UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
Form 10-K
(Mark One)
☒ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 20152016
Or
☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period fromto
Commission file number: 001-34416
PennyMac Mortgage Investment Trust
(Exact name of registrant as specified in its charter)
Maryland |
(818) 224-7442 (Registrant’s telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes 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 Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes As of June 30, As of February Documents Incorporated By Reference
PENNYMAC MORTGAGE INVESTMENT TRUST FORM 10-K December 31, TABLE OF CONTENTS
1 SPECIAL NOTE REGARDING This Annual Report on Form 10-K (“Report”) contains certain forward-looking statements that are subject to various risks and uncertainties. Forward-looking statements are generally identifiable by use of forward-looking terminology such as “may,” “will,” “should,” “potential,” “intend,” “expect,” “seek,” “anticipate,” “estimate,” “approximately,” “believe,” “could,” “project,” “predict,” “continue,” “plan” or other similar words or expressions. Forward-looking statements are based on certain assumptions, discuss future expectations, describe future plans and strategies, contain financial and operating projections or state other forward-looking information. Examples of forward-looking statements include the following: projections of our revenues, income, earnings per share, capital structure or other financial items; descriptions of our plans or objectives for future operations, products or services; forecasts of our future economic performance, interest rates, profit margins and our share of future markets; and descriptions of assumptions underlying or relating to any of the foregoing expectations regarding the timing of generating any revenues. Our ability to predict results or the actual effect of future events, actions, plans or strategies is inherently uncertain. Although we believe that the expectations reflected in such forward-looking statements are based on reasonable assumptions, our actual results and performance could differ materially from those set forth in the forward-looking statements. There are a number of factors, many of which are beyond our control that could cause actual results to differ significantly from management’s expectations. Some of these factors are discussed below. You should not place undue reliance on any forward-looking statement and should consider the following uncertainties and risk factors, as well as the risks, risk factors and uncertainties discussed elsewhere in this Report and any subsequent Quarterly Reports on Form 10-Q. Factors that could cause actual results to differ materially from historical results or those anticipated include, but are not limited to: changes in our investment objectives or investment or operational strategies, including any new lines of business or new products and services that may subject us to additional risks; volatility in our industry, the debt or equity markets, the general economy or the real estate finance and real estate markets specifically, whether the result of market events or otherwise; events or circumstances which undermine confidence in the financial markets or otherwise have a broad impact on financial markets, such as the sudden instability or collapse of large depository institutions or other significant corporations, terrorist attacks, natural or man-made disasters, or threatened or actual armed conflicts; changes in general business, economic, market, employment and political conditions, or in consumer confidence and spending habits from those expected; declines in real estate or significant changes in U.S. housing prices or activity in the U.S. housing market; the availability of, and level of competition for, attractive risk-adjusted investment opportunities in mortgage loans and mortgage-related assets that satisfy our investment objectives; the inherent difficulty in winning bids to acquire mortgage loans, and our success in doing so; the concentration of credit risks to which we are exposed; the degree and nature of our competition; our dependence on our manager and servicer, potential conflicts of interest with such entities and their affiliates, and the performance of such entities; changes in personnel and lack of availability of qualified personnel at our manager, servicer or their affiliates; the availability, terms and deployment of short-term and long-term capital; the adequacy of our cash reserves and working capital; our ability to maintain the desired relationship between our financing and the interest rates and maturities of our assets; 2 unanticipated increases or volatility in financing and other costs, including a rise in interest rates; the performance, financial condition and liquidity of borrowers; the ability of our servicer, which also provides us with fulfillment services, to approve and monitor correspondent sellers and underwrite loans to investor standards; incomplete or inaccurate information or documentation provided by customers or counterparties, or adverse changes in the financial condition of our customers and counterparties; our indemnification and repurchase obligations in connection with mortgage loans we purchase and later sell or securitize: the quality and enforceability of the collateral documentation evidencing our ownership and rights in the assets in which we invest; increased rates of delinquency, default and/or decreased recovery rates on our investments; the performance of mortgage loans underlying mortgage-backed securities (“MBS”) in which we retain credit risk; our ability to foreclose on our investments in a timely manner or at all; increased prepayments of the mortgages and other loans underlying our the degree to which our hedging strategies may or may not protect us from interest rate volatility; the effect of the accuracy of or changes in the estimates we make about uncertainties, contingencies and asset and liability valuations when measuring and reporting upon our financial condition and results of operations; our failure to maintain appropriate internal controls over financial reporting; technologies for loans and our ability to mitigate security risks and cyber intrusions; our ability to obtain and/or maintain licenses and other approvals in those jurisdictions where required to conduct our business; our ability to detect misconduct and fraud; our ability to comply with various federal, state and local laws and regulations that govern our business; developments in the secondary markets for our mortgage loan products; legislative and regulatory changes that impact the mortgage loan industry or housing market; changes in regulations or the occurrence of other events that impact the business, operations or prospects of government agencies such as the Government National Mortgage Association (“Ginnie Mae”), the Federal Housing Administration (the “FHA”) or the Veterans Administration (the “VA”), the U.S. Department of Agriculture (“USDA”), or government-sponsored entities such as the Federal National Mortgage Association (“Fannie Mae”) or the Federal Home Loan Mortgage Corporation (“Freddie Mac”) (Fannie Mae, Freddie Mac and Ginnie Mae are each referred to as an “Agency” and, collectively, as the “Agencies”), or such changes that increase the cost of doing business with such entities; the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) and its implementing regulations and regulatory agencies, and any other legislative and regulatory changes that impact the business, operations or governance of mortgage lenders and/or publicly-traded companies; the Consumer Financial Protection Bureau (“CFPB”) and its issued and future rules and the enforcement thereof; changes in government support of homeownership; changes in government or government-sponsored home affordability programs; limitations imposed on our business and our ability to satisfy complex rules for us to qualify as a real estate investment trust (“REIT”) for U.S. federal income tax purposes and qualify for an exclusion from the Investment Company Act of 1940 (the “Investment Company Act”) and the ability of certain of our subsidiaries to qualify as REITs or as taxable REIT subsidiaries (“TRSs”) for U.S. federal income tax purposes, as applicable, and our ability and the ability of our subsidiaries to operate effectively within the limitations imposed by these rules; changes in governmental regulations, accounting treatment, tax rates and similar matters (including changes to laws governing the taxation of REITs, or the exclusions from registration as an investment company); 3 the effect of public opinion on our reputation; the occurrence of natural disasters or other events or circumstances that could impact our operations; and our organizational structure and certain requirements in our charter documents. 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.
4 The following description of our business should be read in conjunction with the information included elsewhere in this Report. This description contains forward-looking statements that involve risks and uncertainties. Actual results could differ significantly from the projections and results discussed in the forward-looking statements due to the factors described under the caption “Risk Factors” and elsewhere in this Report. References in this Report to “we,” “our,” “us,” “PMT,” or the “Company” refer to PennyMac Mortgage Investment Trust and its consolidated subsidiaries, unless otherwise indicated. Our Company We are a specialty finance company that invests primarily in residential mortgage loans and mortgage-related assets. We were organized in Maryland on May 18, 2009, and began operations on August 4, 2009. We conduct our operations through two segments: correspondent production and investment activities. For financial information concerning our reportable segments see Note The management of our business and execution of our operations is performed on our behalf by subsidiaries of PennyMac Financial Services, Inc. (“PFSI” or “PennyMac”). PFSI is a specialty financial services firm with a comprehensive mortgage platform and integrated business focused on the production and servicing of U.S. We are managed by PNMAC Capital Management, LLC (“PCM” or our “Manager”), an indirect wholly-owned subsidiary of PennyMac and an investment adviser registered with the Securities and Exchange Commission (“SEC”) that specializes in, and focuses on, U.S. All of the loans we acquire in our correspondent production operations (as described below) are fulfilled on our behalf by another indirect wholly-owned PennyMac subsidiary, PennyMac Loan Services, LLC (“PLS” or our “Servicer”), which also services the mortgage loans we hold in our residential mortgage investment portfolio and the mortgage loans for which we retain the obligation to service as a result of our correspondent production. Our objective is to provide attractive risk-adjusted returns to our investors over the long-term, primarily through dividends and secondarily through capital appreciation. Our targeted investments are in the U.S. mortgage market, including credit sensitive assets such as distressed mortgage loans, credit risk transfer (“CRT”) securities related to our correspondent production, non-Agency subordinate bonds, small-balance commercial real estate (including multifamily) loans and subordinate interests; and interest rate sensitive assets such as MSRs, ESS, MBS, and non-Agency senior MBS. In addition to our investment activities, we are engaged in correspondent production, which is the acquisition of newly originated, prime credit quality, first-lien residential mortgage loans that have been underwritten to investor guidelines, pooling such loans into MBS and selling the resulting securities into the secondary markets. We purchase Agency-eligible mortgage loans and jumbo mortgage loans. A jumbo mortgage loan is a loan in an amount that exceeds the maximum loan amount for eligible loans under Agency guidelines. We then sell or securitize Agency-eligible mortgage loans meeting the guidelines of Fannie Mae and Freddie Mac on a servicing-retained basis whereby we retain the related MSRs; government mortgage loans (insured by the FHA or guaranteed by the VA), which we sell to PLS, a Ginnie Mae approved issuer and servicer; and jumbo mortgage loans, which, generally on a servicing-retained basis, we securitize or sell to third parties. Our correspondent production business has grown through purchases from approved mortgage originators that meet specific criteria related to management experience, financial strength, risk management controls and loan quality. We have elected to be taxed as a REIT for U.S. federal income tax purposes and we intend to maintain our exclusion from regulation under the Investment Company Act. Therefore, we are required to invest a substantial majority of our assets in loans secured by real estate and in real estate-related assets. Subject to maintaining our REIT qualification and our Investment Company Act exclusion, we do not have any limitations on the amounts we may invest in any of our targeted asset classes. 5 We are externally managed and advised by PCM pursuant to a management agreement. PCM specializes in and focuses on PCM is responsible for administering our business activities and day-to-day operations, including developing our investment strategies, sourcing and acquiring mortgage loans and mortgage-related assets for our investment portfolio, and developing the appropriate approach to be taken by PLS for each loan as it performs its specialty servicing. Pursuant to the terms of the management agreement, PCM provides us with our senior management team, including our officers and support personnel. PCM is subject to the supervision and oversight of our board of trustees and has the functions and authority specified in the management agreement.
We also have a loan servicing agreement with PLS, pursuant to which PLS provides primary and special servicing for our portfolio of residential mortgage We have a commercial mortgage loan servicing agreement with Midland Loan Services, a Division of PNC Bank, National Association (“Midland”), pursuant to which Midland provides the master servicing for commercial mortgage loans that we acquire and may also provide special servicing, as necessary. We also have a commercial mortgage loan servicing oversight agreement with PLS, pursuant to which PLS provides oversight of Midland, including vendor management, review of reports and procedures for accuracy and timeliness, and monitoring Midland’s activities and performance. Investment Strategy and Targeted Asset Classes Our Manager continually evaluates the markets for investment opportunities on our behalf. To date, we have invested in mortgage loans, a substantial portion of which are distressed and acquired at discounts to their unpaid principal balances; MSRs; ESS; mortgage-related securities; small balance (typically under $10 million) commercial real estate loans, including newly originated multifamily loans; and other mortgage-related, real estate and financial assets. 6 Our targeted asset classes and the principal investments we make and/or expect to make in each class are as follows:
Over time, our targeted asset classes may change as a result of changes in the opportunities that are available in the market, among other factors. We may not invest in certain of the investments described above if we believe those types of investments will not provide us with attractive opportunities or if we believe other types of our targeted assets provide us with better opportunities. Our Portfolios Investment Activities Our portfolio of mortgage investments was comprised of the following:
7 In our correspondent production activities, we acquire newly originated loans from mortgage lenders, sell the loans to an Agency or other third party, sell the loans to PLS in the case of government loans, or otherwise pool loans into MBS, sell the resulting securities into the MBS markets and retain the MSRs. During Following is a summary of our correspondent production activities:
PCM has worked to expand our sources of assets to position us to take advantage of market opportunities and market changes. Examples of such investments Creation and acquisition of MSRs and ESS related to MSRs. We believe that MSR and ESS investments may allow us to earn attractive current returns and to leverage the mortgage loan servicing and origination capabilities of PLS to enhance the assets’ value. We intend to continue to retain the MSRs that we receive as a portion of the proceeds from our sale or securitization of mortgage loans through our correspondent production operation. CRT transactions. We have entered into credit risk transfer agreements (“CRT Agreements”) with Fannie Mae, whereby we sell pools of mortgage loans into Fannie Mae-guaranteed securitizations while retaining a portion of the Acquisition of small balance (typically under $10 million) commercial real estate loans that finance multifamily and other commercial real estate or securities backed by such mortgage loans. During the year ended December 31, 2016, we purchased $18.1 million of commercial real estate loans at fair value. To the extent that we transfer correspondent production mortgage loans into private label securitizations, we may retain a portion of the securities and residual interests created in such securitization transactions. We expect our future securitizations will be accounted for as secured borrowings. 8 We have pursued growth of our investment portfolio by using a combination of equity and borrowings, generally in the form of borrowings under agreements to repurchase. We use borrowings to finance our investments and not to speculate on changes in interest rates. Our board of trustees has authorized a common share repurchase program under which we may repurchase up to $200 million of our outstanding common shares. During the years ended December 31, 2016 and 2015, we repurchased 7.4 million and 1.0 million common shares at a cost of $98.4 million and $16.3 million, respectively. The repurchased common shares were canceled upon settlement of the repurchase transactions and returned to the authorized but unissued share pool. During 2014, we issued 3.8 million common shares under an ATM Equity Offering Sales Agreementsm and received net proceeds totaling
Since 2010, we have maintained multiple master repurchase agreements with money center banks to finance our investments in distressed assets. Our objective is to use these facilities to finance nonperforming mortgage loan and real estate investments pending liquidation, sale, securitization or other structured financing. The aggregate principal amount outstanding under the facilities in existence as of December 31, Since 2010, we have also maintained multiple master repurchase agreements and mortgage loan participation and sale agreements with money center banks to fund newly originated prime mortgage loans purchased from correspondent In 2013, our wholly-owned subsidiary, PennyMac Corp. (“PMC”), issued in a private offering $250 million aggregate principal amount of 5.375% Exchangeable Senior Notes due 2020 (the “Exchangeable Notes”). The net proceeds were used to fund our business and investment activities, including the acquisition of distressed mortgage loans or other investments; the funding of the continued growth of our correspondent production business, including the purchase of jumbo loans; the repayment of other indebtedness; and general corporate purposes. Since 2015, we have maintained multiple loan and security agreements with money center banks to finance mortgage servicing rights relating to mortgage loans serviced for Fannie Mae and Freddie Mac. The aggregate principal balance outstanding under the facilities in existence as of December 31, 2016 was $275.1 million. In Our borrowings are made under agreements that include various covenants, including profitability, the maintenance of specified levels of cash, adjusted tangible net worth and overall leverage limits. Our ability to borrow under these facilities is limited by the amount of qualifying assets that we hold and that are eligible to be pledged to secure such Subject to maintaining our qualification as a REIT and exclusion from registration under the Investment Company Act, we may hedge the interest rate risk associated with the financing of our portfolio. 9 Our board of trustees has adopted the policies set forth below for our investments and borrowings. PCM reviews our compliance with the investment policies regularly and reports periodically to our board of trustees regarding such compliance. No investment shall be made that would cause us to fail to qualify as a REIT for U.S. federal income tax purposes; No investment shall be made that would cause us to be regulated as an investment company under the Investment Company Act; and With the exception of real estate and housing, no single industry shall represent greater than 20% of the investments or aggregate risk exposure in our portfolio. These investment policies may be changed by a majority of our board of trustees without the approval of, or prior notice to, our shareholders. Investment Allocation Policy Investment opportunities in pools of mortgage loans that are consistent with our investment objectives, on the one hand and the investment objectives of the PennyMac funds and other future entities or accounts managed by PCM, on the other hand, have been and will be allocated among us and the PennyMac funds and the other entities or accounts generally on a pro rata basis. This is and has been based upon relative amounts of investment capital (including undrawn capital commitments) available for new investments by us, the PennyMac funds and any other relevant entities or accounts, or by assigning opportunities among the relevant entities such that investments assigned among us, such funds, entities or accounts are fair and equitable over time; provided that PCM, in its sole discretion, may allocate investment opportunities in any other manner that it deems to be fair and equitable. As of December 31, 2011, the commitment periods for the PennyMac funds had ended and the ability of the PennyMac funds to make new investments has therefore been significantly reduced. As the investment programs of the various entities and accounts managed by PCM change and develop over time, additional issues and considerations may affect PCM’s and our allocation policy and PCM’s and our expectations with respect to the allocation of investment opportunities among the various entities and accounts managed by PCM. Notwithstanding PCM’s intention to effect fair and equitable allocations of investment opportunities, we expect that our performance will differ from the performance of the PennyMac funds and any other PennyMac-managed entity or account for many reasons, including differences in the legal or regulatory characteristics, or tax classification, of the entities or accounts or due to differing fee structures or the idiosyncratic differences in the outcome of individual mortgage loans. We have not adopted a policy that expressly prohibits our trustees, officers, shareholders or affiliates from having a direct or indirect financial interest in any investment to be acquired or disposed of by us or in any transaction to which we are a party or have an interest. We do not have a policy that expressly prohibits any such persons from engaging for their own account in business activities of the types conducted by us. However, our code of business conduct and ethics contains a conflicts of interest policy that prohibits our trustees and officers, as well as employees of PennyMac and its subsidiaries who provide services to us, from engaging in any transaction that involves an actual or apparent conflict of interest with us without the appropriate approval. We also have written policies and procedures for the review and approval of related party transactions, including oversight by designated committees of our board of trustees and PFSI’s board of directors. Operating and Regulatory Structure REIT Qualification We have elected to be treated as a REIT under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”) beginning with our taxable year ended December 31, 2009. Our qualification as a REIT depends upon our ability to meet on a continuing basis, through actual investment and operating results, various complex requirements under the Internal Revenue Code relating to, among other things, the sources of our gross income, the composition and values of our assets, our distribution levels and the diversity of ownership of our common shares. We believe that we are organized in conformity with the requirements for qualification and taxation as a REIT under the Internal Revenue Code, and that our manner of operation enables us to meet the requirements for qualification and taxation as a REIT. As a REIT, we generally are not subject to U.S. federal income tax on our REIT taxable income we distribute to our shareholders. If we fail to qualify as a REIT in any taxable year and do not qualify for certain statutory relief provisions, we will be subject to U.S. federal income tax at regular corporate rates and may be precluded from qualifying as a REIT for the subsequent four taxable years following the year during which we lost our REIT qualification. Accordingly, our failure to qualify as a REIT could have a material adverse impact on our results of operations and amounts available for distribution to our shareholders. 