Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
Form 10-Q
(Mark One)
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2021
or
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 001-38727
PennyMac Financial Services, Inc.
(Exact name of registrant as specified in its charter)
Delaware
83-1098934
(State or other jurisdiction of
(IRS Employer
incorporation or organization)
Identification No.)
3043 Townsgate Road, Westlake Village, California
91361
(Address of principal executive offices)
(Zip Code)
(818) 224-7442
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, $0.0001 par value
PFSI
New York Stock Exchange
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 ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ☒
Accelerated filer ☐
Non-accelerated filer ☐
Smaller reporting company ☐
Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
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 August 3, 2021
62,055,841
PENNYMAC FINANCIAL SERVICES, INC.
FORM 10-Q
June 30, 2021
TABLE OF CONTENTS
Page
Special Note Regarding Forward-Looking Statements
3
PART I. FINANCIAL INFORMATION
6
Item 1.
Financial Statements (Unaudited):
Consolidated Balance Sheets
Consolidated Statements of Income
7
Consolidated Statements of Changes in Stockholders’ Equity
8
Consolidated Statements of Cash Flows
9
Notes to Consolidated Financial Statements
10
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
62
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
80
Item 4.
Controls and Procedures
82
PART II. OTHER INFORMATION
83
Legal Proceedings
Item 1A.
Risk Factors
84
Unregistered Sales of Equity Securities and Use of Proceeds
Defaults Upon Senior Securities
Mine Safety Disclosures
Item 5.
Other Information
Item 6.
Exhibits
85
2
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q (“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 the section entitled “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2020, filed with the Securities and Exchange Commission (“SEC”) on February 25, 2021.
Factors that could cause actual results to differ materially from historical results or those anticipated include, but are not limited to:
4
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, results of operations 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.
5
Item 1. Financial Statements
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
June 30,
December 31,
2021
2020
(in thousands, except share amounts)
ASSETS
Cash
$
324,158
532,716
Short-term investments at fair value
3,720
15,217
Loans held for sale at fair value (includes $10,451,126 and $11,457,678 pledged to creditors)
10,884,506
11,616,400
Assets purchased from PennyMac Mortgage Investment Trust under agreements to resell pledged to creditors
—
80,862
Derivative assets
371,269
711,238
Servicing advances, net (includes valuation allowance of $140,270 and $181,433; $311,896 and $413,484 pledged to creditors)
519,028
579,528
Mortgage servicing rights at fair value (includes $3,408,088 and $2,577,964 pledged to creditors)
3,412,648
2,581,174
Operating lease right-of-use assets
75,829
74,934
Investment in PennyMac Mortgage Investment Trust at fair value
1,580
1,105
Receivable from PennyMac Mortgage Investment Trust
61,883
87,005
Loans eligible for repurchase
7,613,244
14,625,447
Other (includes $60,857 and $166,418 pledged to creditors)
612,273
692,169
Total assets
23,880,138
31,597,795
LIABILITIES
Assets sold under agreements to repurchase
8,254,543
9,654,797
Mortgage loan participation purchase and sale agreements
512,253
521,477
Obligations under capital lease
7,677
11,864
Notes payable secured by mortgage servicing assets
1,296,731
1,295,840
Unsecured senior notes
1,288,769
645,820
Excess servicing spread financing payable to PennyMac Mortgage Investment Trust at fair value
131,750
Derivative liabilities
43,910
42,638
Mortgage servicing liabilities at fair value
100,091
45,324
Accounts payable and accrued expenses
369,766
308,398
Operating lease liabilities
96,463
94,193
Payable to PennyMac Mortgage Investment Trust
136,660
140,306
Payable to exchanged Private National Mortgage Acceptance Company, LLC unitholders under tax receivable agreement
31,815
35,165
Income taxes payable
570,052
622,700
Liability for loans eligible for repurchase
Liability for losses under representations and warranties
44,335
32,688
Total liabilities
20,366,309
28,208,407
Commitments and contingencies – Note 16
STOCKHOLDERS’ EQUITY
Common stock—authorized 200,000,000 shares of $0.0001 par value; issued and outstanding, 64,483,965 and 70,905,532 shares, respectively
Additional paid-in capital
618,337
1,047,052
Retained earnings
2,895,486
2,342,329
Total stockholders' equity
3,513,829
3,389,388
Total liabilities and stockholders’ equity
The accompanying notes are an integral part of these consolidated financial statements.
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Quarter ended June 30,
Six months ended June 30,
(in thousands, except per share amounts)
Revenues
Net gains on loans held for sale at fair value:
From non-affiliates
594,196
687,765
1,362,785
954,131
From PennyMac Mortgage Investment Trust
(11,548)
(5,592)
(25,796)
72,324
582,648
682,173
1,336,989
1,026,455
Loan origination fees:
90,163
54,660
186,008
108,251
7,128
4,288
15,320
8,268
97,291
58,948
201,328
116,519
Fulfillment fees from PennyMac Mortgage Investment Trust
54,020
52,815
114,855
94,755
Net loan servicing fees:
Loan servicing fees:
208,275
199,178
419,028
397,831
20,015
15,533
39,108
30,054
Other
31,731
28,543
61,330
57,298
260,021
243,254
519,466
485,183
Change in fair value of mortgage servicing rights and mortgage servicing liabilities
(336,268)
(205,789)
(112,805)
(1,241,002)
Change in fair value of excess servicing spread financing payable to PennyMac Mortgage Investment Trust
636
(1,037)
15,158
Mortgage servicing rights hedging results
91,118
(15,764)
(351,033)
1,020,806
(245,150)
(220,917)
(464,875)
(205,038)
Net loan servicing fees
14,871
22,337
54,591
280,145
Net interest (expense) income:
Interest income:
80,797
46,526
162,491
117,872
792
387
2,010
47,318
162,878
119,882
Interest expense:
To non-affiliates
102,431
50,835
208,864
110,373
To PennyMac Mortgage Investment Trust
2,372
1,280
4,346
53,207
210,144
114,719
Net interest (expense) income
(21,634)
(5,889)
(47,266)
5,163
Management fees from PennyMac Mortgage Investment Trust
11,913
8,288
20,362
17,343
Change in fair value of investment in and dividends received from PennyMac Mortgage Investment Trust
144
543
545
(314)
Results of real estate acquired in settlement of loans
540
296
1,320
(411)
2,459
2,123
4,214
3,804
Total net revenues
742,252
821,634
1,686,938
1,543,459
Expenses
Compensation
265,067
179,886
523,896
348,322
Loan origination
75,675
50,921
163,067
96,925
Technology
34,236
21,905
67,908
41,012
Servicing
31,290
56,503
50,473
98,669
Professional services
24,834
12,500
38,120
25,904
Occupancy and equipment
9,029
8,293
18,067
16,331
22,606
11,264
39,884
21,204
Total expenses
462,737
341,272
901,415
648,367
Income before provision for income taxes
279,515
480,362
785,523
895,092
Provision for income taxes
75,286
127,685
204,426
236,172
Net income
204,229
352,677
581,097
658,920
Earnings per share
Basic
3.10
4.53
8.61
8.42
Diluted
2.94
4.39
8.16
8.11
Weighted average shares outstanding
65,890
77,790
67,493
78,240
69,399
80,424
71,248
81,241
Dividend declared per share
0.20
0.12
0.40
0.24
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (UNAUDITED)
Quarter ended June 30, 2021
Additional
Total
Number of
Par
paid-in
Retained
stockholders'
shares
value
capital
earnings
equity
(in thousands)
Balance, March 31, 2021
66,961
762,585
2,704,822
3,467,414
Stock-based compensation
96
10,621
Issuance of common stock in settlement of directors' fees
1
50
Repurchase of common stock
(2,574)
(1)
(154,919)
(154,920)
Common stock dividend ($0.20 per share)
(13,565)
Balance, June 30, 2021
64,484
Quarter ended June 30, 2020
Balance, March 31, 2020
79,190
1,341,219
1,022,902
2,364,129
141
9,306
48
(6,975)
(237,161)
(237,162)
Common stock dividend ($0.12 per share)
(9,805)
Balance, June 30, 2020
72,358
1,113,412
1,365,774
2,479,193
Six months ended June 30, 2021
Balance, December 31, 2020
70,906
803
14,622
101
(7,227)
(443,438)
(443,439)
Common stock dividends ($0.40 per share)
(27,940)
Six months ended June 30, 2020
Balance, December 31, 2019
78,515
1,335,107
726,392
2,061,507
1,053
19,491
(7,213)
(241,282)
(241,283)
Common stock dividends ($0.24 per share)
(19,538)
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Cash flow from operating activities
Adjustments to reconcile net income to net cash used in operating activities:
Net gains on loans held for sale at fair value
(1,336,989)
(1,026,455)
Change in fair value of mortgage servicing rights, mortgage servicing liabilities and excess servicing spread
113,842
1,225,844
351,033
(1,020,806)
Capitalization of interest and advances on loans held for sale
(1,925)
(33,198)
Accrual of interest on excess servicing spread financing payable to PennyMac Mortgage Investment Trust
Amortization debt issuance costs
13,977
5,565
Change in fair value of investment in common shares of PennyMac Mortgage Investment Trust
(475)
362
Results of real estate acquired in settlement in loans
(1,320)
411
Stock-based compensation expense
19,771
19,125
(Reversal of) Provision for servicing advance losses
(33,590)
34,061
Impairment of capitalized software
728
Depreciation and amortization
14,967
10,725
Amortization of right-of-use assets
6,918
6,017
Purchase of loans held for sale from PennyMac Mortgage Investment Trust
(35,474,697)
(26,112,503)
Origination of loans held for sale
(27,731,285)
(11,820,127)
Purchase of loans held for sale from non-affiliates
(2,664,336)
(1,461,210)
Purchase of loans from Ginnie Mae securities and early buyout investors
(11,562,768)
(2,995,791)
Sale to non-affiliates and principal payments of loans held for sale
79,007,900
40,526,005
Sale to PennyMac Mortgage Investment Trust of loans held for sale
2,248,869
Repurchase of loans subject to representations and warranties
(43,914)
(34,518)
Sale of real estate acquired in settlement of loans
9,503
19,559
Decrease in servicing advances
12,543
2,411
Decrease (increase) in receivable from PennyMac Mortgage Investment Trust
18,058
(171)
Decrease (increase) in other assets
63,006
(132,288)
Increase in accounts payable and accrued expenses
61,121
39,792
Decrease in operating lease liabilities
(8,265)
(6,888)
Decrease in payable to PennyMac Mortgage Investment Trust
(28,584)
(24,761)
Payments to exchanged Private National Mortgage Acceptance Company, LLC unitholders under tax receivable agreement
(3,350)
(Decrease) increase in income taxes payable
(52,648)
232,301
Net cash provided by operating activities
1,331,598
365,597
Cash flow from investing activities
Decrease in short-term investments
11,497
66,865
Net change in assets purchased from PMT under agreement to resell
17,411
Net settlement of derivative financial instruments used for hedging of mortgage servicing rights
(345,621)
995,223
Purchase of mortgage servicing rights
(24,707)
Purchase of furniture, fixtures, equipment and leasehold improvements
(5,049)
(3,472)
Acquisition of capitalized software
(21,594)
(33,270)
Decrease (increase) in margin deposits
134,666
(31,913)
Net cash (used in) provided by investing activities
(145,239)
986,137
Cash flow from financing activities
Sale of assets under agreements to repurchase
69,437,269
39,561,048
Repurchase of assets sold under agreements to repurchase
(70,839,012)
(39,933,232)
Issuance of mortgage loan participation purchase and sale certificates
12,508,356
11,548,130
Repayment of mortgage loan participation purchase and sale certificates
(12,517,580)
(11,509,683)
Repayment of obligations under capital lease
(4,187)
(4,061)
Issuance of unsecured senior notes
650,000
Repayment of excess servicing spread financing
(134,624)
(17,430)
Payment of debt issuance costs
(18,648)
(14,240)
Issuance of common stock pursuant to exercise of stock options
3,397
5,631
Payment of withholding taxes relating to stock-based compensation
(8,546)
(5,265)
Payment of dividend to holders of common stock
Net cash used in financing activities
(1,394,954)
(629,923)
Net (decrease) increase in cash and restricted cash
(208,595)
721,811
Cash and restricted cash at beginning of period
532,781
188,578
Cash and restricted cash at end of period
324,186
910,389
Cash and restricted cash at end of period are comprised of the following:
910,257
Restricted cash included in Other assets
28
132
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note 1—Organization
PennyMac Financial Services, Inc. (“PFSI” or the “Company”) is a holding corporation and its primary assets are direct and indirect equity interests in Private National Mortgage Acceptance Company, LLC (“PennyMac”). The Company is the managing member of PennyMac, and it operates and controls all of the businesses and affairs of PennyMac, and consolidates the financial results of PennyMac and its subsidiaries.
PennyMac is a Delaware limited liability company which, through its subsidiaries, engages in mortgage banking and investment management activities. PennyMac’s mortgage banking activities consist of residential mortgage loan production and servicing. PennyMac’s investment management activities and a portion of its loan servicing activities are conducted on behalf of PennyMac Mortgage Investment Trust (“PMT”), a publicly-traded real estate mortgage investment trust that invests primarily in mortgage-related assets. PennyMac’s primary wholly owned subsidiaries are:
PLS is approved as a seller/servicer of mortgage loans by the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”) and as an issuer of securities guaranteed by the Government National Mortgage Association (“Ginnie Mae”). PLS is a licensed Federal Housing Administration (“FHA”) Nonsupervised Title II Lender with the U.S. Department of Housing and Urban Development (“HUD”) and a lender/servicer with the Veterans Administration (“VA”) and U.S. Department of Agriculture (“USDA”) (each of the above an “Agency” and collectively the “Agencies”).
Note 2—Basis of Presentation and Recently Adopted Accounting Pronouncement
Basis of Presentation
The accompanying consolidated financial statements have been prepared in compliance with accounting principles generally accepted in the United States (“GAAP”) as codified in the Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”) for interim financial information and with the Securities and Exchange Commission’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 GAAP for complete financial statements. This interim consolidated information should be read together with the Company’s Annual Report on Form 10-K for the year ended December 31, 2020.
The accompanying unaudited consolidated financial statements reflect all normal recurring adjustments necessary to present fairly the financial position, income, and cash flows for the interim periods presented, but are not necessarily indicative of income to be anticipated for the full year ending December 31, 2021. Intercompany accounts and transactions have been eliminated.
Preparation of financial statements in compliance with GAAP requires management to make judgments and estimates 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.
Note 3—Concentration of Risk
A substantial portion of the Company’s activities relate to PMT. Revenues generated from PMT (generally comprised of gains on loans held for sale, loan origination and fulfillment fees, loan servicing fees, change in fair value of excess servicing spread financing (“ESS”), net interest, management fees, and change in fair value of investment in and dividends received from PMT) totaled 11% and 9% of total net revenue for the quarters ended June 30, 2021 and 2020, respectively, and 10% and 15% for the six months ended June 30, 2021 and 2020, respectively.
Note 4—Related Party Transactions
Transactions with PMT
Operating Activities
Mortgage Loan Production Activities and MSR Recapture
The Company sells newly originated loans to PMT under a mortgage loan purchase agreement. The Company has typically utilized the mortgage loan purchase agreement for the purpose of selling to PMT conforming balance non-government insured or guaranteed loans, as well as prime jumbo residential mortgage loans.
Through June 30, 2020, pursuant to the terms of an MSR recapture agreement by and between the Company and PMT, if the Company refinanced mortgage loans for which PMT previously held the MSRs, the Company was generally required to transfer and convey to PMT cash in an amount equal to 30% of the fair market value of the MSRs related to all such mortgage loans. On June 30, 2020, the MSR recapture agreement was amended and restated for a term of five years (the “2020 MSR Recapture Agreement”).
Effective July 1, 2020, the 2020 MSR Recapture Agreement changes the recapture fee payable by the Company to a tiered amount equal to:
The “recapture rate” means, during each month, the ratio of (i) the aggregate unpaid principal balance of all recaptured loans, to (ii) the aggregate unpaid principal balance of all mortgage loans for which the Company held the MSRs and that were refinanced or otherwise paid off in such month. The Company has also agreed to allocate sufficient resources to target a recapture rate of 15%.
The Company provides PMT with certain mortgage banking services, including fulfillment and disposition-related services, for which it receives a monthly fulfillment fee.
