase in gains recognized at payoff for the quarter ended September 30, 2013 compared to the quarter ended September 30, 2012 was due to growth in our portfolio of mortgage loans for the quarter ended September 30, 2013 compared to the quarter ended September 30, 2012.
67
The following tables present a summary of loan modifications completed for the periods presented:
Modification type(1)
Rate reduction
Term extension
Capitalization of interest and fees
Principal forbearance
Principal reduction
Defaults of mortgage loans modified in the prior year period
As a percentage of balance of loans before modification
Defaults during the period of mortgage loans modified since acquisitions(3)
Repayments and sales of mortgage loans modified in the prior year period
The following table summarizes the average impact of the modifications noted above to the terms of the loans modified for the periods presented:
Category
Loan balance
Remaining term (months)
Interest rate
Forbeared principal
Implementing long-term, sustainable loan modification is one means by which we strive to enhance the value of the distressed mortgage loans which we have typically purchased at discounts to their unpaid principal balance. Before the disruption of the mortgage securitization markets in 2008, an active market in securitizations of reperforming and modified mortgage loans existed. As a result of the disruptions that occurred in 2008, the market for securities backed by such loans has become highly illiquid. We continue to monitor and explore the market for securitizations backed by reperforming and modified mortgage loans as a means of recovering our investment in such loans in the future. However, this form of recovery of our investment in modified mortgage loans has not been a practical alternative for us through this date.
Unlike liquidation of a defaulted mortgage loan, we expect that recovery of our investment in a performing modified mortgage loan will take place generally over a period of several years, during which we earn and collect interest income on the loan. Our
68
current expectations are that we will receive cash on modified mortgage loans through monthly borrower payments, HAMP incentive payments, payoffs or acquisition of the property securing the loans and liquidation of the property in the event the borrower subsequently defaults. Due to the recent addition of new modification programs, both through HAMP and proprietary programs, trends in default performance are difficult to discern. However, the addition of these new modification programs has resulted in the volume of our modification activity increasing in the most recent quarter.
In addition, large-scale refinancing of modified mortgage loans is not expected to occur for an extended period. Borrowers who have recently modified their mortgage loans typically have credit profiles that do not qualify them for refinancing or have loans on properties whose loan-to-value ratios exceed current underwriting guidelines for new mortgage loans. Further, modified mortgage loans require a period of acceptable borrower performance, generally 12 months of timely mortgage payments, for consideration in most Agency refinance programs.
However, certain programs such as the FHA’s Negative Equity Refinance Program allow homeowners whose modified mortgage amount exceeds the value of the property securing the loan to refinance immediately following a modification. Our utilization of this program has increased in 2013, as indicated by the increase in payoffs of modified loans both on a quarterly and nine-month comparative basis. We continue to explore methods of accelerating recovery of our investment of modified mortgage loans through solicitations of refinancings of such loans into Agency-eligible loans which result in a full or partial repayment of our investment.
During the quarter and nine month periods ended September 30, 2013, we recognized gains on MBS of $493,000, net of hedging losses, relating to purchases of MBS totaling $199.6 million during the third quarter of 2013. The gains we recorded arose due to decreases in market yields on MBS at the end of the third quarter of 2013. During the third quarter of 2013, we also purchased an Agency debt security. We recorded gains on that security totaling $578,000 during the quarter. We sold that security during the month of October 2013 and recognized an additional gain of $140,000 on the sale. During the quarter and nine months ended September 30, 2013, we recognized a net valuation gain on MBS totaling $493,000. This compares to a loss of $0.5 million and a gain of $0.6 million during the quarter and nine month periods ended September 30, 2012.
69
Net Interest Income
Net interest income is summarized below for the periods presented:
Agencies mortgage-backed securities
Total investment activities
Other interest
Asset backed secured financing
Notes payable secured by warehouse notes receivable
Interest bearing liabilities
Other interest—Servicing
70
Mortgage-backed securities:
Fannie Mae 30-year fixed
Non-Agency subprime
Non-Agency Alt-A
Non-Agency prime jumbo
Total mortgage-backed securities
Note payable secured by warehouse notes receivable
71
72
United States Treasury security
Mortgage loans under forward purchase
73
The effects of changes in the composition of our investments on our interest income during the periods presented are summarized below:
Money market investment
Mortgage backed securities:
Agencies
FNMA conventional
Non-agency subprime
Non-agency Alt-A
Non-agency prime jumbo
Total mortgage backed securities
Borrowings under forward purchase agreement
Other interest—servicing
74
In the quarter and nine months ended September 30, 2013, we earned interest income of $35.3 million and $79.0 million, respectively, compared to $19.7 million and $52.2 million for the quarter and nine months ended September 30, 2012.
We earned interest income on our portfolio of Agency MBS totaling $345,000 for the quarter and nine month periods ended September 30, 2013. During the quarter and nine-month periods ended September 30, 2012, we recognized interest income totaling $502,000 and $2.1 million, respectively, on our portfolio of Non-Agency MBS. The interest income we recognized on MBS during 2013 represents interest we earned on the securities we purchased during the third quarter, whereas the interest income we recognized on MBS during the 2012 periods reflect interest income we earned through the date of sale during the third quarter of 2012.
In the quarter and nine months ended September 30, 2013, we recognized interest income on mortgage loans at fair value and mortgage loans under forward purchase agreements at fair value of $21.9 million and $49.8 million, including $13.2 million and $25.0 million of interest capitalized pursuant to loan modifications respectively, which compares to $13.0 million and $37.9 million, including $3.4 million and $16.4 million of interest capitalized pursuant to loan modifications, respectively, in the quarter and nine months ended September 30, 2012. The increases in interest income are due primarily to growth in the average balance of our mortgage loan portfolio of $781.1 million and $541.3 million, or 87% and 67%, respectively, for the quarter and nine months ended September 30, 2013 when compared to the same period in 2012. During the quarter and nine months ended September 30, 2013, we recognized annualized interest on mortgage loans at fair value and mortgage loans under forward purchase agreements at fair value of 5.24% and 4.93%, respectively, on our portfolio of mortgage loans at fair value as measured by the portfolio’s average fair value. This compares to 5.71% and 6.19% for the quarter and nine months ended September 30, 2012. The decrease in yield during the quarter and nine months ended September 30, 2013 as compared to the same period in 2012 is due primarily to the decrease in the weighted average coupon of performing mortgage loans and the increase in the proportion of nonperforming loans in our portfolio. At September 30, 2013, our investment in performing mortgage loans had a weighted average coupon of 4.09% compared to 4.17% at September 30, 2012.
At September 30, 2013, approximately 74% of the fair value of our mortgage loan portfolio was nonperforming, as compared to 66% at September 30, 2012. We do not accrue interest on nonperforming loans and generally do not recognize revenues during the period we hold REO. We calculate the yield on our mortgage loan portfolio based on the portfolio’s average fair value, which most closely reflects our investment in the mortgage loans. Accordingly, the yield we realize is substantially higher than would be recorded based on the loans’ unpaid balances as we typically purchase our mortgage loans at substantial discounts to their unpaid principal balances.
During the quarter and nine months ended September 30, 2013, we incurred interest expense totaling $19.5 million and $44.9 million, respectively, as compared to $8.3 million and $21.7 million during the quarter and nine months ended September 30, 2012. Our interest cost on interest bearing liabilities was 3.41% and 2.90%, respectively, for the quarter and nine months ended September 30, 2013 as compared to 3.62% and 3.52%, respectively, for the quarter and nine months ended September 30, 2012. The increase in interest expense reflects our increased use of borrowings in support of growth of our balance sheet throughout 2012 and 2013 along with the addition of $250.0 million in exchangeable senior notes during the quarter ended June 30, 2013.
Nonperforming loans and REO generally take longer to generate cash flow than performing loans due to the time required to work with borrowers to resolve payment issues through our modification programs and to acquire and liquidate the property securing the mortgage loans. The value and returns we realize from these assets are determined by our ability to cure the borrowers’ defaults, or when curing of borrower defaults is not a viable solution, by our ability to effectively manage the liquidation process. As a participant in HAMP, we are required to comply with the process specified by the HAMP program before liquidating a loan, and this may extend the liquidation process. At September 30, 2013, we held $1.5 billion in fair value of nonperforming loans and $99.7 million in carrying value of REO.
Net Loan Servicing Fees
When we sell mortgage loans, we generally enter into a contract to service the mortgage loans and recognize the value of such contracts as MSRs. Under these contracts, we are required to perform loan servicing functions in exchange for fees and the right to other compensation. The servicing functions, which are performed on our behalf by PLS, typically include, among other responsibilities, collecting and remitting loan payments; responding to borrower inquiries; accounting for principal and interest, holding custodial (impound) funds for payment of property taxes and insurance premiums; counseling delinquent mortgagors; and supervising foreclosures and property dispositions.
75
Net loan servicing fees are summarized below:
Our servicing fees increased $10.5 million and $30.9 million, respectively, during the quarter and nine months ended September 30, 2013 compared to the same periods ended September 30, 2012 due to the growth in our mortgage loan servicing portfolio. Correspondent lending activity—presently the primary source of our mortgage loan servicing portfolio—began to increase in the fourth quarter of 2011. As a result, our mortgage loan servicing portfolio during the quarter and nine months ended September 30, 2012 was much smaller than during the quarter and nine months ended September 30, 2013.
Effective February 1, 2013, we entered into an MSR recapture agreement that requires PLS to transfer to us the MSRs with respect to new mortgage loans originated in refinancing transactions where PLS refinances a mortgage loan for which we previously held the MSRs. PLS is generally required to transfer MSRs relating to such mortgage loans (or, under certain circumstances, other mortgage loans) that have an aggregate unpaid principal balance that is not less than 30% of the aggregate unpaid principal balance of all the loans so originated. Where the fair value of the aggregate MSRs to be transferred for the applicable month is less than $200,000, PLS may, at its option, settle in cash with PMT in an amount equal to such fair market value in lieu of transferring such MSRs. We recognized approximately $86,000 and $586,000, respectively, of such income during the quarter and nine months ended September 30, 2013.
Amortization, impairment and changes in fair value of MSRs have a significant effect on net loan servicing fees, 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.