10 Even though we have elected to be taxed as a REIT, we are subject to some U.S. federal, state and local taxes on our income or property. A portion of our business is conducted through, and a portion of our income is earned in, our TRS that is subject to corporate income taxation. In general, a TRS of ours may hold assets and engage in activities that we cannot hold or engage in directly and may engage in any real estate or non-real estate related business. A TRS is subject to U.S. federal, state and local corporate income taxes. To maintain our REIT election, at the end of each quarter no more than 25% (20% for years beginning after December 31, 2017) of the value of a REIT’s assets may consist of stock or securities of one or more TRSs. If our TRS generates net income, our TRS can declare dividends to us, which will be included in our taxable income and necessitate a distribution to our shareholders. Conversely, if we retain earnings at the TRS level, no distribution is required and we can increase shareholders’ equity of the consolidated entity. As discussed in Section 1A of this Report entitledRisk Factors, the combination of the requirement to maintain no more than 25% (20% for years beginning after December 31, 2017) of our assets in the TRS coupled with the effect of TRS dividends on our income tests creates compliance complexities for us in the maintenance of our qualified REIT status. The dividends paid deduction of a REIT for qualifying dividends to its shareholders is computed using our taxable income as opposed to net income reported on our financial statements. Taxable income generally differs from net income reported on our financial statements because the determination of taxable income is based on tax laws and regulations and not financial accounting principles. Licensing We and PLS are required to be licensed to conduct business in certain jurisdictions. PLS is, or is taking steps to become, licensed in those jurisdictions and for those activities where it believes it is cost effective and appropriate to become licensed. Through our wholly owned subsidiaries, we are also licensed, or are taking steps to become licensed, in those jurisdictions and for those activities where we believe it is cost effective and appropriate to become licensed. In jurisdictions in which neither we nor PLS is licensed, we do not conduct activity for which a license is required. Our failure or the failure by PLS to obtain any necessary licenses promptly, comply with applicable licensing laws or satisfy the various requirements or to maintain them over time could materially and adversely impact our business. Competition In our correspondent production activities, we compete with large financial institutions and with other independent residential mortgage loan producers and servicers. We compete on the basis of product offerings, technical knowledge, manufacturing quality, speed of execution, rate and fees. In acquiring mortgage assets, we compete with specialty finance companies, private funds, other mortgage REITs, thrifts, banks, mortgage bankers, insurance companies, mutual funds, institutional investors, investment banking firms, governmental bodies and other entities, which may also be focused on acquiring Because the availability of pools of mortgage assets may fluctuate, the competition for assets and sources of financing may increase. Increased competition for assets may result in our accepting lower returns for acquisitions of residential mortgage loans and other assets or adversely influence our ability to In the face of this competition, we have access to PCM’s professionals and their industry expertise, which we believe provides us with a competitive advantage and helps us assess investment risks and determine appropriate pricing for certain potential investments. We expect 11 We believe that current market and regulatory conditions may have adversely affected the financial condition and operations of certain owners of mortgage assets. Further, regulatory and capital issues have contributed to the decision by certain financial institutions to exit or curtail their correspondent production business and to reduce their portfolios of MSRs. Not having a legacy portfolio or the same regulatory or capital issues may enable us to compete more effectively for attractive business or investment opportunities. However, we can provide no assurance that we will be able to achieve our business goals or expectations due to the competitive and other risks that we face. Staffing We have agreement. Available Information Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements and amendments to those reports filed with or furnished to the United States Securities and Exchange Commission (the “SEC”) pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, are available free of charge atwww.pennymacmortgageinvestmenttrust.com through the investor relations section of our website as soon as reasonably practicable after electronically filing such material with the SEC. The SEC maintains an Internet site that contains reports, proxy and information statements and other information regarding our filings at www.sec.gov. In addition, the public may read and copy the materials we file with the SEC at the SEC’s Public Reference Room at 100 F. Street, NE, Washington, D.C. 20549. Information regarding the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. The above references to our website and the SEC’s website do not constitute incorporation by reference of the information contained on those websites and should not be considered part of this document. In addition to the other information set forth in this Report, you should carefully consider the following factors, which could materially affect our business, financial condition or results of operations in future periods. The risks described below are not the only risks that we face. Additional risks not Risks Related to Our Management and Relationship with Our Manager and Its Affiliates We are dependent upon PCM and PLS and their resources and may not find suitable replacements if any of our service agreements with PCM or PLS are terminated. In accordance with our management agreement, we are externally advised and managed by PCM, which makes all or substantially all of our investment, financing and risk management decisions, and has significant discretion as to the implementation of our operating policies and strategies. Under our loan servicing agreement with PLS, PLS provides primary servicing and special servicing for our portfolios of mortgage loans and MSRs, and under our mortgage banking No assurance can be given that the strategies of PCM, PLS or their affiliates under any of these agreements will be successful, that any of them will conduct complete and accurate due diligence or provide sound advice, or that any of them will act in our best interests with respect to the allocation of their resources to our business. The failure of any of them to do any of the above, conduct the business in accordance with applicable laws and regulations or hold all licenses or registrations necessary to conduct the business as currently operated would materially and adversely affect our ability to continue to execute our business plan. In addition, the terms of these agreements extend until If our management agreement or loan servicing agreement is terminated or not renewed, we will have to obtain the services from another service provider. We may not be able to replace these services in a timely manner or on favorable terms, or at all. With respect to our mortgage banking 12 mortgage loans from our correspondent sellers that we know will ultimately be purchased from us by PLS. While we generally have exclusive rights to these services from PLS during the term of our mortgage banking PFSI, the parent company of PCM and PLS, PFSI’s growth since it commenced operations has caused significant demands on its operational, accounting and legal infrastructure, and increased expenses. The ability of PCM and PLS to provide us with the services we require to be successful depends, among other things, on the ability of PFSI, including PCM and PLS, to maintain an operating platform and management system sufficient to address its growth. This may require PFSI to incur significant additional expenses and to commit additional senior management and operational resources to support its growth. There can be no assurance that PFSI will be able to effectively develop its expanding operations or that PFSI will continue to grow successfully. PFSI’s failure to do so could adversely affect the ability of PCM and PLS to manage us, The management fee structure could cause disincentive and/or create greater investment risk. Pursuant to our management agreement, PCM is entitled to receive a base management fee that is based on our shareholders’ equity (as defined in our management agreement) at the end of each quarter. As a result, significant base management fees would be payable to PCM for a given quarter even if we experience a net loss during that quarter. PCM’s right to non-performance-based compensation may not provide sufficient incentive to PCM to devote its time and effort to source and maximize risk-adjusted returns on our investment portfolio, which could, in turn, materially and adversely affect the market price of our common shares and/or our ability to make distributions to our shareholders. Conversely, PCM is also entitled to receive incentive compensation under our management agreement based on our performance in each quarter. In evaluating investments and other management strategies, the opportunity to earn incentive compensation based on our net income may lead PCM to place undue emphasis on higher yielding investments and the maximization of short-term income at the expense of other criteria, such as preservation of capital, maintenance of sufficient liquidity and/or management of market risk, in order to achieve higher incentive compensation. Investments with higher yield potential are generally riskier and more speculative. The servicing fee structure could create a conflict of interest. For its services under our loan servicing agreement, PLS is entitled to servicing fees that we believe are competitive with those charged by primary servicers and specialty servicers and include fixed per-loan monthly amounts based on the delinquency, bankruptcy and/or foreclosure status of the serviced loan or the REO, as well as activity fees that generally are calculated as a percentage of unpaid principal balance or proceeds realized. PLS is also entitled to customary ancillary income and certain On our behalf, PLS also refinances performing and nonperforming loans and originates new loans to facilitate the disposition of real estate that we acquire through foreclosure. In order to provide PLS with an incentive to produce such loans, Termination of our management agreement is difficult and costly. It is difficult and costly to terminate, without cause, our management agreement. Our management agreement provides that it may be terminated by us without cause under limited circumstances and the payment to PCM of a significant termination fee. The cost to us of terminating our management agreement may adversely affect our desire or ability to terminate our management agreement with PCM without cause. PCM may also terminate our management agreement upon at least 60 days’ prior written notice if we default in the performance of any material term of our management agreement and the default continues for a period of 30 days after written notice to us, or where we terminate our loan servicing agreement, our mortgage banking 13 related party agreements with PCM or PLS without cause (at any time other than at the end of the current term or any automatic renewal term), whereupon in any case we would be required to pay to PCM a significant termination fee.
Existing or future entities or accounts managed by PCM may compete with us for, or may participate in, investments, any of which could result in conflicts of interest. BlackRock and HC Partners, PFSI’s strategic investors, could compete with us or transact business with us. Although our agreements with PCM and PLS provide us with certain exclusivity and other rights and we and PCM have adopted an allocation policy to specifically address some of the conflicts relating to our investment opportunities, there is no assurance that these measures will be adequate to address all of the conflicts that may arise or will address such conflicts in a manner that is favorable to us. Certain of the funds that PCM currently advises have, and certain of the funds that PCM may in the future advise may have, investment objectives that overlap with ours, including funds which have different fee structures, and potential conflicts may arise with respect to decisions regarding how to allocate investment opportunities among those funds and us. We are also limited in our ability to acquire assets that are not qualifying real estate assets and/or real estate related assets, whereas the PennyMac funds and other entities or accounts that PCM manages now or may manage in the future are not, or may not be, as applicable, so limited. In addition, PCM and/or the PennyMac funds and the other entities or accounts managed by PCM now or in the future may participate in some of our investments, which may not be the result of arm’s length negotiations and may involve or later result in potential conflicts between our interests in the investments and those of PCM or such other entities. In addition, PFSI’s strategic investors, BlackRock and HC Partners, each own significant investments in PFSI. Affiliates of each of BlackRock and HC Partners currently manage investment vehicles and separate accounts that may compete directly or indirectly with us. BlackRock and HC Partners are under no obligation to provide us with any financial or operational assistance, or to present opportunities to us for matters in which they may become involved. We may enter into transactions with BlackRock or HC Partners or with market participants with which BlackRock or HC Partners has business relationships, and such transactions and/or relationships could influence the decisions made by PCM with respect to the purchase or sale of assets and the terms of such purchase or sale. Such activities could have an adverse effect on the value of the positions held by us, or may result in BlackRock and/or HC Partners having interests adverse to ours. We may encounter conflicts of interest in our Manager’s efforts to appropriately allocate its time and services between its own activities, the management of the PennyMac funds and the management of us, and the loss of the services of our Manager’s management team could adversely affect us. Pursuant to our management agreement, PCM is obligated to provide us with the services of its senior management team, and the members of that team are required to devote such time to us as is necessary and appropriate, commensurate with our level of activity. The members of PCM’s senior management team may have conflicts in allocating their time and services between the operations of PFSI and our activities, the PennyMac funds and other entities or accounts that they manage now or in the future. The experience of PFSI’s senior managers is valuable to us. PFSI’s management team has significant experience in the mortgage loan production, servicing and Our failure to deal appropriately with various issues that may give rise to reputational risk, including conflicts of interest and legal and regulatory requirements, could Maintaining our reputation is critical to attracting and retaining customers, trading counterparties, investors and employees. If we fail to deal with, or appear to fail to deal with, various issues that may give rise to reputational risk, we could significantly harm our business. Such issues include, but are not limited to, conflicts of interest, legal and regulatory requirements, and any of the other risks discussed in this Item 1A. As we expand the scope of our businesses, we confront potential conflicts of interest relating to our investment activities that are managed by PCM. The SEC and certain other regulators have increased their scrutiny of potential conflicts of interest, and as we expand the scope of our business, we must continue to monitor and address any conflicts between our interests and those of PFSI. We have implemented procedures and controls to be followed when real or potential conflicts of interest arise, but it is possible that potential or perceived conflicts could give rise to the dissatisfaction of, or litigation by, our investors or regulatory enforcement actions. Appropriately dealing with conflicts of interest is complex and difficult, and our reputation could be damaged if we fail, or appear to fail, to deal appropriately with one or more potential or actual conflicts of interest. Regulatory scrutiny, litigation or 14 reputational risk incurred in connection with conflicts of interest would adversely affect our business in a number of ways and may adversely affect our results of operations. Reputational risk incurred in connection with conflicts of interest could negatively affect our business, strain our working relationships with regulators and government agencies, expose us to litigation and regulatory action, impact our ability to attract and retain customers, trading counterparties, investors and employees and adversely affect our results of operations. Reputational risk from negative public opinion is inherent in our business and can result from a number of factors. Negative PCM and PLS both have limited liability and indemnity rights. Our agreements with PCM and PLS provide that PCM and PLS will not assume any responsibility other
Risks Related to Our Business Regulatory Risks We operate in a highly regulated industry and the continually changing federal, state and local laws and regulations could materially and adversely affect our business, financial condition and results of operations.
Federal, state and local governments have proposed or enacted numerous new laws, regulations and rules related to mortgage loans. Laws, regulations, rules and judicial and administrative decisions relating to mortgage loans include those pertaining to real estate settlement procedures, equal credit opportunity, fair lending, fair credit reporting, truth in lending, fair debt collection practices, service members protections, compliance with net worth and financial statement delivery requirements, compliance with federal and state disclosure and licensing requirements, the establishment of maximum interest rates, finance charges and other charges, qualified mortgages, licensing of loan officers and other personnel, loan officer compensation, secured transactions, property valuations, servicing transfers, payment processing, escrow, communications with consumers, loss mitigation, collection, foreclosure, bankruptcies, repossession and claims-handling procedures, and other trade practices and privacy regulations providing for the use and safeguarding ofnon-public personal financial information of borrowers. PLS and service providers it uses, including outside counsel retained to process foreclosures and Our failure or the failure of PLS to operate effectively and in compliance with these laws, regulations and rules could subject us to lawsuits or governmental actions and damage our reputation, which could materially and adversely affect our business, financial condition and results of operations. In
The failure of the mortgage lenders from whom loans were acquired through our correspondent production activities to
15 incur The outcome of the 2016 U.S. Presidential and Congressional elections could result in significant policy changes or regulatory uncertainty in our industry. While it is not possible to predict when and whether significant policy or regulatory changes would occur, any such changes on the federal, state or local level could significantly impact, among other things, our operating expenses, the availability of mortgage financing, interest rates, consumer spending, the economy and the geopolitical landscape. To the extent that the new government administration takes action by proposing and/or passing regulatory policies that could have a negative impact on our industry, such actions may have a material adverse effect on our business, financial condition, results of operations and our ability to make distributions to our shareholders. The
The Under the Dodd-Frank Act, the CFPB is empowered with broad supervision, rulemaking and examination authority to enforce laws involving consumer financial products and services and to ensure, among other things, that consumers receive clear and accurate disclosures regarding financial products and are protected from hidden fees and unfair, deceptive or abusive acts or practices. The CFPB has adopted a number of final regulations under the Dodd-Frank Act regarding truth in lending, “ability to repay,” home mortgage loan disclosure, home loan origination, fair credit reporting, fair debt collection practices, foreclosure protections, and mortgage servicing rules, including provisions regarding loss mitigation, early intervention, periodic statement requirements and lender-placed insurance. In October 2016, the CFPB further revised its rules under Regulations X and Z impacting lender-placed insurance notices, delinquency and early intervention, loss mitigation, periodic statement requirements, and successors-in-interest to borrowers. The CFPB also has enforcement authority with respect to the conduct of third-party service providers of financial institutions. The CFPB has made it clear that it expects non-bank entities to maintain an effective process for managing risks associated with third-party vendor relationships, including compliance-related risks. In connection with this vendor risk management process, we are expected to perform due diligence reviews of potential vendors, review vendors’ policies and procedures and internal training materials to confirm compliance-related focus, include enforceable consequences in contracts with vendors regarding failure to comply with consumer protection requirements, and take prompt action, including terminating the relationship, in the event that vendors fail to meet our expectations. The CFPB is also applying greater scrutiny to compensation payments to third-party providers for marketing services and may issue guidance that narrows the range of acceptable payments to third-party providers as part of marketing services agreements, lead generation agreements and other In addition to its supervision and examination authority, the 16 Rules and regulations promulgated under the
We are highly dependent on the Agencies and the Federal Housing Finance Agency (“FHFA”), as the conservator of Fannie Mae and Freddie Mac, and any changes in these entities or their current roles could materially and adversely affect our business, liquidity, financial Our ability to generate revenues through mortgage loan sales depends to a significant degree on programs administered by the Agencies and others that facilitate the issuance of MBS in the secondary market. These Agencies play a critical role in the mortgage industry and we have significant business relationships with them. Presently, almost all of the newly originated conforming loans that we acquire from mortgage lenders through our correspondent production activities qualify under existing standards for inclusion in mortgage securities backed by the Agencies. We also derive other material financial benefits from these relationships, including the assumption of credit risk by these Agencies on loans included in such mortgage securities in exchange for our payment of guarantee fees, our retention of such credit risk through structured transactions that lower our guarantee fees, and the ability to avoid certain loan inventory finance costs through streamlined loan funding and sale procedures. Any changes in laws and regulations affecting the relationship between Fannie Mae and Freddie Mac and the U.S. federal government could adversely affect our business and prospects. Although the U.S. Treasury has committed capital to Fannie Mae and Freddie Mac, these actions may not be adequate for their needs. If Fannie Mae and Freddie Mac are adversely affected by events such as ratings downgrades, inability to obtain necessary government funding, lack of success in resolving repurchase demands to lenders, foreclosure problems and delays and problems with mortgage insurers, they could suffer losses and fail to honor their guarantees and other obligations. Any discontinuation of, or significant reduction in, the operation of Fannie Mae or Freddie Mac or any significant adverse change in their capital structure, financial condition, activity levels in the primary or secondary mortgage markets or underwriting criteria could materially and adversely affect our business, liquidity, financial condition, results of operations and our ability to make distributions to our shareholders. Under the new government administration, the roles of Fannie Mae and Freddie Mac could be significantly restructured, reduced or eliminated and the nature of the guarantees could be considerably limited relative to historical measurements. Elimination of the traditional roles of Fannie Mae and Freddie Mac, or any changes to the nature or extent of the guarantees provided by Fannie Mae and Freddie Mac or the fees, terms and guidelines that govern our selling and servicing relationships with them, such as increases in the guarantee fees we are required to pay, initiatives that increase the number of repurchase demands and/or the manner in which they are pursued, or possible limits on delivery volumes imposed upon us and other sellers/servicers, could also materially and adversely affect our business, including our ability to sell and securitize loans that we acquire through our correspondent production activities, and the performance, liquidity and market value of our investments. Moreover, any changes to the nature of the GSEs or their guarantee obligations could redefine what constitutes an Agency MBS and could have broad adverse implications for the market and our business, financial condition and results of operations. Our ability to generate revenues from newly originated loans that we acquire through our correspondent production activities is also highly dependent on the fact that the Agencies have not historically acquired such loans directly from mortgage lenders, but have instead relied on banks and non-bank aggregators such as us to acquire, aggregate and securitize or otherwise sell such loans to investors in the secondary market. Certain of the Agencies have begun approving new and smaller lenders that traditionally may not have qualified for such approvals. To the extent that these lenders choose to sell directly to the Agencies rather than through loan aggregators like us, this reduces the number of loans available for purchase, and it could materially and adversely affect our business and results of operations. Similarly, to the extent the Agencies increase the number of purchases and sales for their own accounts, our business and results of operations could be materially and adversely affected.