Through June 30, 2020, pursuant to the terms of a mortgage banking services agreement, the monthly fulfillment fee was an amount equal to:
11
PMT does not hold the Ginnie Mae approval required to issue Ginnie Mae MBS and act as a servicer. Accordingly, under the agreement, the Company purchases mortgage loans underwritten in accordance with the Ginnie Mae MBS Guide “as is” and without recourse of any kind from PMT at PMT’s cost less an administrative fee plus accrued interest and, through June 30, 2020, a sourcing fee ranging from two to three and one-half basis points, generally based on the average number of calendar days mortgage loans are held by PMT before being purchased by the Company. While the Company purchases these mortgage loans “as is” and without recourse of any kind from PMT, where the Company has a claim for repurchase, indemnity or otherwise against a correspondent seller, it is entitled, at its sole expense, to pursue any such claim through or in the name of PMT.
Effective July 1, 2020, the fulfillment fees and sourcing fees were revised as follows:
Following is a summary of loan production activities, including MSR recapture between the Company and PMT:
Net gains on loans held for sale to PMT (primarily cash)
70
81,294
Mortgage servicing rights and excess servicing spread recapture incurred
(5,662)
(8,970)
Sale of loans held for sale to PMT
2,742
Tax service fees earned from PMT included in Loan origination fees
Fulfillment fee revenue
Sourcing fees included in cost of loans purchased from PMT
1,630
3,324
3,368
7,485
Unpaid principal balance of loans purchased from PMT
16,297,216
11,080,565
33,856,791
24,950,845
12
Loan Servicing
The Company and PMT have entered into a loan servicing agreement (the “Servicing Agreement”), pursuant to which the Company provides servicing for PMT’s portfolio of residential mortgage loans and subservicing for its portfolio of MSRs. The Servicing Agreement provides for servicing fees of per-loan monthly amounts based on the delinquency, bankruptcy and/or foreclosure status of the serviced loan or the real estate acquired in settlement of loans (“REO”). The Company also remains entitled to customary ancillary income and market-based fees and charges relating to loans it services for PMT. These include boarding and deboarding fees, liquidation and disposition fees, assumption, modification and origination fees and a percentage of late charges.
Prime Servicing
Special Servicing (Distressed loans)
Following is a summary of loan servicing fees earned from PMT:
Loan type serviced:
Loans acquired for sale at fair value
630
607
1,173
1,143
Distressed loans
188
217
488
Mortgage servicing rights
19,305
14,738
37,718
28,423
On June 30, 2020, the Servicing Agreement was amended and restated for a term of five years (the “2020 Servicing Agreement”). The terms of the 2020 Servicing Agreement are substantially similar to those in the prior servicing agreement except that they now include fees relating to COVID-19 related forbearance and modification activities provided for under the CARES Act.
13
Investment Management Activities
The Company has a management agreement with PMT (“Management Agreement”), pursuant to which the Company oversees PMT’s business affairs in conformity with the investment policies that are approved and monitored by its board of trustees, for which PFSI collects a base management fee and may collect a performance incentive fee. The Management Agreement provides that:
The performance incentive fee is equal to the sum of: (a) 10% of the amount by which PMT’s “net income” for the quarter exceeds (i) an 8% return on equity plus the “high watermark,” up to (ii) a 12% return on PMT’s “equity”; plus (b) 15% of the amount by which PMT’s “net income” for the quarter exceeds (i) a 12% return on PMT’s “equity” plus the “high watermark,” up to (ii) a 16% return on PMT’s “equity”; plus (c) 20% of the amount by which PMT’s “net income” for the quarter exceeds a 16% return on “equity” plus the “high watermark.”
For the purpose of determining the amount of the performance incentive fee:
“Net income” is defined as net income or loss attributable to PMT’s common shares of beneficial interest computed in accordance with GAAP adjusted for certain other non-cash charges determined after discussions between the Company and PMT’s independent trustees and approval by a majority of PMT’s independent trustees.
“Equity” is the weighted average of the issue price per common share of all of PMT’s public offerings, multiplied by the weighted average number of common shares outstanding (including restricted share units) in the rolling four-quarter period.
The “high watermark” is the quarterly adjustment that 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 average Fannie Mae 30-year MBS yield (the “Target Yield”) for the four quarters then ended. 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 the Company to earn a performance incentive fee are adjusted cumulatively based on the performance of PMT’s “net income” over (or under) the Target Yield, until the “net income” in excess of the Target Yield exceeds the then-current cumulative high watermark amount, and a performance incentive fee is earned.
The base management fee and the performance incentive fee are both receivable quarterly in arrears. The performance incentive fee may be paid in cash or a combination of cash and PMT’s common shares (subject to a limit of no more than 50% paid in common shares), at PMT’s option.
In the event of termination of the Management Agreement between PMT and the Company, the Company may be entitled to a termination fee in certain circumstances. The termination fee is equal to three times the sum of (a) the average annual base management fee, and (b) the average annual performance incentive fee earned by the Company, in each case during the 24-month period immediately preceding the date of termination.
14
Following is a summary of the base management and performance incentive fees earned from PMT:
Base management
8,648
17,097
Performance incentive
3,265
Expense Reimbursement
Under the Management Agreement, PMT reimburses the Company for its organizational and operating expenses, including third-party expenses, incurred on PMT’s behalf, it being understood that the Company and its affiliates shall allocate a portion of their personnel’s time to provide certain legal, tax and investor relations services for the direct benefit of PMT. With respect to the allocation of the Company’s and its affiliates’ personnel compensation, the Company was reimbursed $120,000 per fiscal quarter through June 30, 2020.
PMT is also required to pay its pro rata portion of rent, telephone, utilities, office furniture, equipment, machinery and other office, internal and overhead expenses of the Company and its affiliates required for PMT’s and its subsidiaries’ operations. These expenses are allocated based on the ratio of PMT’s proportion of gross assets compared to all remaining gross assets managed by the Company as calculated at each fiscal quarter end.
On June 30, 2020, the Management Agreement was amended and restated for a term of five years (the “2020 Management Agreement”). The terms of the 2020 Management Agreement are materially consistent with those of the prior management agreement, except that, effective July 1, 2020, PMT’s reimbursement of PCM’s and its affiliates’ compensation expenses was increased from $120,000 to $165,000 per fiscal quarter, such amount to be reviewed annually and not preclude reimbursement for any other services performed by the Company or its affiliates.
The Company received reimbursements from PMT for expenses as follows:
Reimbursement of:
Common overhead incurred by the Company
1,268
1,585
1,839
3,125
165
120
330
240
Expenses incurred on PMT's behalf, net
7,804
1,438
9,140
2,709
9,237
3,143
11,309
6,074
Payments and settlements during the period (1)
74,441
136,352
187,182
170,035
15
Investing Activities
Master Repurchase Agreement
On December 19, 2016, the Company, through PLS, entered into a master repurchase agreement with one of PMT’s wholly-owned subsidiaries, PennyMac Holdings, LLC (“PMH”) (the “PMH Repurchase Agreement”), pursuant to which PMH may borrow from the Company for the purpose of financing PMH’s participation certificates representing beneficial ownership in ESS. PLS then re-pledges such participation certificates to PNMAC GMSR ISSUER TRUST (the “Issuer Trust”) under a master repurchase agreement by and among PLS, the Issuer Trust and PennyMac, as guarantor (the “PC Repurchase Agreement”). The Issuer Trust was formed for the purpose of allowing PLS to finance MSRs and ESS relating to such MSRs (the “GNMA MSR Facility). In the first quarter of 2021, PLS repurchased the ESS from PMH at fair market value, effectively terminating the borrowing arrangements allowing PMH to finance its participation certificates representing beneficial ownership in ESS. Such ESS is now included in PLS's participation certificates representing beneficial ownership in ESS.
The Company holds an investment in PMT in the form of 75,000 common shares of beneficial interest.
Following is a summary of investing activities between the Company and PMT:
Interest income relating to Assets purchased from PennyMac Mortgage Investment Trust under agreements to resell
Assets purchased from PennyMac Mortgage Investment Trust under agreements to
resell
Common shares of beneficial interest of PennyMac Mortgage Investment Trust:
Fair value
Number of shares
75
Financing Activities
Spread Acquisition and MSR Servicing Agreements
The Company has a master spread acquisition and MSR servicing agreement with PMT (the “Spread Acquisition Agreement”) which was amended and restated effective December 19, 2016, pursuant to which the Company may sell to PMT, from time to time, the right to receive participation certificates representing beneficial ownership in ESS arising from Ginnie Mae MSRs acquired by the Company, in which case the Company generally would be required to service or subservice the related mortgage loans for Ginnie Mae. The primary purpose of the amendment and restatement was to facilitate the continued financing of the ESS owned by PMT in connection with the parties’ participation in the GNMA MSR Facility.
16
To the extent the Company refinances any of the mortgage loans relating to the ESS it has issued, the Spread Acquisition Agreement also contains recapture provisions requiring that the Company transfer to PMT, at no cost, the ESS relating to a certain percentage of the unpaid principal balance of the newly originated mortgage loans. However, under the Spread Acquisition Agreement, in any month where the transferred ESS relating to newly originated Ginnie Mae mortgage loans is not equal to at least 90% of the product of the excess servicing fee rate and the unpaid principal balance of the refinanced mortgage loans, the Company is also required to transfer additional ESS or cash in the amount of such shortfall. Similarly, in any month where the transferred ESS relating to modified Ginnie Mae mortgage loans is not equal to at least 90% of the product of the excess servicing fee rate and the unpaid principal balance of the modified mortgage loans, the Spread Acquisition Agreement contains provisions that require the Company to transfer additional ESS or cash in the amount of such shortfall. To the extent the fair market value of the aggregate ESS to be transferred for the applicable month is less than $200,000, the Company may, at its option, settle its obligation to PMT in cash in an amount equal to such fair market value in lieu of transferring such ESS.
During the quarter ended March 31, 2021, the Company repurchased ESS from PMT and repaid its outstanding ESS financing payable to PMT.
Following is a summary of financing activities between the Company and PMT:
Quarter ended
June 30, 2020
Excess servicing spread financing:
Balance at beginning of period
157,109
178,586
Issuance pursuant to recapture agreement
483
557
862
Accrual of interest
Repayment
(8,122)
Change in fair value
(636)
1,037
(15,158)
Balance at end of period
151,206
Recapture incurred pursuant to refinancings by the Company of mortgage loans subject to excess servicing spread financing included in Net gains on loans held for sale at fair value
535
614
916
17
Receivable from and Payable to PMT
Amounts receivable from and payable to PMT are summarized below:
Receivable from PMT:
Allocated expenses and expenses incurred on PMT's behalf
17,002
38,142
Fulfillment fees
16,467
20,873
Management fees
8,686
Correspondent production fees
9,764
13,065
Servicing fees
6,737
6,213
Interest on assets purchased under agreements to resell
26
Payable to PMT:
Amounts advanced by PMT to fund its servicing advances
117,444
132,154
19,216
8,152
Exchanged Private National Mortgage Acceptance Company, LLC Unitholders
On May 8, 2013, the Company entered into a tax receivable agreement with certain former owners of PennyMac that provides for the payment from time to time by the Company to PennyMac’s exchanged unitholders of an amount equal to 85% of the amount of the net tax benefits, if any, that the Company is deemed to realize as a result of (i) increases in tax basis of PennyMac’s assets resulting from exchanges of ownership interests in PennyMac and (ii) certain other tax benefits related to entering into the tax receivable agreement, including tax benefits attributable to payments under the tax receivable agreement.
Although a reorganization in November 2018 eliminated the potential for unitholders to exchange any additional units subject to this tax receivable agreement, the Company continues to be subject to the agreement and will be required to make payments, to the extent any of the tax benefits specified above are deemed to be realized, under the tax receivable agreement to those certain prior owners of PennyMac who effected exchanges of ownership interests in PennyMac for the Company’s common stock prior to the closing of the reorganization.
The Company has recorded $31.8 million and $35.2 million, Payable to exchanged Private National Mortgage Acceptance Company, LLC unitholders under tax receivable agreement as of June 30, 2021 and December 31, 2020, respectively. The Company made $3.4 million of payments under the tax receivable agreement during the quarter and six months ended June 30, 2021 and did not make any payments during the six months ended June 30, 2020.
.
18
Note 5—Loan Sales and Servicing Activities
The Company, through PLS, originates or purchases and sells loans in the secondary mortgage market without recourse for credit losses. However, the Company maintains continuing involvement with the loans in the form of servicing arrangements and the liability under representations and warranties it makes to purchasers and insurers of the loans.
The following table summarizes cash flows between the Company and transferees as a result of the sale of loans in transactions where the Company maintains continuing involvement with the loans as servicer:
Cash flows:
Sales proceeds
41,739,700
21,188,988
Servicing fees received (1)
201,866
158,871
397,648
325,427
The following table summarizes unpaid principal balance (the “UPB”) of the loans sold by the Company in which it maintains continuing involvement in the form of owned servicing obligations:
Unpaid principal balance of loans outstanding
227,560,336
199,655,361
Delinquencies (1):
30-89 days
4,574,834
6,041,366
90 days or more:
Not in foreclosure
13,173,282
17,799,621
In foreclosure
481,974
581,683
Foreclosed
6,444
10,893
Bankruptcy
1,201,936
1,230,696
Delinquent loans in COVID-19 pandemic-related forbearance:
1,383,601
2,626,617
90 days or more
9,019,414
12,181,174
10,403,015
14,807,791
19
The following tables summarize the UPB of the Company’s loan servicing portfolio:
Contract
servicing and
rights owned
subservicing
loans serviced
Investor:
Non-affiliated entities:
Originated
Purchased
31,050,313
258,610,649
PennyMac Mortgage Investment Trust
204,174,462
Loans held for sale
10,438,935
269,049,584
473,224,046
Delinquent loans (1):
30 days
4,175,393
708,701
4,884,094
60 days
1,432,015
198,221
1,630,236
15,364,421
2,988,774
18,353,195
624,204
28,514
652,718
7,191
21,557
28,748
21,603,224
3,945,767
25,548,991
1,582,002
149,224
1,731,226
854,161
140,175
994,336
791,271
134,304
925,575
10,402,947
2,467,315
12,870,262
12,048,379
2,741,794
14,790,173
Custodial funds managed by the Company (2)
10,262,380
4,937,986
15,200,366
20
December 31, 2020
41,612,940
241,268,301
174,418,591
11,063,938
252,332,239
426,750,830
5,217,949
901,965
6,119,914
2,393,267
348,416
2,741,683
21,781,226
4,473,217
26,254,443
751,586
33,312
784,898
12,938
37,131
50,069
30,156,966
5,794,041
35,951,007
1,698,418
153,179
1,851,597
1,745,257
334,498
2,079,755
1,479,753
259,019
1,738,772
14,904,052
3,690,505
18,594,557
18,129,062
4,284,022
22,413,084
10,660,517
6,086,725
16,747,242
Following is a summary of the geographical distribution of loans included in the Company’s loan servicing portfolio for the top five and all other states as measured by UPB:
State
California
65,386,177
60,591,363
Florida
39,712,103
35,360,190
Texas
38,627,464
34,591,419
Virginia
29,487,339
26,209,701
Maryland
22,372,406
19,974,809
All other states
277,638,557
250,023,348
21
Note 6—Fair Value
Most of the Company’s assets and certain of its liabilities are measured at or based on their fair values. The Company groups its assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the observability of the significant inputs used to determine fair value. These levels are:
As a result of the difficulty in observing certain significant valuation inputs affecting “Level 3” fair value assets and liabilities, the Company is required to make judgments regarding these items’ fair values. Different persons in possession of the same facts may reasonably arrive at different conclusions as to the inputs to be applied in valuing these assets and liabilities and their fair values. Such differences may result in significantly different fair value measurements. Likewise, due to the general illiquidity of some of these assets and liabilities, subsequent transactions may be at values significantly different from those reported.
Fair Value Accounting Elections
The Company identified its MSRs, its mortgage servicing liabilities (“MSLs”) and all of its non-cash financial assets other than Assets purchased from PennyMac Mortgage Investment Trust under agreements to resell, to be accounted for at fair value so changes in fair value will be reflected in income as they occur and more timely reflect the results of the Company’s performance. The Company has also identified its ESS financing to be accounted for at fair value as a means of hedging the related MSRs’ fair value risk.