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 the Manager’s discounted cash flow model are based on market factors and include the historical performance of its MSRs, which the Manager believes 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 speeds and discount rates. 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. PCM’s valuation committee reviews and approves the fair value estimates of our MSRs.
We account for MSRs at either our estimate of the asset’s fair value with changes in fair value recorded in current period earnings or using the amortization method with the MSRs carried at the lower of estimated amortized cost or fair value based on whether we view the underlying mortgages as being sensitive to prepayments resulting from changing market interest rates. We have identified an initial mortgage interest rate of 4.5% as the threshold for whether such mortgage loans are sensitive to changes in interest rates:
76
Our MSRs are summarized by the basis on which we account for the assets below as of the dates presented:
Basis of Accounting
Fair value
Lower of amortized cost or fair value:
Amortized cost
Total MSR:
Unpaid balance of mortgage loans underlying MSRs
MSRs carried at
77
Key assumptions used in determining the fair value of MSRs and estimates of the sensitivity of MSR values to changes in these assumptions as of the dates presented are as follows:
Pricing spread(2)
Prepayment speed(3)
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 preceding sensitivity analyses 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 preceding estimates should not be viewed as earnings forecasts.
Results of Real Estate Acquired in Settlement of Loans
Results of REO includes the gains or losses we record upon sale of the properties as well as valuation adjustments we record during the period we hold those properties. During the quarter and nine months ended September 30, 2013, we recorded net losses of $2.3 million and $7.5 million in Results of real estate acquired in settlement of loans as compared to net gains totaling $1.3 million and $7.6 million, respectively, for the quarter and six months ended September 30, 2012.
78
Results of REO are summarized below:
The shift in results of REO from a gain during the quarter and nine months ended September 30, 2012 to a loss during the quarter and nine months ended September 30, 2013 was largely due to valuation adjustments on several large REO properties.
Our expenses are summarized below for the periods presented:
Expenses payable to PennyMac Financial Services, Inc.
Increased expenses during the quarter and nine months ended September 30, 2013 compared to the same period in 2012 were primarily a result of the substantial growth in our equity, our correspondent lending activities and the Company’s investment portfolio.
Loan fulfillment fees represent fees we pay to PLS for the services it performs on our behalf in connection with our acquisition, packaging and sale of mortgage loans. The fee is calculated as a percentage of the unpaid principal balance of the mortgage loans purchased. Loan fulfillment fees and related fulfillment volume are summarized below:
Fulfillment fee expense
Unpaid principal balance of loans fulfilled by PLS
The increases of $1.1 million and $37.5 million during the quarter and nine months ended September 30, 2013 compared to the same periods in 2012 are due to the growth in the volume of Agency-eligible and jumbo mortgage loans we purchased in our correspondent lending activities that continued from 2012 through the second quarter of 2013. During the quarter ended September 30, 2013, the mortgage market has been contracting in response to rising interest rates. Accordingly, our correspondent lending volume has also decreased during the third quarter of 2013 from the levels observed during the six months ended June 30, 2013.
Loan servicing fees increased from $4.6 million and $13.2 million, respectively, in the quarter and nine months ended September 30, 2012 to $10.7 million and $27.3 million, respectively, in the quarter and nine months ended September 30, 2013 as our average investment in mortgage loans increased by 87% and 67%, respectively, from the quarter and nine months ended September 30, 2012 and our servicing portfolio increased 291% from $6.1 billion at September 30, 2012 to $23.7 billion at September 30, 2013. Included in loan servicing fees are activity-based fees, which increased by $2.5 million and $4.7 million, respectively, generally relating to the increase in loan liquidation activities.
79
Loan servicing fees payable to PennyMac Financial Services, Inc. and subsidiaries are summarized below for the periods presented:
The components of our management fee payable to PennyMac Financial Services, Inc. are summarized below:
Management fees increased by $4.9 million and $15.5 million, respectively, in the quarter and nine months ended September 30, 2013 compared to the same period in 2012, due to the combined effect of growth in shareholders’ equity on the base management fee we pay to PCM combined with recognition of performance incentive fees in 2013 which we did not incur in 2012. The increase in performance incentive fees resulted in part from a change in our management agreement with PCM. Effective February 1, 2013, the management agreement was amended to adjust the basis on which both the base management fee and performance incentive fee are determined. Specifically, we amended:
We expect our management fees to fluctuate in the future based on: (1) changes in our shareholders’ equity with respect to our base management fee; and (2) the level of our profitability in excess of the return thresholds specified in our management agreement with respect to the performance incentive fee.
Professional services expense increased during the nine months ended September 30, 2013 as compared to the nine months ended September 30, 2012 due to the heightened level of mortgage investment acquisition activity during the quarter ended March 31, 2013, which requires support in the form of due diligence and legal consultations.
Other expense items increased commensurately with increased business activity and asset growth.
Income Taxes
We had elected to treat two of our subsidiaries as TRSs. In the quarter ended September 30, 2012, we revoked the election to treat our wholly owned subsidiary that is the sole general partner of our Operating Partnership as a TRS. As a result, beginning September 1, 2012 only PMC is treated as a TRS. Income from a TRS is only included as a component of REIT taxable income to the extent that the TRS makes dividend distributions of income to the REIT. No such dividend distributions have been made to date.
A TRS is subject to corporate federal and state income tax. Accordingly, a provision for income taxes for PMC and, for the period for which TRS treatment had been elected, the sole general partner of our Operating Partnership is included in the accompanying Consolidated Statements of Income.
80
In general, cash dividends declared by us will be considered ordinary income to shareholders for income tax purposes. Some portion of the dividends may be characterized as capital gain distributions or a return of capital.
Below is a reconciliation of U.S. GAAP year to date net income to taxable income and the allocation of taxable income between the TRS and the REIT:
Net gain (loss) on investments
State tax deduction (income)
REIT dividend deduction
Net expense and deductions
81
Following is a summary of key balance sheet items as of the dates presented:
Investments:
Debt securities
Other liabilities
Shareholders’ equity
Total assets increased by approximately $1.7 billion or 66% during the period from December 31, 2012 through September 30, 2013. Growth in total assets reflects growth of investments totaling $1.6 billion or 66% from December 31, 2012. We financed our asset growth through additional borrowings of $1.4 billion resulting in an increase of 109% compared to December 31, 2012. Net mortgage loan investments (excluding correspondent lending loans) increased by $1.4 billion or 120% compared to December 31, 2012. The increase is related to purchases of $1.0 billion and fair valuation changes of $158.8 million partially offset by repayments of $201.9 million during the period. The valuation changes resulted from growth in our portfolio of mortgage investments along with continuing improvements in the performance of the residential real estate market and fair value appreciation of the loans as they progress toward their ultimate resolution. Through our correspondent lending activities, we also purchased newly-originated mortgage loans totaling $26.0 billion. Our acquisitions are summarized below.
82
Following is a summary of our correspondent lending acquisitions:
Fair value of correspondent lending loans purchased:
Agency eligible
Jumbo
Fair value of correspondent lending loans in inventory at period-end
During the quarter and nine months ended September 30, 2013, we purchased for sale $8.2 billion and $26.0 billion, respectively, in fair value of correspondent lending loans compared to $6.6 billion and $12.0 billion, respectively, in fair value of correspondent lending loans during the quarter and nine months ended September 30, 2012. Of our acquisitions during the nine months ended September 30, 2013, we transferred $550.5 million in fair value of jumbo loans to our investment portfolio in a financing transaction whereby we issued approximately $170 million in securities to finance such loans and financed the remaining retained securities through our repurchase agreement. The increase in correspondent purchases is a result of our growing correspondent seller network relationships and bulk purchase of fixed-rate jumbo loans totaling $379.1 million. During the quarter ended September 30, 2013, our correspondent lending volume began to decrease as a result of rising interest rates which had the effect of reducing consumer demand for mortgage loans.
Our ability to continue the expansion of our correspondent lending business is subject to, among other factors, our ability to source additional mortgage loan volume, our ability to obtain additional inventory financing and our ability to fund the portion of the loans not financed, either through cash flows from business activities or the raising of additional equity capital. There can be no assurance that we will be successful in increasing our borrowing capacity or in obtaining the additional equity capital necessary or that we will be able to identify additional sources of mortgage loans.
Investment Portfolio
Following is a summary of our acquisitions of mortgage investments other than correspondent lending acquisitions as shown in the preceding table:
MBS
Distressed mortgage loans(1) (2)
Performing
Nonperforming
Our acquisitions during the quarters ended September 30, 2013 and 2012 were financed primarily through the use of borrowings. We continue to identify additional means of increasing our investment portfolio through cash flow from existing investments, borrowings, and transactions that minimize current cash outlays. However, we expect that, over time, our ability to continue our investment activities portfolio growth will depend on our ability to raise additional equity capital.
83
Mortgage Backed Securities
We acquired our current portfolio of MBS during the quarter ended September 30, 2013. The securities we purchased consist of Fannie Mae and Freddie Mac MBS with 3.5% coupon rates backed by 30-year fixed-rate mortgage loans. We held no MBS at December 31, 2012.
The relationship of the fair value of our mortgage loans at fair value (excluding mortgage loans acquired for sale at fair value) to the fair value of the real estate collateral underlying the loans is summarized below:
The collateral values presented above do not represent our assessment of the amount of future cash flows to be realized from the mortgage loans and/or underlying collateral. Future cash flows will be influenced by, among other considerations, our asset disposition strategies with respect to individual loans, the costs and expenses we incur in the disposition process, changes in borrower performance and the underlying collateral values.
Collateral values summarized above are estimated and may change over time due to various factors including our level of access to the properties securing the loans, changes in the real estate market or the condition of individual properties. Collateral values noted do not include any costs that would typically be incurred in obtaining the property in settlement of the loan, readying the property for sale or in the sale of a property.