Because we and 17 Our failure or the
We and PLS are also required to hold the Agency approvals in order to sell mortgage loans to the Agencies and service such mortgage loans on their behalf. Our failure, or the failure of PLS, to satisfy the various requirements necessary to maintain such Agency approvals over time would also restrict our direct business In addition, we and PLS are subject to Our or our Servicer’s inability to meet certain net worth and liquidity requirements imposed by the Agencies could have a material adverse effect on our business, financial condition and results of operation. Effective December 31, 2015, each of the Agencies In order to meet these minimum financial requirements, we and our Servicer are required to maintain cash and cash equivalents in amounts that may adversely affect our or its business, financial condition and results of operations, and this
The U.S. government, through the FHA, the Federal Deposit Insurance Corporation and the U.S. Treasury, has established loan modification and refinance programs designed to provide homeowners with assistance in avoiding residential mortgage loan foreclosures. We can provide no assurance that we will be eligible to use any government programs or, if eligible, that we will be able to utilize them successfully. Further, the incentives provided by such programs may increase competition for, and the pricing of, our Compliance with changing regulation of corporate governance and public disclosure has resulted, and will continue to result, in increased compliance costs and pose challenges for our Manager’s management team. Changing federal and state Many aspects of the Dodd-Frank Act are subject to rulemaking and will take effect over several years, making it difficult to anticipate the overall financial impact on us and, more generally, the financial services and mortgage industries. Additionally, we cannot predict whether there will be additional proposed laws 18 A prolonged economic slowdown, recession or The risks associated with our investments are more acute during periods of economic slowdown or recession, especially if these periods are accompanied by high unemployment and declining real estate values. A weakening economy, high unemployment and declining real estate values significantly increase the likelihood that borrowers will default on their debt service obligations and that we will incur losses on our investments in the event of a default on a particular investment because the fair value of any collateral we foreclose upon may be insufficient to cover the full amount of such investment or may require a significant amount of time to realize. These factors may also increase the likelihood of re-default rates even after we have completed loan modifications. Any period of increased payment delinquencies, foreclosures or losses could adversely affect the net interest income generated from our portfolio and our ability to make and finance future investments, which would materially and adversely affect our business, financial Difficult conditions in the mortgage, real estate and financial markets and the economy generally may adversely affect the performance and market value of our investments. The success of our business strategies and our results of operations are materially affected by current conditions in the mortgage markets, the financial markets and the economy generally. Continuing concerns over factors including inflation, deflation, unemployment, personal and business income taxes, healthcare, energy costs, geopolitical issues, the availability and cost of credit, the mortgage markets and the real estate markets have contributed to increased volatility and unclear expectations for the economy and markets going forward. The mortgage markets have been and continue to be affected by changes in the lending landscape, defaults, credit losses and significant liquidity concerns. A destabilization of the real estate and mortgage markets or deterioration in these markets may adversely affect the performance and fair value of our investments, reduce our loan production volume, reduce the profitability of servicing mortgages or adversely affect our ability to sell mortgage loans that we acquire, either at a profit or at all. Any of the foregoing could materially and adversely affect our business, financial condition and results of operations. A disruption in the MBS market could materially and adversely affect our business, financial condition and results of operations. In our correspondent production activities, we deliver newly originated Agency-eligible mortgage loans that we acquire to Fannie Mae or Freddie Mac to be pooled into Agency MBS securities or transfer government loans that we acquire to PLS, which pools them into Ginnie Mae MBS securities. Disruptions in the general MBS market have occurred in the past. Any significant disruption or period of illiquidity in the general MBS market would directly affect our liquidity because no existing alternative secondary market would likely be able to accommodate on a timely basis the volume of loans that we typically acquire and sell in any given period. Accordingly, if the MBS market experiences a period of illiquidity, we might be prevented from selling the loans that we acquire into the secondary market in a timely manner or at favorable prices or we may be required to repay a portion of the debt securing these assets, which could materially and adversely affect our business, financial condition, results of operations and our ability to make distributions to our shareholders. We finance our investments with borrowings, which may materially and adversely affect our return on our investments and may reduce cash available for distribution to our shareholders. We currently leverage and, to the extent available, we intend to continue to leverage our investments through borrowings, the level of which may vary based on the particular characteristics of our investment portfolio and on market conditions. We have leveraged certain of our investments through repurchase mortgage loans to lenders (i.e., repurchase agreement counterparties) and receive cash from the lenders. The lenders are obligated to resell the same assets back to us at the end of the term of the transaction. Because the cash we receive from the lender when we initially sell the assets to the lender is less than the fair value of those assets (this difference is referred to as the haircut), if the lender defaults on its obligation to resell the same assets back to us we could incur a loss on the transaction equal to the amount of the haircut (assuming there was no change in the fair value of the assets). In addition, repurchase agreements generally allow the counterparties, to varying degrees, to determine a new fair value of the collateral to reflect current market conditions. If a counterparty lender determines that the fair value of the collateral has decreased, it may initiate a margin call and require us to either post additional collateral to cover such decrease or repay a portion of the outstanding borrowing. Should this occur, in order to obtain cash to satisfy a margin call, we may be required to liquidate assets at a disadvantageous time, which could cause us to incur further losses. In the event we are unable to satisfy a margin call, our counterparty may sell the collateral, which may result in significant losses to us.
In addition, we invest in certain assets, including MSRs and ESS, for which financing has historically been difficult to obtain. We currently leverage certain of our 19 secured by such Ginnie Mae assets. The notes are repaid through the
Each of the Our repurchase agreements to finance nonperforming loans and other distressed mortgage assets are complex and difficult to manage. This is due in part to the nature of the underlying assets securing such financings, which do not produce consistent cash flows and which require specific activities to be performed at specific points in time in order to preserve value. Our inability to comply with the terms and conditions of these facilities could materially and adversely impact us.
We may in the future utilize other sources of borrowings, including term loans, bank credit facilities and structured financing arrangements, among others. The amount of leverage we employ varies depending on the asset class being financed, our available capital, our ability to obtain and access financing arrangements with lenders and the lenders’ and rating agencies’ estimate of, among other things, the stability of our investment portfolio’s cash flow. Our return on our investments and cash available for distribution to our shareholders may be reduced to the extent that changes in market conditions increase the cost of our financing relative to the income that can be derived from the investments acquired. Our debt service payments also reduce cash flow available for distribution to shareholders. In the event we are unable to meet our debt service obligations, we risk the loss of some or all of our assets to foreclosure or sale to satisfy the obligations. Our credit and financing agreements contain financial and restrictive covenants that could adversely affect our financial condition and our ability to operate our businesses. Although our governing documents contain no limitation on the amount of debt we may incur, the lenders under our repurchase agreements require us and/or our subsidiaries to comply with various financial covenants, including those relating to tangible net worth, profitability and our ratio of total liabilities to tangible net worth. Our lenders also require us to maintain minimum amounts of cash or cash equivalents sufficient to maintain a specified liquidity position. If we are unable to maintain these liquidity levels, we could be forced to sell additional investments at a loss and our financial condition could deteriorate rapidly. Our existing credit and financing agreements also impose other financial and non‑financial covenants and restrictions on us that impact our flexibility to determine our operating policies and investment strategies by limiting our ability to incur certain types of indebtedness; grant liens; engage in consolidations, mergers and asset sales, make restricted payments and investments; and enter into transactions with affiliates. In our credit and financing agreements, we agree to certain covenants and restrictions and we make representations about the assets sold or pledged under these agreements. We also agree to certain events of default (subject to certain materiality thresholds and grace periods), including payment defaults, breaches of financial and other covenants and/or certain representations and warranties, cross-defaults, servicer termination events, ratings downgrades, guarantor defaults, bankruptcy or insolvency proceedings and other events of default and remedies customary for these types of agreements. If we default on our obligations under a credit or financing agreement, fail to comply with certain covenants and restrictions or breach our representations and are unable to cure, the lender may be able to terminate the transaction or its commitments, accelerate any amounts outstanding, require us to post additional collateral or repurchase the assets, and/or cease entering into any other credit transactions with us. Because our credit and financing agreements typically contain cross‑default provisions, a default that occurs under any one agreement could allow the lenders under our other agreements to also declare a default, thereby exposing us to a variety of lender remedies, such as those described above, and potential losses arising therefrom. Any losses that we incur on our credit and financing agreements could materially and adversely affect our business, financial condition and results of operations. 20 As the servicer of the assets subject to our repurchase agreements, PLS is also subject to various financial covenants, including those relating to tangible net worth, liquidity, profitability and its ratio of total liabilities to tangible net worth. PLS’ failure to comply with any of these covenants would generally result in a servicer termination event or event of default under one or more of our repurchase agreements. Thus, in addition to relying upon PCM to manage our financial covenants, we rely upon PLS to manage its own financial covenants in order to ensure our compliance with our repurchase agreements and our continued access to liquidity and capital. A servicer termination event or event of default resulting from PLS’ breach of its financial or other covenants could materially and adversely impact our business, financial condition, liquidity, results of operations and our ability to make distributions to shareholders. Until non-recourse long-term financing structures become available to us and we We have used and, in the future, may use securitization and other non-recourse long-term financing for our investments. In such structures, our lenders typically have only a claim against the assets included in the securitizations rather than a general claim against us as an entity. Such long-term financing has been limited and, in certain instances, unavailable for certain of our investments. Prior to any such future financing, we would seek to finance our investments with relatively short-term facilities until a sufficient portfolio is accumulated or such financing becomes available. As a result, we would be subject to the risks that we would not be able to obtain suitable non-recourse long-term financing or otherwise acquire, during the period that any short-term facilities are available, sufficient eligible assets or securities to maximize the efficiency of a securitization. We also bear the risk that we would not be able to obtain new short-term facilities or would not be able to renew any short-term facilities after they expire should we need more time to obtain long-term financing or seek and acquire sufficient eligible assets or securities for a future securitization. If we are unable to obtain and renew short-term facilities or to consummate securitizations to finance our investments on a long-term basis, we may be required to seek other forms of potentially less attractive financing or to liquidate assets at an inopportune time or unfavorable price. In addition, conditions in the capital markets may make the issuance of any securitization less attractive to us even when we do have sufficient eligible assets or securities. While we would intend to retain the unrated equity component of securitizations and, therefore, still have exposure to any investments included in such securitizations, our inability to enter into such securitizations may increase our overall exposure to risks associated with direct ownership of such investments, including the risk of default. We may not be able to raise the debt or equity capital required to finance our assets and grow our businesses. The growth of our businesses requires continued access to debt and equity capital that may or may not be available on favorable terms or at the desired times, or at all. In addition, we invest in certain assets, including distressed loans and REO, as well as MSRs and ESS, for which financing has historically been difficult to obtain. Our inability to continue to maintain debt financing for distressed loans and REO, or MSRs and ESS, could require us to seek equity capital that may be more costly or unavailable to us. We are also dependent on a limited number of banking institutions that extend us credit on terms that we have determined to be commercially reasonable. These banking institutions are subject to their own regulatory supervision, liquidity and capital requirements, risk management frameworks and risk thresholds and tolerances, any of which may change materially and negatively impact their business strategies, including their extension of credit to us specifically or mortgage lenders and servicers generally. Certain banking institutions have already exited, and others may in the future decide to exit, the mortgage business. Such actions may increase our cost of capital and limit or otherwise eliminate our access to capital, in which case our business, financial condition and results of operations would be materially and adversely affected. In addition, our ability to finance ESS relating to Ginnie Mae MSRs is currently dependent on pass through financing we obtain through our Servicer, which retains the MSRs associated with the ESS we acquire. After our initial acquisition of ESS, we then finance the acquired ESS with our Servicer under an underlying loan and security agreement, and our Servicer, in turn, re-pledges the ESS (along with the related MSRs it retains) to a third party lender under a master repurchase agreement. There can be no assurance that our Servicer will continue to make this pass through financing available to us or that the third party lender will continue to either permit our Servicer to provide such pass through financing to us or otherwise provide financing to our Servicer for MSRs and ESS. This financing arrangement also subjects us to the credit risk of PLS. To the extent PLS does not apply our payments of principal and interest under the loan and security agreement to the allocable portion of its borrowings under the master repurchase agreement, or to the extent PLS otherwise defaults under the master repurchase agreement, our ESS would be at a risk of total loss. In addition, we provide a guarantee to the third party lender for the amount of borrowings under the master repurchase agreement that are allocable to the pass through financing of our ESS. In the event we are unable to satisfy our obligations under the guaranty following a default by PLS, this could cause us to default under other financing arrangements and/or have a material adverse effect on our business, financial 21 We cannot assure you that we will have access to any debt or equity capital on favorable terms or at the desired times, or at all. Our inability to raise such capital or obtain financing on favorable terms could materially and adversely impact our business, financial condition, liquidity, results of operations and our ability to make distributions to shareholders. In addition, we have been authorized to repurchase up to $200 million of our common shares pursuant to a share repurchase program approved by our board of trustees. As of December 31, 2016, we had $ 85.3 million of our common shares remaining under the current board authorization, and we may continue to repurchase shares to the extent we believe it is in the Company’s best interest to do so. Increased activity in our share repurchase program will have the effect of reducing our common shares outstanding, market value and shareholders’ equity, any or all of which could adversely affect the assessment by our lenders, credit providers or other counterparties regarding our net worth and, therefore, negatively impact our ability to raise new capital. Future issuances of debt securities, which would rank senior to our common shares, and future issuances of equity securities, which would dilute the holdings of our existing shareholders and may be senior to our common shares, may materially and adversely affect the market price of our common shares. In order to grow our business, we may rely on additional equity issuances, which may rank senior and/or be dilutive to our shareholders, or on less efficient forms of debt financing that rank senior to our shareholders and require a larger portion of our cash flow from operations, thereby reducing funds available for our operations, future business opportunities, cash distributions to our shareholders and other purposes. In 2013, our wholly-owned subsidiary, PMC, issued $250 million of Exchangeable Notes that are exchangeable under certain circumstances for our common shares. Upon liquidation, holders of our debt securities and other loans and preferred shares would receive a distribution of our available assets before holders of our common shares and holders of the Exchangeable Notes could receive a distribution of PMC’s available assets before holders of our common shares. Subject to applicable law, our board of trustees has the authority, without further shareholder approval, to issue additional debt, common shares and preferred shares on the terms and for the consideration it deems appropriate. We have issued, and/or intend to issue, additional common shares and securities convertible into, or exchangeable or exercisable for, common shares under our equity incentive plan. We have also filed a shelf registration statement, from which we have issued and may in the future issue additional common shares, including, without limitation, through our “at-the-market” equity program. We also may issue from time to time additional common shares in connection with property, portfolio or business acquisitions and may grant demand or piggyback registration rights in connection with such issuances. Because our decision to issue securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict the effect, if any, of future issuances of our common shares, preferred shares or other equity-based securities or the prospect of such issuances on the market price of our common shares. Issuances of a substantial amount of such securities, or the perception that such issuances might occur, could depress the market price of our common shares. Our preferred shares, if issued, would likely have a preference on distribution payments, including liquidating distributions, which could limit our ability to make distributions, including liquidating distributions, to holders of our common shares. Thus, holders of our common shares bear the risk that our future issuances of debt or equity securities or other borrowings will reduce the market price of our common shares and dilute their ownership in us. Interest rate fluctuations could significantly decrease our results of operations and cash flows and the market value of our investments. Interest rates are highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond our control. Interest rate fluctuations present a variety of risks to our operations. Our primary interest rate exposures relate to the yield on our investments, their market value and the financing cost of our debt, as well as any Changes in interest rates affect our net interest income, which is the difference between the interest income we earn on our interest earning investments and the interest expense we incur in financing these investments. Interest rate fluctuations resulting in our interest expense exceeding interest income may result in operating losses for us. An increase in prevailing interest rates could adversely affect the volume of newly originated mortgages available for purchase in our correspondent production activities. 22 Changes in the level of interest rates also may affect our ability to make investments, the value of our investments (including our pipeline of mortgage loan commitments) and any related hedging instruments, the value of newly originated loans acquired through our correspondent production segment, and our ability to realize gains from the disposition of assets. Changes in interest rates may also affect borrower default rates and may impact our ability to refinance or modify loans and/or to sell REO. In addition, with respect to the MSRs and ESS we own, decreasing interest rates may cause a large number of borrowers to refinance, which may result in the loss of any such mortgage servicing business and associated write-downs of such MSRs and ESS. Any such scenario could materially and adversely affect us. Hedging against interest rate exposure may materially and adversely affect our results of operations and cash flows. We pursue hedging strategies to reduce our exposure to changes in interest rates. Our hedging activity varies in scope based on the level of interest rates, the type of investments held, and changing market conditions. However, while we enter into such transactions seeking to reduce interest rate risk, unanticipated changes in interest rates may result in poorer overall investment performance than if we had not engaged in any such hedging transactions. Interest rate hedging may fail to protect or could adversely affect us because, among other things, it may not fully eliminate interest rate risk, it could expose us to counterparty and default risk that may result in greater losses or the loss of unrealized profits, and it will create additional expense, while any income it generates to offset losses may be limited by federal tax provisions applicable to REITs. Thus hedging activity, while intended to limit losses, may materially and adversely affect our results of operations and cash flows. We utilize derivative financial instruments, which could subject us to risk of loss. We utilize derivative financial instruments for hedging purposes, which may include swaps, options and futures. However, the prices of derivative financial instruments, including futures and options, are highly volatile, as are payments made pursuant to swap agreements. As a result, the cost of utilizing derivatives may reduce our income that would otherwise be available for distribution to shareholders or for other purposes, and the derivative instruments that we utilize may fail to effectively hedge our positions. We are also subject to credit risk with regard to the counterparties involved in the derivative transactions. The use of derivative instruments is also subject to an increasing number of laws and regulations, including the Dodd-Frank Act and its implementing regulations. These laws and regulations are General Risks Initiating new business activities or significantly expanding existing business activities may expose us to new risks and will increase our cost of doing business. Initiating new business activities or significantly expanding existing business activities, such as our entry into small balance multifamily production and non-delegated correspondent production, are ways to grow our businesses and respond to changing circumstances in our industry; however, they may expose us to new risks and regulatory compliance requirements. We cannot be certain that we will be able to manage these risks and compliance requirements effectively. Furthermore, our efforts may not succeed and any revenues we earn from any new or expanded business initiative may not be sufficient to offset the initial and ongoing costs of that initiative, which would result in a loss with respect to that initiative. We may not be able to successfully operate our business or generate sufficient operating cash flows to make or sustain distributions to our shareholders. There can be no assurance that we will be able to generate sufficient cash to pay our operating expenses and make distributions to our shareholders. The results of our operations and our ability to make or sustain distributions to our shareholders depends on many factors, including the availability of attractive risk-adjusted investment opportunities that satisfy our investment strategies and our success in identifying and consummating them on favorable terms, the level and expected movement of home prices, the level and volatility of interest rates, readily accessible short-term and long-term financing on favorable terms, and conditions in the financial markets, real estate market and the economy, as to which no assurance can be given. We also face substantial competition in acquiring attractive investments, both in our investment activities and correspondent production activities. While we try to diversify our investments among various types of mortgages and mortgage-related assets, the competition for such assets may compress margins and reduce yields, making it difficult for us to make investments with attractive risk-adjusted returns. There can be no assurance that we will be able to successfully transition out of investments producing lower returns into investments that produce better returns, or that we will not seek investments with greater risk to obtain the same level of 23 returns. Any or all of these factors could cause the value of our investments to decline substantially and have a material adverse effect on our business, financial condition, results of operations and cash flows. Competition for mortgage assets may limit the availability of desirable investments and result in reduced risk-adjusted returns. Our profitability depends, in part, on our ability to continue to acquire our targeted investments at favorable prices. As described in greater detail elsewhere in this Report, we compete in our investment activities with other mortgage REITs, specialty finance companies, private funds, thrifts, banks, mortgage bankers, insurance companies, mutual funds, institutional investors, investment banking firms, depository institutions, governmental bodies and other entities, many of which focus on acquiring mortgage assets. Many of our competitors also have competitive advantages over us, including size, financial strength, access to capital, cost of funds, federal pre-emption and higher risk tolerance. Competition may result in fewer investments, higher prices, acceptance of greater risk, lower yields and a narrower spread of yields over our financing costs. We may change our investment strategies and policies without shareholder consent, and this may materially and adversely affect the market value of our common shares and our ability to make distributions to our shareholders. PCM is authorized by our board of trustees to follow very broad investment policies and, therefore, it has great latitude in determining the types of assets that are proper investments for us, as well as the individual investment decisions. In the future, PCM may make investments with lower rates of return than those anticipated under current market conditions and/or may make investments with greater risks to achieve those anticipated returns. Our board of trustees will periodically review our investment policies and our investment portfolio but will not review or approve each proposed investment by PCM unless it falls outside our investment policies or constitutes a related party transaction. In addition, in conducting periodic reviews, our board of trustees will rely primarily on information provided to it by PCM. Furthermore, PCM may use complex strategies, and transactions entered into by PCM may be costly, difficult or impossible to unwind by the time they are reviewed by our board of trustees. We also may change our investment strategies and policies and targeted asset classes at any time without the consent of our shareholders, and this could result in our making investments that are different in type from, and possibly riskier than our current investments or the investments currently contemplated. Changes in our investment strategies and policies and targeted asset classes may expose us to new risks or increase our exposure to interest rate risk, counterparty risk, default risk and real estate market fluctuations, and this could materially and adversely affect the market value of our common shares and our ability to make distributions to our shareholders.