22
Assets and Liabilities Measured at Fair Value on a Recurring Basis
Following is a summary of assets and liabilities that are measured at fair value on a recurring basis:
Level 1
Level 2
Level 3
Assets:
Short-term investments
Loans held for sale at fair value
7,066,245
3,818,261
Derivative assets:
Interest rate lock commitments
344,128
Forward purchase contracts
55,765
Forward sales contracts
39,597
MBS put options
13,106
MBS call options
687
Swaption purchase contracts
11,041
Put options on interest rate futures purchase contracts
2,664
Call options on interest rate futures purchase contracts
2,297
Total derivative assets before netting
4,961
120,196
469,285
Netting
(98,016)
Total derivative assets
Mortgage servicing rights at fair value
Investment in PennyMac Mortgage Investment Trust
10,261
7,186,441
7,575,037
14,673,723
Liabilities:
Derivative liabilities:
518
23,274
68,347
Total derivative liabilities before netting
91,621
92,139
(48,229)
Total derivative liabilities
100,609
144,001
23
6,941,231
4,675,169
679,961
133,267
1,451
14,302
11,939
5,520
1,391
6,911
160,959
847,831
(136,593)
23,233
7,102,190
7,936,304
14,925,134
2,935
1,276
251,149
252,425
255,360
(212,722)
180,009
219,712
24
As shown above, all or a portion of the Company’s loans held for sale, Interest Rate Lock Commitments (“IRLCs”), MSRs, ESS and MSLs are measured using Level 3 fair value inputs. Following are roll forwards of assets and liabilities measured at fair value using “Level 3” inputs at either the beginning or the end of the period presented:
Net interest
Mortgage
Loans held
rate lock
servicing
Assets
for sale
commitments (1)
rights
5,202,065
337,940
3,268,910
8,808,915
Purchases and issuances, net
6,828,094
351,934
7,180,028
Capitalization of interest and advances
60,439
Sales and repayments
(3,866,340)
Mortgage servicing rights resulting from loan sales
483,362
Changes in fair value included in income arising from:
Changes in instrument-specific credit risk
179,792
Other factors
332,435
(339,624)
(7,189)
172,603
Transfers from Level 3 to Level 2
(4,585,789)
Transfers to loans held for sale
(678,699)
343,610
7,574,519
Changes in fair value recognized during the quarter relating to assets still held at June 30, 2021
74,184
78,170
Liabilities
Mortgage servicing liabilities:
46,026
Mortgage servicing liabilities resulting from loan sales
57,421
Changes in fair value included in income
(3,356)
Changes in fair value recognized during the quarter relating to liabilities still outstanding at June 30, 2021
25
Repurchase
agreement
derivatives
806,587
315,194
8,187
2,193,697
3,323,665
288,856
496,149
785,005
14,994
(60,364)
225,534
1,132
297,198
(205,692)
91,506
92,638
(389,486)
(740,477)
661,719
368,064
2,213,539
3,251,509
Changes in fair value recognized during the quarter relating to assets still held at June 30, 2020
(717)
161,655
Excess
spread
financing
liabilities
29,761
186,870
Issuance of excess servicing spread financing pursuant to a recapture agreement with PennyMac Mortgage Investment Trust
Repayments
97
(539)
29,858
181,064
Changes in fair value recognized during the quarter relating to liabilities still outstanding at June 30, 2020
677,026
7,933,369
11,056,535
829,867
11,886,402
78,844
(4,795,241)
953,895
227,946
152,822
(122,421)
30,401
258,347
(7,424,910)
Transfers to real estate acquired in settlement of loans
(82)
(1,316,105)
Changes in fair value recognized during the period relating to assets still held at June 30, 2021
135,823
357,012
177,074
64,383
(9,616)
(8,579)
Changes in fair value recognized during the period relating to liabilities still outstanding at June 30, 2021
27
383,878
136,650
2,926,790
3,455,505
1,930,087
838,129
25,760
2,793,976
33,021
(799,292)
507,849
(6,391)
497,116
(1,246,860)
(749,744)
(756,135)
(878,893)
(691)
Transfers of interest rate lock commitments to loans held for sale
(1,103,831)
Changes in fair value recognized during the period relating to assets still held at June 30, 2020
(563)
(879,359)
29,140
207,726
6,576
(5,858)
(21,016)
Changes in fair value recognized during the period relating to liabilities still outstanding at June 30, 2020
The Company had transfers among the fair value levels arising from the return to salability in the active secondary market of certain loans held for sale and from transfers of IRLCs to loans held for sale at fair value upon purchase or funding.
Assets and Liabilities Measured at Fair Value under the Fair Value Option
Net changes in fair values included in income for assets and liabilities carried at fair value as a result of management’s election of the fair value option by income statement line item are summarized below:
Net gains on
Net
loans held
loan
for sale at
fair value
fees
761,841
739,797
422,217
534,105
Excess servicing spread financing payable to PennyMac Mortgage Investment Trust
Mortgage servicing liabilities
3,356
(97)
539
1,411,960
1,138,515
1,289,539
(108,345)
9,616
5,858
8,579
21,016
Following are the fair value and related principal amounts due upon maturity of loans held for sale:
Principal
amount
Fair
due upon
maturity
Difference
Current through 89 days delinquent
10,526,148
10,079,813
446,335
11,304,308
10,743,814
560,494
90 days or more delinquent:
330,472
327,869
2,603
275,419
280,595
(5,176)
27,886
31,253
(3,367)
36,673
39,529
(2,856)
445,571
552,462
29
Assets Measured at Fair Value on a Nonrecurring Basis
Following is a summary of assets that were measured at fair value on a nonrecurring basis:
Real estate acquired in settlement of loans
2,863
1,450
The following table summarizes the (losses) gains recognized on assets when they were remeasured at fair value on a nonrecurring basis:
(434)
(1,001)
(743)
(2,283)
Fair Value of Financial Instruments Carried at Amortized Cost
The Company’s Assets purchased from PennyMac Mortgage Investment Trust under agreements to resell pledged to creditors, Assets sold under agreements to repurchase, Mortgage loan participation purchase and sale agreements, Obligations under capital lease, Notes payable secured by mortgage servicing assets and Unsecured senior notes are carried at amortized cost.
These assets and liabilities are classified as “Level 3” fair value items due to the Company’s reliance on unobservable inputs to estimate their fair values. The Company has concluded that the fair values of these assets and liabilities other than the 2018-GTI Term Notes and 2018-GT2 Term Notes included in Notes payable secured by mortgage servicing assets and the Unsecured senior notes approximate their carrying values due to their short terms and/or variable interest rates.
The Company estimates the fair value of the Notes payable secured by mortgage servicing assets and the Unsecured senior notes based on non-affiliate broker indications of fair value. The fair value and carrying value of these notes are summarized below:
Carrying value
1,298,603
1,268,304
1,309,750
685,750
Valuation Governance
Most of the Company’s financial assets, and all of its MSRs, ESS, derivative liabilities and MSLs, are carried at fair value with changes in fair value recognized in current period income. Certain of the Company’s financial assets and derivative liabilities and all of its MSRs, ESS, and MSLs are “Level 3” fair value assets and liabilities which require use of unobservable inputs that are significant to the estimation of the items’ fair values. Unobservable inputs reflect the Company’s own judgments about the factors that market participants use in pricing an asset or liability, and are based on the best information available under the circumstances.
Due to the difficulty in estimating the fair values of “Level 3” fair value assets and liabilities, the Company has assigned the responsibility for estimating the fair value of these items to specialized staff and subjects the valuation process to significant senior management oversight. The Company’s Financial Analysis and Valuation group (the “FAV group”) is the Company’s specialized staff responsible for estimating the fair values of “Level 3” fair value assets and liabilities other than IRLCs.
30
With respect to the non-IRLC “Level 3” valuations, the FAV group reports to the Company’s senior management valuation committee, which oversees the valuations. The FAV group monitors the models used for valuation of the Company’s “Level 3” fair value assets and liabilities, including the models’ performance versus actual results, and reports those results to the Company’s senior management valuation committee. The Company’s senior management valuation committee includes the Company’s chief operating, financial, investment and risk officers as well as other senior members of the Company’s finance, capital markets and risk management staffs.
The FAV group is responsible for reporting to the Company’s senior management valuation committee on the changes in the valuation of the non-IRLC “Level 3” fair value assets and liabilities, including major factors affecting the valuation and any changes in model methods and inputs. To assess the reasonableness of its valuations, the FAV group presents an analysis of the effect on the valuation of changes to the significant inputs to the models.
The Company has assigned responsibility for developing the fair values of IRLCs to its Capital Markets Risk Management staff. The fair values developed by the Capital Markets Risk Management staff are reviewed by the Company’s Capital Markets Operations group.
Valuation Techniques and Inputs
Following is a description of the techniques and inputs used in estimating the fair values of “Level 2” and “Level 3” fair value assets and liabilities:
Loans Held for Sale
Most of the Company’s loans held for sale at fair value are saleable into active markets and are therefore categorized as “Level 2” fair value assets. The fair values of “Level 2” fair value loans are determined using their contracted selling price or quoted market price or market price equivalent.
Certain of the Company’s loans held for sale are not saleable into active markets and are therefore categorized as “Level 3” fair value assets. Loans held for sale categorized as “Level 3” fair value assets include:
Loans become eligible for resale into a new Ginnie Mae security when the loans become current either through completion of a modification of the loan’s terms or after six months of timely payments following either the completion of certain types of payment deferral programs or borrower reperformance and when the issuance date of the new security is at least 210 days after the date the loan was last delinquent.
The Company uses a discounted cash flow model to estimate the fair value of its “Level 3” fair value loans held for sale. The significant unobservable inputs used in the fair value measurement of the Company’s “Level 3” fair value loans held for sale are discount rates, home price projections, voluntary prepayment/resale and total prepayment 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.
31
Following is a quantitative summary of key “Level 3” fair value inputs used in the valuation of loans held for sale:
Fair value (in thousands)
Key inputs (1):
Discount rate:
Range
2.0% – 9.2%
2.8% – 9.2%
Weighted average
2.0%
2.8%
Twelve-month projected housing price index change:
4.8% – 5.3%
2.7% – 3.5%
5.1%
3.0%
Voluntary prepayment/resale speed (2):
0.4% – 26.8%
0.4% – 31.3%
22.0%
21.9%
Total prepayment speed (3):
0.4% – 37.6%
0.5% – 42.9%
28.8%
29.2%
Changes in fair value of loans held for sale attributable to changes in the loan’s instrument-specific credit risk are measured with reference to the change in the respective loan’s delinquency status and performance history at period end from the later of the beginning of the period or acquisition date. Changes in fair value of loans held for sale are included in Net gains on loans held for sale at fair value in the Company’s consolidated statements of income.
Derivative Financial Instruments
Interest Rate Lock Commitments
The Company categorizes IRLCs as “Level 3” fair value assets or liabilities. 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 loan will be funded or purchased (the “pull-through rate”).
The significant unobservable inputs used in the fair value measurement of the Company’s IRLCs are the pull-through rate and the estimated fair value of MSR attributable to the mortgage loans it has committed to purchase. Significant changes in the pull-through rate or the MSR component of the IRLCs, in isolation, could result in significant changes in the IRLCs’ fair value measurement. The financial effects of changes in these inputs are generally inversely correlated as increasing interest rates have a positive effect on the fair value of the MSR component of IRLC fair value, but increase the pull-through rate for the loan principal and interest payment cash flow component, which has decreased in fair value. Changes in fair value of IRLCs are included in Net gains on loans held for sale at fair value in the consolidated statements of income.
32
Following is a quantitative summary of key unobservable inputs used in the valuation of IRLCs:
Fair value (in thousands) (1)
Key inputs (2):
Pull-through rate:
8.0% – 100%
10.1% – 100%
82.7%
Mortgage servicing rights value expressed as:
Servicing fee multiple:
(14.7) – 6.5
0.7 – 5.3
3.6
Percentage of loan commitment amount
(2.1)% – 3.1%
0.1% – 2.6%
1.2%
Hedging Derivatives
Fair values of derivative financial instruments actively traded on exchanges are categorized by the Company as “Level 1” fair value assets and liabilities; fair values of derivative financial instruments based on observable interest rates, volatilities and prices in the MBS or other markets are categorized by the Company as “Level 2” fair value assets and liabilities.
Changes in the fair value of hedging derivatives are included in Net gains on loans held for sale at fair value, or Net loan servicing fees – Hedging results, as applicable, in the consolidated statements of income.
Mortgage Servicing Rights
MSRs are categorized as “Level 3” fair value assets. The Company uses a discounted cash flow approach to estimate the fair value of MSRs. The key inputs used in the estimation of the fair value of MSRs include the applicable pricing spread (discount rate), prepayment rates (prepayment speed), and annual per-loan cost to service the underlying loans, all of which are unobservable. 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 inputs are not directly related. Changes in the fair value of MSRs are included in Net loan servicing fees—Change in fair value of mortgage servicing rights and mortgage servicing liabilities in the consolidated statements of income.
33
Following are the key inputs used in determining the fair value of MSRs received by the Company when it retains the obligation to service the mortgage loans it sells:
(Amount recognized and unpaid principal balance of underlying loans in thousands)
MSR and pool characteristics:
Amount recognized
Unpaid principal balance of underlying loans
36,830,098
20,066,302
71,773,352
38,396,686
Weighted average servicing fee rate (in basis points)
36
38
Pricing spread (2):
6.0% – 16.9%
8.1% – 18.1%
6.8% – 18.1%
8.9%
9.9%
9.2%
9.1%
Annual total prepayment speed (3):
6.7% – 17.7%
8.8% – 29.1%
6.2% – 16.7%
8.8% – 49.8%
8.5%
13.0%
8.1%
13.7%
Equivalent average life (in years):
4.0 – 8.8
2.9 – 8.1
4.1 – 9.0
1.5 – 8.1
8.1
6.3
8.3
6.1
Per-loan annual cost of servicing:
$80 – $117
$79 – $110
$81 – $117
$77 – $110
$104
$101
$99
34
Following is a quantitative summary of key inputs used in the valuation of the Company’s MSRs and the effect on the fair value from adverse changes in those inputs:
(Fair value, unpaid principal balance of underlying
loans and effect on fair value amounts in thousands)
$ 3,412,648
$ 2,581,174
Pool characteristics:
$ 252,475,400
$ 238,410,809
Weighted average note interest rate
3.3%
3.6%
35
6.3% – 16.1%
8.0% – 17.6%
8.4%
10.1%
Effect on fair value of:
5% adverse change
($56,330)
($46,356)
10% adverse change
($110,804)
($90,936)
20% adverse change
($214,519)
($175,137)
7.9% – 29.1%
10.1% – 32.9%
10.5%
3.0 – 7.8
2.3 – 7.7
6.9
6.0
($72,028)
($66,536)
($141,434)
($130,253)
($272,904)
($249,843)
Annual per-loan cost of servicing:
$79 – $117
$107
($31,198)
($25,482)
($62,395)
($50,964)
($124,790)
($101,929)
The preceding sensitivity analyses are limited in that they were performed as of a particular date; only contemplate the movements in the indicated inputs; do not incorporate changes to other inputs; are subject to the accuracy of the models and inputs used; and do not incorporate other factors that would affect the Company’s overall financial performance in such events, including operational adjustments made by management to account for changing circumstances. For these reasons, the preceding estimates should not be viewed as earnings forecasts.
Excess Servicing Spread Financing at Fair Value
ESS is categorized as a “Level 3” fair value liability. Because ESS is a claim to a portion of the cash flows from MSRs, the fair value measurement of the ESS is similar to that of MSRs. The Company uses the same discounted cash flow approach to measuring the ESS as it uses to measure MSRs except that certain inputs relating to the cost to service the mortgage loans underlying the MSRs and certain ancillary income are not included as these cash flows do not accrue to the holder of the ESS.
The key inputs used in the estimation of ESS fair value include pricing spread and prepayment speed. Significant changes to either of those inputs in isolation could result in a significant change in the fair value of ESS. Changes in these key inputs are not directly related.
ESS is generally subject to fair value increases when mortgage interest rates increase. Increasing mortgage interest rates normally discourage mortgage refinancing activity. Decreased refinancing activity increases the life of the mortgage loans underlying the ESS, thereby increasing the fair value of this financing. Changes in the fair value of ESS are included in Net loan servicing fees—Change in fair value of excess servicing spread payable to PennyMac Mortgage Investment Trust. During the quarter ended March 31, 2021, the Company repaid its outstanding ESS financing payable to PMT.
Following are the key inputs used in determining the fair value of ESS financing:
$ 131,750
Unpaid principal balance of underlying loans (in thousands)
$ 15,833,050
Average servicing fee rate (in basis points)
Average excess servicing spread (in basis points)
4.9% – 5.3%
9.6% – 18.3%
11.7%
2.3 – 6.6
5.8
Mortgage Servicing Liabilities
MSLs are categorized as “Level 3” fair value liabilities. The Company uses a discounted cash flow approach to estimate the fair value of MSLs. The key inputs used in the estimation of the fair value of MSLs include the applicable pricing spread, prepayment speed, and the annual per-loan cost to service the underlying loans. Changes in the fair value of MSLs are included in Net servicing fees—Change in fair value of mortgage servicing rights and mortgage servicing liabilities in the consolidated statements of income.