Following is a summary of the distribution of our mortgage loans at fair value (excluding mortgage loans acquired for sale at fair value):
Loan type
ARM/Hybrid
Lien position
1st lien
2nd lien
Unsecured
84
Occupancy
Owner occupied
Investment property
Loan age
Less than 12 months
12 - 35 months
36 - 59 months
60 months or more
Origination FICO score
Less than 600
600-649
650-699
700-749
750 or greater
Current loan-value(1)
Less than 80%
80% - 99.99%
100% - 119.99%
120% or greater
85
Geographic distribution
New York
Payment status
Current
30 days delinquent
60 days delinquent
90 days or more delinquent
In foreclosure
We believe that our current fair value estimates are representative of fair value at the reporting date. However, the market for distressed mortgage assets is illiquid with very few market participants. Furthermore, our business strategy is to enhance value during the period in which the loans are held. Therefore, any resulting appreciation or depreciation in the fair value of the loans is recorded during such holding period and ultimately realized at the end of the holding period.
86
Following is a comparison of the valuation techniques and key inputs we use in the valuation of our financial assets using “Level 3” inputs:
Financial statement item
Valuation technique
Key inputs
Agency debt security(1)
Underlying collateral
loss percentage(4)
(11.8%)
(13.1%)
(3.7%)
(1.1%)
(2.4%)
(2.2%)
(23.5%)
(20.6%)
(11.9%)
—
(3.9%)
(2.1%)
Total prepayment speed (Life total
CPR)(6)
(22.9%)
We monitor and value our investments in pools of distressed mortgage loans either by acquisition date or by payment status of the loans. Most of the measures we use to value and monitor the loan portfolio, such as projected prepayment and default speeds and discount rates, are applied or output at the pool level. The characteristics of the individual loans, such as loan size, loan-to-value ratio and current delinquency status, can vary widely within a pool.
The weighted average discount rate used in the valuation of mortgage loans at fair value decreased from 13.1% at December 31, 2012 to 11.8% at September 30, 2013 as market participant expected returns for similar assets decreased during the period and we acquired pools of mortgage loans with lower discount rates.
The weighted average twelve-month projected housing price index (“HPI”) change increased from 1.1% at December 31, 2012 to 3.7% at September 30, 2013 due to improvements observed in the residential housing sector increasing the expectation of positive home price appreciation.
The total prepayment speed of our mortgage loans at fair value portfolio increased from 20.6% at December 31, 2012 to 23.5% at September 30, 2013, primarily due to an increase in the proportion of nonperforming loans in the portfolio.
87
Following is a summary of our REO by attribute as of the dates presented:
Property type
1 - 4 dwelling units
Planned unit development
Condominium/Co-op
5+ dwelling units
Pennsylvania
Maryland
South Carolina
Illinois
Connecticut
88
Following is a summary of the status of our portfolio of acquisitions by quarter acquired (excluding acquisitions for the quarter ended September 30, 2013 due to close proximity of current status to quarter-end):
Pool factor*
Collection status:
Delinquency
30 days
60 days
over 90 days
Our cash flows resulted in a net increase in cash of $66.3 million during the nine months ended September 30, 2013. The increase was due to cash provided through our financing activities exceeding cash used in our operating and investing activities. Cash used by operating activities totaled $432.2 million during the nine months ended September 30, 2013 and $662.2 million during the nine months ended September 30, 2012, primarily due to growth in our inventory of mortgage loans acquired for sale.
89
Net cash used by investing activities was $759.5 million for the nine months ended September 30, 2013. This use of cash reflects the growth of our investment portfolio. We used cash to purchase MBS totaling $199.6 million and mortgage loans with fair values of $779.0 million during the nine months ended September 30, 2013. Offsetting this use in cash were cash inflows from repayments of mortgage loans and sales of REO totaling $201.9 million and $98.2 million, respectively. During the nine months ended September 30, 2012, cash used by investing activities totaled $54.5 million primarily due to cash used for purchases of $411.4 million of mortgage loans at fair value and $112.2 million of MBS exceeding cash flows from repayments, sales and liquidations of our investments of $496.0 million.
Approximately 50% of our investments, comprised of short-term investments, non-correspondent lending mortgage loans, REO and MSRs, were nonperforming assets as of September 30, 2013. Nonperforming assets include mortgage loans delinquent 90 or more days and REO. Accordingly, we expect that these assets will require a longer period to produce cash flow and the timing and amount of cash flows from these assets is less certain than for performing assets. During the nine months ended September 30, 2013, we transferred $120.4 million of mortgage loans to REO and realized cash proceeds from the sales and repayments of mortgage loans at fair values and REO totaling $201.9 million and $98.2 million, respectively.
Our investing activities include the purchase of long-term assets which are not presently cash flowing or are at risk of interruption of cash flows in the near future. Furthermore, much of the investment income we recognize is in the form of valuation adjustments we record recognizing our estimates of the net appreciation in value of the assets as we work with borrowers to either modify their loans or acquire the property securing their loans in settlement thereof. Accordingly, the cash associated with a substantial portion of our revenues is often realized as part of the proceeds of the liquidation of the assets, either through payoff or sale of the mortgage loan or through acquisition and sale of the property securing the loans, many months after we record the revenues.
The following table illustrates the net gain (loss) in value that we accumulated over the period during which we owned the liquidated assets, as compared to the proceeds actually received and the additional net gain (loss) realized upon liquidation of such assets:
The amounts included in accumulated gains and gains on liquidation do not include the cost of managing the liquidated assets.
90
Accumulated gains include the amount of accumulated valuation gains and losses recognized throughout the holding period—which may be substantial depending on the collection status of the loan at acquisition and on our success in working with the borrower to resolve the source of distress in the loan—and in the case of REO, includes direct transaction costs incurred in the sale of the property. Accordingly, the preceding amounts do not represent periodic earnings on a cash basis and the amount of gain will have accumulated over varying periods depending on the holding periods and liquidation speed for individual assets.
The primary expenses incurred at a loan level in managing our portfolio of distressed assets are servicing and activity fees. From the time of acquisition of the distressed assets through their liquidation dates, we incurred servicing and activity fees of $3.0 million for assets liquidated during the quarter ended September 30, 2013; $2.5 million for assets liquidated during the quarter ended September 30, 2012; and $9.0 million and $6.6 million for assets liquidated during the nine months ended September 30, 2013 and 2012, respectively. We do not allocate other costs of managing our assets at a loan level.
Net cash provided by financing activities was $1.3 billion for the nine months ended September 30, 2013, during which we completed an underwritten offering of our common shares, increased borrowings through the issuance of long-term debt in the form of exchangeable senior notes with a maturity date of May 1, 2020, the sale of a portion of our securities backed by our investment in jumbo mortgage loans and increased borrowings in the form of sales of assets under agreements to repurchase. We increased borrowings primarily for the purpose of financing growth in our inventory of mortgage loans acquired for sale, mortgage loans at fair value and acquisition of MSRs through our loan sale activity. As discussed below in Liquidity and Capital Resources, our Manager continues to evaluate and pursue additional sources of financing to provide us with future investing capacity.
We do not raise equity or enter into borrowings for the purpose of financing the payment of dividends. We believe that our cash flows from the liquidation of our investments, which include accumulated gains recorded during the periods we hold those investments, along with our cash earnings, are adequate to fund our operating expenses and dividend payment requirements. However, as our business continues to grow, we manage our liquidity in the aggregate and are reinvesting our cash flows in new investments as well as using such cash to fund our dividend requirements.
Our liquidity reflects our ability to meet our current obligations (including the purchase of loans from correspondent lenders, our operating expenses and, when applicable, retirement of, and margin calls relating to, our debt and derivatives positions), make investments as our Manager identifies them and make distributions to our shareholders. We generally need to distribute at least 90% of our taxable income each year (subject to certain adjustments) to our shareholders to qualify as a REIT under the Internal Revenue Code. This distribution requirement limits our ability to retain earnings and thereby replenish or increase capital to support our activities.
We expect our primary sources of liquidity to be proceeds from liquidations from our portfolio of distressed assets, cash earnings on our investments, cash flows from business activities, and proceeds from borrowings and/or additional equity offerings. We do not expect repayments from contractual cash flows from our investments to be a primary source of liquidity as the majority of our distressed asset investments are nonperforming. Our portfolio of distressed mortgage loans was acquired with the expectation that the majority of the cash flows associated with this investment would result from liquidation of the property securing the loan, rather than from scheduled principal payments. Our mortgage loans acquired for sale are generally held by the Company for fifteen days or less, and therefore are not expected to generate significant cash flows from principal repayments.
Our current leverage strategy is to finance our assets where we believe such borrowing is prudent and appropriate. We have made borrowings in the form of borrowings under forward purchase agreements, sales of assets under agreements to repurchase, and a note payable secured by mortgage loans at fair value. We have entered into two long-term financing agreements during the nine months ended September 30, 2013. To the extent available to us, we expect in the future to obtain long-term financing for assets with estimated future lives of more than one year; this may include term financing and securitization of performing (including newly purchased jumbo mortgage loans), nonperforming and/or reperforming mortgage loans.
During the nine months ended September 30, 2013, we completed two long term financing transactions:
In September, we financed $550.5 million of jumbo loans through a private-label securitization transaction. We sold $174.5 million of senior bonds backed by the loans and retained the remaining securities from the transaction, with a portion intended
91
as long-term investments. We intend to sell a portion of the securities in the future as market conditions for private-label securities improve. We do not have plans to do additional financings through private-label securitizations until market conditions for such transactions improve.
We will continue to finance most of our assets on a short-term basis until the markets for long-term financing improve. Our short-term financings will be primarily in the form of agreements to repurchase and other secured lending and structured finance facilities, pending the ultimate disposition of the assets, whether through sale, securitization or liquidation. Because a significant portion of our current debt facilities consist of short-term borrowings, we expect to renew these facilities in advance of maturity in order to ensure our ongoing liquidity and access to capital or otherwise allow ourselves sufficient time to replace any necessary financing.
Our repurchase agreements represent the sales of assets together with agreements for us to buy back the assets at a later date. During the nine months ended September 30, 2013, the average balance outstanding under agreements to repurchase securities, mortgage loans, mortgage loans acquired for sale, mortgage loans held by variable interest entity and REO totaled $1.5 billion, and the maximum daily amount outstanding under such agreements totaled $2.6 billion. The difference between the maximum and average daily amounts outstanding was due to our use of proceeds from the senior exchangeable note and equity offerings to temporarily reduce our borrowings until those proceeds could be reinvested. The total facility size of our borrowings was approximately $2.9 billion at September 30, 2013.