Our correspondent production activities could subject us to increased risk of loss. In our correspondent production activities, we acquire newly originated loans, including jumbo loans, from mortgage lenders and sell or securitize those loans to or through the Agencies or other third party investors. We also sell the resulting securities into the MBS markets. However, there can be no assurance that PLS will continue to be successful in operating this business on our behalf or that we will continue to be able to capitalize on these opportunities on favorable terms or at all. In particular, we have committed, and expect to continue to commit, capital and other resources to this operation; however, PLS may not be able to continue to source sufficient asset acquisition opportunities to justify the expenditure of such capital and other resources. In the event that PLS is unable to continue to source sufficient opportunities for this operation, there can be no assurance that we would be able to acquire such assets on favorable terms or at all, or that such assets, if acquired, would be profitable to us. In addition, we may be unable to finance the acquisition of these assets and/or may be unable to sell the resulting MBS in the secondary mortgage market on favorable terms or at all. We are also subject to the risk that the fair value of the acquired loans may decrease prior to their disposition. The occurrence of any one or more of these risks could adversely impact our business, financial condition, liquidity and results of operations and our ability to make distributions to our shareholders.
Our correspondent production activities are currently dependent, in part, upon the ability of PLS to effectively interface with our mortgage 24 We are not an approved Ginnie Mae issuer and servicer, and an increase in the percentage or amount of government loans we acquire could be detrimental to us. We are not approved as a Ginnie Mae issuer and servicer. As a result, we are unable to produce or acquire Ginnie Mae MSRs and we earn significantly less income in connection with our acquisition of government loans as opposed to conventional loans. Further, market demand for government loans over conventional loans may increase or PLS may offer pricing to our approved correspondent sellers for government loans that is more competitive in the market than pricing for conventional loans, the result of which may be our acquisition of a greater proportion or amount of government loans. Any significant increase in the percentage or amount of government loans we acquire could adversely impact our business, financial condition, liquidity and results of operations, and our ability to make distributions to shareholders. The industry in which we operate is highly competitive, and is likely to become more competitive, and our inability to compete successfully or decreased margins resulting from increased competition could adversely affect our business, financial condition, results of operations and our ability to make distributions to our shareholders. We operate in a highly competitive industry that could become even more competitive as a result of economic, legislative, regulatory and technological changes. Competition in acquiring newly originated mortgage loans comes from large commercial banks and savings institutions and other independent mortgage lenders and servicers. Many of these institutions have significantly greater resources and access to capital than we do, which may give them the benefit of a lower cost of funds. Additionally, our existing and potential competitors may decide to modify their business models to compete more directly with our correspondent production business. For example, non-bank loan servicers may try to leverage their servicing operations to develop or expand a correspondent production business. Since the withdrawal of a number of large participants from these markets following the financial crisis in 2008, there have been relatively few large non-bank participants. As more non-bank entities enter these markets, our correspondent production activities may generate lower margins in order to effectively compete.
We could incur substantial losses and
We could be harmed by misconduct or fraud that is difficult to detect. We are exposed to risks relating to misconduct by our employees, employees of PennyMac and its subsidiaries, contractors we use, or other third parties with whom we have relationships. For example, such employees could execute unauthorized transactions, use our assets improperly or without authorization, perform improper activities, use confidential information for improper purposes, or misrecord or otherwise try to hide improper activities from us. This type of misconduct could also relate to our assets managed by PCM. This type of misconduct can be difficult to detect and if not prevented or detected could result in claims or enforcement actions against us or losses. Accordingly, misconduct by the employees of PennyMac and its subsidiaries, contractors, or others could subject us to losses or regulatory sanctions and seriously harm our reputation. Our controls may not be effective in detecting this type of activity. If we fail to maintain an effective system of internal controls, we may not be able to accurately determine our financial results or prevent fraud. Effective internal controls are necessary for us to provide reliable financial reports and effectively prevent fraud. We may in the future discover areas of our internal controls that need improvement. Section 404 of the Sarbanes-Oxley Act requires us to evaluate and report on our internal 25 significant deficiency Technology failures could damage our business operations and increase our costs, which could adversely affect our business, financial condition and results of operations. The financial services industry as a whole is characterized by rapidly changing technologies, and system disruptions and failures caused by fire, power loss, telecommunications outages, unauthorized intrusion, computer viruses and disabling devices, natural disasters and other similar events may interrupt or delay the ability of PCM or PLS to provide services to our customers on our behalf. Security breaches, acts of vandalism and developments in computer capabilities could result in a compromise or breach of the technology used to protect our customers’ personal information and transaction data. Despite efforts by PCM or PLS to ensure the integrity of their systems, it is possible that they may not be able to anticipate or implement effective preventive measures against all security breaches, especially because the methods of attack change frequently or are not recognized until launched, and because security attacks can originate from a wide variety of sources, including third parties such as persons involved with organized crime or associated with external service providers. Those parties may also attempt to fraudulently induce employees, vendors, customers or other users of these systems to disclose sensitive information in order to gain access to our data or that of our customers or clients. These risks may increase in the future along with the industry’s increase in its reliance on the Internet and use of web-based product offerings. A successful penetration or circumvention of the security of our systems or a defect in the integrity of PCM’s or PLS’ systems or cybersecurity could cause serious negative consequences for our business, including regulatory sanctions, significant disruption of our operations, misappropriation of our confidential information or that of our customers, or damage to PCM’s or PLS’ computers or operating systems and to those of our customers and counterparties. Any of the foregoing events could result in violations of applicable privacy and other laws, financial loss to us, to PCM or PLS, or to our customers, loss of confidence in us, customer dissatisfaction, significant litigation exposure and harm to our reputation, all of which could have a material adverse effect on our business, financial condition, results of operations and our ability to make distributions to our shareholders. Cybersecurity risks and cyber incidents may adversely affect our business by causing a disruption to our operations, a compromise or corruption of our confidential information, and/or damage to our business relationships, all of which could negatively impact our financial results. A cyber incident is considered to be any adverse event that threatens the confidentiality, integrity or availability of our information resources. These incidents may be an intentional attack or an unintentional event and could involve gaining unauthorized access to our information systems for purposes of misappropriating assets, stealing confidential information, corrupting data or causing operational disruption. The result of these incidents may include disrupted operations, misstated or unreliable financial data, liability for stolen assets or information, increased cybersecurity protection and insurance costs, litigation and damage to our investor relationships. As our reliance on technology has increased, so have the risks posed by information systems, both internal and those provided to us by third-party service providers. While we have implemented policies and procedures designed to help mitigate cybersecurity risks and cyber intrusions, there can be no assurance that any such cyber intrusions will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any cyber intrusions or failures, interruptions and security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our business, financial condition and results of operations. Terrorist attacks and other acts of violence or war may materially and adversely affect the real estate industry generally and our business, financial condition, liquidity and results of operations. Terrorist attacks and other acts of violence or war may cause disruptions in the U.S. financial markets, including the real estate capital markets, and negatively impact the U.S. economy in general. Any future terrorist attacks, the anticipation of any such attacks, the consequences of any military or other response by the United States and its allies, and other armed conflicts could cause consumer confidence and spending to decrease or result in increased volatility in the United States and worldwide financial markets and economy. The economic impact of these events could also materially and adversely affect the collectability of some of our loans and the credit quality of our loans and investments and the properties underlying our interests. 26 We may suffer losses as a result of the adverse impact of any future attacks and these losses may adversely impact our performance and may cause the market value of our common shares to decline or be more volatile. We cannot predict the severity of the effect that potential future armed conflicts and terrorist attacks would have on us. Losses resulting from these types of events may not be fully insurable. Risks Related to Our Investments
In conjunction with our correspondent business, we have entered into credit risk transfer agreements (“CRT Agreements”) with Fannie Mae, whereby we sell pools of mortgage loans into Fannie Mae-guaranteed securitizations while retaining a portion of the credit risk underlying such mortgage loans and an IO ownership interest in such mortgage loans. Our retention of credit risk subjects us to risks associated with delinquency and foreclosure similar to the risks associated with owning the underlying mortgage loans, and exposes us to risk of loss greater than the risks associated with selling the mortgage loans to Fannie Mae without the retention of such credit risk. Any loss we incur may be significant and may reduce distributions to our CRT Agreements also represent a type of investment that is new to the market and, as such, inherently uncertain and illiquid. There can be no assurance that this investment type will continue to be In addition, although our CRT Agreements have been structured to produce qualifying assets for the purposes of A significant portion of our investments is A significant portion of our investments is in the form of mortgage loans, which are directly exposed to losses resulting from default and foreclosure. In the event of a foreclosure, we may assume direct ownership of the underlying real estate. The liquidation proceeds upon sale of such real estate may not be sufficient to recover our investment in the loan, resulting in a loss to us. In addition, the foreclosure process may be lengthy and expensive, and any delays or costs involved in the effectuation of a foreclosure of the loan or a liquidation of the underlying property may further reduce the proceeds and thus increase the loss. The mortgage loans in which we invest and the mortgage loans underlying the MBS in which we invest subject us to costs and losses arising from delinquency We Our investments in mortgage loans and MBS also subject us to the risks of residential real estate and residential real estate-related investments, including, among others: (i) declines in the value of residential real estate; (ii) risks related to general and local economic conditions; (iii) lack of available mortgage funding for borrowers to refinance or sell their homes; (iv) overbuilding; (v) the general deterioration of the borrower’s ability to keep a rehabilitated nonperforming mortgage loan current; (vi) increases in property taxes and operating expenses; (vii) changes in zoning laws; (viii) costs resulting from the clean-up of, and liability to third parties for damages resulting from, environmental problems, such as indoor mold; (ix) casualty or condemnation losses; (x) uninsured damages from floods, earthquakes or other natural disasters; (xi) limitations on and variations in rents; (xii) fluctuations in interest rates; (xiii) fraud by borrowers, originators and/or sellers of mortgage loans; (xiv) undetected deficiencies and/or inaccuracies in underlying mortgage loan documentation and calculations; and (xv) failure of the borrower to adequately maintain the property, particularly during times of financial difficulty. To the extent that assets underlying our investments are concentrated geographically, by property type or in certain other respects, we may be subject to certain of the foregoing risks to a greater extent. Additionally, we may be required to foreclose on a mortgage loan and such actions would subject us to greater concentration of the risks of the residential real estate markets and risks related to the ownership and management of real property.
In the event of the bankruptcy of a mortgage loan borrower, the mortgage loan to such borrower will be deemed to be secured only to the extent of the value of the underlying collateral at the time of bankruptcy (as determined by the bankruptcy court), and the lien securing the mortgage loan will be subject to the avoidance powers of the bankruptcy trustee or debtor-in-possession to the extent the lien is unenforceable under state law. A significant portion of the residential mortgage loans that we We
Our acquisition of mortgage servicing rights exposes us to significant risks. MSRs arise from contractual agreements between us and the investors (or their agents) in mortgage securities and mortgage loans. We generally acquire MSRs in connection with our sale of mortgage loans to the Agencies where we assume the obligation to service such loans on their behalf. We may also purchase MSRs from third-party sellers. Any MSRs we acquire are initially recorded at fair value on our balance sheet. The determination of the fair value of MSRs requires our management to make numerous estimates and assumptions. Such estimates and assumptions include, without limitation, estimates of future cash flows associated with MSRs based upon assumptions involving interest rates as well as the prepayment rates, delinquencies and foreclosure rates of the underlying serviced mortgage loans. The ultimate realization of the fair value of MSRs may be materially different than the values of such MSRs as may be reflected in our consolidated balance sheet as of any particular date. The use of different estimates or assumptions in connection with the valuation of these assets could produce materially different fair values for such assets, which could have a material adverse effect on our business, financial condition, results of operations and cash flows. Accordingly, there may be material uncertainty about the fair value of any MSRs we acquire. Changes in interest rates are a key driver of the performance of MSRs. Historically, the fair value of MSRs has increased when interest rates rise and decreased when interest rates decline due to the effect those changes in interest rates have on prepayment estimates. We may pursue various hedging strategies to seek to reduce our exposure to adverse changes in fair value resulting from changes in interest rates. Our hedging activity will vary in scope based on the level and volatility of interest rates, the type of assets held and other changing market conditions. Interest rate hedging may fail to protect or could adversely affect us. To the extent we do not utilize Prepayment speeds significantly affect MSRs. Prepayment speed is the measurement of how quickly borrowers pay down the unpaid principal balance of their loans or how quickly loans are otherwise brought current, modified, liquidated or charged off. We base the price we pay for MSRs and the rate of amortization of those assets on, among other things, our projection of the cash flows from the related pool of mortgage loans. Our expectation of prepayment speeds is a significant assumption underlying those cash flow projections. If prepayment speed expectations increase significantly, the fair value of the MSRs could decline and we may be required to record a non-cash charge, which would have a negative impact on our financial results. Furthermore, a significant increase in prepayment speeds could materially reduce the ultimate cash flows we receive from MSRs, and we could ultimately receive substantially less than what we paid for such assets. Moreover, delinquency rates have a significant impact on the valuation of any MSRs. An increase in delinquencies generally results in lower revenue because typically we only collect servicing fees from Agencies or mortgage owners for performing loans. Our expectation of delinquencies is also a significant assumption underlying our cash flow projections. If delinquencies are significantly greater than we expect, the estimated fair value of the MSRs could be diminished. When the estimated fair value of MSRs is reduced, we could suffer a loss, which 28 Furthermore, MSRs and the related servicing activities are subject to numerous federal, state and local laws and regulations and may be subject to various judicial and administrative decisions imposing various requirements and restrictions on our business. Our failure to comply, or the failure of the servicer to comply, with the laws, rules or regulations to which we or they are subject by virtue of ownership of MSRs, whether actual or alleged, could expose us to fines, penalties or potential litigation liabilities, including costs, settlements and judgments, any of which could have a material adverse effect on our business, financial condition and results of operations and our ability to make distributions to our shareholders. Our acquisition of excess servicing spread exposes us to significant risks. We Because the ESS is a component of the related MSR, the risks of owning the ESS are Further, as a condition to our purchase of the ESS, we were required to subordinate our interests to those of the applicable Agency. To the extent PLS fails to maintain its Agency approvals, such failure could result in PLS’ loss of the applicable MSR in its entirety, thereby extinguishing our interest in the related ESS. With respect to our ESS relating to PLS’ Ginnie Mae MSRs, we sold our interest in such ESS to PLS under a repurchase agreement and PLS, in turn, pledged such ESS along with its interest in all of its Ginnie Mae MSRs to a special purpose entity, which issues variable funding notes and term notes that are secured by such Ginnie Mae assets and repaid through the cash flows received by the special purpose entity as the lender under a repurchase agreement with PLS. Accordingly, our interest in the Ginnie Mae ESS is also subordinated to the rights of We cannot independently protect our MSR or ESS assets from borrower refinancing and are dependent upon PLS to do so for our benefit. While PLS has agreed pursuant to the terms of an MSR recapture agreement to transfer to us a portion of the MSRs relating to mortgage loans it refinances, we are not independently capable of protecting our MSR asset from borrower refinancing through targeted solicitations to, and origination of, refinance loans for borrowers in our servicing portfolio. Accordingly, unlike traditional mortgage originators and many servicers, we must rely upon PLS to refinance mortgage loans in our servicing portfolio that would otherwise be targeted by third-party lenders. Historically, PLS has had limited success soliciting loans in our servicing portfolio, and there can be no assurance that PLS will either have or allocate the time and resources required to effectively and efficiently protect our MSR assets. Its failure to do so, or the termination of our MSR recapture agreement, could result in accelerated runoff of our MSR assets, decreasing its value and adversely impacting our business, financial condition, results of operations and our ability to make distributions to our shareholders. Similarly, while PLS has agreed pursuant to the terms of our spread acquisition agreements to transfer to us a portion of the ESS relating to mortgage loans it refinances, we are not independently capable of protecting our ESS asset from borrower refinancing by third-party lenders through targeted solicitations to, and origination of, refinance loans for borrowers in our portfolio of ESS. Accordingly, we must also rely upon PLS to refinance these mortgage loans that would otherwise be targeted by third-party lenders. There can be no assurance that PLS will either have or allocate the required time and resources 29 Investments in subordinated loans and subordinated MBS could subject us to increased risk of losses.
In general, losses on an asset securing a mortgage loan included in a securitization will be borne first by the equity holder of the property, then by a cash reserve fund or letter of credit provided by the borrower, if any, and then by the “first loss” subordinated security holder and then by the “second loss” subordinated security holder. In the event of default and the exhaustion of any equity support, reserve fund, letter of credit and any classes of securities junior to those in which we invest, we may not recover all or even a significant part of our investment, which could result in losses. In addition, if the underlying mortgage portfolio has been serviced ineffectively by the loan servicer or overvalued by the originator, or if the values of the assets subsequently decline and, as a result, less collateral is available to satisfy interest and principal payments due on the related MBS, the securities in which we invest may suffer significant losses. The prices of these types of lower credit quality investments are generally more sensitive to adverse actual or perceived economic downturns or individual issuer developments than more highly rated investments. An economic downturn or a projection of an economic downturn, for example, could cause a decline in the price of lower credit quality investments because the ability of obligors to make principal and interest payments or to refinance may be impaired. Our investments in loans to and debt securities of real estate companies will be subject to the specific risks relating to the particular borrower or issuer of the securities and to the general risks of investing in real estate-related loans and securities, which could result in significant losses. We may invest in loans to and debt securities of real estate companies, including REITs. These investments involve special risks relating to the particular borrower or issuer of the securities, including the financial condition, liquidity, results of operations, business and prospects of the borrower or issuer. Investments in REIT debt securities may also be subject to risks relating to transfer restrictions, substantial market price volatility resulting from changes to prevailing interest rates, and, in the case of subordinated investments, the seniority of claims of banks and other senior lenders to the issuer. In addition, real estate companies often invest, and REITs generally are required to invest substantially, in real estate or real estate-related assets and are subject to some or all of the risks inherent with real estate and real estate-related investments referred to in this Report. These risks may adversely affect the value of our debt securities of real estate companies and the ability of the issuers thereof to make principal and interest payments in a timely manner, or at all, which could result in significant losses for us. Our investments in commercial mortgage loans and other commercial real estate-related loans are dependent upon the success of the small balance multifamily We acquire mortgage loans secured by small balance multifamily oversupply of, or a reduction in demand for, multifamily housing and commercial properties; a favorable single-family real estate or interest rate environment that may result in a significant number of potential residents of multifamily properties deciding to purchase homes instead of renting; rent control or stabilization laws, or other laws regulating multifamily housing, which could affect the profitability of multifamily developments; the inability of residents and tenants to pay rent; 30 increased operating costs, including increased real property taxes, maintenance, insurance and utilities costs. Moreover, other factors may adversely affect the small balance multifamily The failure of PLS or any other servicer to effectively service our portfolio of mortgage loans would materially and adversely affect us. Pursuant to our loan servicing agreement, PLS provides us with primary and special servicing. PLS’ loan servicing activities include collecting principal, interest and escrow account payments, if any, with respect to mortgage loans, as well as managing loss mitigation, which may include, among other things, collection activities, loan workouts, modifications, foreclosures, short sales and sales of REO. The ability of PLS or any other servicer or subservicer to effectively service our portfolio of mortgage loans is critical to our success, particularly given our strategy of maximizing the fair value of the distressed mortgage loans that we acquire through proprietary loan modification programs, special servicing and other initiatives focused on keeping borrowers in their homes; or in the case of nonperforming loans, effecting property resolutions in a timely, orderly and economically efficient manner. The failure of PLS or any other servicer or subservicer to effectively service our portfolio of mortgage loans would adversely impact our business, financial condition, liquidity, results of operations and our ability to make distributions to our shareholders.