Following are the key inputs used in determining the fair value of MSLs:
6,135,249
2,857,492
Servicing fee rate (in basis points)
Key inputs:
Pricing spread (1)
7.7%
7.6%
Annual total prepayment speed (2)
31.8%
33.3%
Equivalent average life (in years)
3.5
3.2
Annual per-loan cost of servicing
278
305
Note 7—Loans Held for Sale at Fair Value
Loans held for sale at fair value include the following:
Loan type
Government-insured or guaranteed
5,115,678
5,683,786
Conventional conforming
1,950,567
1,257,445
Purchased from Ginnie Mae pools serviced by the Company
3,789,022
4,661,378
Repurchased pursuant to representations and warranties
29,239
13,791
Fair value of loans pledged to secure:
9,917,262
10,912,178
533,864
545,500
10,451,126
11,457,678
Note 8—Derivative Financial Instruments
The Company holds and issues derivative financial instruments in connection with its operating activities. Derivative financial instruments are created as a result of the Company’s loan production activities and when the Company enters into derivative transactions as part of its interest rate risk management activities. Derivative financial instruments created as a result of the Company’s loan production activities are IRLCs that are created when the Company commits to purchase or originate a loan for sale.
The Company engages in interest rate risk management activities in an effort to moderate the effect of changes in market interest rates on the fair value of certain of the its assets. To manage this fair value risk resulting from interest rate risk, the Company uses derivative financial instruments acquired with the intention of reducing the risk that changes in market interest rates will result in unfavorable changes in the fair value of the Company’s IRLCs, inventory of loans held for sale and its MSRs.
The Company does not designate and qualify any of its derivatives for hedge accounting. The Company records all derivative financial instruments at fair value and records changes in fair value in current period income.
37
Derivative Notional Amounts and Fair Value of Derivatives
The Company had the following derivative financial instruments recorded on its consolidated balance sheets:
Notional
Derivative
Instrument
amount (1)
assets
Not subject to master netting arrangements:
13,879,343
20,624,535
Used for hedging purposes (2):
24,712,770
31,689,543
37,785,066
50,438,967
11,450,000
12,025,000
750,000
5,455,000
3,375,000
3,450,000
4,750,000
350,000
850,000
Treasury futures purchase contracts
705,000
1,065,000
Treasury futures sale contracts
1,480,000
1,555,000
Interest rate swap futures purchase contracts
4,040,000
4,801,700
Interest rate swap futures sale contracts
250,000
711,700
Total derivatives before netting
Deposits (received from) placed with derivative counterparties, net
(49,787)
76,129
Derivative Balances and Netting of Financial Instruments
The Company has elected to present net derivative asset and liability positions, and cash collateral obtained from or posted to its counterparties when subject to a master netting arrangement that is legally enforceable on all counterparties in the event of default. The derivatives that are not subject to a master netting arrangement are IRLCs.
Offsetting of Derivative Assets
Following are summaries of derivative assets and related netting amounts:
Gross
Gross amount
Net amount
amount of
offset in the
of assets in the
recognized
consolidated
balance sheet
Derivatives not subject to master netting arrangements - IRLCs
Derivatives subject to master netting arrangements:
Forward sale contracts
125,157
27,141
167,870
31,277
Derivative Assets, Financial Instruments, and Cash 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.
Gross amount not
Financial
collateral
instruments
received
JPMorgan Chase Bank, N.A.
11,325
17,149
Bank of America, N.A.
5,972
RJ O'Brien
6,910
Barclays Capital
3,166
Morgan Stanley Bank, N.A.
2,443
Citibank, N.A.
2,026
Others
1,717
2,749
39
Offsetting of Derivative Liabilities and Financial Liabilities
Following is a summary of net derivative liabilities and assets sold under agreements to repurchase and related netting amounts. Assets sold under agreements to repurchase do not qualify for netting.
of liabilities
in the
Derivatives not subject to master netting arrangements – Interest rate lock commitments
Derivatives subject to a master netting arrangement:
43,392
39,703
Total derivatives
Assets sold under agreements to repurchase:
Amount outstanding
8,262,251
9,663,995
Unamortized debt issuance cost
(7,708)
(9,198)
8,346,682
8,298,453
9,910,157
9,697,435
40
Derivative Liabilities, Financial Instruments, 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 qualify under the accounting guidance for netting. All assets sold under agreements to repurchase are secured by sufficient collateral or have fair value that exceeds the liability amount recorded on the consolidated balance sheets.
Gross amounts
not offset in the
pledged
2,214,762
(2,214,762)
2,752,279
(2,752,279)
Credit Suisse First Boston Mortgage Capital LLC
1,873,730
(1,866,023)
7,707
3,947,752
(3,943,149)
4,603
1,053,871
(1,053,871)
634,523
(626,550)
7,973
Goldman Sachs
788,182
(788,182)
Royal Bank of Canada
728,898
(728,898)
406,348
(406,348)
BNP Paribas
372,377
(372,377)
337,823
(336,545)
1,278
353,729
(353,729)
331,546
(331,546)
348,272
(348,272)
596,729
(596,729)
Wells Fargo Bank, N.A.
349,852
(342,509)
7,343
169,085
(165,224)
3,861
204,515
(193,628)
10,887
505,625
(505,625)
Mizuho Securities
14,225
6,491
Federal Home Loan Mortgage Corporation
12,928
3,230
2,569
8,306,161
(8,262,251)
9,706,633
(9,663,995)
Following are the gains (losses) recognized by the Company on derivative financial instruments and the income statement lines where such gains and losses are included:
Derivative activity
Income statement line
Net gains on loans held for sale at fair value (1)
5,670
52,871
(333,416)
231,414
Hedged item:
Interest rate lock commitments and loans held for sale
(167,734)
(101,115)
294,804
(326,672)
Net loan servicing fees–Hedging results
41
Note 9—Mortgage Servicing Rights and Mortgage Servicing Liabilities
Mortgage Servicing Rights at Fair Value
The activity in MSRs is as follows:
Additions:
Resulting from loan sales
Purchases
533,609
Change in fair value due to:
Changes in valuation inputs used in valuation model (1)
(239,514)
(98,681)
73,376
(1,014,543)
Other changes in fair value (2)
(100,110)
(107,011)
(195,797)
(232,317)
Total change in fair value
Fair value of mortgage servicing rights pledged to secure Assets sold under agreements to repurchase and Notes payable secured by mortgage servicing assets
3,408,088
2,577,964
Mortgage Servicing Liabilities at Fair Value
The activity in MSLs is summarized below:
Changes in fair value due to:
11,083
9,673
17,847
14,105
(14,439)
(9,576)
(27,463)
(19,963)
42
Contractual servicing fees relating to MSRs and MSLs are recorded in Net loan servicing fees—Loan servicing fees—From non-affiliates on the consolidated statements of income; other fees relating to MSRs and MSLs are recorded in Net loan servicing fees—Loan servicing fees—Other on the Company’s consolidated statements of income. Such amounts are summarized below:
Contractual servicing fees
Other fees:
Late charges
6,665
8,490
14,596
21,103
7,768
5,971
15,622
10,821
222,708
213,639
449,246
429,755
Note 10—Leases
The Company has operating lease agreements relating to its facilities. The Company’s operating lease agreements have remaining terms ranging from less than one year to ten years; some of the operating lease agreements include options to extend the term for up to five years. None of the Company’s operating lease agreements require the Company to make variable lease payments.
The Company’s lease agreements are summarized below:
(dollars in thousands)
Lease expense:
Operating leases
4,508
4,034
8,874
7,966
Short-term leases
420
224
470
480
Net lease expense included in Occupancy and equipment
4,928
4,258
9,344
8,446
Other information:
Payments for operating leases
5,149
4,354
10,185
8,794
Operating lease right-of-use assets recognized
4,570
4,964
7,813
6,498
Period end weighted averages:
Remaining lease term (in years)
5.9
6.6
Discount rate
4.1%
4.2%
Lease payments of the Company’s operating lease liabilities are summarized below:
Twelve months ended June 30,
2022
19,401
2023
18,968
2024
17,503
2025
15,929
2026
14,324
Thereafter
20,945
Total lease payments
107,070
Less imputed interest
(10,607)
Operating lease liability
43
Note 11—Other Assets
Other assets are summarized below:
Margin deposits
103,863
116,881
Capitalized software, net
91,712
81,434
Prepaid expenses
57,800
53,975
Deposits securing Assets sold under agreements to repurchase and Notes payable secured by mortgage servicing assets
49,934
153,054
Net servicing fee receivables
31,012
42,282
Furniture, fixture, equipment and building improvements, net
32,887
32,217
8,548
12,158
236,517
200,168
Deposits pledged to secure Assets sold under agreements to repurchase and Notes payable secured by mortgage servicing assets
Assets pledged to secure Obligations under capital lease:
6,024
7,675
4,899
5,689
60,857
166,418
Note 12—Short-Term Borrowings
The borrowing facilities described throughout these Notes 12 and 13 contain various covenants, including financial covenants governing the Company’s net worth, debt-to-equity ratio, profitability and liquidity. Management believes that the Company was in compliance with these covenants as of June 30, 2021.
Assets Sold Under Agreements to Repurchase
The Company has multiple borrowing facilities in the form of asset sales under agreements to repurchase. These borrowing facilities are secured by loans held for sale at fair value, assets purchased from PMT under agreements to resell or participation certificates backed by mortgage servicing assets. Eligible assets are sold at advance rates based on the fair value (as determined by the lender) of the assets sold. Interest is charged at a rate based on LIBOR. Loans and MSRs financed under these agreements may be re-pledged by the lenders.
Fannie Mae MSR Facility
On April 28, 2021, the Company, through PLS, PennyMac, and PFSI Issuer Trust - FMSR, entered into a structured finance transaction, allowing PLS to finance Fannie Mae MSRs and ESS (the “Fannie Mae MSR Facility”). In connection with the Fannie Mae MSR Facility, PLS pledges and/or sells to PFSI Issuer Trust - FMSR participation certificates representing beneficial interests in MSRs and ESS pursuant to the terms of a master repurchase agreement, dated as of April 28, 2021, by and between PLS, PFSI Issuer Trust - FMSR and PennyMac (the “PC Repurchase Agreement”). In return, PFSI Issuer Trust - FMSR (a) has issued to PLS the Series 2021-MSRVF1 Note, dated April 28, 2021, known as the “PFSI ISSUER TRUST - FMSR Collateralized Notes, Series 2021-MSRVF1” (the “FMSR VFN”), and (b) may, from time to time, issue to institutional investors term notes, in each case secured on a pari passu basis by the participation certificates relating to the MSRs and ESS. The maximum principal balance of the FMSR VFN is $1,000,000,000. The Company did not borrow under the facility during the quarter ended June 30, 2021.
44
Under the PC Repurchase Agreement, PLS grants to PFSI Issuer Trust – FMSR a security interest in all of its right, title and interest in, to and under participation certificates representing beneficial interests in MSRs and ESS, including all of its rights and interests in any MSRs and ESS it thereafter owns or acquires. The principal amount paid by PFSI Issuer Trust - FMSR for the participation certificates under the PC Repurchase Agreement is based upon a percentage of the market value of the underlying MSRs (inclusive of the ESS). Upon PLS’s repurchase of the participation certificates, PLS is required to repay PFSI Issuer Trust - FMSR the principal amount relating thereto plus accrued interest (at a rate reflective of the current market and consistent with the weighted average note rate of the FMSR VFN and any outstanding term notes) to the date of such repurchase.
PLS also entered into a master repurchase agreement on April 28, 2021 (the “FMSR VFN Repurchase Agreement”) with CSFB, as administrative agent, and Credit Suisse AG, Cayman Islands Branch (“CSCIB”), as purchaser, pursuant to which PLS sold the FMSR VFN to CSCIB with an agreement to repurchase such FMSR VFN at a later date. The FMSR VFN Repurchase Agreement has an initial term extending through March 31, 2023. The FMSR VFN Repurchase Agreement provides for a maximum purchase price of $250 million, all of which is committed. The principal amount paid by CSCIB for the FMSR VFN is based upon a percentage of the market value of such FMSR VFN. Upon PLS’s repurchase of the FMSR VFN, PLS is required to repay CSCIB the principal amount relating thereto plus accrued interest (at a rate reflective of the current market based on a spread above LIBOR with index replacement provisions related to the transition from LIBOR) to the date of such repurchase. Under the FMSR VFN Repurchase Agreement, in the event any such transactions are deemed to be loans and not sales and purchases, PLS granted to CSCIB a security interest in all of its right, title and interest in, to and under the FMSR VFN and all rights to reimbursement or payment of the FMSR VFN and/or amounts due in respect thereof.
Ginnie Mae MSR Facility
In connection with the GNMA MSR Facility, PLS pledges and/or sells to the Issuer Trust participation certificates representing beneficial interests in MSRs and ESS pursuant to the terms of the PC Repurchase Agreement. In return, the Issuer Trust (a) has issued to PLS, pursuant to the terms of an indenture, the Series 2016-MSRVF1 Variable Funding Note, dated December 19, 2016, known as the “PNMAC GMSR ISSUER TRUST MSR Collateralized Notes, Series 2016-MSRVF1” (the “VFN”), and (b) has issued and may, from time to time pursuant to the terms of any supplemental indenture, issue to institutional investors additional term notes, in each case secured on a pari passu basis by the participation certificates relating to the MSRs and ESS. The maximum principal balance of the VFN is $1,000,000,000.
On April 1, 2020, the Company issued a series of variable funding notes, the Series 2020-SPIADVF1 Notes (“GMSR Servicing Advance Notes”), to be sold under agreement to repurchase pursuant to a Master Repurchase Agreement, dated as of April 1, 2020, with Credit Suisse First Boston Mortgage Capital LLC, acting as administrative agent on behalf of Credit Suisse AG, Cayman Islands Branch, as buyer (the “GMSR Servicing Advances Repurchase Agreement”).
The GMSR Servicing Advances Repurchase Agreement provides the Company with financing secured by its servicing advances to pay, in accordance with the Ginnie Mae requirements, in the event borrowers are delinquent: (i) regularly scheduled monthly principal and interest to mortgage-backed securities holders; (ii) taxes, homeowner’s insurance, and other escrowed items; and (iii) other expenses related to servicing delinquent loans as specified by (A) state and federal laws and (B) government agencies, including the FHA, the VA, and the USDA.
The borrowing capacity under the GMSR Servicing Advances Repurchase Agreement, shared with VFN financing capacity, is $600 million, all of which is committed and may be used to finance the servicing advances related to delinquent FHA, VA, and USDA loans, including delinquencies caused by forbearance provided to the borrower in accordance with the CARES Act.
45
Assets sold under agreements to repurchase are summarized below:
Average balance of assets sold under agreements to repurchase
7,571,340
2,529,217
7,999,580
2,833,444
Weighted average interest rate (1)
2.07
%
2.32
2.13
2.74
Total interest expense
44,623
17,487
96,802
43,171
Maximum daily amount outstanding
10,856,677
3,769,495
Carrying value:
Unpaid principal balance
Unamortized debt issuance costs
Weighted average interest rate
1.86
1.90
Available borrowing capacity (2):
Committed
666,772
372,803
Uncommitted
6,695,976
2,163,202
7,362,748
2,536,005
Fair value of assets securing repurchase agreements:
Assets purchased from PennyMac Mortgage Investment Trust under agreements to resell
Servicing advances (3)
311,896
413,484
Mortgage servicing rights (3)
3,209,383
2,490,267
Deposits (3)
Margin deposits placed with counterparties (4)
10,875
5,625
46
Following is a summary of maturities of outstanding advances under repurchase agreements by maturity date:
Remaining maturity at June 30, 2021
Within 30 days
3,532,563
Over 30 to 90 days
3,396,557
Over 90 to 180 days
987,861
Over 180 days to one year
295,270
Over one year to two year
50,000
Total assets sold under agreements to repurchase
Weighted average maturity (in months)
2.2
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 is summarized by counterparty below as of June 30, 2021:
Counterparty
Amount at risk
maturity of advances
Facility maturity
Credit Suisse First Boston Mortgage Capital LLC (1)
2,126,158
March 31, 2023
724,309
August 18, 2021
397,300
July 31, 2021
June 7, 2023
JP Morgan Chase Bank, N.A.