As of September 30, 2013 and December 31, 2012, we financed our investments in MBS, mortgage loans at fair value and REO, and our inventory of mortgage loans acquired for sale at fair value, under agreements to repurchase and forward purchase agreements as follows:
Assets financed
Total assets in classes of assets financed
Borrowings
Percentage of invested assets pledged
Advance rate against pledged assets
As discussed above, all of our repurchase agreements and forward purchase agreements have short-term maturities:
Our debt financing agreements require us and certain of our subsidiaries to comply with various financial covenants. As of the filing of this Report, these financial covenants currently include the following:
92
Although these financial covenants limit the amount of indebtedness we may incur and impact 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.
PLS is also subject to various financial covenants, both as a borrower under its own financing arrangements and as the servicer under certain of our debt financing agreements. The most significant financial covenants currently include the following:
Our transactions relating to securities sold under agreements to repurchase contain margin call provisions that, upon notice from the applicable lender at its option, require us to transfer cash or additional securities 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 an agreement to repurchase, although in some instances we may agree with the lender upon certain thresholds (in dollar amounts or percentages based on the market value of the assets) that must be exceeded before a margin deficit will arise. 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.
The transactions relating to mortgage loans and/or equity interests in special purpose entities holding real property under agreements to repurchase contain margin call provisions that, upon notice from the applicable lender at its option, require us to transfer cash or additional mortgage loans or real property, as applicable, 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 an agreement to repurchase. 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.
Our Manager continues to explore a variety of additional means of financing our continued growth, including debt financing through bank warehouse lines of credit, additional repurchase agreements, term financing, securitization transactions and additional equity offerings. However, there can be no assurance as to how much additional financing capacity such efforts will produce, what form the financing will take or that such efforts will be successful. Further, counterparty credit sensitivity and collateral documentation requirements have made it difficult to obtain financing for REO, the result of which could place stress on our capital and liquidity positions at certain times during the foreclosure cycles of the related nonperforming loans.
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 $2.2 billion for the financing of assets under agreements to repurchase with maturities between November 19, 2013 and the earlier to occur of October 31, 2014 or the rolling maturity date that is 364 days from any date of determination, as well as forward purchase agreements with maturities between June 16, 2014 and June 30, 2014. We also had contractual obligations of $250.0 million in exchangeable senior notes with a maturity date of May 1, 2020.
As of September 30, 2013, we had contractual obligations to purchase mortgage loans for resale totaling approximately $642.0 million and mortgage loans at fair value totaling approximately $316.8 million. Of the $642.0 million in commitments to purchase mortgage loans for resale, we recorded IRLCs of $11.5 million on our balance sheet as assets under the caption Derivative assets and $30 thousand as liabilities under the caption Derivative liabilities.
All agreements to repurchase assets that matured between September 30, 2013 and the date of this Report have been renewed, extended or repaid and are described in Note 17—Mortgage Loans Acquired for Sale Sold Under Agreements to Repurchase, Note 18—Mortgage Loans at Fair Value Sold Under Agreements to Repurchase and Note 19—Real Estate Acquired in Settlement of Loans Financed Under Agreements to Repurchase in the accompanying consolidated financial statements.
93
Payment obligations under these agreements are summarized below:
Commitments to purchase mortgage loans from correspondent lenders
Commitments to purchase distressed mortgage loans
Long-term debt
The amount at risk (the fair value of the assets pledged plus the related margin deposit, less the amount advanced by the counterparty and interest payable) relating to the Company’s assets sold under agreements to repurchase and forward purchase agreements is summarized by counterparty below as of September 30, 2013:
Barclays Bank PLC
Management Agreement. We are externally managed and advised by our Manager pursuant to a management agreement, which was amended and restated effective February 1, 2013. Our management agreement requires our Manager to oversee our business affairs in conformity with the investment policies that are approved and monitored by our Board. Our Manager is responsible for our day-to-day management and will perform such services and activities related to our assets and operations as may be appropriate.
Pursuant to our management agreement, our Manager collects a base management fee and may collect a performance incentive fee, both payable quarterly and in arrears. The term of our management 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.
The base management fee is calculated at a defined annualized percentage of “shareholders’ equity.” Our “shareholders’ equity” is defined as the sum of the net proceeds from any issuances of our equity securities since our inception (weighted for the time outstanding during the measurement period); plus our retained earnings at the end of the quarter; less any amount that we pay for repurchases of our common shares (weighted for the time held during the measurement period); and excluding one-time events pursuant to changes in GAAP and certain other non-cash charges after discussions between our Manager and our independent trustees and approval by a majority of our independent trustees.
Pursuant to our management agreement, the base management fee is equal to the sum of (i) 1.5% per annum of shareholders’ equity up to $2 billion, (ii) 1.375% per annum of shareholders’ equity in excess of $2 billion and up to $5 billion, and (iii) 1.25% per annum of shareholders’ equity in excess of $5 billion. The base management fee is paid in cash.
The performance incentive fee is calculated at a defined annualized percentage of the amount by which “net income,” on a rolling four-quarter basis and before deducting the incentive fee, exceeds certain levels of return on “equity.” 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 GAAP and certain other non-cash charges determined after discussions between our Manager and our independent trustees and approval by a majority of our independent trustees. For this purpose, “equity” is the weighted average of the issue price per common share of all of our public offerings, multiplied by the weighted average number of common shares outstanding (including restricted share units) in the four-quarter period.
94
The performance incentive fee is calculated quarterly and escalates as net income (stated as a percentage of return on equity) increases over certain thresholds. On each calculation date, the threshold amounts represent a stated return on equity, plus or minus a “high watermark” adjustment. The performance fee payable for any quarter is equal to: (a) 10% of the amount by which net income for the quarter exceeds (i) an 8% return on equity plus the high watermark, up to (ii) a 12% return on equity; plus (b) 15% of the amount by which net income for the quarter exceeds (i) a 12% return on equity plus the high watermark, up to (ii) a 16% return on equity; plus (c) 20% of the amount by which net income for the quarter exceeds a 16% return on equity plus the high watermark.
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 MBS Yield (the target yield) for such quarter. If the net 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 our Manager to earn a performance incentive fee are adjusted cumulatively based on the performance of our 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 performance incentive fee may be paid in cash or in our common shares (subject to a limit of no more than 50% paid in common shares), at our option.
Under our management agreement, our Manager is entitled to reimbursement of its organizational and operating expenses, including third-party expenses, incurred on our behalf. Our Manager may also be entitled to a termination fee under certain circumstances. Specifically, the termination fee is payable for (1) our termination of our management agreement without cause, (2) our Manager’s termination of our management agreement upon a default by us in the performance of any material term of the agreement that has continued uncured for a period of 30 days after receipt of written notice thereof or (3) our Manager’s termination of the agreement after the termination by us without cause (excluding a non-renewal) of our MBWS agreement, our MSR recapture agreement, or our servicing agreement (each as described and/or defined below). 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 less than 24 months, annualized) performance incentive fee, in each case earned by our Manager during the 24-month period before termination.
Our management agreement also provides that, prior to the undertaking by our Manager or its affiliates of any new investment opportunity or any other business opportunity requiring a source of capital with respect to which our Manager or its affiliates will earn a management, advisory, consulting or similar fee, our Manager shall present to us such new opportunity and the material terms on which our Manager proposes to provide services to us before pursuing such opportunity with third parties.
Servicing Agreement. We have entered into a servicing agreement with our Servicer pursuant to which our Servicer provides servicing for our portfolio of residential mortgage loans. The loan servicing provided by our Servicer includes collecting principal, interest and escrow account payments, if any, with respect to mortgage loans, as well as managing loss mitigation, which may include, among other things, collection activities, loan workouts, modifications, foreclosures and short sales. Our Servicer also engages in certain loan origination activities that include refinancing mortgage loans and financings that facilitate sales of real estate owned properties, or REOs. The term of our 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 agreement.
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.
The base servicing fees for loans subserviced by our Servicer on our 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 our 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, our Servicer is entitled to an additional servicing fee per loan falling within a range of $10 to $75 per month and based on the delinquency, bankruptcy and foreclosure status of the loan or the related underlying real estate. Our Servicer is also entitled to customary ancillary income and certain market-based fees and charges, including boarding and deboarding fees, liquidation and disposition fees, and assumption, modification and origination fees.
Except as otherwise provided in our MSR recapture agreement, when our Servicer effects a refinancing of a loan on our behalf and not through a third-party lender and the resulting loan is readily saleable, or our Servicer originates a loan to facilitate the disposition of the real estate acquired by us in settlement of a loan, our Servicer is entitled to receive from us market-based fees and compensation consistent with pricing and terms our Servicer offers unaffiliated third parties on a retail basis.
To the extent that our Servicer participates in HAMP (or other similar mortgage loan modification programs), our Servicer is entitled to retain any incentive payments made to it and to which it is entitled under HAMP, provided that, with respect to any incentive payments paid to our Servicer in connection with a mortgage loan modification for which we previously paid our Servicer a modification fee, our Servicer is required to reimburse us an amount equal to the incentive payments.
95
In addition, because we do not have any employees or infrastructure, our Servicer 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. For these services, our Servicer receives a supplemental fee of $25 per month for each distressed whole loan and $3.25 per month for each other subserviced loan. Our Servicer is entitled to reimbursement for all customary, bona fide reasonable and necessary out-of-pocket expenses incurred by our Servicer in connection with the performance of its servicing obligations.
Mortgage Banking and Warehouse Services Agreement. We have also entered into a mortgage banking and warehouse services agreement (the “MBWS agreement”), pursuant to which our Servicer provides us with certain mortgage banking services, including fulfillment and disposition-related services, with respect to loans acquired by us from correspondent lenders, and certain warehouse lending services, including fulfillment and administrative services, with respect to loans financed by us for our warehouse lending clients. The term of our MBWS 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.
Under our MBWS agreement, our Servicer has agreed to provide the mortgage banking services exclusively for our benefit, and our Servicer and its affiliates are prohibited from providing such services for any other third party. However, such exclusivity and prohibition shall not apply, and certain other duties instead will be imposed upon our Servicer, if we are unable to purchase or finance mortgage loans as contemplated under our MBWS agreement for any reason.