Our inability to promptly foreclose upon defaulted mortgage loans could increase our cost of doing business and/or diminish our expected return on investments. Our ability to promptly foreclose upon defaulted mortgage loans and liquidate the underlying real property plays a critical role in our valuation of the assets in which we invest and our expected return on those investments. There are a variety of factors that may inhibit our ability, through PLS, to foreclose upon a mortgage loan and liquidate the real property within the time frames we model as part of our valuation process. These factors include, without limitation: extended foreclosure timelines in states that require judicial foreclosure, including states where we hold high concentrations of mortgage loans; significant collateral documentation deficiencies; federal, state or local laws that are borrower friendly, including legislative action or initiatives designed to provide homeowners with assistance in avoiding residential mortgage loan foreclosures and that serve to delay the foreclosure process; HAMP and similar programs that require specific procedures to be followed to explore the refinancing of a mortgage loan prior to the commencement of a foreclosure proceeding; and declines in real estate values and sustained high levels of unemployment that increase the number of foreclosures and place additional pressure on the already overburdened judicial and administrative systems. In addition, certain issues, including “robo-signing,” have been identified throughout the mortgage industry that relate to affidavits used in connection with the mortgage loan foreclosure process. A substantial portion of our investments are nonperforming mortgage loans, many of which are already subject to foreclosure proceedings at the time of purchase. While we have obtained assurances from PLS about its own practices relative to foreclosure proceedings and its proper use of affidavits, there can be no assurance that similar practices have been followed in connection with mortgage loans that are already subject to foreclosure proceedings at the time of purchase. To the extent we determine that any of these loans are impacted by these issues, we may be required to re-commence the foreclosure proceedings relating to such loans, thereby resulting in additional delay that could impair our ability to meet the required statute of limitations and have the effect of increasing our cost of doing business and/or diminishing our expected return on our investments. The uncertainty surrounding these issues could also result in legal, regulatory or industry changes to the foreclosure process as a whole, any or all of which could lengthen the foreclosure process and negatively impact our business. A decline in the fair value of the real estate underlying our mortgage loans or that we acquire, whether through foreclosure or otherwise, may result in reduced risk-adjusted returns or losses, and our ownership of real estate may subject us to risks and losses not adequately covered by insurance. The fair value of the real estate that we own or that underlies mortgage loans that we own is subject to market conditions. Changes in the real estate market may adversely affect the fair value of the collateral and thereby lower the There are certain types of losses, generally of a catastrophic nature, that result from events such as earthquakes, floods, hurricanes, terrorism or acts of war, and that may be uninsurable or not economically insurable. Inflation, changes in building codes 31 and ordinances, environmental considerations and other factors, including terrorism or acts of war, also might make the insurance proceeds insufficient to repair or replace a property if it is damaged or destroyed. Under these circumstances, the insurance proceeds received might not be adequate to restore our economic position with respect to the affected real property. Any uninsured loss could result in the loss of cash flow from, and the asset value of, the affected property. We have also implemented an REO rental program, whereby we are the lessor of real estate, generally REO acquired upon foreclosure of defaulted loans, to the extent we determine that renting the property would produce a better return on investment than liquidation. There can be no assurance that this investment strategy will prove to be either profitable or more successful than liquidation. Further, our ongoing investment in the real estate will be subject to the market risk described above, as well as other risks associated with the rental business, including, without limitation, extended periods of vacancy, unfavorable landlord-tenant laws, and contractual disputes with our property managers. Any or all of these risks could subject us to loss, materially and adversely affect the value of our real estate investments and reduce or eliminate the returns we might have otherwise realized upon liquidation of the real estate. Many of our investments are unrated or, where any credit ratings are assigned to our investments, they will be subject to ongoing evaluations and revisions and we cannot assure you that those ratings will not be downgraded. Many of our current investments are not, and many of our future investments will not be, rated by any rating agency. Therefore, PCM’s assessment of the value and pricing of our investments may be difficult and the accuracy of such assessment is inherently uncertain. However, certain of our investments may be rated. If rating agencies assign a lower-than expected rating or reduce or withdraw, or indicate that they may reduce or withdraw, their ratings of our investments in the future, the fair value of these investments could significantly decline, which would materially and adversely affect the fair value of our investment portfolio and could result in losses upon disposition or the failure of borrowers to satisfy their debt service obligations to us. We may be materially and adversely affected by risks affecting borrowers or the asset or property types in which our investments may be concentrated at any given time, as well as from unfavorable changes in the related geographic regions. Our assets are not subject to any geographic, diversification or concentration limitations except that we will be concentrated in mortgage-related investments. Accordingly, our investment portfolio may be concentrated by geography, asset, property type and/or borrower, increasing the risk of loss to us if the particular concentration in our portfolio is subject to greater risks or is undergoing adverse developments. In addition, adverse conditions in the areas where the properties securing or otherwise underlying our investments are located (including business layoffs or downsizing, industry slowdowns, changing demographics and other factors) and local real estate conditions (such as oversupply or reduced demand) may have an adverse effect on the value of our investments. A material decline in the demand for real estate in these areas may materially and adversely affect us. Concentration or a lack of diversification can increase the correlation of non-performance and foreclosure risks among our investments.
Many of our investments are illiquid and we may not be able to adjust our portfolio in response to changes in economic and other conditions. Our investments in distressed mortgage loans, MSRs, ESS, CRT Agreements, commercial mortgage loans, securities and mortgage loans held in a consolidated variable interest entity may be illiquid. As a result, it may be difficult or impossible to obtain or validate third-party pricing on the investments we purchase. Illiquid investments typically experience greater price volatility, as a ready market does not exist, and can be more difficult to value. The contractual restrictions on transfer or the illiquidity of our investments may make it difficult for us to sell such investments if the need or desire 32 Fair values of many of our investments are estimates and their ultimately reduced values may materially and adversely affect periodic reported results and credit availability, which may reduce earnings and, in turn, cash available for distribution to our shareholders. The fair values of some of our investments are not readily determinable. We measure the fair value of these investments monthly, but the fair value at which our assets are recorded may differ from their realizable value. Ultimate realization of the fair value of an asset depends to a great extent on economic and other conditions that change during the time period over which the investment is held and are beyond the control of PCM, us or our board of trustees. Further, fair value is only an estimate based on good faith judgment of the price at which an investment can be sold since market prices of investments can only be determined by negotiation between a willing buyer and seller. In certain cases, PCM’s estimation of the fair value of our investments includes inputs provided by third-party dealers and pricing services, and valuations of certain securities or other assets in which we invest are often difficult to obtain and are subject to judgments that may vary among market participants. Changes in the estimated fair values of those assets are directly charged or credited to earnings for the period. If we were to liquidate a particular asset, the realized value may be more than or less than the amount at which such asset was recorded. Accordingly, in either event, the value of our common shares could be materially and adversely affected by our determinations regarding the fair value of our investments, and such valuations may fluctuate over short periods of time. PCM utilizes analytical models and data in connection with the valuation of our investments, and any incorrect, misleading or incomplete information used in connection therewith would subject us to potential risks. Given the illiquidity and complexity of our investments and strategies, PCM must rely heavily on models and data, including analytical models (both proprietary models developed by PCM and those supplied by third parties) and information and data supplied by third parties. Models and data are used to value investments or potential investments and also in connection with hedging our investments. In the event models and data prove to be incorrect, misleading or incomplete, any decisions made in reliance thereon expose us to potential risks. For example, by relying on incorrect models and data, especially valuation models, PCM may be induced to buy certain investments at prices that are too high, to sell certain other investments at prices that are too low or to miss favorable opportunities altogether. Similarly, any hedging based on faulty models and data may prove to be unsuccessful. Liability relating to environmental matters may impact the fair value of properties that we may acquire or the properties underlying our investments. Under various U.S. federal, state and local laws, an owner or operator of real property may become liable for the costs of removal of certain hazardous substances released on its property. These laws often impose liability without regard to whether the owner or operator was responsible for, or aware of, the release of such hazardous substances. The presence of hazardous substances may also adversely affect an owner’s ability to sell real estate, borrow using the real estate as collateral or make debt payments to us. In addition, if we take title to a property, the presence of hazardous substances may adversely affect our ability to sell the property, and we may become liable to a governmental entity or to third parties for various fines, damages or remediation costs. Any of these liabilities or events may materially and adversely affect the value of the relevant asset and/or our business, financial condition, liquidity, results of operations and our ability to make distributions to our shareholders. We depend on the accuracy and completeness of information about borrowers and counterparties and any misrepresented information could adversely affect our business, financial condition and results of operations. In connection with our correspondent production activities, we may rely on information furnished by or on behalf of borrowers and counterparties, including financial statements and other financial information. We also may rely on representations of borrowers and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. If any of this information is intentionally or negligently misrepresented and such misrepresentation is not detected prior to loan funding, the fair value of the loan may be significantly lower than expected. Our controls and processes may not have detected or may not detect all misrepresented information in our loan acquisitions or from our business clients. Any such misrepresented information could materially and adversely affect our business, financial condition, results of operations and our ability to make distributions to our shareholders. We are subject to counterparty risk and may be unable to seek indemnity or require our counterparties to repurchase mortgage loans if they breach representations and warranties, which could cause us to suffer losses. When we purchase nonperforming assets or newly originated loans through our correspondent production activities, our counterparty typically makes customary representations and warranties to us about such assets or loans. Our residential mortgage loan purchase agreements may entitle us to seek indemnity or demand repurchase or substitution of the loans in the event our counterparty breaches a representation or warranty given to us. However, there can be no assurance that our mortgage loan purchase agreements will contain appropriate representations and warranties, that we will be able to enforce our contractual right to demand repurchase or 33 substitution, or that our counterparty will remain solvent or otherwise be able to honor its obligations under our mortgage loan purchase agreements. Further, a significant portion of our nonperforming assets was purchased from or through a small number of sellers who generally also provide us with financing, creating a concentration of risk and a potential conflict of interest with key sources of financing. Our inability to obtain indemnity or require repurchase of a significant number of loans could materially and adversely affect our business, financial condition, liquidity, results of operations and our ability to make distributions to our shareholders. We may be required to repurchase mortgage loans or indemnify investors if we breach representations and warranties, which could materially and adversely affect our earnings. When we sell loans, we are required to make customary representations and warranties about such loans to the loan purchaser. As part of our correspondent production activities, PLS re-underwrites a percentage of the loans that we acquire, and we rely upon PLS to ensure quality underwriting by our correspondent sellers, accurate third-party appraisals, and strict compliance with the representations and warranties that we require from our correspondent sellers and that are required from us by our investors. Our residential mortgage loan sale agreements may require us to repurchase or substitute loans or indemnify the purchaser against future losses in the event we breach a representation or warranty given to the loan We During any period in which a Risks Related to Our Organization and Structure Certain provisions of Maryland law, our staggered board of trustees and certain provisions in our declaration of trust could each inhibit a change in our control. Certain provisions of the Maryland General Corporation Law (the “MGCL”) applicable to a Maryland real estate investment trust may have the effect of inhibiting a third party from making a proposal to acquire us or of impeding a change in our control under circumstances that otherwise could provide the holders of our common shares with the opportunity to realize a premium over the then prevailing market price of such common shares. In addition, our board of trustees is divided into three classes of trustees. Trustees of each class will be elected for three-year terms upon the expiration of their current terms, and each year one class of trustees will be elected by our shareholders. The staggered terms of our trustees may reduce the possibility of a tender offer or an attempt at a change in control, even though a tender offer or change in control might be in the best interests of our shareholders. Further, our declaration of trust authorizes us to issue additional authorized but unissued common shares and preferred shares. Our board of trustees may, without shareholder approval, increase the aggregate number of our authorized common shares or the number of shares of any class or series that we have authority to issue and classify or reclassify any unissued common shares or preferred shares and may set the preferences, rights and other terms of the classified or reclassified shares. As a result, our board may establish a class or series of common shares or preferred shares or take other actions that could delay or prevent a transaction or a change in our control that might involve a premium price for our common shares or otherwise be in the best interests of our shareholders. 34 Our rights and the rights of our shareholders to take action against our trustees and officers are limited, which could limit shareholder recourse in the event of actions not in the best interest of our shareholders. Our declaration of trust limits the liability of our present and former trustees and officers to us and our shareholders for money damages to the maximum extent permitted under Maryland law. Under current Maryland law, our present and former trustees and officers will not have any liability to us or our shareholders for money damages other than liability resulting from either (a) actual receipt of an improper benefit or profit in money, property or services or (b) active and deliberate dishonesty by the trustee or officer that was established by a final judgment and is material to the cause of action. Our declaration of trust authorizes us to indemnify our present and former trustees and officers for actions taken by them in those capacities to the maximum extent permitted by Maryland law. Our bylaws require us to indemnify each present and former trustee or officer, to the maximum extent permitted by Maryland law, in the defense of any proceeding to which he or she is made, or threatened to be made, a party by reason of his or her service to us. In addition, we may be obligated to pay or reimburse the expenses incurred by our present and former trustees and officers without requiring a preliminary determination of their ultimate entitlement to indemnification. As a result, we and our shareholders may have more limited rights against our present and former trustees and officers than might otherwise exist absent the current provisions in our declaration of trust and bylaws or that might exist with other companies, which could limit shareholder recourse in the event of actions not in the best interest of our shareholders. Our declaration of trust contains provisions that make removal of our trustees difficult, which could make it difficult for our shareholders to effect changes to our management. Our declaration of trust provides that, subject to the rights of holders of any series of preferred shares, a trustee may be removed only for “cause” (as defined in our declaration of trust), and then only by the affirmative vote of at least two-thirds of the votes entitled to be cast generally in the election of trustees. Vacancies generally may be filled only by a majority of the remaining trustees in office, even if less than a quorum, for the full term of the class of trustees in which the vacancy occurred. These requirements make it more difficult to change our management by removing and replacing trustees and may prevent a change in our control that is in the best interests of our shareholders. Our bylaws include an exclusive forum provision that could limit our shareholders’ ability to obtain a judicial forum viewed by the shareholders as more favorable for disputes with us or our trustees or officers. Our bylaws provide that the Circuit Court for Baltimore City, Maryland, or, if that Court does not have jurisdiction, the United States District Court for the District of Maryland, Baltimore Division, is the exclusive forum for any derivative action or proceeding brought on our behalf; any action asserting a claim of breach of fiduciary duty; any action asserting a claim against us arising pursuant to any provision of the Maryland REIT Law; or any action asserting a claim against us that is governed by the internal affairs doctrine. This exclusive forum provision may limit a shareholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our trustees or officers, which may discourage such lawsuits against us and our trustees and officers. Alternatively, if a court were to find the choice of forum provision contained in our bylaws to be inapplicable or unenforceable in an action, we may incur additional costs associated with resolving such action in other jurisdictions, which could adversely affect our business and financial condition.
Failure to maintain Because we are organized as a holding company that conducts business primarily through our Operating Partnership and its wholly-owned subsidiaries, our status under the Investment Company Act is dependent upon the status of our Operating Partnership which, as a holding company, in turn, will have its status determined by the status of its subsidiaries. If our Operating Partnership or one or more of its subsidiaries fail to maintain their exceptions or exclusions from the Investment Company Act and we do not have available to us another basis on which we may avoid registration, we may have to register under the Investment Company Act. This could subject us to substantial regulation with respect to our capital structure (including our ability to use leverage), management, operations, transactions with affiliated persons (as defined in the Investment Company Act), portfolio composition, including restrictions with respect to diversification and industry concentration, and other matters. It could also cause the breach of covenants we or our subsidiaries have made under certain of our financing arrangements, which could result in an event of default, acceleration of debt and/or termination. In August 2011, the SEC solicited public comment through a concept release on a wide range of issues relating to the Section 3(c)(5)(C) exemption from the Investment Company Act, including the nature of the assets that qualify for purposes of the exemption and whether mortgage-related REITs should be regulated in a manner similar to investment companies. There can be no assurance that the laws and regulations governing the Investment Company Act status of REITs, including guidance and interpretations from the Division of Investment Management of the SEC regarding the exceptions and exclusions therefrom, will not 35 change in a manner that adversely affects our operations. If the SEC takes action that could result in our or our subsidiaries’ failure to maintain an exception or exclusion from the Investment Company Act, we could, among other things, be required to (a) restructure our operations to avoid being required to register as an investment company, (b) effect sales of our assets in a manner that, or at a time when, we would not otherwise choose to do so or (c) register as an investment company (which, among other things, would require us to comply with the leverage constraints applicable to investment companies), any of which could negatively affect the value of our common shares, the sustainability of our business model, and our ability to make distributions to our shareholders, which could, in turn, materially and adversely affect our business and the market price of our common shares. Further, a loss of our Investment Company Act exception or exclusion would allow PCM to terminate our management agreement with us, and our loan servicing agreement with PLS is subject to early termination in the event our management agreement is terminated for any reason. If either of these agreements is terminated, we will have to obtain the services on our own, and we may not be able to replace these services in a timely manner or on favorable terms, or at all. This would have a material adverse effect on our ability to continue to execute our business strategy. The failure of PennyMac Corp. to avail itself of an appropriate exemption from registration as an investment company under the Investment Company Act could have a material and adverse effect on our business. We intend to operate so that we and each of our subsidiaries are not required to register as investment companies under the Investment Company Act. We believe that our subsidiary, PennyMac Corp. (“PMC”), to the extent it does not qualify under Section 3(c)(5)(C), would qualify for the exemption provided in Section 3(c)(6) because it has been, and is expected to continue to be, primarily engaged, directly or through majority-owned subsidiaries, in (1) the business of purchasing or otherwise acquiring mortgages or other liens on and interests in real estate (from which not less than 25% of its gross income during its last fiscal year was and will continue to be derived), together with (2) an additional business or businesses other than investing, reinvesting, owning, holding, or trading in securities, namely the business of servicing mortgages. Although we expect not less than 25% of PMC’s gross income to be derived from originating, purchasing, or acquiring mortgages or liens on and interests in real estate, there can be no assurances that the composition of PMC’s gross income will remain the same over time. To date, the SEC staff has provided limited guidance with respect to the applicability of Section 3(c)(6), and PMC has not sought a no-action letter from the SEC staff respecting its position. If PMC is ultimately unable to rely on the Section 3(c)(6) exemption due to a failure to meet the 25% of gross income test or to the extent that the SEC staff provides negative guidance regarding the applicability or scope of the exemption, we may be required to either (a) register as an investment company, or (b) substantially restructure our business, change our investment strategy and/or the manner in which we conduct our operations in order to qualify for another Investment Company Act exemption and avoid being required to register as an investment company, either of which could materially and adversely affect our business, liquidity, financial condition, results of operations, and ability to pay dividends. In the case of a restructuring, PMC could temporarily rely on Rule 3a-2 for its exemption from registration. Rule 3a-2 provides a safe harbor exemption, not to exceed one year, for companies that have a bona fide intent to be engaged in an excepted activity but temporarily fail to meet the requirements for an exemption. In such case, PMC would likely be required to restructure its business by acquiring and/or disposing of assets in order to meet an exemption under Section 3(c)(5)(C), depending on the composition of its assets at the time. The SEC staff’s position on Section 3(c)(5)(C) generally requires that an issuer maintain at least 55% of its assets in mortgages and other liens on and interests in real estate (qualifying assets) and at least 80% of its assets in qualifying assets plus real estate-related assets. PMC would be more limited in its ability to hold MSRs or would be required to acquire and hold more mortgage loans and real estate to adjust the composition of its assets to meet the 55% and 80% tests. If PMC is required to register as an investment company, we would be required to comply with a variety of substantive requirements under the Investment Company Act that impose, among other things: limitations on capital structure; restrictions on specified investments; prohibitions on transactions with affiliates; compliance with reporting, record keeping, voting and proxy disclosure; and, other rules and regulations that would significantly increase our operating expenses. Further, if PMC was or is required to register as an investment company, PMC would be in breach of various representations and warranties contained in its credit and other agreements resulting in a default as to certain of our contracts and obligations. This could also subject us to civil or criminal actions or regulatory proceedings, or result in a court appointed receiver to take control of us and liquidate our business, any or all of which could have a material adverse effect on our business, financial condition, results of operations, and ability to pay dividends. 36 Rapid changes in the values of our investments may make it more difficult for us to maintain our REIT qualification or exclusion from the Investment Company Act. If the