207,772
August 3, 2021
September 30, 2022
1,891
August 6, 2021
June 6, 2023
124,512
July 18, 2021
July 30, 2021
77,468
October 8, 2021
December 23, 2022
55,641
September 26, 2021
June 14, 2022
44,701
August 28, 2021
November 2, 2022
Barclays Bank PLC
41,978
August 26, 2021
November 3, 2022
20,750
September 16, 2021
October 6, 2022
11,835
The Company is subject to margin calls during the period the repurchase agreements are outstanding and therefore may be required to repay a portion of the borrowings before the respective agreements mature if the fair value (as determined by the applicable lender) of the assets securing those agreements decreases.
Mortgage Loan Participation Purchase and Sale Agreements
Certain of the borrowing facilities secured by loans held for sale are in the form of mortgage loan participation purchase and sale agreements. Participation certificates, each of which represents an undivided beneficial ownership interest in mortgage loans that have been pooled with Fannie Mae, Freddie Mac or Ginnie Mae, are sold to a lender pending the securitization of the mortgage loans and sale of the resulting securities. A commitment to sell the securities resulting from the pending securitization between the Company and a non-affiliate is also assigned to the lender at the time a participation certificate is sold.
The purchase price paid by the lender for each participation certificate is based on the trade price of the security, plus an amount of interest expected to accrue on the security to its anticipated delivery date, minus a present value adjustment, any related hedging costs and a holdback amount that is based on a percentage of the purchase price. The holdback amount is not required to be paid to the Company until the settlement of the security and its delivery to the lender.
47
The mortgage loan participation purchase and sale agreements are summarized below:
Average balance
254,343
240,119
265,390
243,965
1.36
1.53
1.35
2.09
1,039
1,061
2,134
2,871
528,844
540,977
1.48
1.39
Fair value of loans pledged to secure mortgage loan participation purchase and sale agreements
Corporate Revolving Line of Credit
The Company, through its subsidiary PennyMac, entered into an amended and restated credit agreement on November 18, 2016, as amended (the “Credit Agreement”) under which PennyMac established a revolving line of credit in an amount not to exceed $150 million. PennyMac did not borrow under the revolving line of credit during the periods presented and terminated the Credit Agreement on September 29, 2020 concurrent with the issuance the Unsecured Senior Notes described below.
Note 13—Long-Term Debt
Obligations Under Capital Lease
The Company has a capital lease transaction secured by certain fixed assets and capitalized software. The capital lease matures on June 13, 2022 and bears interest at a spread over one-month LIBOR.
Obligations under capital lease are summarized below:
9,072
17,272
10,169
18,367
2.10
2.70
2.12
3.05
104
107
271
10,468
18,145
20,810
2.15
Assets pledged to secure obligations under capital lease:
Capitalized software
Furniture, fixtures and equipment
Notes Payable Secured by Mortgage Servicing Assets
Term Notes
The Company, through the Issuer Trust described in Note 12—Short-Term Borrowings—Assets Sold Under Agreements to Repurchase, issued term notes (the “Term Notes”) to qualified institutional buyers under Rule 144A of the Securities Act of 1933, as amended (the “Securities Act”). The Term Notes rank pari passu with each other and with the VFN issued by the Issuer Trust to PLS and are secured by certain participation certificates relating to Ginnie Mae mortgage servicing assets that are financed pursuant to the GNMA MSR Facility.
Following is a summary of the issued and outstanding Term Notes:
Issuance date
Principal balance
Stated interest rate (1)
Stated maturity date (2)
(Annual)
February 28, 2018 (the "GT1 Notes")
2.85%
2/25/2023
August 10, 2018 (the "GT2 Notes")
2.65%
8/25/2023
1,300,000
MSR Note Payable
On February 1, 2018, the Company issued a note payable that is secured by Freddie Mac MSRs. Interest is charged at a rate based on LIBOR plus the applicable contract margin. The facility expires on March 31, 2023. The maximum amount that the Company may borrow under the note payable is $600 million, less any amount outstanding under the agreement to repurchase pursuant to which the Company finances the VFN. The Company did not borrow under this note payable during the periods presented.
Notes payable secured by mortgage servicing assets are summarized below:
2.91
3.28
2.90
3.86
10,104
11,109
19,992
25,955
49
(3,269)
(4,160)
2.84
2.93
Assets pledged to secure notes payable (1):
Servicing advances
3,164,980
2,421,326
Deposits
Unsecured Senior Notes
The Company issued unsecured senior notes (the “Unsecured Notes”) to qualified institutional buyers under Rule 144A of the Securities Act. The Unsecured Notes are senior unsecured obligations of the Company and will rank senior in right of payment to any future subordinated indebtedness of the Company, equally in right of payment with all existing and future senior indebtedness of the Company and effectively subordinated to any future secured indebtedness of the Company to the extent of the fair value of collateral securing such indebtedness.
The Unsecured Notes are fully and unconditionally guaranteed, jointly and severally, on a senior unsecured basis by PFSI’s existing and future wholly-owned domestic subsidiaries (other than certain excluded subsidiaries defined in the indenture under which the Unsecured Notes were issued). The guarantees are senior unsecured obligations of the guarantors and will rank senior in right of payment to any future subordinated indebtedness of the guarantors, equally in right of payment with all existing and future senior indebtedness of the guarantors and effectively subordinated to any future secured indebtedness of the guarantors to the extent of the fair value of collateral securing such indebtedness. The Unsecured Notes and the guarantees are structurally subordinated to the indebtedness and liabilities of the Company’s subsidiaries that do not guarantee the Unsecured Notes.
Following is a summary of the Unsecured Notes issued:
Coupon interest rate
Maturity date
September 29, 2020
500,000
5.38%
October 15, 2025
October 19, 2020
150,000
February 11, 2021
4.25%
February 15, 2029
Before October 15, 2022 or February 15, 2024 for the Unsecured Notes issued during 2020 and 2021, respectively, the Company may, at its option redeem earlier in accordance with the terms of the Unsecured Notes:
Six months ended
1,152,762
4.81
16,169
28,839
Unamortized debt issuance costs, net of issuance premiums
(11,231)
(4,180)
5.38
Maturities of Long-Term Debt
Maturities of long-term debt obligations (based on final maturity dates) are as follows:
Unsecured Notes
2,607,677
Note 14—Liability for Losses Under Representations and Warranties
Following is a summary of the Company’s liability for losses under representations and warranties:
38,428
23,202
21,446
Provision for losses on loans sold:
Resulting from sales of loans
10,304
4,189
20,357
7,901
Reduction in liability due to change in estimate
(3,640)
(1,270)
(7,325)
(2,946)
Losses incurred, net
(757)
(212)
(1,385)
(492)
25,909
Unpaid principal balance of loans subject to representations and warranties at end of period
234,327,924
192,064,630
51
Note 15—Income Taxes
The Company’s effective income tax rates were 26.9% and 26.6% for the quarters ended June 30, 2021 and 2020, respectively, and 26.0% and 26.4% for the six months ended June 30, 2021 and 2020, respectively. The difference in the effective tax rates for the six months ended June 30, 2021 compared to the six months ended June 30, 2020 was primarily due to an increase in tax deductions in 2021 related to equity compensation. Substantially all of this increase in tax deductions related to equity compensation was realized in the quarter ended March 31, 2021.
The CARES Act, passed in March 2020, introduced a number of tax law changes which are generally taxpayer favorable and in December 2020, the Taxpayer Certainty and Disaster Tax Relief Act was signed into law. No material changes in our effective income tax rates resulted from either Act.
Note 16—Commitments and Contingencies
Litigation
From time to time, the Company may be a party to legal proceedings, lawsuits and other claims arising in the ordinary course of its business. The amount, if any, of ultimate liability with respect to such matters cannot be determined, but despite the inherent uncertainties of litigation, management believes that the ultimate disposition of any such proceedings and exposure will not have, individually or taken together, a material adverse effect on the financial condition, results of operations, or cash flows of the Company.
On November 5, 2019, Black Knight Servicing Technologies, LLC, a wholly-owned indirect subsidiary of Black Knight, Inc. (“BKI”), filed a Complaint and Demand for Jury Trial in the Circuit Court for the Fourth Judicial Circuit in and for Duval County, Florida (the “Florida State Court”), captioned Black Knight Servicing Technologies, LLC v. PennyMac Loan Services, LLC, Case No. 2019-CA-007908 (the “BKI Complaint”). Allegations contained within the BKI Complaint include breach of contract and misappropriation of MSP® System trade secrets in order to develop an imitation mortgage-processing system intended to replace the MSP® System. The BKI Complaint seeks damages for breach of contract and misappropriation of trade secrets, injunctive relief under the Florida Uniform Trade Secrets Act and declaratory judgment of ownership of all intellectual property and software developed by or on behalf of PLS as a result of its wrongful use of and access to the MSP® System and related trade secret and confidential information. On March 30, 2020, the Florida State Court granted a motion to compel arbitration filed by the Company. Consequently, on April 27, 2020, PennyMac dismissed its federal court action without prejudice to pursue those claims in arbitration as well. While no assurance can be provided as to the ultimate outcome of this claim or the account of any losses to the Company, the Company believes the BKI Complaint is without merit and plans to vigorously defend the matter, which remains pending.
52
Regulatory Matters
The Company and/or its subsidiaries are subject to various state and federal regulations related to its loan production and servicing operations by the various states it operates in as well as federal agencies such as the Consumer Financial Protection Bureau (“CFPB”), HUD, and the FHA and is subject to the requirements of the Agencies to which it sells loans and for which it performs loan servicing activities. As a result, the Company may become involved in information-gathering requests, reviews, investigations and proceedings (both formal and informal) by such various federal, state and local regulatory bodies.
On January 7, 2021, PLS received a letter from the CFPB notifying PLS that, in accordance with the CFPB’s discretionary Notice and Opportunity to Respond and Advise (“NORA”) process, the CFPB’s Office of Enforcement was considering recommending that the CFPB take legal action against PLS for alleged violations of the Real Estate Settlement Procedures Act and Truth in Lending Act. The CFPB's examination covered the period from March 2015 through September 2016. Should the CFPB commence an action, it may seek restitution, civil monetary penalties, injunctive relief, or other corrective action, the extent of which remains uncertain at this time. Notably, certain of the alleged violations were originally self-identified by PLS and remediated prior to the CFPB's examination, and all alleged violations were fully remediated as of August 2017. PLS confirmed these remediation actions as well as full restitution to any affected borrowers in its response to the NORA letter submitted on February 8, 2021. While the NORA process remains open and pending at this time, and there can be no assurance as to the nature or extent of any actions taken by the CFPB with regard to these alleged violations, the Company does not believe that the ultimate resolution of this matter will have a material adverse effect on its financial statements or operations.
Commitments to Purchase and Fund Mortgage Loans
The Company’s commitments to purchase and fund loans totaled $13.9 billion as of June 30, 2021.
Note 17—Stockholders’ Equity
In February 2021, the Company’s board of directors approved an increase to the Company’s common stock repurchase program from $500 million to $1 billion.
Following is a summary of activity under the stock repurchase program:
Cumulative
total (1)
Shares of common stock repurchased
2,574
6,975
7,227
7,213
16,933
Cost of shares of common stock repurchased
154,920
237,162
443,439
241,283
795,866
53
Note 18—Net Gains on Loans Held for Sale
Net gains on loans held for sale at fair value is summarized below:
From non-affiliates:
Cash gains:
Loans
387,305
502,416
470,017
614,173
Hedging activities
(325,651)
(227,013)
410,574
(349,679)
61,654
275,403
880,591
264,494
Non-cash gains:
Mortgage servicing rights and mortgage servicing liabilities resulting from loan sales
425,941
889,512
501,273
Provisions for losses relating to representations and warranties:
Pursuant to loan sales
(10,304)
(4,189)
(20,357)
(7,901)
Reductions in liability due to change in estimate
3,640
1,270
7,325
2,946
Changes in fair values of loans and derivatives held at period end:
(50,322)
10,978
54,900
(61,102)
Hedging derivatives
157,917
125,898
(115,770)
23,007
From PennyMac Mortgage Investment Trust (1)
54
Note 19—Net Interest (Expense) Income
Net interest (expense) income is summarized below:
Cash and short-term investments
747
1,893
1,734
3,604
76,453
32,586
151,277
79,012
Placement fees relating to custodial funds
3,597
12,047
9,480
35,256
From PennyMac Mortgage Investment Trust—Assets purchased from PennyMac Mortgage Investment Trust under agreements to resell
To non-affiliates:
Corporate revolving line of credit
472
975
Interest shortfall on repayments of mortgage loans serviced for Agency securitizations
29,144
18,954
58,580
33,825
Interest on mortgage loan impound deposits
1,304
1,648
2,410
3,305
To PennyMac Mortgage Investment Trust—Excess servicing spread financing at fair value
55
Note 20—Stock-based Compensation
As of June 30, 2021, the Company had one stock-based compensation plan. Following is a summary of the stock-based compensation activity:
Grants:
Units:
Performance-based restricted share units ("RSUs")
310
422
Stock options
249
273
Time-based RSUs
171
Grant date fair value:
Performance-based RSUs
18,237
14,788
5,116
2,770
150
10,066
10,823
33,419
28,381
Vestings and exercises:
Performance-based RSUs vested
640
603
Stock options exercised
185
324
Time-based RSUs vested
307
348
Compensation expense
8,894
6,757
Note 21—Earnings Per Share of Common Stock
Basic earnings per share of common stock is determined by dividing net income by the weighted average number of shares of common stock outstanding during the quarter. Diluted earnings per share of common stock is determined by dividing net income by the weighted average number of shares of common stock outstanding, assuming all dilutive securities were issued.
Potentially dilutive securities include non-vested stock-based compensation awards. The Company applies the treasury stock method to determine the diluted weighted average number of shares of common stock outstanding based on the outstanding stock-based compensation awards.
The following table summarizes the basic and diluted earnings per share calculations:
Weighted average basic shares of common stock outstanding
Effect of dilutive securities:
Common shares issuable under stock-based compensation plan
3,509
2,634
3,755
3,001
Weighted average shares of common stock applicable to diluted earnings per share
Basic earnings per share of common stock
Diluted earnings per share of common stock
56
Calculations of diluted earnings per share require certain potentially dilutive shares to be excluded when their inclusion in the diluted earnings per share calculation would be anti-dilutive. The following table summarizes the weighted-average number of anti-dilutive outstanding performance-based RSUs and stock options excluded from the calculation of diluted earnings per share:
(in thousands except for weighted-average exercise price)
Performance-based RSUs (1)
308
215
292
79
110
Stock options (2)
173
189
Total anti-dilutive shares and units
774
388
591
Weighted average exercise price of anti-dilutive stock options (2)
58.85
35.03
Note 22—Supplemental Cash Flow Information
Cash paid for interest
208,015
127,806
Cash paid for income taxes, net
257,074
3,871
Non-cash investing activity:
Unsettled portion of MSR acquisitions
Operating right-of-use assets recognized
Non-cash financing activity:
Issuance of Excess servicing spread payable to PennyMac Mortgage Investment Trust pursuant to a recapture agreement
Note 23—Regulatory Capital and Liquidity Requirements
The Company, through PLS and PennyMac, is required to maintain specified levels of capital and liquidity to remain a seller/servicer in good standing with the Agencies. Such capital and liquid asset requirements generally are tied to the size of the Company’s loan servicing portfolio, loan origination volume and delinquency rates.
The Company is subject to financial eligibility requirements established by the Federal Housing Finance Agency (“FHFA”) for sellers/servicers eligible to sell or service mortgage loans with Fannie Mae and Freddie Mac. The eligibility requirements include:
57
The Company is also subject to financial eligibility requirements for Ginnie Mae single-family issuers. The eligibility requirements include net worth of $2.5 million plus 35 basis points of PLS' outstanding Ginnie Mae single-family obligations and a liquidity requirement equal to the greater of $1.0 million or 10 basis points of PLS' outstanding Ginnie Mae single-family securities.
The Agencies’ capital and liquidity requirements, the calculations of which are specified by each Agency, are summarized below:
Agency–company subject to requirement
Actual (1)
Requirement (1)
Capital
Fannie Mae & Freddie Mac – PLS
5,243,429
658,510
4,454,680
633,331
Ginnie Mae – PLS
4,785,193
977,600
3,794,112
1,058,641
HUD – PLS
2,500
Liquidity
317,877
88,189
506,096
84,444
217,186
215,722
Adjusted net worth / Total assets ratio
Tangible net worth / Total assets ratio
Noncompliance with an Agency’s requirements can result in such Agency taking various remedial actions up to and including terminating PennyMac’s ability to sell loans to and service loans on behalf of the respective Agency.