In consideration for the mortgage banking services provided by our Servicer with respect to our acquisition of mortgage loans, our Servicer is entitled to a fulfillment fee based on the type of mortgage loan that we acquire 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 sold in accordance with the Ginnie Mae Mortgage-Backed Securities Guide, (iii) 0.80% for 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 PLS 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.
At this time, we do not hold the Ginnie Mae approval required to issue Ginnie Mae MBS and act as a servicer. Accordingly, under our MBWS agreement, our Servicer currently purchases loans saleable in accordance with the Ginnie Mae Mortgage-Backed Securities Guide “as is” and without recourse of any kind from us at our cost less an administrative fee plus accrued interest and a sourcing fee of three basis points.
In the event that we purchase mortgage loans with an aggregate unpaid principal balance in any month greater than $2.5 billion, our Servicer has agreed to discount the amount of such fulfillment fees by reimbursing us an amount equal to the product of (i) 0.025%, and (ii) the amount of unpaid principal balance in excess of $2.5 billion and less than or equal to $5.0 billion, plus (b) the product of (i) 0.05%, and (ii) the amount of unpaid principal balance in excess of $5 billion.
In consideration for the mortgage banking services provided by our Servicer with respect to our acquisition of mortgage loans under our Servicer’s early purchase program, our Servicer is entitled to fees accruing (i) at a rate equal to $25,000 per annum, and (ii) in the amount of $50 for each mortgage loan that we acquire. In consideration for the warehouse services provided by our Servicer with respect to mortgage loans that we finance for our warehouse lending clients, with respect to each facility, our Servicer is entitled to fees accruing (i) at a rate equal to $25,000 per annum, and (ii) in the amount of $50 for each mortgage loan that we finance thereunder. Where we have entered into both an early purchase agreement and a warehouse lending agreement with the same client, our Servicer shall only be entitled to one $25,000 per annum fee and, with respect to any mortgage loan that becomes subject to both such agreements, only one $50 per loan fee.
Notwithstanding any provision of our MBWS agreement to the contrary, if it becomes reasonably necessary or advisable for our Servicer to engage in additional services in connection with post-breach or post-default resolution activities for the purposes of a correspondent lending agreement, a warehouse agreement or a re-warehouse agreement, then we have generally agreed with our Servicer to negotiate in good faith for additional compensation and reimbursement of expenses to be paid to our Servicer for the performance of such additional services.
MSR Recapture Agreement. Effective February 1, 2013, we entered into an MSR recapture agreement with our Servicer. Pursuant to the terms of our MSR recapture agreement, if our Servicer refinances via its retail lending business loans for which we previously held the mortgage servicing rights, or MSRs, our Servicer is generally required to transfer and convey to us, without cost to us, the MSRs with respect to new mortgage loans originated in those refinancings (or, under certain circumstances, other mortgage loans) that have an aggregate unpaid principal balance that is not less than 30% of the aggregate 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, our Servicer may, at its option, wire cash to us in an amount equal to such fair market value in lieu of transferring such MSRs. The initial term of our MSR recapture agreement expires, unless terminated earlier in accordance with the terms of the agreement, on February 1, 2017, subject to automatic renewal for additional 18-month periods, unless terminated in accordance with the terms of the agreement.
96
Reimbursement Agreement. In connection with the initial public offering of our common shares (“IPO”), on August 4, 2009, we entered into an agreement with our Manager pursuant to which we agreed to reimburse our Manager for the $2.9 million payment that it made to the underwriters for the IPO (the “Conditional Reimbursement”) if we satisfied certain performance measures over a specified period of time. Effective February 1, 2013, we amended the terms of the reimbursement agreement to provide for the reimbursement of our Manager of the Conditional Reimbursement if we are required to pay our Manager performance incentive fees under our 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 reimbursement agreement also provides for the payment to the IPO underwriters of the payment that we agreed to make to them at the time of the IPO if we satisfied certain performance measures over a specified period of time. As our Manager earns performance incentive fees under our management agreement, the IPO underwriters will be paid at a rate of $20 of payments for every $100 of performance incentive fees earned by our Manager. The payment to the underwriters is subject to a maximum reimbursement in any particular 12-month period of $2.0 million and the maximum amount that may be paid under the agreement is $5.9 million.
In the event the termination fee is payable to our Manager under our management agreement and our Manager and the underwriters have 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.
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 real estate risk, credit risk, interest rate risk, prepayment risk, inflation risk and market value risk. A substantial portion of our investments are comprised of nonperforming loans. We believe that such assets’ fair values respond primarily to changes in the fair value of the real estate securing such loans.
The following table summarizes the estimated change in fair value of our portfolio of mortgage loans at fair value as of September 30, 2013, given several hypothetical (instantaneous) changes in home values from those used in the determination of fair value:
$
%
The following table summarizes the estimated change in fair value of our mortgage loans at fair value held by variable inerest entity as of September 30, 2013, net of the effect of changes in fair value of the related asset-backed secured financing of fair value, given several hypothetical (instantaneous) changes in interest rates and parallel shifts in the yield curve:
(dollar amounts in thousands)
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:
97
The following tables summarize the estimated change in fair value of MSRs accounted for using the fair value option method as of September 30, 2013, given several shifts in pricing spreads, prepayment speed and annual per-loan cost of servicing:
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:
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 1A. “Risk Factors” in our Annual Report for the year ended December 31, 2012.
Factors that could cause actual results to differ materially from historical results or those anticipated include, but are not limited to:
98
99
Other factors that could also cause results to differ from our expectations may not be described in this Report or any other document. Each of these factors could by itself, or together with one or more other factors, adversely affect our business, income and/or financial condition.
Forward-looking statements speak only as of the date they are made, and we undertake no obligation to update any forward-looking statement to reflect the impact of circumstances or events that arise after the date the forward-looking statement was made.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
In response to this Item 3, the information set forth on pages 97 through 98 is incorporated herein by reference.
Item 4. Controls and Procedures
Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures. However, 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 failures within the Company to disclose material information otherwise required to be set forth in our periodic reports.
Our management has conducted an evaluation, with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Report as required by paragraph (b) of Rules 13a-15 and 15d-15 under the Exchange Act. Based on our evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective, as of the end of the period covered by this Report, to provide reasonable assurance that information required to be disclosed by us in the 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.
Internal Control over Financial Reporting
There has been no change in our internal control over financial reporting during the quarter ended September 30, 2013 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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 under Item 1A. “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2012, filed with the SEC on February 28, 2013.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None
Item 3. Defaults Upon Senior Securities
100
Item 4. Mine Safety Disclosures
Not applicable
Item 5. Other Information
101
Item 6. Exhibits
Exhibit
Number
Exhibit Description
Declaration of Trust of PennyMac Mortgage Investment Trust, as amended and restated (incorporated by reference to Exhibit 3.1 of our Quarterly Report on Form 10-Q for the quarter ended September 30, 2009).
Amended and Restated Bylaws of PennyMac Mortgage Investment Trust (incorporated by reference to Exhibit 3.1 of our Current Report on Form 8-K filed on August 13, 2013).
Specimen Common Share Certificate of PennyMac Mortgage Investment Trust (incorporated by reference to Exhibit 4.1 of our Quarterly Report on Form 10-Q for the quarter ended September 30, 2009).
Indenture for Senior Debt Securities, dated as of April 30, 2013, among PennyMac Corp., PennyMac Mortgage Investment Trust and The Bank of New York Mellon Trust Company, N.A. (incorporated by reference to Exhibit 4.1 of our Current Report on Form 8-K filed on April 30, 2013).
First Supplemental Indenture, dated as of April 30, 2013, among PennyMac Corp., PennyMac Mortgage Investment Trust and The Bank of New York Mellon Trust Company, N.A. (incorporated by reference to Exhibit 4.2 of our Current Report on Form 8-K filed on April 30, 2013).
Form of 5.375% Exchangeable Senior Notes due 2020 (included in Exhibit 4.3).
Amended and Restated Limited Partnership Agreement of PennyMac Operating Partnership, L.P. (incorporated by reference to Exhibit 10.2 of our Quarterly Report on Form 10-Q for the quarter ended September 30, 2009).
Registration Rights Agreement, dated as of August 4, 2009, among PennyMac Mortgage Investment Trust, Stanford L. Kurland, David A. Spector, BlackRock Holdco II, Inc., Highfields Capital Investments LLC and Private National Mortgage Acceptance Company, LLC (incorporated by reference to Exhibit 10.1 of our Quarterly Report on Form 10-Q for the quarter ended September 30, 2009).
Underwriting Fee Reimbursement Agreement, dated as of August 4, 2009, among PennyMac Mortgage Investment Trust, PennyMac Operating Partnership, L.P. and PNMAC Capital Management, LLC (incorporated by reference to Exhibit 10.7 of our Quarterly Report on Form 10-Q for the quarter ended September 30, 2009).
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 1.6 of our Current Report on Form 8-K filed on February 7, 2013).
Management Agreement, dated as of August 4, 2009, among PennyMac Mortgage Investment Trust, PennyMac Operating Partnership, L.P. and PNMAC Capital Management, LLC (incorporated by reference to Exhibit 10.3 of our Quarterly Report on Form 10-Q for the quarter ended September 30, 2009).
Amendment No. 1 to Management Agreement, dated March 3, 2010, among PennyMac Mortgage Investment Trust, PennyMac Operating Partnership, L.P. and PNMAC Capital Management, LLC (incorporated by reference to Exhibit 10.4 of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2010).
Amendment No. 2 to Management Agreement, dated May 16, 2012, among PennyMac Mortgage Investment Trust, PennyMac Operating Partnership, L.P. and PNMAC Capital Management, LLC (incorporated by reference to Exhibit 1.1 of our Current Report on Form 8-K filed on May 22, 2012).
Amended and Restated Management Agreement, dated as of February 1, 2013, among PennyMac Mortgage Investment Trust, PennyMac Operating Partnership, L.P. and PNMAC Capital Management, LLC (incorporated by reference to Exhibit 1.1 of our Current Report on Form 8-K filed on February 7, 2013).
Flow Servicing Agreement, dated as of August 4, 2009, between PennyMac Operating Partnership, L.P. and PennyMac Loan Services, LLC (incorporated by reference to Exhibit 10.4 of our Quarterly Report on Form 10-Q for the quarter ended September 30, 2009).