Risks Related to Taxation Our failure to qualify as a REIT would result in higher taxes and reduced cash available for distribution to our shareholders. We are organized and operate in a manner so as to qualify as a REIT for U.S. federal income tax purposes. Our qualification as a REIT depends on our satisfaction of certain asset, income, organizational, distribution, shareholder ownership and other requirements on a continuing basis. If we were to lose our REIT status in any taxable year, corporate-level income taxes, including alternative minimum taxes, and applicable state and local taxes, would apply to all of our taxable income at federal and state tax rates, and distributions to our shareholders would not be deductible by us in computing our taxable income. Any such corporate tax liability could be substantial and would reduce the amount of cash available for distribution to our shareholders, which in turn would have an adverse impact on the value of our common shares. Unless we were entitled to relief under certain Internal Revenue Code provisions, we also would be disqualified from taxation as a REIT for the four taxable years following the year during which we ceased to qualify as a REIT. Even if we qualify as a REIT, we face tax liabilities that reduce our cash flow, and a significant portion of our income may be earned through TRSs that are subject to U.S. federal income taxation. Even if we qualify for taxation as a REIT, we may be subject to certain U.S. federal, state and local taxes on our income and assets, including taxes on any undistributed income, tax on income from some activities conducted as a result of a foreclosure, and state or local income, property and transfer taxes, such as mortgage recording taxes. Any of these taxes would decrease cash available for distribution to our shareholders. We also engage in business activities that are required to be conducted in a TRS. In order to meet the REIT qualification requirements, or to avert the imposition of a 100% tax that applies to certain gains derived by a REIT from dealer property or inventory, we hold a significant portion of our assets through, and derive a significant portion of our taxable income and gains in, a TRS, subject to the limitation that securities in TRSs may not represent more than 25% (20% for years beginning after December 31, 2017) of our assets in order for us to remain qualified as a REIT. All taxable income and gains derived from the assets held from time to time in our TRS are subject to regular corporate income taxation. The percentage of our assets represented by a TRS and the amount of our income that we can receive in the form of TRS dividends are subject to statutory limitations that could jeopardize our REIT status. Currently, no more than 25% of the value of a REIT’s assets may consist of stock or securities of one or more TRSs (at the end of each quarter). For taxable years beginning after December 31, 2017, no more than 20% of the value of a REIT’s assets may consist of stock or securities of one or more TRSs. We expect to continue to have one or more TRSs when this change to the TRS rule becomes effective, and may potentially have to modify our activities or the capital structure of those TRSs in order to comply with the new limitation and maintain our qualification as a REIT. While we intend to manage our affairs so as to satisfy this requirement, there can be no assurance that we will be able to do so in all market circumstances and even if we are able to do so, compliance with this rule may reduce our flexibility in operating our business. Although a TRS is subject to U.S. federal, state and local income tax on its taxable income, we may from time to time need to make distributions of such after-tax income in order to keep the value of our TRS below 25% (or 20% for taxable years beginning after December 31, 2017) of our total assets. However, for purposes of one of the tests we must satisfy to qualify as a REIT, at least 75% of our gross income must in each taxable year generally be from real estate assets. While we monitor our compliance with both this income test and the limitation on the percentage of our assets represented by TRS securities, the two may at times be in conflict with one another. That is, it is possible that we may wish to distribute a dividend from a TRS in order to reduce the value of our TRS below 25% (20% for years beginning after December 31, 2017) of the required percentage of our assets, but be unable to do so without violating the requirement that 75% of our gross income in the taxable year be derived from real estate assets. There can be no assurance that we will be able to comply with both of these tests in all market conditions. 37 Dividends payable by REITs do not generally qualify for the reduced tax rates applicable to certain corporate dividends. The Internal Revenue Code provides for a 20% maximum federal income tax rate for dividends paid by corporations to eligible domestic shareholders that are individuals, trusts or estates. Dividends paid by REITs, however, are generally not eligible for the reduced rates. The more favorable rates applicable to regular corporate dividends could cause investors who are individuals, trusts and estates to perceive investments in REITs to be relatively less attractive than investments in the stocks of non-REIT corporations that pay dividends, which could materially and adversely affect the value of the stock of REITs, including our common shares. We have not established a minimum distribution payment level and no assurance can be given that we will be able to make distributions to our shareholders in the future at current levels or at all. We are generally required to distribute to our shareholders at least 90% of our taxable income each year for us to qualify as a REIT under the Internal Revenue Code, which requirement we currently intend to satisfy. To the extent we satisfy the 90% distribution requirement but distribute less than 100% of our taxable income, we will be subject to U.S. federal corporate income tax on our undistributed taxable income. We have not established a minimum distribution payment level, and our ability to make distributions to our shareholders may be materially and adversely affected by the risk factors discussed in this Report and any subsequent Quarterly Reports on Form 10-Q. Although we have made, and anticipate continuing to make, quarterly distributions to our shareholders, our board of trustees has the sole discretion to determine the timing, form and amount of any future distributions to our shareholders, and such determination will depend upon, among other factors, our historical and projected results of operations, financial condition, cash flows and liquidity, maintenance of our REIT qualification and other tax considerations, capital expenditure and other expense obligations, debt covenants, contractual prohibitions or other limitations and applicable law and such other matters as our board of trustees may deem relevant from time to time. Among the factors that could impair our ability to continue to make distributions to our shareholders are: our inability to invest the net proceeds from our equity offerings; our inability to make attractive risk-adjusted returns on our current and future investments; non-cash earnings or unanticipated expenses that reduce our cash flow; defaults in our investment portfolio or decreases in its value; and the fact that anticipated operating expense levels may not prove accurate, as actual results may vary from estimates. As a result, no assurance can be given that we will be able to continue to make distributions to our shareholders in the future or that the level of any future distributions will achieve a market yield or increase or even be maintained over time, any of which could materially and adversely affect the market price of our common shares. The REIT distribution requirements could materially and adversely affect our ability to execute our business strategies. We intend to continue to make distributions to our shareholders to comply with the requirements of the Internal Revenue Code and to avoid paying corporate income tax on undistributed income. However, differences in timing between the recognition of taxable income and the actual receipt of cash could require us to sell assets, borrow funds on a short-term or long-term basis, or issue equity to meet the distribution requirements of the Internal Revenue Code. We may find it difficult or impossible to meet distribution requirements in certain circumstances. Due to the nature of the assets in which we invest and may invest and to our accounting elections for such assets, we may be required to recognize taxable income from those assets in advance of our receipt of cash flow on or proceeds from disposition of such assets. As a result, to the extent such income is not realized within a TRS, the requirement to distribute a substantial portion of our net taxable income could cause us to: (i) sell assets in adverse market conditions, (ii) borrow on unfavorable terms, (iii) distribute amounts that would otherwise be invested in future acquisitions, capital expenditures or repayment of debt or (iv) make a taxable distribution of our shares as part of a distribution in which shareholders may elect to receive shares or (subject to a limit measured as a percentage of the total distribution) cash, in order to comply with REIT requirements. We may be required to report taxable income early in our holding period for certain investments in excess of the economic income we ultimately realize from them. We acquire and/or expect to acquire in the secondary market debt instruments that we may significantly modify for less than their face amount, MBS issued with original issue discount, MBS acquired at a market discount, or debt instruments or MBS that are delinquent as to mandatory principal and interest payments. In each case, we may be required to report income regardless of whether corresponding cash payments are received or are ultimately collectible. If we eventually collect less than we had previously reported as income, there may be a bad debt deduction available to us at that time or we may record a capital loss in a disposition of such asset, but our ability to benefit from that bad debt deduction would depend on our having taxable income or capital gains, respectively, in 38 that later taxable year. This possible “income early, losses later” phenomenon could materially and adversely affect us and our shareholders if it were persistent and in significant amounts. The share ownership limits applicable to us that are imposed by the Internal Revenue Code for REITs and our declaration of trust may restrict our business combination opportunities. In order for us to maintain our qualification as a REIT under the Internal Revenue Code, not more than 50% in value of our outstanding shares may be owned, directly or indirectly, by five or fewer individuals (as defined in the Internal Revenue Code to include certain entities) at any time during the last half of each taxable year following our first year. Our declaration of trust, with certain exceptions, authorizes our board of trustees to take the actions that are necessary and desirable to preserve our qualification as a REIT. Under our declaration of trust, no person may own more than 9.8% by vote or value, whichever is more restrictive, of our outstanding common shares or more than 9.8% by vote or value, whichever is more restrictive, of our outstanding shares of beneficial interest. Our board may grant an exemption to the share ownership limits in its sole discretion, subject to certain conditions and the receipt of certain representations and undertakings. These share ownership limits are based upon direct or indirect ownership by “individuals,” which term includes certain entities. Ownership limitations are common in the organizational documents of REITs and are intended, among other purposes, to provide added assurance of compliance with the tax law requirements and to minimize administrative burdens. However, our share ownership limits might also delay or prevent a transaction or a change in our control that might involve a premium price for our common shares or otherwise be in the best interests of our shareholders. Complying with the REIT requirements can be difficult and may cause us to forego otherwise attractive opportunities or liquidate otherwise attractive investments. To qualify as a REIT for U.S. federal income tax purposes, we must continually satisfy tests concerning, among other things, the sources of our income, the nature and diversification of our assets, the amounts we distribute to our shareholders and the ownership of our shares. We may be required to make distributions to our shareholders at disadvantageous times or when we do not have funds readily available for distribution. Thus, compliance with the REIT requirements may hinder our ability to make certain attractive investments or require us to liquidate from our portfolio otherwise attractive investments. If we are compelled to liquidate our investments, we may be unable to comply with these requirements, ultimately jeopardizing our qualification as a REIT, or we may be subject to a 100% tax on any resultant gain if we sell assets that are treated as dealer property or inventory. These actions could have the effect of reducing our income and amounts available for distribution to our shareholders. Complying with the REIT requirements may limit our ability to hedge effectively. The REIT provisions of the Internal Revenue Code may limit our ability to hedge our assets, liabilities and operations. Under current law, any income If our Operating Partnership failed to qualify as a disregarded entity for U.S. federal income tax purposes, we could fail to qualify as a REIT and suffer other adverse consequences. We believe that our Operating Partnership is organized and operated in a manner so as to be treated as a disregarded entity, and not an association or publicly traded partnership taxable as a corporation, for U.S. federal income tax purposes. As a disregarded entity, it is not subject to U.S. federal income tax on its income. Instead, its income is included in the calculation of our income. No assurance can be provided, however, that the IRS will not challenge its status as a partnership or disregarded entity for U.S. federal income tax purposes, or that a court would not sustain such a challenge. If the IRS were successful in treating our Operating Partnership as an association or publicly-traded partnership taxable as a corporation for U.S. federal income tax purposes, we could fail to meet the gross income tests and certain of the asset tests applicable to REITs and, accordingly, could cease to qualify as a REIT. Also, the failure of our Operating Partnership to qualify as a partnership or a disregarded entity would cause it to become subject to U.S. federal corporate income tax, which would reduce significantly the amount of its cash available for debt service and for distribution. 39 The tax on prohibited transactions limits our ability to engage in transactions, including certain methods of securitizing mortgage loans that would be treated as sales for U.S. federal income tax purposes. A REIT’s net income from prohibited transactions is subject to a 100% tax. In general, prohibited transactions are sales or other dispositions of property, other than foreclosure property, but including mortgage loans, held primarily for sale to customers in the ordinary course of business. We might be subject to this tax if we were to dispose of or securitize loans in a manner that was treated as a sale of the loans for U.S. federal income tax purposes. Therefore, in order to avoid the prohibited transactions tax, we may choose to engage in certain sales of loans through a TRS and not at the REIT level, and may limit the structures we utilize for our securitization transactions, even though the sales or structures might otherwise be beneficial to us. We may hold a substantial amount of assets in one or more TRSs that are subject to corporate income tax on its earnings, which may reduce the cash flow generated by us and our subsidiaries in the aggregate, and our ability to make distributions to our shareholders. The taxable mortgage pool (“TMP”) rules may increase the taxes that we or our shareholders may incur, and may limit the manner in which we effect future securitizations. Certain of our securitizations may likely be considered to result in the creation of TMPs for U.S. federal income tax purposes. A TMP is always classified as a corporation for U.S. federal income tax purposes. However, as long as a REIT owns 100% of a TMP, such classification generally does not result in the imposition of corporate income tax, because the TMP is a “qualified REIT subsidiary.” Prior to September 1, 2012, the requirement that a TMP be wholly-owned by a REIT in order to be a qualified REIT subsidiary In the case of such wholly-REIT owned TMPs, certain categories of our shareholders, such as foreign shareholders otherwise eligible for treaty benefits, shareholders with net operating losses, and tax exempt shareholders that are subject to unrelated business income tax, could be subject to increased taxes on a portion of their dividend income received from us that is attributable to the TMP or “excess inclusion income.” In addition, to the extent that our shares are owned in record name by tax exempt “disqualified organizations,” such as certain government-related entities that are not subject to tax on unrelated business income, we may incur a corporate level tax on our allocable portion of excess inclusion income from such a wholly-REIT owned TMP. In that case and to the extent feasible, we may reduce the amount of our distributions to any disqualified organization whose share ownership gave rise to the tax, or we may bear such tax as a general corporate expense. To the extent that our shares owned by disqualified organizations are held in record name by a broker/dealer or other nominee, the broker/dealer or other nominee would be liable for the corporate level tax on the portion of our excess inclusion income allocable to the shares held by the broker/dealer or other nominee on behalf of disqualified organizations. While we intend to attempt to minimize the portion of our distributions that is subject to these rules, the law is unclear concerning computation of excess inclusion income, and its amount could be significant. In the case of any TMP that would be taxable as a domestic corporation if it were not wholly-REIT owned, we would be precluded from selling equity interests in these securitizations to outside investors, or selling any debt securities issued in connection with these securitizations that might be considered to be equity interests for tax purposes. This marketing limitation may prevent us from selling more junior or non-investment grade debt securities in such securitizations and maximizing our proceeds realized in those offerings. New legislation or administrative or judicial action, in each instance potentially with retroactive effect, could make it more difficult or impossible for us to qualify as a REIT. The rules dealing with federal income taxation, including the present U.S. federal income tax treatment of REITs, may be modified, possibly with retroactive effect, by legislative, judicial or administrative action at any time, which could affect the U.S. federal income tax treatment of an investment in our common shares. 40 We also may enter into certain transactions where the REIT eligibility of the assets subject to such transactions is uncertain. In circumstances where the application of these rules and regulations affecting our investments is not clear, we may have to interpret them and their application to us. If the IRS were to take a position adverse to our interpretation, the consequences of such action could materially and adversely affect our business, financial condition, liquidity, results of operations, and our ability to make distributions to our shareholders. An IRS administrative pronouncement with respect to investments by REITs in distressed debt secured by both real and personal property, if interpreted adversely to us, could cause us to pay penalty taxes or potentially to lose our REIT status. Most of the mortgage loans that we acquire are acquired by us at a discount from their outstanding principal amount, because our pricing is generally based on the value of the underlying real estate that secures those mortgage loans. Treasury Regulation Section 1.856-5(c) (the “interest apportionment regulation”) provides rules for determining what portion of the interest income from mortgage loans that are secured by both real and personal property is treated as “interest on obligations secured by mortgages on real property or on interests in real property.” Under the interest apportionment regulation, if a mortgage covers both real property and other property, a REIT is required to apportion its annual interest income to the real property security based on a fraction, the numerator of which is the value of the real property securing the loan, determined when the REIT commits to acquire the loan, and the denominator of which is the highest “principal amount” of the loan during the year. The IRS issued a The interest apportionment regulation applies only if the debt in question is secured both by real property and personal property. We believe that all of the mortgage loans that we acquire at a discount under the circumstances contemplated by Revenue Procedure 2011-16 are secured only by real property and no other property value is taken into account in our underwriting and pricing. Accordingly, we believe that the interest apportionment regulation does not apply to our portfolio. Nevertheless, if the IRS were to assert successfully that our mortgage loans were secured by property other than real estate, that the interest apportionment regulation applied for purposes of our REIT testing, and that the position taken in Revenue Procedure 2011-16 should be applied to our portfolio, then depending upon the value of the real property securing our loans and their face amount, and the sources of our gross income generally, we might not be able to meet the 75% REIT gross income test, and possibly the asset tests applicable to REITs. If we did not meet this test, we could potentially either lose our REIT status or be required to pay a tax penalty to the IRS. With respect to the 75% REIT asset test, Revenue Procedure 2011-16 provides a safe harbor under which the IRS will not challenge a REIT’s treatment of a loan as being a real estate asset in an amount equal to the lesser of (1) the fair market value of the real property securing the loan determined as of the date the REIT committed to acquire the loan or (2) the fair market value of the loan on the date of the relevant quarterly REIT asset testing date. This safe harbor, if it applied to us, would help us comply with the REIT asset tests following the acquisition of distressed debt if the value of the real property securing the loan were to subsequently decline. However, if the value of the real property securing the loan were to increase, the safe harbor rule of Revenue Procedure 2011-16, read literally, could have the peculiar effect of causing the corresponding increase in the value of the loan to not be treated as a real estate asset. We do not believe, however, that this was the intended result in situations in which the value of a loan has increased because the value of the real property securing the loan has increased, or that this safe harbor rule applies to debt that is secured solely by real property. However, for taxable years beginning after December 31, 2015, Internal Revenue Code Section 856(c)(9) was added and clarifies Revenue Procedure 2011-16. Subparagraph (B) of Section 856(c)(9) allows a REIT to treat personal property that is secured by a mortgage on both real property and personal property as a real estate asset, and the interest income as derived from a mortgage secured by real property, if the fair value of the personal property does not exceed fifteen percent 15% of the total fair value of all property secured by the mortgage. Nevertheless, if the IRS took the position that the safe harbor rule applied in these scenarios, then we might not be able to meet the various quarterly REIT asset tests if the value of the real estate securing our loans increased, and thus the value of our loans increased by a corresponding amount. If we did not meet one or more of these tests, then we could potentially either lose our REIT status or be required to pay a tax penalty to the IRS. None.