Note 24—Segments
The Company operates in three segments: production, servicing and investment management.
Two of the segments are in the mortgage banking business: production and servicing. The production segment performs loan origination, acquisition and sale activities. The servicing segment performs servicing of loans, execution and management of early buyout loan transactions and servicing of loans sourced and managed by the investment management segment for PMT, including executing the loan resolution strategy identified by the investment management segment relating to distressed mortgage loans.
The investment management segment represents the activities of the Company’s investment manager, which include sourcing, performing diligence, bidding and closing investment asset acquisitions and managing the acquired assets and correspondent production activities for PMT.
58
Financial performance and results by segment are as follows:
Mortgage Banking
Investment
Production
Management
Revenue: (1)
419,293
163,355
Loan origination fees
Net interest income (expense):
Interest income
31,830
48,967
Interest expense
36,913
65,515
102,428
(5,083)
(16,548)
(21,631)
(3)
925
1,555
1,588
Total net revenue
566,151
162,603
728,754
13,498
321,709
131,679
453,388
9,349
244,442
30,924
275,366
4,149
Segment assets at quarter end
7,670,877
16,185,956
23,856,833
23,305
619,728
62,445
19,205
28,113
12,642
40,560
53,202
6,563
(12,447)
(5,884)
(5)
361
351
712
2,250
2,962
738,415
72,686
811,101
10,533
200,352
135,098
335,450
5,822
538,063
(62,412)
475,651
4,711
5,419,219
17,789,046
23,208,265
18,210
23,226,475
59
935,256
401,733
61,361
101,517
74,985
135,153
210,138
(13,624)
(33,636)
(47,260)
(6)
1,227
2,122
3,349
2,730
6,079
1,239,042
424,810
1,663,852
23,086
631,705
252,142
883,847
17,568
607,337
172,668
780,005
5,518
Segment assets at year end
936,363
90,092
45,790
74,092
32,799
81,906
114,705
12,991
(7,814)
5,177
(14)
(329)
3,057
3,079
1,160,979
362,094
1,523,073
20,386
382,785
253,664
636,449
11,918
778,194
108,430
886,624
8,468
60
Note 25—Subsequent Events
Management has evaluated all events and transactions through the date the Company issued these consolidated financial statements. During this period:
The purposes of the Syndicated GMSR Servicing Spread Agreement are to (1) add Citibank as a syndicate buyer, and (2) increase the maximum purchase price from $400 to $500 million, all of which is committed on a 50-50 pro rata basis between CSCIB and Citibank. The purpose of the Syndicated GMSR SAR Agreement is to add Citibank as a syndicate buyer, with the maximum purchase price of $600 million unchanged, all of which is committed on a 50-50 pro rata basis between CSCIB and Citibank. Each syndicated facility is subject to certain terms and limitations as further described in the Company’s Current Report on Form 8-K filed with the SEC on August 5, 2021.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Cautionary Statement Regarding Forward-Looking Statements
The following discussion and analysis of financial condition and results of operations should be read with the consolidated financial statements including the related notes of PennyMac Financial Services, Inc. (“PFSI”) included within this Quarterly Report on Form 10-Q.
Statements contained in this Quarterly Report on Form 10-Q may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements involve known and unknown risks, uncertainties and other factors, which may cause actual results to be materially different from those expressed or implied in such statements. You can identify these forward-looking statements by words such as “may,” “will,” “should,” “expect,” “anticipate,” “believe,” “estimate,” “intend,” “plan” and other similar expressions. You should consider our forward-looking statements in light of the risks discussed under the heading “Risk Factors,” as well as our consolidated financial statements, related notes, and the other financial information appearing elsewhere in this Quarterly Report on Form 10-Q and our other filings with the United States Securities and Exchange Commission (“SEC”). The forward-looking statements contained in this Quarterly Report on Form 10-Q are made as of the date hereof and we assume no obligation to update or supplement any forward-looking statements.
Overview
The following discussion and analysis provides information that we believe is relevant to an assessment and understanding of our consolidated results of operations and financial condition. Unless the context indicates otherwise, references in this Quarterly Report on Form 10-Q to the words “we,” “us,” “our” and the “Company” refer to PFSI.
Our Company
We are a specialty financial services firm primarily focused on the production and servicing of U.S. residential mortgage loans (activities which we refer to as mortgage banking) and the management of investments related to the U.S. mortgage market. We believe that our operating capabilities, specialized expertise, access to long-term investment capital, and our management’s experience across all aspects of the mortgage business will allow us to profitably grow these activities and capitalize on other related opportunities as they arise in the future.
We operate and control all of the business and affairs and consolidate the financial results of Private National Mortgage Acceptance Company, LLC (“PennyMac”). We conduct our business in three segments: production, servicing (together, production and servicing comprise our mortgage banking activities) and investment management.
Our principal mortgage banking subsidiary, PennyMac Loan Services, LLC (“PLS”), is a non-bank producer and servicer of mortgage loans in the United States. PLS is a seller/servicer for the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”), each of which is a government-sponsored entity. PLS is also an approved issuer of securities guaranteed by the Government National Mortgage Association (“Ginnie Mae”), a lender of the Federal Housing Administration (“FHA”), and a lender/servicer of the Veterans Administration (“VA”) and the U.S. Department of Agriculture (“USDA”). We refer to each of Fannie Mae, Freddie Mac, Ginnie Mae, FHA, VA and USDA as an “Agency” and collectively as the “Agencies.” PLS is able to service loans in all 50 states, the District of Columbia, Guam and the U.S. Virgin Islands, and originate loans in 49 states and the District of Columbia, either because PLS is properly licensed in a particular jurisdiction or exempt or otherwise not required to be licensed in that jurisdiction.
Our investment management subsidiary is PNMAC Capital Management, LLC (“PCM”), a Delaware limited liability company registered with the SEC as an investment adviser under the Investment Advisers Act of 1940, as amended. PCM has an investment management contract with PennyMac Mortgage Investment Trust (“PMT”), a mortgage real estate investment trust listed on the New York Stock Exchange under the ticker symbol PMT.
Results of Operations
Our results of operations are summarized below:
(dollars in thousands, except per share amounts)
Revenues:
Expenses:
56,469
32,057
96,071
63,439
Annualized return on average common stockholders' equity
23.3
56.0
33.2
Income before provision for income taxes by segment:
Mortgage banking:
Total mortgage banking
Investment management
Adjusted Earnings Before Interest, Taxes, Depreciation and Amortization ("EBITDA") (1)
471,440
616,550
1,145,748
918,872
During the period:
Interest rate lock commitments issued
34,271,160
25,964,546
70,389,873
50,769,540
At end of period:
Interest rate lock commitments outstanding
12,245,054
Unpaid principal balance of loan servicing portfolio:
Owned:
252,475,400
233,807,729
2,130,520
4,672,171
240,610,420
Subserviced for PMT
147,695,455
388,305,875
Net assets of PennyMac Mortgage Investment Trust
2,343,390
2,235,277
Book value per share
54.49
34.26
63
We define “Adjusted EBITDA” as net income plus provision for income taxes, depreciation and amortization, excluding decrease (increase) in fair value of MSRs and mortgage servicing liabilities (“MSLs”), due to changes in valuation inputs used in valuation model, increase (decrease) in fair value of ESS payable to PMT, hedging losses (gains) associated with MSRs, stock-based compensation and interest expense on corporate debt or corporate revolving credit facilities and capital leases.
We believe that the presentation of Adjusted EBITDA provides useful information to investors regarding our results of operations because each measure assists both investors and management in analyzing and benchmarking the performance and value of our business. However, other companies may define Adjusted EBITDA differently, and as a result, our measures of Adjusted EBITDA may not be directly comparable to those of other companies.
Adjusted EBITDA measures have limitations as analytical tools, and should not be considered in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are:
Because of these limitations, Adjusted EBITDA measures are not intended as alternatives to net income as an indicator of our operating performance and should not be considered as measures of discretionary cash available to us to invest in the growth of our business or as measures of cash that will be available to us to meet our obligations.
The following table presents a reconciliation of Adjusted EBITDA to our net income, the most directly comparable financial measure calculated and presented in accordance with GAAP, for each of the periods indicated:
Income before provisions for income taxes
7,335
5,373
Decrease (increase) in fair value of MSRs and MSLs due to changes in valuation inputs used in valuation model
250,597
108,354
(55,529)
1,028,648
(Increase) decrease in fair value of ESS payable to PennyMac Mortgage Investment Trust
Hedging (gains) losses associated with MSRs
(91,118)
15,764
Stock‑based compensation
Interest expense on corporate debt or corporate revolving credit facilities and capital lease
16,217
576
28,946
1,246
Adjusted EBITDA
The United States continues to be impacted by the COVID-19 pandemic (the “Pandemic” or “COVID-19”) and the effects of market and government responses to the Pandemic. These developments have resulted in continued economic uncertainty, financial hardships and unemployment for many existing borrowers.
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As part of its response to the Pandemic, the federal government included requirements in the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act that we provide borrowers with loans we service for the Agencies with substantial payment forbearance. As a result of the CARES Act and other regulatory requirements, our costs to service delinquent loans in our servicing portfolio have increased and may require us to finance advances of principal and interest payments to the investors holding these loans, as well as property taxes, insurance and other costs to protect investors’ interest in the properties collateralizing the loans. As of June 30, 2021, 4.5% of loans in our predominately government-insured or guaranteed MSR portfolio were in forbearance plans and delinquent resulting in an increase in the level of servicing advances we have been required to make in order to fund borrower delinquencies.
The Pandemic has had a mixed effect on the earnings of our servicing segment by reducing the amount of placement fees we earn on custodial deposits related to these loans and increasing our cost to service due to higher delinquency and default rates, offset by gains we recognize when we are able to modify and resell previously delinquent government loans. In order to mitigate the risks and costs of maintaining delinquent government loans in Ginnie Mae securities or in our loan inventory, we sell a portion of those loans to third-party investors; we increased the volume of our sales of these loans in the quarter ended June 30, 2021, and serviced $6.1 billion in UPB of these loans for third-party investors at the end of the period.
In our production segment, gain on sale margins reflect both the strong but moderating demand for loans due to historically low interest rates as well as growth in loan production from our consumer direct and broker direct channels from the same periods in 2020. The mortgage origination market for 2020 was estimated at $4.0 trillion and current forecasts estimate of the origination market range from $3.6 trillion to $4.2 trillion for 2021. The increase in demand for mortgage loans in 2020, combined with constraints on mortgage industry origination capacity that existed before the Pandemic, allowed us to realize higher gain-on sale margins in our production segment in 2020. As industry capacity has adjusted to demand, our gain on sale margins have moderated from 2020 levels, and in certain channels reflect the effects of significant competitive pressures.
The current environment caused by the Pandemic in the United States is historically unprecedented and the source of much uncertainty surrounding future economic and market prospects and the ongoing effects on our future prospects are difficult to anticipate. For further discussion of the potential impacts of the Pandemic please also see the section entitled “Risk Factors” in Part II. Item 1A. and in our Annual Report on Form 10-K for the year ended December 31, 2020, filed with the Securities and Exchange Commission (“SEC”) on February 25, 2021.
For the quarter ended June 30, 2021, income before provision for income taxes decreased $200.8 million compared to the same period in 2020. The decrease was primarily due to a $99.5 million decrease in Net gains on loans held for sale at fair value due to lower gain on sale margins across all production channels during the quarter ended June 30, 2021 compared to the same period in 2020 and a $121.5 million increase in total expenses, partially offset by a $38.3 million increase in origination fees due to an increase in production volume. The increase in total expenses was mainly due to increases in compensation and origination expenses reflecting the growth of our mortgage banking activities.
For the six months ended June 30, 2021, income before provision for income taxes decreased $109.6 million compared to the same period in 2020. The decrease was primarily due to an increase in total expenses and a decrease in net loan servicing fees, partially offset by an increase in production revenue (Net gains on loans held for sale at fair value, Loan origination fees and Fulfillment fees from PennyMac Mortgage Investment Trust), which reflects higher production volume during the six months ended June 30, 3021 compared to the same period in 2020. The decrease in net servicing fees reflects negative valuation adjustments net of hedging results during the six months ended June 30, 2021 as compared to the same period in 2020. The increase in total expenses was mainly due to increases in compensation and origination expenses reflecting the growth of our mortgage banking activities.
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Net Gains on Loans Held for Sale at Fair Value
During the quarter and six months ended June 30, 2021, we recognized Net gains on loans held for sale at fair value totaling $582.6 million and $1.3 billion, respectively, a decrease of $99.5 million during the quarter ended June 30, 2021 compared to the same period in 2020 and an increase of $310.5 million during the six months ended June 30, 2021 compared to the same period in 2020. The decrease during the quarter ended June 30, 2021compared to the same period in 2020 was primarily due to decreases in gain on sale margins across all channels and the increase during the six months ended June 30, 2021 compared to the same period in 2020 was primarily due to an increase in production volume.
Our net gains on loans held for sale are summarized below:
Total cash gains
Change in fair value of loans and derivative financial instruments outstanding at end of period:
113,265
189,747
(394,286)
193,319
Total non-cash gains
532,542
412,362
482,194
689,637
Total gains on sale from non-affiliates
From PennyMac Mortgage Investment Trust (primarily cash)
Interest rate lock commitments issued:
Government-insured or guaranteed mortgage loans
23,397,624
18,069,299
48,544,503
37,098,437
Conventional mortgage loans
10,873,536
7,895,247
21,845,370
13,661,123
Jumbo mortgage loans
8,304
Home equity lines of credit
1,676
4,918,253
Commitments to fund and purchase loans
66
Our gains on loans held for sale include both cash and non-cash elements. We recognize a significant portion of our gains on loans held for sale when we make a commitment to purchase or fund a mortgage loan. We recognize this gain in the form of an interest rate lock commitment. We adjust our initial gain amount as the loan purchase or origination process progresses until the loan is either funded or cancelled. We also receive non-cash proceeds on sale that include our estimate of the fair value of MSRs and we incur liabilities for mortgage servicing liabilities (which represent the fair value of the costs we expect to incur in excess of the fees we receive for the early buyout of delinquent loans (“EBO loans”) we have resold to third party investors) and for the fair value of our estimate of the losses we expect to incur relating to the representations and warranties we provide in our loan sale transactions.
Non-cash elements of gain on sale of loans held for sale
The MSRs, MSLs, and liability for representations and warranties we recognize represent our estimate of the fair value of future benefits and costs we will realize for years in the future. These estimates represented approximately 72% and 66% of our gain on sale of loans held for sale at fair value for the quarter and six months ended June 30, 2021, respectively, as compared to 33% and 48% for the quarter and six months ended June 30, 2020, respectively. These estimates change as circumstances change and changes in these estimates are recognized in income in subsequent periods. How we measure and update our measurements of IRLCs, MSRs and MSLs is detailed in Note 6 – Fair value – Valuation Techniques and Inputs to the consolidated financial statements included in this Quarterly Report.
Our agreements with the purchasers and insurers include representations and warranties related to the loans we sell. The representations and warranties require adherence to purchaser and insurer 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 loans with the identified defects or indemnify the purchaser or insurer. In such cases, we bear any subsequent credit losses on the loans. Our credit losses may be reduced by any recourse we have to correspondent originators that sold such 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 correspondent seller.
Our representations and warranties are generally not subject to stated limits of exposure. However, we believe that the current UPB of loans sold by us and subject to representation and warranty liability to date represents the maximum exposure to repurchases related to representations and warranties.
The level of the liability for losses under representations and warranties is difficult to estimate and requires considerable judgment. The level of loan repurchase losses is dependent on economic factors, purchaser or insurer loss mitigation strategies, and other external conditions that may change over the lives of the underlying loans. Our estimate of the liability for representations and warranties is developed by our credit administration staff and approved by our senior management credit committee which includes our senior executives and senior management in our loan production, loan servicing and credit risk management areas.
The method used to estimate our losses on representations and warranties is a function of our estimate of future defaults, loan repurchase rates, the severity of loss in the event of default, if applicable, 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.
We recorded provisions for losses under representations and warranties relating to current loan sales as a component of Net gains on loans held for sale at fair value totaling $10.3 million and $20.4 million for the quarter and six months ended June 30, 2021, respectively, compared to $4.2 million and $7.9 million for the quarter and six months ended June 30, 2020, respectively. The increase in the provision relating to current loan sales is primarily attributable to increased sales of loans supplemented by increased loss assumptions relating to our securitizations of reperforming early buyout loans. We also recorded reductions in the liability of $3.6 million and $7.3 million during the quarter and six months ended June 30, 2021, respectively, compared to $1.3 million and $2.9 million during the quarter and six months ended June 30, 2020, respectively. The reductions in the liability resulted from previously sold loans meeting performance criteria established by the Agencies which significantly limit the likelihood of certain repurchase or indemnification claims.