102
Amendment No. 1 to Flow Servicing Agreement, dated as of March 3, 2010, between PennyMac Operating Partnership, L.P. and PennyMac Loan Services, LLC (incorporated by reference to Exhibit 10.6 of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2010).
Amendment No. 2 to Flow Servicing Agreement, dated as of March 8, 2011, between PennyMac Operating Partnership, L.P. and PennyMac Loan Services, LLC (incorporated by reference to Exhibit 10.8 of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2011).
Amendment No. 3 to Flow Servicing Agreement, dated as of May 17, 2011, by and between PennyMac Operating Partnership, L.P. and PennyMac Loan Services, LLC (incorporated by reference to Exhibit 10.9 of our Quarterly Report on Form 10-Q for the quarter ended June 30, 2011).
Amended and Restated Flow Servicing Agreement, dated as of February 1, 2013, between PennyMac Operating Partnership, L.P. and PennyMac Loan Services, LLC (incorporated by reference to Exhibit 1.2 of our Current Report on Form 8-K filed on February 7, 2013).
Second Amended and Restated Flow Servicing Agreement, dated as of March 1, 2013, between PennyMac Operating Partnership, L.P. and PennyMac Loan Services, LLC (incorporated by reference to Exhibit 10.14 of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2013).
PennyMac Mortgage Investment Trust 2009 Equity Incentive Plan (incorporated by reference to Exhibit 10.5 of our Quarterly Report on Form 10-Q for the quarter ended September 30, 2009).
Form of Restricted Share Unit Award Agreement under the PennyMac Mortgage Investment Trust 2009 Equity Incentive Plan (incorporated by reference to Exhibit 10.8 to Amendment No. 3 to the Company’s Registration Statement on Form S-11, filed with the SEC on July 24, 2009).
Master Repurchase Agreement, dated as of November 2, 2010, among PennyMac Corp., PennyMac Mortgage Investment Trust Holdings I, LLC, and Wells Fargo Bank, National Association (incorporated by reference to Exhibit 10.11 of our Quarterly Report on Form 10-Q for the quarter ended September 30, 2010).
Amendment Number One to Master Repurchase Agreement, dated as of August 18, 2011, among PennyMac Corp., PennyMac Mortgage Investment Trust Holdings I, LLC, and Wells Fargo Bank, National Association (incorporated by reference to Exhibit 10.13 of our Quarterly Report on Form 10-Q for the quarter ended September 30, 2011).
Amendment Number Two to Master Repurchase Agreement, dated as of September 28, 2011, among PennyMac Corp., PennyMac Mortgage Investment Trust Holdings I, LLC, and Wells Fargo Bank, National Association (incorporated by reference to Exhibit 10.14 of our Quarterly Report on Form 10-Q for the quarter ended September 30, 2011).
Amendment Number Three to Master Repurchase Agreement, dated as of December 30, 2011, among PennyMac Corp., PennyMac Mortgage Investment Trust Holdings I, LLC, and Wells Fargo Bank, National Association (incorporated by reference to Exhibit 10.15 of our Annual Report on Form 10-K for the year ended December 31, 2011).
Amendment Number Four to Master Repurchase Agreement, dated as of December 28, 2012, among PennyMac Corp., PennyMac Mortgage Investment Trust Holdings I, LLC, and Wells Fargo Bank, National Association (incorporated by reference to Exhibit 10.17 of our Annual Report on Form 10-K for the year ended December 31, 2012).
Guaranty Agreement, dated as of November 2, 2010, by PennyMac Mortgage Investment Trust in favor of Wells Fargo Bank, National Association (incorporated by reference to Exhibit 10.12 of our Quarterly Report on Form 10-Q for the quarter ended September 30, 2010).
Amendment Number One to Guaranty Agreement, dated as of August 18, 2011, by PennyMac Mortgage Investment Trust in favor of Wells Fargo Bank, National Association (incorporated by reference to Exhibit 10.16 of our Quarterly Report on Form 10-Q for the quarter ended September 30, 2011).
Amendment Number Two to Guaranty Agreement, dated as of September 28, 2011, by PennyMac Mortgage Investment Trust in favor of Wells Fargo Bank, National Association (incorporated by reference to Exhibit 10.17 of our Quarterly Report on Form 10-Q for the quarter ended September 30, 2011).
Master Repurchase Agreement, dated as of November 2, 2010, among Credit Suisse First Boston Mortgage Capital, LLC, PennyMac Corp., PennyMac Mortgage Investment Trust and PennyMac Operating Partnership, L.P. (incorporated by reference to Exhibit 10.13 of our Quarterly Report on Form 10-Q for the quarter ended September 30, 2010).
103
Amendment Number One to Master Repurchase Agreement, dated as of May 20, 2011, among Credit Suisse First Boston Mortgage Capital LLC, PennyMac Corp., PennyMac Mortgage Investment Trust and PennyMac Operating Partnership, L.P. (incorporated by reference to Exhibit 10.15 of our Quarterly Report on Form 10-Q for the quarter ended June 30, 2011).
Amendment Number Two to Master Repurchase Agreement, dated as of July 14, 2011, among Credit Suisse First Boston Mortgage Capital LLC, PennyMac Corp., PennyMac Mortgage Investment Trust and PennyMac Operating Partnership, L.P (incorporated by reference to Exhibit 10.20 of our Quarterly Report on Form 10-Q for the quarter ended September 30, 2011).
Amendment Number Three to Master Repurchase Agreement, dated as of October 7, 2011, among Credit Suisse First Boston Mortgage Capital LLC, PennyMac Corp., PennyMac Mortgage Investment Trust and PennyMac Operating Partnership, L.P (incorporated by reference to Exhibit 10.21 of our Quarterly Report on Form 10-Q for the quarter ended September 30, 2011).
Amendment Number Four to Master Repurchase Agreement, dated as of November 1, 2011, among Credit Suisse First Boston Mortgage Capital LLC, PennyMac Corp., PennyMac Mortgage Investment Trust and PennyMac Operating Partnership, L.P (incorporated by reference to Exhibit 10.22 of our Quarterly Report on Form 10-Q for the quarter ended September 30, 2011).
Amendment Number Five to Master Repurchase Agreement, dated as of November 30, 2011, among Credit Suisse First Boston Mortgage Capital LLC, PennyMac Corp., PennyMac Mortgage Investment Trust and PennyMac Operating Partnership, L.P. (incorporated by reference to Exhibit 1.1 of our Current Report on Form 8-K filed on November 30, 2011).
Amendment Number Six to Master Repurchase Agreement, dated as of March 29, 2012, among Credit Suisse First Boston Mortgage Capital LLC, PennyMac Corp., PennyMac Mortgage Investment Trust and PennyMac Operating Partnership, L.P. (incorporated by reference to Exhibit 10.25 of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2012).
Amendment Number Seven to Master Repurchase Agreement, dated as of July 25, 2012, among Credit Suisse First Boston Mortgage Capital LLC, PennyMac Corp., PennyMac Mortgage Investment Trust and PennyMac Operating Partnership, L.P. (incorporated by reference to Exhibit 1.1 of our Current Report on Form 8-K filed on July 31, 2012).
Amendment Number Eight to Master Repurchase Agreement, dated as of September 26, 2012, among Credit Suisse First Boston Mortgage Capital LLC, PennyMac Corp., PennyMac Mortgage Investment Trust and PennyMac Operating Partnership, L.P. (incorporated by reference to Exhibit 1.1 of our Current Report on Form 8-K filed on October 1, 2012).
Amendment Number Nine to Master Repurchase Agreement, dated as of October 29, 2012, among Credit Suisse First Boston Mortgage Capital LLC, PennyMac Corp., PennyMac Mortgage Investment Trust and PennyMac Operating Partnership, L.P. (incorporated by reference to Exhibit 1.1 of our Current Report on Form 8-K filed on October 29, 2012).
Amended and Restated Master Repurchase Agreement, dated as of June 1, 2013, among Credit Suisse First Boston Mortgage Capital LLC, PennyMac Corp., PennyMac Mortgage Investment Trust and PennyMac Operating Partnership, L.P. (incorporated by reference to Exhibit 10.1 of our Current Report on Form 8-K filed June 5, 2013).
Amendment Number 1 to Amended and Restated Master Repurchase Agreement, dated as of August 29, 2013, among Credit Suisse First Boston Mortgage Capital LLC, PennyMac Corp., PennyMac Mortgage Investment Trust and PennyMac Operating Partnership, L.P. (incorporated by reference to Exhibit 10.1 of our Current Report on Form 8-K filed September 5, 2013).
Guaranty, dated as of November 2, 2010, by PennyMac Mortgage Investment Trust and PennyMac Operating Partnership, L.P. and Credit Suisse First Boston Mortgage Capital, LLC (incorporated by reference to Exhibit 10.14 of our Quarterly Report on Form 10-Q for the quarter ended September 30, 2010).
Master Repurchase Agreement, dated as of December 9, 2010, among PennyMac Corp., PennyMac Mortgage Investment Trust Holdings I, LLC, and PennyMac Loan Services, LLC, and Citibank, N.A. (incorporated by reference to Exhibit 1.1 of our Current Report on Form 8-K filed on December 15, 2010).
Amendment Number One to Master Repurchase Agreement, dated as of February 25, 2011, by and among Citibank, N.A. and PennyMac Corp., PennyMac Mortgage Investment Trust Holdings I, LLC and PennyMac Loan Services, LLC (incorporated by reference to Exhibit 1.1 of our Current Report on Form 8-K filed on March 3, 2011).
104
Amendment Number Two to Master Repurchase Agreement, dated as of December 8, 2011, by and among Citibank, N.A. and PennyMac Corp., PennyMac Mortgage Investment Trust Holdings I, LLC and PennyMac Loan Services, LLC (incorporated by reference to Exhibit 10.28 of our Annual Report on Form 10-K for the year ended December 31, 2011).
Amendment Number Three to Master Repurchase Agreement, dated as of February 24, 2012, by and among Citibank, N.A. and PennyMac Corp., PennyMac Mortgage Investment Trust Holdings I, LLC and PennyMac Loan Services, LLC (incorporated by reference to Exhibit 10.30 of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2012).