41 We do not own or lease any property. Our operations are carried out on our behalf at the principal executive offices of PennyMac, at
From time to time, we may be involved in various legal actions, claims and
Not applicable. 42
Our common shares are listed on the New York Stock Exchange (Symbol: PMT). As of February For the year ended December 31,
For the year ended December 31,
We intend to pay quarterly dividends and to distribute to our shareholders at least 90% of our taxable income in each year (subject to certain adjustments). This is one requirement to qualify for the tax benefits accorded to a REIT under the Internal Revenue Code. We have not established a minimum dividend payment level and our ability to pay dividends may be adversely affected for the reasons described in Item 1A of this Report in the section entitledRisk Factors. All distributions are made at the discretion of our board of trustees and depend on our earnings, our financial condition, maintenance of our REIT status and such other factors as our board of trustees may deem relevant from time to time. Unregistered Sales of Equity Securities and Use of Proceeds There were no sales of unregistered equity securities during the year ended December 31, 43 The following table provides information about our common share repurchases
Equity Compensation Plan Information We have adopted an equity incentive plan which provides for the issuance of equity based awards, including share options, restricted shares, restricted share units, unrestricted common share awards, LTIP units (a special class of partnership interests in our Operating Partnership) and other awards based on our shares that may be awarded by us directly to our officers and trustees, and the members, officers, trustees, directors and employees of PFSI and its subsidiaries or other entities that provide services to us and the employees of such other entities. The equity incentive plan is administered by our compensation committee, pursuant to authority delegated by our board of trustees, which has the authority to make awards to the eligible participants referenced above, and to determine what form the awards will take, and the terms and conditions of the awards. Our equity incentive plan allows for grants of equity-based awards up to an aggregate of 8% of our issued and outstanding common shares on a diluted basis at the time of the award. However, the total number of shares available for issuance under the plan cannot exceed 40 million. The following table provides information as of December 31,
44
45 We are a specialty finance company that invests primarily in residential mortgage loans and mortgage-related assets. Our objective is to provide attractive risk-adjusted returns to our investors over the long-term, primarily through dividends and secondarily through capital appreciation. We have We are externally managed by During the year ended December 31, 2016, we purchased newly originated prime credit quality mortgage loans with fair values totaling $66.1 billion, as compared to $46.4 billion for the same period in 2015, in furtherance of our correspondent production business. To the extent that we purchase mortgage loans that are insured by the U.S. Department of Housing and Urban Development (“HUD”) through the Federal Housing Administration (the “FHA”), or insured or guaranteed by the Veterans Administration (the “VA”) or U.S. Department of Agriculture (“USDA”), we and PLS have agreed that PLS will fulfill and purchase such mortgage loans, as PLS is a Ginnie Mae-approved issuer and we are not. This arrangement has enabled us to compete with other correspondent aggregators that purchase both government and conventional mortgage loans. We We believe that CRT Agreements are a long-term investment that can produce attractive risk-adjusted returns through our own mortgage production while aligning with Fannie Mae’s strategic goal to attract private capital investment in GSE credit risk. We believe there is significant potential for investment in front-end credit risk transfer and MSRs that result from our correspondent production activities as we redeploy capital from the liquidation of distressed whole loans. During the year ended December 31, 2016, we made investments in CRT Agreements totaling $306.5 million, and held CRT related investments (composed of restricted cash and derivative financial instruments) totaling $465.7 million at December 31, 2016. We have invested in distressed mortgage loans through direct acquisitions of mortgage loan portfolios from institutions such as banks and mortgage companies. We seek to maximize the fair value of the distressed mortgage loans that we
We also
Acquisition of REIT-eligible mortgage-backed or mortgage-related securities. We Acquisition of ESS relating to MSRs held by PFSI. During the Acquisition of small balance (typically under $10 million) commercial real estate loans. During the year ended December 31, 46 Our We believe that we qualify to be taxed as a Observations on Current Market Our business is affected by macroeconomic conditions in the United States, including economic growth, unemployment rates, the residential housing market and interest rate levels and expectations. The U.S. economy continues to grow, albeit at a modest pace, as reflected in recent economic data. During Residential real estate activity Changes in fixed-rate residential mortgage loan interest rates generally follow changes in long-term U.S. Treasury yields. Following the U.S. presidential election, an increase in Treasury yields led to an increase in mortgage loan interest rates. In addition, the Federal Open Market Committee (FOMC) of the Federal Reserve announced a 25 basis point increase in the target range for the federal funds rate at its December 2016 meeting. Thirty-year fixed mortgage interest rates ranged from a low of 3.41% to a high of 4.32% during 2016, while during 2015 thirty-year fixed mortgage interest rates ranged from a low of 3.59% to a high of 4.09% Mortgage lenders originated an estimated We believe that there is significant long-term market opportunity to invest in GSE CRT Agreements on certain of the loans acquired through our correspondent production activity. CRT Agreements align with the We believe there is
Preparation of financial statements in compliance with accounting principles generally accepted in the United States (“GAAP”) requires us to make estimates and judgments 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. Certain of these estimates significantly influence the portrayal of our financial condition and results, and they require our Manager to make difficult, subjective or complex judgments. Our critical accounting policies primarily relate to our fair value estimates. Fair value We group financial statement items measured at or based on fair value in three levels based on the markets in which the assets are traded and the observability of the inputs used to determine fair value. These levels are:
Our consolidated balance sheet is substantially comprised of assets that are measured at or based on their fair values. At December 31, As a result of the difficulty in observing certain significant valuation inputs affecting “Level 3” Because the fair value of “Level 3” 48 its Financial Analysis and Valuation group (the “FAV group”) The fair value of our IRLCs is developed by our Manager’s Capital Markets Risk Management staff and is reviewed by our Manager’s Capital Markets Operations group in the exercise of their internal control activities. Following is a discussion relating to our Manager’s approach to measuring the Interest Rate Lock Commitments Our net gain on mortgage loans acquired for sale includes our estimates of gains or losses we expect to realize upon the sale of mortgage loans we have committed to purchase but have not yet purchased or sold. Therefore, we recognize a substantial portion of our net gain on mortgage loans acquired for sale at fair value before we purchase the mortgage loan. In the course of our correspondent production activities, we make contractual commitments to correspondent lenders to purchase mortgage loans at specified terms. We call these commitments We carry IRLCs as either derivative assets or derivative liabilities on our consolidated balance sheet. The fair value of IRLCs is transferred to the fair value of mortgage loans acquired for sale at fair value when the mortgage loan is funded. An active, observable market for IRLCs does not exist. Therefore, we measure the fair value of IRLCs using methods and inputs we believe that market participants use in pricing IRLCs. We estimate the fair value of an IRLC based on quoted Agency MBS prices, our estimates of the fair value of the MSRs we expect to receive in the sale of the mortgage loans and the probability that the mortgage loan will be purchased as a percentage of the commitment we have made (the “pull-through rate”). Pull-through rates and MSR fair values are based on our estimates as these inputs are difficult to observe in the mortgage marketplace. Changes in our estimate of the probability that a mortgage loan will fund and changes in mortgage market interest rates are recognized as A shift in the market for IRLCs or a change in our Manager’s assessment of an input to the valuation of IRLCs can have a significant effect on the amount of gain on sale of mortgage loans acquired for sale for the period. Our Manager believes that the fair value of IRLCs is most sensitive to changes in pull-through rate inputs. Following is a quantitative summary of the effect of changes in pull-through inputs on the fair value of
Mortgage Loans We carry mortgage loans at their fair values. We recognize changes in the fair value of mortgage loans in current period income as a component ofNet Our Manager categorizes mortgage loans that are saleable into active markets as “Level 2” fair value 49
Our Manager estimates the fair value of our “Level 3” fair value mortgage loans using a discounted cash flow valuation model. Inputs to the model include current interest rates, loan amount, payment status and property type, and forecasts of future interest rates, home prices, prepayment speeds, defaults and loss severities. A shift in the market for “Level 3” fair value mortgage loans or a change in our Manager’s assessment of an input to the valuation of
Excess Servicing Spread We acquire the right to receive the ESS cash flows relating to certain MSRs over the life of the underlying mortgage loans. We carry our investment in ESS at fair value. We record changes in the fair value of ESS inNet gain on investments. Because ESS is a claim to a portion of the cash flows from MSRs, its valuation process is similar to that of A shift in the market for ESS or a change in our Manager’s assessment of an input to the valuation of ESS can have a significant effect on the fair value of ESS and in our income for the period. We believe that the most significant “Level 3” fair value inputs to the valuation of ESS are the pricing spread (discount rate) and prepayment speed. Following is a summary of the effect on fair value of various changes to these inputs on our fair value
Real Estate Acquired in Settlement of Loans We measure REO based on its fair value on a nonrecurring basis and carry REO at the lower of cost or fair value. We determine the fair value of REO by using a current estimate of fair value from a broker’s price opinion, a full appraisal or the price given in a current contract of sale of the property. We record changes in fair value and gains and losses on sale of REO in the consolidated statement of income under the captionResults of real estate acquired in settlement of loans. 50
MSRs represent the value of a contract that obligates us to service the mortgage loans on behalf of the owner of the loan in exchange for servicing fees and the right to collect certain ancillary income from the borrower. We recognize MSRs at our estimate of the fair value of the contract to service the loans.
After the initial recognition of MSRs, we account for such assets based on the class of MSRs: originated MSRs backed by mortgage loans with initial interest rates of less than or equal to 4.5%; and originated MSRs backed by mortgage loans with initial interest rates of more than 4.5%. Originated MSRs backed by mortgage loans with initial interest rates of less than or equal to 4.5% are accounted for using the amortization method. Originated MSRs backed by loans with initial interest rates of more than 4.5% are accounted for at fair value with changes in fair value recorded in current period income. As economic fundamentals influencing the underlying mortgage loans and market demand for MSRs change, our estimate of the fair value of our MSRs will also change. As a result, we will record changes in fair value for the MSRs we carry at fair value, and we may recognize changes in fair value relating to our MSRs carried at the lower of amortized cost or fair value depending on the relationship of the asset’s fair value to its carrying value at the measurement date. Changes in fair value of MSRs are recognized as a component of Net mortgage loan servicing fees. MSRs Accounted for Using the Amortization Method We amortize MSRs accounted for using the amortization method. MSR amortization is determined by applying the ratio of the net MSR cash flows projected for the current period to the estimated total remaining net MSR cash flows. The estimated total net MSR cash flows are determined at the beginning of each month using prepayment inputs applicable at that time. We also evaluate MSRs accounted for using the amortization method for impairment with reference to the assets’ fair value at the measurement date. Impairment occurs when the current fair value of the MSR falls below the asset’s amortized cost. If MSRs are impaired, the impairment is recognized in current period income and the carrying value of the MSRs is adjusted through a valuation allowance. If the fair value of impaired MSRs subsequently increases, we recognize the increase in fair value in current period income and, through a reduction in the valuation allowance, adjust the carrying value of the MSRs to a level not in excess of amortized cost. When evaluating MSRs for impairment, we stratify the assets by predominant risk characteristic including loan type We periodically review the various impairment strata to determine whether the fair value of the impaired MSRs in a given stratum is likely to recover. When we conclude that recovery of the fair value is unlikely in the foreseeable future, a write-down of the cost of the MSRs for that stratum to its estimated recoverable value is charged to the valuation allowance. Amortization and impairment of MSRs accounted for using the amortization method are included in current period income as a component ofNet mortgage loan servicing fees. MSRs Accounted for at Fair Value We include changes in fair value of MSRs accounted for at fair value in current period income as a component ofNet mortgage loan servicing fees. 51 A shift in the market for MSRs or a change in our Manager’s assessment of an input to the valuation of MSRs can have a significant effect on the fair value of MSRs and in our income for the period. We believe the most significant “Level 3” fair value inputs to the valuation of MSRs are the pricing spread (discount rate), prepayment speed and annual per-loan cost of servicing. Following is a summary of the effect on fair value of various changes to these key inputs that our Manager uses in making its fair value Shift in
The preceding asset analyses hold constant all of the inputs other than the input that is being changed to show an estimate of the effect on fair value of a change in a specific input. We expect that in a market shock event, multiple inputs would be affected and the effects of these changes may compound or counteract each other. Furthermore, certain of our MSRs are accounted for using the amortization method and are carried at the lower of amortized cost or fair value. Such assets’ carrying value may not be immediately affected as a result of a change in input values depending on the carrying value (carrying value is the amortized cost reduced by the applicable valuation allowance) of the MSR asset before the change in input occurs and whether the input change causes our estimate of fair value to change to a level below the amortized cost of those MSRs. Therefore the preceding analyses are not projections of the effects of a shock event or a change in our Manager’s estimate of an input and should not be relied upon as earnings projections. Critical Accounting Policies Not Tied to Fair Value Liability for Representations and Warranties We record a provision for losses relating to our representations and warranties as part of our mortgage loan sale The level of the liability for representations and warranties is difficult to estimate and requires considerable As economic fundamentals change, as investor and Agency evaluations of their loss mitigation strategies (including claims under representations and warranties) change and as the mortgage market and general economic conditions affect our correspondent
We enter into various types of on- and off-balance sheet transactions with special purpose entities (“SPEs”), which are trusts that are established for a limited purpose. Generally, SPEs are formed in connection with securitization transactions. In a securitization transaction, we transfer mortgage loans on our balance sheet to an SPE, which then issues to investors various forms of interests in those assets. In a securitization transaction, we typically receive cash and/or interests in an SPE in exchange for the assets we transfer. SPEs are generally considered variable interest entities (“VIEs”). A VIE is an entity having either a total equity investment that is insufficient to finance its activities without additional subordinated financial support or whose equity investors lack the ability to control the entity’s activities. Variable interests are investments or other interests that will absorb portions of a VIE’s expected losses or receive portions of the VIE’s expected residual returns. The primary beneficiary of a VIE is the party that has both the power to direct the activities that most significantly impact the VIE and a variable interest that could potentially be significant to the VIE. 52 When an SPE is a VIE, holders of variable interests in that entity must evaluate whether they are the VIE’s primary beneficiary. The primary beneficiary of a VIE must consolidate the assets and liabilities of the VIE onto its consolidated balance sheet. Therefore, the evaluation of a securitization as a VIE and our status as the VIE’s primary beneficiary can have a significant effect on our balance sheet. We evaluate the securitization trust into which For financial reporting purposes, the underlying
Income Taxes We have elected to be taxed as a REIT and Our TRS is subject to federal and state income taxes. Income taxes are provided for using the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted rates expected to apply to taxable income in the years in which we expect those temporary differences to be recovered or settled. The effect on deferred taxes of a change in tax rates is recognized in income in the period in which the change occurs. A valuation allowance is established if, in our judgment, realization of deferred tax assets is not more likely than not. We recognize tax benefits relating to tax positions we take only if it is more likely than not that the position will be sustained upon examination by the appropriate taxing authority. A tax position that meets this standard is recognized as the largest amount that exceeds 50 percent likelihood of being realized upon settlement. We will classify any penalties and interest as a component of income tax expense. 53 The following is a summary of our key performance
During the year ended December 31, 2016, we recorded net income of $75.8 million, or $1.08 per diluted share. During the year ended December 31, 2015, we recorded net income of $90.1 million, or $1.16 per diluted share. During the year ended December 31, 2014, we recorded net income of $194.5 million, or $2.47 per diluted share. Our net income In our correspondent production activities, our net investment income increased by $68.7 million during the year ended December 31, 2016, as compared to the same period in 2015, from $100.0 million to $168.7 million. Our net gain on mortgage loans acquired for sale
Our net income decreased during 2015 as compared to 2014, primarily due to a decrease in pretax income in our investment activities segment of $130.2 million, or 76%, from $170.6 million to $40.4 million. During 2015, we recognized net investment income totaling $148.8 million from our investment activities, a decrease of $145.9 million, or 50%, from $294.7 million during 2014. Our average investment portfolio was approximately $3.4 billion during 2015, an increase of $258.5 million, or 8%, over 2014. 54 In our correspondent production activities, our net investment income increased during 2015 compared to 2014 by $37.9 million, or 61%, from $62.1 million to $100.0 million.
During the year ended December 31, 2016, we recorded net investment income of $272.1 million, comprised primarily of $106.4 million of net gain on mortgage loans acquired for sale, $72.4 million of net interest income, $54.8 million of net loan servicing fees, and $42.0 million of mortgage loan origination fees, partially offset by $19.1 million of losses from results of REO. During the year ended December 31, 2015, we recorded net investment income of $248.8 million, comprised primarily of During 2014, we recorded net investment income of $356.7 million, comprised primarily of net gain on investments of $201.8 million, supplemented by $86.8 million of net interest income, $37.9 million of net loan servicing fees, net gain on mortgage loans acquired for sale of $35.6 million, and $18.2 million of loan origination fees, partially offset by $32.5 million of losses from results of REO. Net investment income includes non-cash fair value 55 The amounts of non-cash
Cash is generated when mortgage loan investments are monetized through payoffs, paydowns or sales, when payments of principal and interest occur on such mortgage loans, generally after they are modified, or when the property securing a mortgage loan that has been settled through acquisition of the property 56 The following table illustrates the proceeds received during the period from dispositions and paydowns of distressed mortgage loan investments and REO, net gain in fair value that we accumulated over the
The amounts included in accumulated gains and gains on liquidation do not include the cost of managing the liquidated assets which may be substantial depending on the collection status of the mortgage loan at acquisition and on our success in working with the borrower to resolve the distress in the mortgage loan. Accumulated gains include the amount of accumulated valuation gains and losses recognized throughout the holding period and, in the case of REO, include estimated direct transaction costs to be incurred in the sale of the property. Accordingly, the preceding amounts do not represent periodic earnings on a cash basis and the amount of gain will have accumulated over varying periods depending on the holding periods The primary expenses incurred at a loan level in managing our portfolio of distressed assets are servicing and activity fees. From the time of acquisition of the distressed assets through their deboarding dates, we incurred servicing and activity fees of $37.3 million, $17.3 million 57 Net Gain on Mortgage Loans Acquired for Sale Our net gain on mortgage loans acquired for sale is summarized below:
Our net gain on mortgage loans acquired for sale includes both cash and non-cash elements. We receive proceeds on sale that include both cash and our estimate of the fair value of MSRs. We also recognize a liability for potential losses relating to representations and warranties created in the mortgage loan sales transactions. 58 The Provision for Losses on Representations and Warranties We provide for our estimate of the future losses that we may be required to incur as a result of our breach of representations and warranties to the purchasers of the mortgage loans we sell. Our agreements with the purchasers include representations and warranties related to the mortgage 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 mortgage loan, property eligibility, borrower credit, income and asset requirements, and compliance with applicable federal, state and local law. In the event of a breach of our representations and warranties, we may be required to either repurchase the mortgage loans with the identified defects or indemnify the investor or insurer. In such cases, we bear any subsequent credit loss on the mortgage loans. Our credit loss may be reduced by any recourse we have to correspondent originators that, in turn, had sold such mortgage loans to us and breached similar or other representations and warranties. In such event, we have the right to seek a recovery of related repurchase losses from that correspondent seller. The method PCM uses to estimate the liability for representations and warranties is a function of estimated future defaults, mortgage loan repurchase rates, the potential severity of loss in the Following is a summary of the indemnification and repurchase activity
59 During the year ended December 31, 2016, we repurchased mortgage loans with UPBs totaling $11.4 million and charged losses of The level of the liability for As economic fundamentals change, and as investor and Agency evaluations of their loss mitigation strategies (including claims under representations and warranties) change and as economic conditions affect our correspondent sellers’ ability or willingness to fulfill their recourse obligations to us, the level of repurchase activity and ensuing losses will change, and we may be required to record adjustments to our recorded liability for losses on
60 Net interest income is summarized below:
61
Assets: Correspondent production: Mortgage loans acquired for sale at fair value Investment activities: Short-term investments Mortgage-backed securities Agency Non-Agency prime jumbo Mortgage loans: at fair value at fair value held by variable interest entity under forward purchase agreements at fair value Excess servicing spread from affiliates Total investment activities Other Liabilities: Assets sold under agreements to repurchase Mortgage loans participation and sale agreement Borrowings under forward purchase agreements Asset backed secured financing Exchangeable senior notes Interest shortfall on repayments of mortgage loans serviced for Agency securitizations Interest on mortgage loan impound deposits Net interest income Net interest margin Net interest spread
Assets: Correspondent production: Mortgage loans acquired for sale at fair value Investment activities: Short-term investments Agency mortgage-backed securities Agency debt security Mortgage loans: at fair value at fair value held by variable interest entity under forward purchase agreements at fair value Excess servicing spread from affiliates Total investment activities Other Liabilities: Assets sold under agreements to repurchase Borrowings under forward purchase agreements Asset backed secured financing Exchangeable senior notes Interest shortfall on repayments of mortgage loans serviced for Agency securitizations Interest on mortgage loan impound deposits Net interest income Net interest margin Net interest spread
62
63 The effects of changes in the yields and costs and composition of our investments on our interest income are summarized below:
During the year ended December 31, 2016, we earned net interest income of $72.4 million, as compared to $76.6 million for the year ended December 31, 2015
During the year ended December 31, At December 31, Nonperforming mortgage loans and REO generally take longer than performing mortgage loans to generate cash flow At December 31, During the year ended December 31,
Loan Origination Fees Loan origination fees represent fees we charge correspondent
Net
Our correspondent production activity is the primary source of our mortgage loan servicing portfolio. When we sell mortgage loans, we generally enter into a contract to service the mortgage loans and recognize the fair value of such contracts as MSRs. Under these contracts, we are required to perform mortgage loan servicing functions in exchange for fees and the right to other compensation. The servicing functions, which are performed on our behalf by PLS, typically include, among other responsibilities, collecting and remitting mortgage loan payments; responding to borrower inquiries; accounting for principal and interest, holding custodial (impound) funds for payment of property taxes and insurance premiums; counseling delinquent mortgagors; and supervising foreclosures and property dispositions. 65 Net mortgage loan servicing fees are summarized below:
Net mortgage loan servicing fees increased $5.5 million, or 11%, during 2016, as compared to 2015. The increase in servicing fees was due to a $29.7 million, or 29%, increase in servicing fees, partially offset by a $25.0 million increase in the negative effect of MSRs on net loan servicing fees. Both periods reflect the effect of growth in the Company’s servicing portfolio and the effect of fluctuating mortgage interest rates and prepayment speeds on our MSRs. The increase in net mortgage loan servicing fees is attributable to a 29% increase in the average size of our servicing portfolio measured in UPB during 2016, as compared to 2015. The increase in the negative effect of MSRs reflects an increase in amortization and changes in fair value from the realization of cash flows that result from the growth in our average servicing portfolios and a provision for impairment as a result of the effect of a reduction in interest rates on the expected life of the mortgage loans subject to MSRs during the first half of 2016, as compared to the same period in 2015, partially offset by the effects of gains from hedging derivatives. Net mortgage loan servicing fees increased $11.4 million, or 30%, during 2015, as compared to 2014. The increase was primarily due to a $22.1 million, or 28%, increase in servicing fees, offset by an $11.5 million increase in the effect of MSRs on net loan servicing fees. The increase in servicing fees is attributable to a 25% increase in our average servicing portfolio. The increase in the effect of MSRs on net loan servicing fees was primarily a result of amortization and change in fair value from the realization of cash flows resulting from growth in our average servicing portfolios, partially offset by a reduction in the provision for impairment as a result of the effect of increasing interest rates on the expected life of the mortgage loans subject to MSRs.