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Following is a summary of loan repurchase activity and the UPB of loans subject to representations and warranties:
Indemnification activity:
Loans indemnified by PFSI at beginning of period
14,239
16,245
13,788
15,366
New indemnifications
5,100
1,567
7,255
2,446
Less indemnified loans sold, repaid or refinanced
2,805
1,416
4,509
Loans indemnified by PFSI at end of period
16,534
16,396
Repurchase activity:
Total loans repurchased by PFSI
25,928
18,271
43,914
34,553
Less:
Loans repurchased by correspondent lenders
13,763
10,353
22,452
16,506
Loans repaid by borrowers or resold with defects resolved
1,927
5,921
4,576
7,367
Net loans repurchased with losses chargeable to liability for representations and warranties
10,238
1,997
16,886
10,680
Net losses charged to liability for representations and warranties
757
212
1,385
492
Unpaid principal balance of loans subject to representations and warranties
Liability for representations and warranties
During the quarter and six months ended June 30, 2021, we repurchased loans totaling $25.9 million and $43.9 million in UPB, respectively. We recorded losses of $757,000 and $1.4 million net of recoveries during the quarter and six months ended June 30, 2021, respectively. If the outstanding balance of loans we purchase and sell subject to representations and warranties increases, the loans sold continue to season, economic conditions change, correspondent lenders become unwilling or unable to repurchase defective loans, or investor and insurer loss mitigation strategies are adjusted, the level of repurchase and loss activity may increase.
Loan origination fees increased $38.3 million and $84.8 million during the quarter and six months ended June 30, 2021, respectively, compared to the same periods in 2020. The increases were primarily due to an increase in volume of loans we produced.
Fulfillment fees from PMT represent fees we collect for services we perform on behalf of PMT in connection with the acquisition, packaging and sale of loans. The fulfillment fees were calculated as a percentage of the UPB of the loans we fulfilled for PMT through June 30, 2020. Effective July 1, 2020, fulfillment fees are calculated based on the number of loans we fulfill for PMT.
Fulfillment fees increased $1.2 million and $20.1 million during the quarter and six months ended June 30, 2021 compared to the same periods in 2020. The increases were primarily due to an increase in PMT’s loan production volume, partially offset by the effect of the amendment to the fulfillment fee structure noted above, which generally reduced the fulfillment fees collected per loan fulfilled.
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Net Loan Servicing Fees
Following is a summary of our net loan servicing fees:
Change in fair value of mortgage servicing rights, mortgage servicing liabilities and excess servicing spread financing net of hedging results
Average loan servicing portfolio
461,498,813
386,455,938
449,782,033
381,539,569
Change in fair value of MSRs, MSLs and excess servicing spread are summarized below:
Realization of cash flows
(85,671)
(97,435)
(168,334)
(212,354)
Other changes in fair value of mortgage servicing rights and mortgage servicing liabilities
(250,597)
(108,354)
55,529
(1,028,648)
Change in fair value of excess servicing spread
Hedging results
Total change in fair value of mortgage servicing rights, mortgage servicing liabilities and excess servicing spread financing net of hedging results
Average balances:
3,346,877
2,198,533
3,120,761
2,407,037
62,098
28,537
55,229
28,847
Excess servicing spread financing
154,745
43,484
164,115
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Following is a summary of our loan servicing portfolio:
Loans serviced
Prime servicing:
221,492,618
196,873,590
Acquired
30,982,782
41,537,219
238,410,809
204,132,766
174,360,317
Total prime servicing
473,182,350
426,692,556
Special servicing subserviced for PMT
41,696
58,274
Total loans serviced
Delinquencies:
Owned servicing:
30-89 days (1)
5,607,408
7,611,216
90 days or more (1)
15,995,816
22,545,750
1,645,432
3,225,010
Subserviced for PMT:
906,922
1,250,381
3,038,845
4,543,660
274,479
593,517
Net loan servicing fees decreased $7.5 million during the quarter ended June 30, 2021 compared to the same period in 2020. The decrease was due to an increase of $24.2 million in fair value losses relating to MSRs, MSLs, and ESS, net of hedging results, partially offset by an increase of $16.8 million in loan servicing fees resulting from an increase in our average servicing portfolio during the quarter ended, June 30, 2021 compared to the same period in 2020. The increase in fair value losses was primarily due to a decrease of $142.2 million in fair value of MSRs and MSLs, reflecting the effect on prepayment experience and expectations on the fair value of our investments in MSRs as a result of decreasing interest rates during the quarter ended June 30, 2021 as compared to the quarter ended June 30, 2020, partially offset by an increase of $106.9 million in hedging results.
Net loan servicing fees decreased $225.6 million during the six months ended June 30, 2021 compared to the same period in 2020. The decrease was due to an increase of $259.8 million in fair value losses relating to MSRs, MSLs, and ESS, net of hedging results, partially offset by an increase of $34.3 million in loan servicing fees resulting from an increase in our average servicing portfolio during the six months ended, June 30, 2021 compared to the same period in 2020.
Net Interest (Expense) Income
Net interest (expense) income decreased $15.7 million and $52.4 million, during the quarter and six months ended June 30, 2021, respectively, compared to the same periods in 2020. The decreases were primarily due to:
Management fees are summarized below:
Management fees:
PennyMac Mortgage Investment Trust:
Net assets of PMT at end of period
Management fees increased $3.6 million and $3.0 million during the quarter and six months ended June 30, 2021, respectively, compared to the same periods in 2020. The increases were primarily due to $3.3 million of performance incentive fees earned during the quarter ended June 30, 2021, as result of PMT’s increased profitability during the measurement period ended June 30, 2021, on which its performance incentive fee is based.
Compensation expenses are summarized below:
Salaries and wages
154,406
102,084
298,106
191,399
Incentive compensation
71,888
51,359
144,543
97,340
Taxes and benefits
29,879
19,686
61,476
40,458
Stock and unit-based compensation
Head count:
Average
7,151
4,937
7,008
4,635
Period end
7,231
5,353
Compensation expense increased $85.2 million and $175.6 million, respectively, during the quarter and six months ended June 30, 2021 compared to the same period in 2020. The increases were primarily due to growth in head count made to accommodate the growth in our loan production and servicing activities.
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Loan origination expense increased $24.8 million and $66.1 million, respectively, during the quarter and six months ended June 30, 2021 compared to the same periods in 2020. The increases were primarily due to increased lending activities during the quarter and six months ended June 30, 2021 compared to the same periods during 2020.
Technology expense increased $12.3 million and $26.9 million, respectively, during the quarter and six months ended June 30, 2021, compared to the same periods in 2020. The increases were primarily due to growth in our loan servicing operations and continued investment in our loan production and servicing infrastructure.
Servicing expenses decreased $25.2 million and $48.2 million, respectively, during the quarter and six months ended June 30, 2021, compared to the same periods in 2020. This decreases in servicing expenses were primarily due to reversal of the provision for estimated servicing advances losses recorded in prior periods in the amount of $13.1 million and $33.6 million, respectively, during the quarter and six months ended June 30, 2021, respectively. The reduction reflects the recent improvements in the performance of our servicing portfolio.
Professional expenses increased $12.3 million and $12.2 million, respectively, during the quarter and six months ended June 30, 2021, compared to the same periods in 2020. The increases were primarily due to increases in legal fees and consulting fees related to our investments in technology infrastructure.
Provision for Income Taxes
Our effective income tax rates were 26.9% and 26.0% during the quarter and six months ended June 30, 2021, respectively, compared to 26.6% and 26.4% during the same periods in 2020. The difference in the effective tax rates for the quarter ended June 30, 2021 compared to the six months ended June 30, 2021 was primarily due to an increase in tax deductions in 2021 related to equity compensation. Substantially all of this increase in tax deductions related to equity compensation was realized in the quarter ended March 31, 2021.
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Balance Sheet Analysis
Following is a summary of key balance sheet items as of the dates presented:
327,878
547,933
Servicing advances, net
Investments in and advances to affiliates
63,463
168,972
688,102
767,103
LIABILITIES AND STOCKHOLDERS' EQUITY
Short-term debt
8,766,796
10,176,274
Long-term debt
2,593,177
2,085,274
823,040
698,712
Stockholders' equity
Total liabilities and stockholders' equity
Total assets decreased $7.7 billion from $31.6 billion at December 31, 2020 to $23.9 billion at June 30, 2021. The decrease was primarily due to a decrease of $7.0 billion in loans eligible for repurchase, $731.9 million in loans held for sale at fair value, $340.0 million in derivative assets, $220.1 million in cash and short-term investments, partially offset by an increase of $831.5 million in MSRs. The decrease in loans eligible for repurchase was primarily due to increased early buyout activity and a decrease in delinquent loans in the servicing portfolio during the six months ended June 30, 2021.
Total liabilities decreased $7.8 billion from $28.2 billion at December 31, 2020 to $20.4 billion at June 30, 2021. The decrease was primarily due to the decrease in liability for loans eligible for repurchase.
Cash Flows
Our cash flows are summarized below:
Change
Operating
966,001
Investing
(1,131,376)
Financing
(765,031)
(930,406)
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Our cash flows resulted in a net decrease in cash and restricted cash of $208.6 million during the six months ended June 30, 2021 as discussed below.
Operating activities
Net cash provided by operating activities totaled $1.3 billion during the six months ended June 30, 2021 compared with net cash provided by operating activities of $365.6 million during the same period in 2020. Our cash flows from operating activities are primarily influenced by changes in the levels of our inventory of mortgage loans as shown below:
Cash flows from:
1,659,510
350,725
Other operating sources
(327,912)
14,872
Net cash used in other operating activities totaled $327.9 million during the six months ended June 30, 2021, primarily due to $207.6 million in capitalized interest and advances on loans held for sale.
Investing activities
Net cash used in investing activities during the six months ended June 30, 2021 totaled $145.2 million, primarily due to $345.6 million in net settlement of derivative financial instruments used to hedge our investment in MSRs, partially offset by a $134.7 million decrease in margin deposits. Net cash provided by investing activities during the six months ended June 30, 2020 totaled $986.1 million, primarily due to $995.2 million in net settlement of derivative financial instruments used to hedge our investment in MSRs.
Financing activities
Net cash used in financing activities totaled $1.4 billion during the six months ended June 30, 2021, primarily due to a decrease of $761.0 million in borrowings, $443.4 million of repurchase of our common stock and $134.6 million of repayment of ESS financing. The reduction in borrowings reflects reduced inventory of loans held for sale, combined with repurchase of common stock. Net cash used in financing activities totaled $629.9 million during the six months ended June 30, 2020, primarily due to net repurchase of assets sold under agreements to repurchase, reflecting a reduction in our financing of mortgage loans held for sale and repurchase of common stock.
Liquidity and Capital Resources
Our liquidity reflects our ability to meet our current obligations (including our operating expenses and, when applicable, the retirement of, and margin calls relating to, our debt, and margin calls relating to hedges on our commitments to purchase or originate mortgage loans and on our MSR investments), fund new originations and purchases, and make investments as we identify them. We expect our primary sources of liquidity to be through cash flows from business activities, proceeds from bank borrowings, proceeds from and issuance of equity or debt offerings. We believe that our liquidity is sufficient to meet our current liquidity needs.
The effect of the Pandemic on our operations, liquidity and capital resources remain uncertain and difficult to predict, for further discussion of the potential impacts of the Pandemic please also see the section entitled “Risk Factors” in Part II. Item 1A. and in our Annual Report on Form 10-K for the year ended December 31, 2020, filed with the SEC on February 25, 2021.
The CARES Act allows borrowers with federally-backed loans to request temporary payment forbearance in response to the increased borrower hardships resulting from the COVID-19 pandemic and may require us as the servicer to advance principal and interest to investors for up to four months on Fannie Mae and Freddie Mac loans and longer on
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Ginnie Mae and other government agency backed loans, as well as advancing property taxes, insurance premiums and other expenses. In April 2020, the Company entered into a new Ginnie Mae servicing advance financing transaction allowing the Company to borrow $600 million in excess of our currently outstanding MSR term notes against Ginnie Mae MSRs and servicing advances. The Ginnie Mae servicing advances eligible for financing include advances made to support regularly scheduled monthly principal and interest to mortgage-backed securities holders, taxes, homeowners insurance and escrowed items and other costs related to servicing delinquent loans. We are also in ongoing discussions with our lending partners to align our servicing advance assets and financing capacity, and to further diversify our financing alternatives.
The COVID-19 pandemic has significantly increased the number of loans that are delinquent in our Ginnie Mae MSR portfolio. The Ginnie Mae guidelines provides us with the option to purchase loans that are at least three months delinquent out of the underlying Ginnie Mae securities as an alternative to continuing to advance principal and interest payments to the holders of the Ginnie Mae securities. We refer to such loans as “early buyout” or EBO loans.
During the six months ended June 30, 2021, we purchased $10.9 billion in UPB of EBO loans from our Ginnie Mae MSR portfolio. Our objective is to work with the borrowers to cure the loan delinquency through either borrower reperformance or modification of the loans’ terms. When curing the delinquency is not feasible, we work to settle the loan and collect our claims from the applicable insurer or guarantor. When we are able to cure the delinquency, we are able to re-deliver the cured loan into another Ginnie Mae guaranteed security. Depending on the method used to cure a borrower delinquency, the Ginnie Mae program may require at least a six month period of timely borrower payments before we are able to re-deliver the loan. Therefore, regardless of whether we cure or settle the repurchased loan, our investment in the EBO loans may require a substantial holding period. We have financed our EBO purchases by expanding our borrowing capacity under existing facilities and by procuring a dedicated EBO repurchase agreement facility.
Our current borrowing strategy is to finance our assets where we believe such borrowing is prudent, appropriate and available. Our borrowing activities are in the form of sales of assets under agreements to repurchase, sales of mortgage loan participation purchase and sale certificates, notes payable, a capital lease and unsecured senior notes. A significant amount of our borrowings have short-term maturities and provide for advances with terms ranging from 45 days to 240 days. Because a significant portion of our current debt facilities consists 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.
On April 28, 2021, the Company, through PLS, PennyMac, and PFSI Issuer Trust - FMSR, entered into a structured finance transaction, allowing PLS to finance Fannie Mae MSRs and ESS (the “Fannie Mae MSR Facility”). In connection with the Fannie Mae MSR Facility, PLS pledges and/or sells to PFSI Issuer Trust - FMSR participation certificates representing beneficial interests in MSRs and ESS pursuant to the terms of a master repurchase agreement, dated as of April 28, 2021, by and between PLS, PFSI Issuer Trust - FMSR and PennyMac (the “PC Repurchase Agreement”). In return, PFSI Issuer Trust - FMSR (a) has issued to PLS the Series 2021-MSRVF1 Note, dated April 28, 2021, known as the “PFSI ISSUER TRUST - FMSR Collateralized Notes, Series 2021-MSRVF1” (the “FMSR VFN”), and (b) may, from time to time, issue to institutional investors term notes, in each case secured on a pari passu basis by the participation certificates relating to the MSRs and ESS. The maximum principal balance of the FMSR VFN is $1,000,000,000. We did not borrow under the Fannie Mae MSR Facility during the quarter ended June 30, 2021.
Our repurchase agreements represent the sales of assets together with agreements for us to buy back the respective assets at a later date. The table below presents the average, maximum daily and ending balances:
Maximum daily balance
Balance at period end
The differences between the average and maximum daily balances on our repurchase agreements reflect the fluctuations throughout the month of our inventory as we fund and pool mortgage loans for sale in guaranteed mortgage securitizations.
Our secured financing agreements at PLS require us to comply with various financial covenants. The most significant financial covenants currently include the following:
With respect to servicing performed for PMT, PLS is also subject to certain covenants under PMT’s debt agreements. Covenants in PMT’s debt agreements are equally, or sometimes less, restrictive than the covenants described above.
In addition to the covenants noted above, the indenture governing our Unsecured Notes contains covenants that limit the Company and our restricted subsidiaries’ ability to engage in specified types of transactions. These covenants limit our and our restricted subsidiaries’ ability to, among other things:
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Although these financial covenants limit the amount of indebtedness that we may incur and affect our liquidity through minimum cash reserve requirements, we believe that these covenants currently provide us with sufficient flexibility to successfully operate our business and obtain the financing necessary to achieve that purpose.