Amendment Number Four to Master Repurchase Agreement, dated as of April 13, 2012, by and among Citibank, N.A. and PennyMac Corp., PennyMac Mortgage Investment Trust Holdings I, LLC and PennyMac Loan Services, LLC (incorporated by reference to Exhibit 10.32 of our Quarterly Report on Form 10-Q for the quarter ended June 30, 2012).
Amendment Number Five to Master Repurchase Agreement, dated as of April 20, 2012, by and among Citibank, N.A. and PennyMac Corp., PennyMac Mortgage Investment Trust Holdings I, LLC and PennyMac Loan Services, LLC (incorporated by reference to Exhibit 10.33 of our Quarterly Report on Form 10-Q for the quarter ended June 30, 2012).
Amendment Number Six to Master Repurchase Agreement, dated as of May 31, 2012, by and among Citibank, N.A. and PennyMac Corp., PennyMac Mortgage Investment Trust Holdings I, LLC and PennyMac Loan Services, LLC (incorporated by reference to Exhibit 1.1 of our Current Report on Form 8-K filed on June 5, 2012).
Amendment Number Seven to Master Repurchase Agreement, dated as of November 13, 2012, by and among Citibank, N.A. and PennyMac Corp., PennyMac Mortgage Investment Trust Holdings I, LLC and PennyMac Loan Services, LLC (incorporated by reference to Exhibit 10.39 of our Annual Report on Form 10-K for the year ended December 31, 2012).
Amendment Number Eight to Master Repurchase Agreement, dated as of December 31, 2012, by and among Citibank, N.A. and PennyMac Corp., PennyMac Mortgage Investment Trust Holdings I, LLC and PennyMac Loan Services, LLC (incorporated by reference to Exhibit 10.40 of our Annual Report on Form 10-K for the year ended December 31, 2012).
Amendment Number Nine to Master Repurchase Agreement, dated as of March 12, 2013, by and among Citibank, N.A. and PennyMac Corp., PennyMac Mortgage Investment Trust Holdings I, LLC and PennyMac Loan Services, LLC (incorporated by reference to Exhibit 1.1 of our Current Report on Form 8-K filed on March 13, 2013).
Amendment Number Ten to Master Repurchase Agreement, dated as of April 19, 2013, by and among Citibank, N.A. and PennyMac Corp., PennyMac Mortgage Investment Trust Holdings I, LLC and PennyMac Loan Services, LLC. (incorporated by reference to Exhibit 10.47 of our Quarterly Report on Form 10-Q for the quarter ended June 30, 2013).
Amendment Number Eleven to Master Repurchase Agreement, dated as of June 25, 2013, by and among Citibank, N.A. and PennyMac Corp., PennyMac Mortgage Investment Trust Holdings I, LLC and PennyMac Loan Services, LLC. (incorporated by reference to Exhibit 10.48 of our Quarterly Report on Form 10-Q for the quarter ended June 30, 2013).
Amendment Number Twelve to Master Repurchase Agreement, dated as of July 25, 2013, by and among Citibank, N.A. and PennyMac Corp., PennyMac Mortgage Investment Trust Holdings I, LLC and PennyMac Loan Services, LLC. (incorporated by reference to Exhibit 1.1 of our Current Report on Form 8-K filed on July 31, 2013).
Guaranty Agreement, dated as of December 9, 2010, by PennyMac Mortgage Investment Trust in favor of Citibank, N.A. (incorporated by reference to Exhibit 1.2 of our Current Report on Form 8-K filed on December 15, 2010).
Master Repurchase Agreement, dated as of June 8, 2011, among Credit Suisse First Boston Mortgage Capital LLC, PennyMac Corp., PennyMac Mortgage Investment Trust Holdings I, LLC and PennyMac Mortgage Investment Trust (incorporated by reference to Exhibit 1.1 of our Current Report on Form 8-K filed on June 14, 2011).
Amended and Restated Master Repurchase Agreement, dated as of August 25, 2011, among Credit Suisse First Boston Mortgage Capital LLC, PennyMac Corp., PennyMac Mortgage Investment Trust Holdings I, LLC and PennyMac Mortgage Investment Trust (incorporated by reference to Exhibit 10.28 of our Quarterly Report on Form 10-Q for the quarter ended September 30, 2011).
Amendment No. 1 to Amended and Restated Master Repurchase Agreement, dated as of June 6, 2012, among Credit Suisse First Boston Mortgage Capital, LLC, PennyMac Corp., PennyMac Mortgage Investment Trust Holdings I, LLC and PennyMac Mortgage Investment Trust (incorporated by reference to Exhibit 10.38 of our Quarterly Report on Form 10-Q for the quarter ended June 30, 2012).
105
Amendment No. 2 to Amended and Restated Master Repurchase Agreement, dated as of March 28, 2013, among Credit Suisse First Boston Mortgage Capital, LLC, PennyMac Corp., PennyMac Mortgage Investment Trust Holdings I, LLC and PennyMac Mortgage Investment Trust (incorporated by reference to Exhibit 10.50 of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2013).
Amendment No. 3 to Amended and Restated Master Repurchase Agreement, dated as of May 8, 2013, among Credit Suisse First Boston Mortgage Capital, LLC, PennyMac Corp., PennyMac Mortgage Investment Trust Holdings I, LLC and PennyMac Mortgage Investment Trust (incorporated by reference to Exhibit 10.51 of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2013).
Guaranty, dated as of June 8, 2011, of PennyMac Mortgage Investment Trust in favor of Credit Suisse First Boston Mortgage Capital LLC (incorporated by reference to Exhibit 1.2 of our Current Report on Form 8-K filed on June 14, 2011).
Master Loan and Security Agreement, dated as of September 28, 2011, by and between PCNPL Trust and Wells Fargo Bank, National Association (incorporated by reference to Exhibit 1.1 of our Current Report on Form 8-K filed on October 4, 2011).
Limited Guaranty Agreement, dated as of September 28, 2011, of PennyMac Mortgage Investment Trust in favor of Wells Fargo Bank, National Association (incorporated by reference to Exhibit 1.2 of our Current Report on Form 8-K filed on October 4, 2011).
Master Repurchase Agreement, dated as of November 7, 2011, among Bank of America, N.A., PennyMac Corp., PennyMac Mortgage Investment Trust and PennyMac Operating Partnership, L.P. (incorporated by reference to Exhibit 1.1 of our Current Report on Form 8-K filed on November 14, 2011).
Amendment No. 1 to Master Repurchase Agreement, dated as of August 17, 2012, among Bank of America, N.A., PennyMac Corp., PennyMac Mortgage Investment Trust and PennyMac Operating Partnership, L.P. (incorporated by reference to Exhibit 10.45 of our Quarterly Report on Form 10-Q for the quarter ended September 30, 2012).
Amendment No. 2 to Master Repurchase Agreement, dated as of January 3, 2013, among Bank of America, N.A., PennyMac Corp., PennyMac Mortgage Investment Trust and PennyMac Operating Partnership, L.P. (incorporated by reference to Exhibit 1.1 of our Current Report on Form 8-K filed on January 7, 2013).
Amendment No. 3 to Master Repurchase Agreement, dated as of March 28, 2013, among Bank of America, N.A., PennyMac Corp., PennyMac Mortgage Investment Trust and PennyMac Operating Partnership, L.P. (incorporated by reference to Exhibit 1.1 of our Current Report on Form 8-K filed on April 3, 2013).
Guaranty, dated as of November 7, 2011, by PennyMac Mortgage Investment Trust and PennyMac Operating Partnership, L.P., in favor of Bank of America, N.A. (incorporated by reference to Exhibit 1.1 of our Current Report on Form 8-K filed on November 14, 2011).
Letter Agreement, dated as of July 21, 2011, by and between PennyMac Corp. and Citigroup Global Markets Realty Corp. (incorporated by reference to Exhibit 10.32 of our Quarterly Report on Form 10-Q for the quarter ended September 30, 2011).*
Amendment Number One, dated as of January 6, 2012, to Letter Agreement, dated as of July 12, 2011, by and between PennyMac Corp. and Citigroup Global Markets Realty Corp. (incorporated by reference to Exhibit 10.40 of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2012).*
Amendment Number Two, dated as of February 1, 2012, to Letter Agreement, dated as of July 12, 2011, by and between PennyMac Corp. and Citigroup Global Markets Realty Corp. (incorporated by reference to Exhibit 10.41 of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2012).*
Letter Agreement, dated as of December 20, 2011, by and between PennyMac Corp. and Citigroup Global Markets Realty Corp. (incorporated by reference to Exhibit 10.38 of our Annual Report on Form 10-K for the year ended December 31, 2011).*
Master Repurchase Agreement, dated as of March 29, 2012, among Credit Suisse First Boston Mortgage Capital, LLC, PennyMac Mortgage Investment Trust Holdings I, LLC, PennyMac Mortgage Investment Trust and PennyMac Operating Partnership, L.P. (incorporated by reference to Exhibit 1.1 of our Current Report on Form 8-K filed on March 29, 2012).
Amendment Number One to Master Repurchase Agreement, dated as of July 25, 2012, among Credit Suisse First Boston Mortgage Capital, LLC, PennyMac Mortgage Investment Trust Holdings I, LLC, PennyMac Mortgage Investment Trust and PennyMac Operating Partnership, L.P. (incorporated by reference to Exhibit 1.2 of our Current Report on Form 8-K filed on July 31, 2012).
106
Amendment Number Two to Master Repurchase Agreement, dated as of September 26, 2012, among Credit Suisse First Boston Mortgage Capital, LLC, PennyMac Mortgage Investment Trust Holdings I, LLC, PennyMac Mortgage Investment Trust and PennyMac Operating Partnership, L.P. (incorporated by reference to Exhibit 1.2 of our Current Report on Form 8-K filed on October 1, 2012).
Amendment Number Three to Master Repurchase Agreement, dated as of October 29, 2012, among Credit Suisse First Boston Mortgage Capital, LLC, PennyMac Mortgage Investment Trust Holdings I, LLC, PennyMac Mortgage Investment Trust and PennyMac Operating Partnership, L.P. (incorporated by reference to Exhibit 1.2 of our Current Report on Form 8-K filed on October 29, 2012).
Amendment Number Four to Master Repurchase Agreement, dated as of June 1, 2013, among Credit Suisse First Boston Mortgage Capital, LLC, PennyMac Mortgage Investment Trust Holdings I, LLC, PennyMac Mortgage Investment Trust and PennyMac Operating Partnership, L.P. (incorporated by reference to Exhibit 10.2 of our Current Report on Form 8- K filed on June 5, 2013).
Amendment Number Five to Master Repurchase Agreement, dated as of August 29, 2013, among Credit Suisse First Boston Mortgage Capital, LLC, PennyMac Mortgage Investment Trust Holdings I, LLC, PennyMac Mortgage Investment Trust and PennyMac Operating Partnership, L.P. (incorporated by reference to Exhibit 10.2 of our Current Report on Form 8-K filed on September 5, 2013).
Amendment Number Six to Master Repurchase Agreement, dated as of September 27, 2013, among Credit Suisse First Boston Mortgage Capital, LLC, PennyMac Mortgage Investment Trust Holdings I, LLC, PennyMac Mortgage Investment Trust and PennyMac Operating Partnership, L.P.
Guaranty, dated as of March 29, 2012, by PennyMac Mortgage Investment Trust and PennyMac Operating Partnership, L.P. in favor of Credit Suisse First Boston Mortgage Capital, LLC (incorporated by reference to Exhibit 1.2 of our Current Report on Form 8-K filed on March 29, 2012).
Master Repurchase Agreement, dated as of May 24, 2012, among Citibank, N.A., PennyMac Corp. and PennyMac Loan Services, LLC (incorporated by reference to Exhibit 1.1 of our Current Report on Form 8-K filed on May 30, 2012).
Amendment Number One to Master Repurchase Agreement, dated as of October 15, 2012, among Citibank, N.A., PennyMac Corp. and PennyMac Loan Services, LLC (incorporated by reference to Exhibit 1.1 of our Current Report on Form 8-K filed on October 16, 2012).
Amendment Number Two to Master Repurchase Agreement, dated as of November 13, 2012, among Citibank, N.A., PennyMac Corp. and PennyMac Loan Services, LLC (incorporated by reference to Exhibit 10.62 of our Annual Report on Form 10-K for the year ended December 31, 2012).
Amendment Number Three to Master Repurchase Agreement, dated as of December 31, 2012, among Citibank, N.A., PennyMac Corp. and PennyMac Loan Services, LLC (incorporated by reference to Exhibit 10.72 of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2013).
Amendment Number Four to Master Repurchase Agreement, dated as of May 23, 2013, among Citibank, N.A., PennyMac Corp. and PennyMac Loan Services, LLC. (incorporated by reference to Exhibit 10.77 of our Quarterly Report on Form 10-Q for the quarter ended June 30, 2013).
Amendment Number Five to Master Repurchase Agreement, dated as of June 25, 2013, among Citibank, N.A., PennyMac Corp. and PennyMac Loan Services, LLC. (incorporated by reference to Exhibit 10.78 of our Quarterly Report on Form 10-Q for the quarter ended June 30, 2013).
Amendment Number Six to Master Repurchase Agreement, dated as of July 25, 2013, among Citibank, N.A., PennyMac Corp. and PennyMac Loan Services, LLC. (incorporated by reference to Exhibit 1.2 of our Current Report on Form 8-K filed on July 31, 2013).
Guaranty, dated as of May 24, 2012, by PennyMac Mortgage Investment Trust in favor of Citibank, N.A. (incorporated by reference to Exhibit 1.2 of our Current Report on Form 8-K filed on May 30, 2012).
Master Repurchase Agreement, dated as of July 2, 2012, among Barclays Bank PLC, PennyMac Corp., PennyMac Loan Services, LLC and PennyMac Mortgage Investment Trust (incorporated by reference to Exhibit 1.1 of our Current Report on Form 8-K filed on July 10, 2012).
Amendment No. 1 to Master Repurchase Agreement, dated as of February 1, 2013, among PennyMac Corp., PennyMac Loan Services, LLC, PennyMac Mortgage Investment Trust and Barclays Bank PLC. (incorporated by reference to Exhibit 10.81 of our Quarterly Report on Form 10-Q for the quarter ended June 30, 2013).
Amendment No. 2 to Master Repurchase Agreement, dated as of June 28, 2013, among PennyMac Corp., PennyMac Loan Services, LLC, PennyMac Mortgage Investment Trust and Barclays Bank PLC. (incorporated by reference to Exhibit 10.82 of our Quarterly Report on Form 10-Q for the quarter ended June 30, 2013).
107
Amended and Restated Mortgage Banking Services Agreement, dated as of November 1, 2010, between PennyMac Corp. and PennyMac Loan Services, LLC (incorporated by reference to Exhibit 10.53 of our Quarterly Report on Form 10-Q for the quarter ended June 30, 2012).
Amendment No. 1 to Amended and Restated Mortgage Banking Services Agreement, dated as of July 1, 2011, between PennyMac Corp. and PennyMac Loan Services, LLC (incorporated by reference to Exhibit 10.54 of our Quarterly Report on Form 10-Q for the quarter ended June 30, 2012).
Amendment No. 2 to Amended and Restated Mortgage Banking Services Agreement, dated as of February 29, 2012, between PennyMac Corp. and PennyMac Loan Services, LLC (incorporated by reference to Exhibit 10.55 of our Quarterly Report on Form 10-Q for the quarter ended June 30, 2012).
Amendment No. 3 to Amended and Restated Mortgage Banking Services Agreement, dated as of May 16, 2012, between PennyMac Corp. and PennyMac Loan Services, LLC (incorporated by reference to Exhibit 10.56 of our Quarterly Report on Form 10-Q for the quarter ended June 30, 2012).
Master Repurchase Agreement, dated as of September 28, 2012, among Credit Suisse First Boston Mortgage Capital, LLC, PennyMac Operating Partnership, L.P. and PennyMac Mortgage Investment Trust (incorporated by reference to Exhibit 1.1 of our Current Report on Form 8-K filed on October 3, 2012).
Amendment No. 1 to Master Repurchase Agreement, dated as of May 8, 2013, among Credit Suisse First Boston Mortgage Capital, LLC, PennyMac Operating Partnership, L.P. and PennyMac Mortgage Investment Trust (incorporated by reference to Exhibit 10.80 of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2013).
Guaranty, dated as of September 28, 2012, by PennyMac Mortgage Investment Trust in favor of Credit Suisse First Boston Mortgage Capital, LLC (incorporated by reference to Exhibit 1.2 of our Current Report on Form 8-K filed on October 3, 2012).
Master Repurchase Agreement, dated as of November 20, 2012, among PennyMac Corp., Morgan Stanley Bank, N.A. and Morgan Stanley Mortgage Capital Holdings LLC (incorporated by reference to Exhibit 1.1 of our Current Report on Form 8-K filed on November 26, 2012).
Amendment Number One to Master Repurchase Agreement, dated as of August 20, 2013, among PennyMac Corp., Morgan Stanley Bank, N.A. and Morgan Stanley Mortgage Capital Holdings LLC.
Amendment Number Two to Master Repurchase Agreement, dated as of August 26, 2013, among PennyMac Corp., Morgan Stanley Bank, N.A. and Morgan Stanley Mortgage Capital Holdings LLC.
Guaranty, dated as of November 20, 2012, by PennyMac Mortgage Investment Trust in favor of Morgan Stanley Bank, N.A. and Morgan Stanley Mortgage Capital Holdings LLC (incorporated by reference to Exhibit 1.2 of our Current Report on Form 8-K filed on November 26, 2012).
Mortgage Banking and Warehouse Services Agreement, dated as of February 1, 2013, by and between PennyMac Loan Services, LLC and PennyMac Corp. (incorporated by reference to Exhibit 1.3 of our Current Report on Form 8-K filed on February 7, 2013).
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 10.85 of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2013).
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 our Current Report on Form 8-K filed on August 19, 2013).
MSR Recapture Agreement, dated as of February 1, 2013, by and between PennyMac Loan Services, LLC and PennyMac Corp. (incorporated by reference to Exhibit 1.4 of our Current Report on Form 8-K filed on February 7, 2013).
Amendment No. 1 to MSR Recapture Agreement, dated as of August 1, 2013, by and between PennyMac Loan Services, LLC and PennyMac Corp.
Master Spread Acquisition and MSR 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 1.5 of our Current Report on Form 8-K filed on February 7, 2013).
Amendment No. 1 to Master Spread Acquisition and MSR Servicing Agreement, dated as of September 30, 2013, by and between PennyMac Loan Services, LLC and PennyMac Operating Partnership, L.P.
108
Confidentiality Agreement, dated as of February 6, 2013, between Private National Mortgage Acceptance Company, LLC and PennyMac Mortgage Investment Trust (incorporated by reference to Exhibit 1.7 of our Current Report on Form 8-K filed on February 7, 2013).
Amended and Restated Confidentiality Agreement, dated as of March 1, 2013, between Private National Mortgage Acceptance Company, LLC and PennyMac Mortgage Investment Trust (incorporated by reference to Exhibit 10.89 of our Quarterly Report on Form 10-Q for the quarter ended March 31, 2013).
Letter Agreement, dated as of June 14, 2013, between PennyMac Corp. and Citigroup Global Markets Realty Corp. (incorporated by reference to Exhibit 10.98 of our Quarterly Report on Form 10-Q for the quarter ended June 30, 2013).
Letter Agreement, dated as of June 28, 2013, between PennyMac Corp. and Citigroup Global Markets Realty Corp. (incorporated by reference to Exhibit 10.99 of our Quarterly Report on Form 10-Q for the quarter ended June 30, 2013).
Certification of Stanford L. Kurland pursuant to Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes- Oxley Act of 2002.
Certification of Anne D. McCallion pursuant to Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes- Oxley Act of 2002.
Certification of Stanford L. Kurland pursuant to Rule 13a-14(b) and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Certification of Anne D. McCallion pursuant to Rule 13a-14(b) and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
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 Shareholders’ 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.
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.
(Registrant)
/s/ STANFORD L. KURLAND
/s/ ANNE D. MCCALLION
INDEX OF EXHIBITS