Our repurchase financing agreements also contain margin call provisions that, upon notice from the applicable lender at its option, require us to transfer cash or, in some instances, additional assets in an amount sufficient to eliminate any margin deficit. A margin deficit will generally result from any decline in the market value (as determined by the applicable lender) of the assets subject to the related financing agreement. Upon notice from the applicable lender, we will generally be required to satisfy the margin call on the day of such notice or within one business day thereafter, depending on the timing of the notice.
We are also subject to liquidity and net worth requirements established by the Federal Housing Finance Agency (“FHFA”) for Agency seller/servicers and Ginnie Mae for single-family issuers. FHFA and Ginnie Mae have established minimum liquidity and net worth requirements for their approved non-depository single-family sellers/servicers in the case of Fannie Mae, Freddie Mac, and Ginnie Mae for its approved single-family issuers, as summarized below:
We believe that we are currently in compliance with the applicable Agency requirements.
On August 4, 2021, our Board of Directors increased our common stock repurchase program from $1 billion to $2 billion. Share repurchases may be effected through open market purchases or privately negotiated transactions in accordance with applicable rules and regulations. The stock repurchase program does not have an expiration date and the authorization does not obligate us to acquire any particular amount of common stock. From inception through June 30, 2021, we have repurchased $795.9 million of shares under our stock repurchase program.
We continue to explore a variety of means of financing our continued growth, including debt financing through bank warehouse lines of credit, bank loans, repurchase agreements, securitization transactions and corporate debt. However, there can be no assurance as to how much additional financing capacity such efforts will produce, what form the financing will take or whether such efforts will be successful.
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Off-Balance Sheet Arrangements and Aggregate Contractual Obligations
Off-Balance Sheet Arrangements and Guarantees
As of June 30, 2021, we have not entered into any off-balance sheet arrangements.
Debt Obligations
As described further above in “Liquidity and Capital Resources,” we currently finance certain of our assets through borrowings with major financial institution counterparties in the form of sales of assets under agreements to repurchase, mortgage loan participation purchase and sale agreements, notes payable and a capital lease. The borrower under each of these facilities is PLS or the Issuer Trust with the exception of the capital lease where the borrower is PennyMac. All PLS obligations are guaranteed by PennyMac.
Under the terms of these agreements, PLS is required to comply with certain financial covenants, as described further above in “Liquidity and Capital Resources,” and various non-financial covenants customary for transactions of this nature. As of June 30, 2021, we believe we were in compliance in all material respects with these covenants.
The repurchase agreements also contain margin call provisions that, upon notice from the applicable lender, require us to transfer cash or, in some instances, additional assets in an amount sufficient to eliminate any margin deficit. Upon notice from the applicable lender, we will generally be required to satisfy the margin call on the day of such notice or within one business day thereafter, depending on the timing of the notice.
In addition, the agreements contain events of default (subject to certain materiality thresholds and grace periods), including payment defaults, breaches of covenants and/or certain representations and warranties, cross-defaults, guarantor defaults, servicer termination events and defaults, material adverse changes, bankruptcy or insolvency proceedings and other events of default customary for these types of transactions. The remedies for such events of default are also customary for these types of transactions and include the acceleration of the principal amount outstanding under the agreements and the liquidation by our lenders of the mortgage loans or other collateral then subject to the agreements.
The Company also issued Unsecured Notes that are fully and unconditionally guaranteed, jointly and severally, on a senior unsecured basis by the Company’s existing and future wholly-owned domestic subsidiaries (other than certain excluded subsidiaries defined in the indenture under which the Unsecured Notes were issued). The Company is required to maintain certain financial covenants under terms of the Unsecured Notes. We believe the Company was in compliance with all financial covenants in the Unsecured Notes as of June 30, 2021.
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Our debt obligations have the following size and maturities:
Outstanding
Lender
indebtedness (1)
facility size (2)
facility (2)
Maturity date (2)
(dollar amounts in thousands)
Credit Suisse First Boston Mortgage Capital LLC (3)
1,816,022
4,950,000
1,950,000
2,214,458
3,000,000
304
1,800,000
540,000
Goldman Sachs Bank USA
1,000,000
728,899
600,000
200,000
August 27, 2021
300,000
375,000
342,509
175,000
193,628
August 10, 2021
550,000
June 8, 2022
Notes payable
GMSR 2018-GT1 Notes
February 25, 2023
GMSR 2018-GT2 Notes
August 25, 2023
Unsecured Senior Notes - 5.375%
Unsecured Senior Notes - 4.25%
Credit Suisse AG (3)
September 20, 2021
Banc of America Leasing and Capital LLC
25,000
June 13, 2022
The amount at risk (the fair value of the assets pledged plus the related margin deposit, less the amount advanced by the counterparty and accrued interest) relating to our assets sold under agreements to repurchase is summarized by counterparty below as of June 30, 2021:
maturity of
advances under
repurchase agreement
All debt financing arrangements that matured between June 30, 2021 and the date of this Report have been renewed or extended and are described in Note 12—Short-Term Borrowings to the accompanying consolidated financial statements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Market risk is the exposure to loss resulting from changes in interest rates, foreign currency exchange rates, commodity prices, equity prices, real estate values and other market-based risks. The primary market risks that we are exposed to are fair value risk, interest rate risk and prepayment risk.
Fair Value Risk
Our IRLCs, mortgage loans held for sale, MSRs and MSLs are reported at their fair values. The fair value of these assets fluctuates primarily due to changes in interest rates. The fair value risk we face is primarily attributable to interest rate risk and prepayment risk.
Interest Rate Risk
Interest rate risk is highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations, and other factors beyond our control. Changes in interest rates affect both the fair value of, and interest income we earn from, our mortgage-related investments and our derivative financial instruments. This effect is most pronounced with fixed-rate mortgage assets.
In general, rising interest rates negatively affect the fair value of our IRLCs and inventory of mortgage loans held for sale and positively affect the fair value of our MSRs. Changes in interest rate significantly influence the prepayment speeds of the loans underlying our investments in MSRs and ESS, which can have a significant effect on their fair values. Changes in interest rate are most prominently reflected in the prepayment speeds of the loans underlying our investments in MSRs and ESS and the discount rate used in their valuation.
Our operating results will depend, in part, on differences between the income from our investments and our financing costs. Presently our debt financing is based on a floating rate of interest calculated on a fixed spread over the relevant index, as determined by the particular financing arrangement.
Prepayment Risk
To the extent that the actual prepayment rate on the mortgage loans underlying our MSRs differs from what we projected when we initially recognized these assets and liabilities when we measure fair value as of the end of each reporting period, the carrying value of these assets and liabilities will be affected. In general, a decrease in the principal balances of the mortgage loans underlying our MSRs or an increase in prepayment expectations will decrease our estimates of the fair value of the MSRs, thereby reducing net servicing income, partially offset by the beneficial effect on net servicing income of a corresponding reduction in the fair value of our MSLs and ESS.
Risk Management Activities
We engage in risk management activities primarily in an effort to mitigate the effect of changes in interest rates on the fair value of our assets. To manage this price risk, we use derivative financial instruments acquired with the intention of moderating the risk that changes in market interest rates will result in unfavorable changes in the fair value of our assets, primarily prepayment exposure on our MSR investments as well as IRLCs and our inventory of loans held for sale. Our objective is to minimize our hedging expense and maximize our loss coverage based on a given hedge expense target. We do not use derivative financial instruments other than IRLCs and repurchase agreement derivatives (both of which arise from our operations) for purposes other than in support of our risk management activities.
Our strategies are reviewed daily within a disciplined risk management framework. We use a variety of interest rate and spread shifts and scenarios and define target limits for market value and liquidity loss in those scenarios. With respect to our IRLCs and inventory of loans held for sale, we use MBS forward sale contracts to lock in the price at which we will sell the mortgage loans or resulting MBS, and further use MBS put options to mitigate the risk of our IRLCs not closing at the rate we expect. With respect to our MSRs, we seek to mitigate mortgage-based loss exposure utilizing MBS forward purchase and sale contracts, address exposures to smaller interest rate shifts with Treasury and interest rate swap futures, and use options and swaptions to achieve target coverage levels for larger interest rate shocks.
Fair Value Sensitivities
The following 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 to other variables; are subject to the accuracy of various models and inputs used; and do not incorporate other factors that would affect our overall financial performance in such scenarios, including operational adjustments made by management to account for changing circumstances. For these reasons, the following estimates should not be viewed as earnings forecasts.
The following tables summarize the estimated change in fair value of MSRs as of June 30, 2021, given several shifts in pricing spreads, prepayment speed and annual per loan cost of servicing:
Change in fair value attributable to shift in:
-20%
-10%
-5%
+5%
+10%
+20%
Pricing spread
245,747
118,589
58,275
(56,330)
(110,804)
(214,519)
Prepayment speed
317,347
152,504
74,793
(72,028)
(141,434)
(272,904)
124,790
62,395
31,198
(31,198)
(62,395)
(124,790)
81
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, as amended (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 Rule 13a-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.
Changes in Internal Control over Financial Reporting
There has been no change in our internal control over financial reporting during the three months ended June 30, 2021 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Item 1. Legal Proceedings
From time to time, the Company may be involved in various legal and regulatory proceedings, lawsuits and other claims arising in the ordinary course of its business. The amount, if any, of ultimate liability with respect to such matters cannot be determined, but despite the inherent uncertainties of litigation, management believes that the ultimate disposition of any such proceedings and exposure will not have, individually or taken together, a material adverse effect on the financial condition, results of operations, or cash flows of the Company. Set forth below are material updates to legal proceedings of the Company.
On January 7, 2021, PLS received a letter from the CFPB notifying PLS that, in accordance with the CFPB’s discretionary Notice and Opportunity to Respond and Advise (“NORA”) process, the CFPB’s Office of Enforcement was considering recommending that the CFPB take legal action against PLS for alleged violations of the Real Estate Settlement Procedures Act and Truth in Lending Act. The CFPB's examination covered the period from March 2015 through September 2016. Should the CFPB commence an action, it may seek restitution, civil monetary penalties, injunctive relief, or other corrective action, the extent of which remains uncertain at this time. Notably, certain of the alleged violations were originally self-identified by PLS and remediated prior to the CFPB's examination, and all alleged violations were fully remediated as of August 2017. PLS confirmed these remediation actions as well as full restitution to any affected borrowers in its response to the NORA letter on February 8, 2021. While the NORA process remains open and pending at this time, and there can be no assurance as to the nature or extent of any actions taken by the CFPB with regard to these alleged violations, we do not believe that the ultimate resolution of this matter will have a material adverse effect on our financial statements or operations.
Item 1A. Risk Factors
There have been 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, 2020, filed with the SEC on February 25, 2021.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
There were no sales of unregistered equity securities during the quarter ended June 30, 2021.
The following table summarizes information about our stock repurchase during the quarter ended June 30, 2021:
Total numberof sharespurchased
Average pricepaid per share
Total number of shares purchasedas part of publicly announced plans or program (1)
Approximate dollarvalue of shares thatmay yet bepurchased under the plans or program (1)
April 1, 2021 – April 30, 2021
269,832
59.12
343,212,099
May 1, 2021 – May 31, 2021
1,290,187
60.23
266,551,209
June 1, 2021 – June 30, 2021
1,014,097
62.01
204,133,351
2,574,116
60.50
Item 3. Defaults Upon Senior Securities
None.
Item 4. Mine Safety Disclosures
Not applicable.
Item 5. Other Information
None
Item 6. Exhibits
Incorporated by Reference from the Below-Listed Form (Each Filed under SEC File Number 15-68669 or 001-38727)
Exhibit No.
Exhibit Description
Form
Filing Date
2.1
Contribution Agreement and Plan of Merger, dated as of August 2, 2018, by and among PennyMac Financial Services, Inc., New PennyMac Financial Services, Inc., New PennyMac Merger Sub, LLC, Private National Mortgage Acceptance Company, LLC, and the Contributors.
8-K12B
November 1, 2018
3.1
Amended and Restated Certificate of Incorporation of New PennyMac Financial Services, Inc.
3.1.1
Certificate of Amendment to Amended and Restated Certificate of Incorporation of New PennyMac Financial Services, Inc.
Amended and Restated Bylaws of New PennyMac Financial Services, Inc.
3.2.1
Amendment to Amended and Restated Bylaws of PennyMac Financial Services, Inc. (formerly known as New PennyMac Financial Services, Inc.).
10-Q
November 4, 2019
4.1
Base Indenture, dated as of April 28, 2021, by and among PFSI ISSUER TRUST - FMSR, as Issuer, Citibank, N.A., as Indenture Trustee, Calculation Agent, Paying Agent and Securities Intermediary, PennyMac Loan Services, LLC, as Servicer and Administrator, and Credit Suisse First Boston Mortgage Capital LLC, as Administrative Agent.
8-K
May 3, 2021
10.1
Master Repurchase Agreement, dated as of April 28, 2021, by and among PFSI ISSUER TRUST - FMSR, as Buyer, PennyMac Loan Services, LLC, as Seller, and Private National Mortgage Acceptance Company, LLC, as Guarantor.
10.2
Guaranty, dated as of April 28, 2021, by Private National Mortgage Acceptance Company, LLC, on behalf of PFSI ISSUER TRUST – FMSR for the benefit of Credit Suisse AG, Cayman Islands Branch and any other buyers under the MSRVF1 Repurchase Agreement of the same date.
10.3
Master Repurchase Agreement, dated as of April 28, 2021, by and among Credit Suisse First Boston Mortgage Capital LLC, as administrative agent, Credit Suisse AG, Cayman Islands Branch, as Buyer, and PennyMac Loan Services, LLC, as Seller.
10.4
Guaranty, dated as of April 28, 2021, made by Private National Mortgage Acceptance Company, LLC on behalf of PennyMac Loan Services, LLC for the benefit of the holders of the notes issued pursuant to the Base Indenture of the same date.
10.5
Amendment No. 2 to the Amended and Restated Series 2020-SPIADVF1 Indenture Supplement, dated as of April 1, 2021, among PNMAC GMSR ISSUER TRUST, Citibank, N.A., PennyMac Loan Services, LLC and Credit Suisse First Boston Mortgage Capital LLC.
May 6, 2021
10.6
Amendment No. 4 to the Amended and Restated Series 2016-MSRVF1 Indenture Supplement, dated as of April 1, 2021, among PNMAC GMSR ISSUER TRUST, Citibank, N.A., PennyMac Loan Services, LLC and Credit Suisse First Boston Mortgage Capital LLC.
10.7
Amendment No. 2 to the Fourth Amended and Restated Flow Servicing Agreement, dated as of June 4, 2021, by and between PennyMac Loan Services, LLC and PennyMac Operating Partnership, L.P.
*
10.8†
PennyMac Financial Services, Inc. 2013 Equity Incentive Plan Form of Stock Option Award Agreement.
10.9†
PennyMac Financial Services, Inc. 2013 Equity Incentive Plan Form of Omnibus Amendment to Stock Option Award Agreements.
31.1
Certification of David A. Spector pursuant to Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
Certification of Daniel S. Perotti pursuant to Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1
Certification of David A. Spector 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.
**
32.2
Certification of Daniel S. Perotti 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, formatted in Inline XBRL: (i) the Consolidated Balance Sheets as of June 30, 2021 and December 31, 2020 (ii) the Consolidated Statements of Income for the quarters ended June 30, 2021 and June 30, 2020, (iii) the Consolidated Statements of Changes in Stockholders’ Equity for the quarters ended June 30, 2021 and June 30, 2020, (iv) the Consolidated Statements of Cash Flows for the quarters ended June 30, 2021 and June 30, 2020 and (v) the Notes to the Consolidated Financial Statements.
101.INS
XBRL Instance Document – the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document
101.SCH
Inline XBRL Taxonomy Extension Schema Document
101.CAL
Inline XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF
101.LAB
101.PRE
Inline XBRL Taxonomy Extension Definition Linkbase Document
Inline XBRL Taxonomy Extension Label Linkbase Document
Inline XBRL Taxonomy Extension Presentation Linkbase Document
Cover Page Interactive Data File (embedded within the Inline XBRL document).
*Filed herewith
**The certifications attached hereto as Exhibits 32.1 and 32.2 are furnished to the SEC pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 and shall not be deemed filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, nor shall it be deemed incorporated by reference in any filing under the Securities Act of 1933, except as shall be expressly set forth by specific reference in such filing.
†Indicates management contract or compensatory plan or arrangement.
86
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)
Dated: August 5, 2021
By:
/s/ DAVID A. SPECTOR
David A. Spector
Chairman and Chief Executive Officer
/s/ DANIEL S. PEROTTI
Daniel S. Perotti
Senior Managing Director and
Chief Financial Officer
87