We have entered into an MSR recapture agreement that requires PLS to transfer to us the MSRs with respect to new mortgage loans originated in refinancing transactions where PLS refinances a mortgage loan for which we previously held the MSRs. PLS is generally required to transfer MSRs relating to such mortgage loans (or, under certain circumstances, other mortgage loans) that have an aggregate unpaid principal balance that is not less than 30% of the aggregate unpaid principal balance of all the loans so originated. Where the fair value of the aggregate MSRs to be transferred for the applicable month is less than $200,000, PLS may, at its option, settle in cash with us in an amount equal to such fair market value in place of transferring such MSRs. We recognized MSR recapture income during
66 Our MSRs are summarized by the basis on which we account for the assets as presented below:
Net Gain on Investments Net gain on investments is summarized below:
The decrease in net gain on investments during 2016, as compared to 2015, was caused primarily by losses in our mortgage loans at fair value. The change reflects lower appreciation versus expectations of home values collateralizing the mortgage loans, increased capitalization of interest on mortgage loan modifications which reduces mortgage loan valuation gains, and reduced cash flow expectations relating to certain of our nonperforming loans and less appreciation on our reperforming mortgage loans. The reduced cash flow expectations largely resulted from expectations for longer liquidation periods with the attendant increased holding costs during the collection period and a reduction in expected liquidation proceeds. These reduced gains were partially offset by gains from our CRT Agreements and hedging derivatives gains during 2016, as compared to 2015. 67 The decrease in net gain on investments in 2015, as compared to 2014, was caused primarily by reduced gains in our credit-sensitive investments, primarily from our mortgage loans at fair value, which reflects the effects of slower appreciation in the fair value of such mortgage loans as a result of slower appreciation in the fair value of the real estate collateralizing such loans during 2015, as compared to 2014, and continued seasoning of our portfolio of distressed mortgage loans. These reduced gains were compounded by losses in our interest rate sensitive investments, primarily from our MBS and mortgage loans held in a VIE during 2015, as compared to 2014, resulting from increasing interest rates during 2015. Mortgage-Backed Securities During 2016, we recognized net valuation losses on MBS of $13.2 million, as compared to $5.2 million during 2015. The increase in losses we recorded during 2016 reflect the effects of increasing mortgage interest rates at the end of 2016 on a larger portfolio of MBS. Our investment in MBS totaled $865.1 million at December 31, 2016 as compared to $322.5 million at December 31, 2015. Increasing mortgage interest rates negatively influence the fair value of our investment in MBS. During the year ended December 31, 2014, we recognized net valuation gains on MBS of $10.4 million. The gains we recorded arose due to decreases in market yields on MBS during the period after we purchased the securities. Mortgage Loans at Fair Value – Distressed Mortgage Loans Net (losses) gains on our investment in distressed mortgage loans at fair value are summarized below:
Because we have elected to record our mortgage loans at fair value, a substantial portion of the income we record with respect to such mortgage loans results from changes in fair value. Valuation changes amounted to losses of $8.3 million in the year ended December 31, 2016, as compared to gains of $71.0 million for the year ended December 31, 2015 and $189.5 million for the year ended December 31, 2014. Cash is generated when mortgage loans are monetized through payoffs or sales, when payments of principal and interest occur on such loans, generally after they are modified, or when the property securing a mortgage loan that has been settled through acquisition of the property has been sold. The valuation changes on performing mortgage loans largely reflect the effects of capitalization of delinquent interest on mortgage loans we modify. When we capitalize interest in a mortgage loan modification, we increase the carrying value of the mortgage loan. However, the fair value of the mortgage loan does not immediately increase significantly. Therefore, the interest income we recognize is offset by a valuation loss of corresponding magnitude. Borrower performance and changes in other inputs may result in further valuation changes to the mortgage loan. 68 Following is a summary of interest capitalized in mortgage loan modifications:
Implementing long-term, sustainable loan modification is one means by which we endeavor to increase the fair value of the distressed mortgage loans which we have typically purchased at discounts to their UPB. Gains on nonperforming mortgage loans decreased during 2016, as compared to 2015. The reduction in such gain is due to: (1) smaller increases in our expectations of future cash flows relating to certain of these mortgage loans as a result of lower appreciation versus expectations of the underlying collateral values; (2) reduced cash flow expectations relating to certain of our nonperforming loans during 2016, as compared to 2015 and (3) the effects of our liquidation efforts on our investment in nonperforming loans. Our investment in nonperforming mortgage loans decreased by $480.0 million, or 39%, from $1.2 billion in fair value at December 31, 2015 to $743.0 million at fair value in December 31, 2016. The reduced cash flow expectations largely result from expectations for longer liquidation periods with the attendant increased holding costs during the collection period and a reduction in expected liquidation proceeds. Gains on nonperforming mortgage loans decreased during 2015, as compared to 2014. During 2015, the rate of appreciation in the residential real estate market was similar to 2014. However, as our investment in such assets season, an increasing portion of the mortgage loans remaining in our investment portfolio are progressing to resolution at a slower rate than was experienced in 2014. Absent sale or securitization of reperforming and modified mortgage loans, and unlike liquidation of a defaulted mortgage loan, we expect that recovery of our investment in a performing modified mortgage loan will take place generally over a period of several years, during which we earn and collect interest income on such mortgage loans. Our current expectation is that we will receive cash on modified mortgage loans through monthly borrower payments, payoffs or acquisition of the property securing the mortgage loans and liquidation of the property in the event the borrower subsequently defaults. Due to the continuing evolution of modification programs, trends in default performance are difficult to discern. Although HAMP ended on December 31, 2016, we have other programs in place to continue mortgage loan modifications. Large-scale refinancing of modified distressed mortgage loans is not expected to occur for an extended period. Borrowers who have recently modified their mortgage loans typically have credit profiles that do not qualify them for refinancing or have mortgage loans on properties whose loan-to-value ratios exceed current underwriting guidelines for new mortgage loans. Further, modified mortgage loans generally require a period of acceptable borrower performance for consideration in most Agency refinance programs and many may have below-market interest rates. 69 The following tables present a summary of mortgage loan modifications completed:
The following table summarizes the average effect of the modifications noted above to the terms of the loans modified:
70 The activity in our CRT Agreements is summarized below:
The increase in gains recognized on CRT Agreements is due to growth in the portfolio of mortgage loans subject to CRT Agreements during 2016 as compared to 2015 and the effect of credit spread decreases (credit spreads represent the yield premium demanded by investors in securities backed by the mortgage loans subject to the CRT Agreements as compared to a U.S. Treasury security) on the fair value of the derivative assets included in the CRT Agreements. During 2015, we experienced increased credit spreads related to our CRT Agreements resulting in unrealized losses. ESS Purchased from PFSI We recognized fair value losses relating to our investment in ESS totaling $17.4 million during 2016, as compared to fair value gains totaling $3.2 million during 2015. Mortgage interest rates were lower during most of 2016 than during 2015, causing prepayments to increase as compared to 2015, resulting in a decrease in fair value. The effect of this decrease in fair value was partially offset by a reduced investment in ESS as our average investment in ESS decreased from $340.5 million during 2015 to $317.9 million during 2016. We recognized fair value gains relating to our investment in ESS totaling $3.2 million during 2015 as compared to fair value losses totaling $20.8 million during 2014. Mortgage interest rates increased throughout 2015 causing our estimate of future prepayments to decrease, as compared to 2014, resulting in an increase in fair value. The effect of this increase in fair value was compounded by growth in our investment in ESS. Our average investment in ESS increased from $168.1 million for the year ended December 31, 2014 to $340.5 million for the year ended December 31, 2015. Results of Real Estate Acquired in Settlement of Loans Results of REO includes the gains or losses we record upon sale of the properties as well as valuation adjustments we record during the period we hold those properties. 71 Results of REO are summarized below:
Losses from REOs during 2016 were similar to 2015. The decrease in losses from REOs during 2015, as compared to 2014, was due to the recognition of a larger gain realized on the sale of the properties and lower downward valuation adjustments due to better execution of REO property sales versus original estimates and less unfavorable estimates of home values during the REO holding period. Our expenses are summarized below:
Expenses increased $34.9 million, or 20%, during 2016, as compared to 2015, primarily due to higher mortgage loan fulfillment fees from an increase in the volume of Agency-eligible mortgage loans we purchased in our correspondent production activities. Expenses decreased $1.8 million, or 1%, during the year ended December 31, 2015 compared to the year ended December 31, 2014 due to lower mortgage loan servicing fees reflecting a decrease in activity-based fees from less modification activity and decreased management fees from lower net income, partially offset by increased mortgage loan fulfillment fees reflecting increased correspondent production activities.
Mortgage Loan Fulfillment Fees Mortgage loan fulfillment fees represent fees we pay to PLS for the services it performs on our behalf in connection with our acquisition, packaging and sale of mortgage loans. The fee is calculated as a percentage of the UPB of the mortgage loans purchased. Mortgage loan fulfillment fees and related fulfillment volume are summarized below:
The increase in loan fulfillment fees of $27.9 million during 2016, as compared to 2015, is primarily due to an increase in the volume of Agency-eligible mortgage loans we purchased in our correspondent production activities, partially offset by a decrease in the average fulfillment fee rate charged by PLS due to contractual discretionary reductions in the fulfillment fee by PFSI to facilitate our successful completion of certain mortgage loan sale transactions during the first eight months of 2016, followed by a contractual change in the mortgage banking services agreement with PLS in September 2016 that reduced the stated fulfillment fee rate and eliminated discretionary fee reductions by PLS. Loan fulfillment fees increased in the year ended December 31, 2015 by $9.9 million primarily due to the increase in the volume of Agency-eligible mortgage loans that we purchased in our correspondent production activities. Mortgage Loan Mortgage loan servicing fees
Mortgage loan servicing fees increased by $4.2 million during 2016, as compared to 2015. We incur mortgage loan servicing fees primarily in 73 result of activity-based fees on distressed mortgage loans resulting from increased sales of such loans during 2016 as compared to 2015. Our servicing portfolio increased to $56.3 billion in UPB at December 31,
million, or 34%, during 2015, as compared to 2014, primarily as a result of reduced activity-based fees on distressed mortgage loans resulting from reduced loan modification and resolution activity as compared to 2014. We amended our servicing agreement with PLS effective January 1, 2014, to limit the supplemental servicing fees we pay PLS with respect to non-distressed subserviced mortgage loans to no more than $700,000 per quarter. This supplemental servicing fee was eliminated, effective as of September 1, 2015. During the years ended December 31, 2015
Management Fees The components of our management fee payable to PCM are summarized below:
Management fees decreased by $3.5 million during 2016, as compared to 2015, primarily due to the decrease in our shareholders’ equity, which is the basis for the calculation of our base management fee, as a result of our share repurchases and dividend distributions. Management fees decreased by $10.8 million
We expect our management fees to fluctuate in the future based on: (1) changes in our shareholders’ equity with respect to our base management fee; and (2) the level of our profitability in excess of the return thresholds specified in our management agreement with respect to the performance incentive fee. Mortgage loan collection and liquidation Mortgage loan collection and liquidation expenses increased $3.0 million during 2016 as compared to 2015 and $3.5 million Loan origination Loan origination expenses increased $2.4 million or 52% during 2016 as compared to 2015 and $2.0 million or 78% during 2015 as compared to 2014. These increases reflect the increases in our mortgage loan production over the years presented. Compensation Compensation expense decreased $366,000 during 2016, as compared to 2015, primarily due to decreased share-based compensation expense, reflecting the effects of a generally lower share price in the 2016 period than in the 2015 period on the portion of our restricted share unit grants that are accounted for using variable accounting. 74 Professional services expense decreased $487,000 during 2016, as compared to 2015, primarily due to a decrease in expenses related to our CRT transactions. Professional service expense decreased $1.1 million during 2015, as compared to 2014, primarily due to lower expenses for legal and other professional fees. Other Expenses Other expenses are summarized below:
Other expenses increased during 2016, as compared to 2015, by $1.8 million, primarily due to higher expenses incurred in the management of our real estate held for investment, partially offset by a reduction in common overhead allocation from PFSI. Other expenses increased during the year ended December 31, 2015 as compared to the year ended December 31, 2014 by Income Taxes
A TRS is subject to corporate federal and state income tax. Accordingly, a Our effective tax rate was (22.7)% for the year ended December 31, 2016 and (22.9)% for the year ended December 31, 2015. The relative values between the tax benefit at the taxable REIT subsidiary and our consolidated pretax income drive the fluctuation in the effective tax rate. The primary difference between our effective tax rate and the statutory tax rate is due to non-taxable REIT income resulting from the dividends paid deduction. In general, cash dividends declared by us will be considered ordinary income to shareholders for income tax purposes. Some portion of the dividends may be characterized as capital gain distributions or 75 Below is a reconciliation of GAAP year to date net income to taxable income (loss) and the allocation of taxable income (loss) between the TRS and the REIT:
76 Following is a summary of key balance sheet
Total assets increased by approximately 77 Our asset acquisitions are summarized below.
Correspondent Production Following is a summary of our correspondent
During Our ability to continue the expansion of our correspondent production business is subject to, among other factors, our ability to source additional mortgage loan volume, our ability to obtain additional inventory financing and our ability to fund the portion of the mortgage loans not financed, either through cash flows from business activities or the raising of additional equity capital. There can be no assurance that we will be successful in increasing our borrowing capacity or in obtaining the additional equity capital necessary or that we will be able to identify additional sources of mortgage loans. Investment Following is a summary of our acquisitions of
78 Our acquisitions during Investment Portfolio Composition Mortgage-Backed Securities
Mortgage Loans at Fair Value – Distressed The relationship of the fair value of our distressed mortgage loans at fair value
The collateral values presented above do not represent our assessment of the amount of future cash flows to be realized from the mortgage loans and/or underlying collateral. Future cash flows will be influenced by, among other considerations, borrower performance, our asset disposition strategies with respect to individual loans and the timing of such dispositions, the costs and expenses we incur in the disposition process, The collateral values summarized above are estimated and may change over time due to various factors including our level of access to the properties securing the loans, changes in the real estate market or the condition of individual properties. The collateral values presented do not include any costs that would typically be incurred in obtaining the property in settlement of the mortgage loan, readying the property for sale, holding the property while it is being marketed or in the sale of a property. 79 Following is a summary of the distribution of our portfolio of mortgage loans at fair value (excluding mortgage loans acquired for sale at fair
Origination FICO score Less than 600 600-649 650-699 700-749 750 or greater Current loan-to-value (1) Less than 80% 80% - 99.99% 100% - 119.99% 120% or greater
80
We believe that our current fair value estimates are representative of fair value at the reporting date. However, the market for distressed mortgage assets is illiquid with a limited number of participants. Furthermore, our business strategy is to enhance the fair value of the mortgage loans during the period in which the loans are held. Therefore, any resulting 81 Following is a
We monitor and value our investments in pools of distressed mortgage loans by payment status of the loans. Most of the measures we use to value and monitor the mortgage loan portfolio, such as projected prepayment and default speeds and discount rates, are applied or output at the pool level. The characteristics of the individual loans, such as loan size, loan-to-value ratio and current delinquency status, can vary widely within a pool. The weighted average discount rate used in the valuation of mortgage loans at fair value The weighted average twelve-month projected housing price index The weighted average total prepayment speed used in the valuation of our portfolio of mortgage loans at fair value decreased from Real Estate Acquired in Settlement of Loans Following is a summary of our REO by
Geographic distribution California Florida New Jersey Maryland New York Illinois Other
82
Following is a summary of the status of our portfolio of acquisitions by quarter
Unpaid principal balance Pool factor (1) Collection status: Delinquency Current 30 days 60 days over 90 days In foreclosure REO Unpaid principal balance Pool factor (1) Collection status: Delinquency Current 30 days 60 days over 90 days In foreclosure REO Unpaid principal balance Pool factor (1) Collection status: Delinquency Current 30 days 60 days over 90 days In foreclosure REO
83
84 Our cash flows for the
Our cash flows resulted in a net decrease in cash of Operating activities Cash used by operating activities totaled Investing activities Net cash provided by our investing activities was $194.0 million during 2016, as compared to cash provided by investing activities of $11.5 million during 2015. The increase in cash flows from investing activities reflects proceeds from sales and repayments on our investments, which exceeded our investments primarily consisting of CRT Agreements and MBS during 2016, as compared to 2015. We realized cash inflows from repayments of MBS, sales and repayments of mortgage loans, repayment of ESS, sales of REO and distributions from CRT Agreements totaling $1.3 billion. We used cash to purchase MBS of $765.5 million and made deposits of cash collateral securing CRT Agreements transactions totaling $306.5 million during the year ended December 31, 2016. Net cash provided by investing activities was $11.5 million for the year ended December 31, 2015. This source of cash reflects sales and repayments of our investments in mortgage loans at fair value, MBS, ESS and REO of $663.6 million and a decrease in short-term investments of $98.0 million during 2015. Offsetting these cash inflows during 2015 were purchases of investments in mortgage loans at fair value, MBS and ESS of $598.4 million and deposits of cash collateral securing CRT Agreements of $147.4 million. Net cash provided by investing activities was $28.0 million for the year ended December 31, 2014. This source of cash reflects repayments in excess of new investments in our portfolio during the year. During 2014, repayments and sales of our investments totaled $921.1 million while purchases totaled $839.5 million. Our investing activities
Financing activities Net cash provided by financing activities was $404.0 million during 2016, as compared to $833.4 million 85 Net cash provided by financing activities was $387.0 million for the year ended December 31, 2014. We increased borrowings primarily for the purpose of financing growth in our inventory of mortgage loans acquired for sale. As discussed below inLiquidity and Capital Resources, our Manager continues to evaluate and pursue additional sources of financing to provide us with future investing capacity.
We do not raise equity or enter into borrowings for the purpose of financing the payment of dividends. We believe that our cash flows from the liquidation of our investments, which include accumulated gains recorded during the periods we hold those investments, along with our cash earnings, are adequate to fund our operating expenses and dividend payment requirements. However, Liquidity and Capital Resources Our liquidity reflects our ability to meet our current obligations (including the purchase of loans from correspondent We expect our primary sources of liquidity to be proceeds from liquidations We do not expect repayments from contractual cash flows from our investments in distressed mortgage loans and REO to be a primary source of liquidity as Our current leverage strategy is to finance our assets where we believe such borrowing is prudent, appropriate and available. We have made collateralized borrowings in the form of sales of assets under agreements to repurchase, We will continue to finance most of our assets on a short-term basis until long-term financing becomes more available. Our short-term financings will be primarily in the form of agreements to repurchase and other secured lending and structured finance facilities, pending the ultimate disposition of the assets, whether through sale, securitization or liquidation. Because a significant portion of our current debt facilities 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. 86 As of December 31, 2016 and December 31, 2015, we financed our investments in MBS, mortgage loans acquired for sale at fair value, mortgage loans at fair value, MSRs, ESS, REO and CRT Agreements with sales under agreements to repurchase, notes payable, asset-backed financing and mortgage loan participation and sale agreements. We also financed certain of our investments as of December 31, 2015 with FHLB advances, as follows:
Our repurchase agreements represent the sales of assets together with agreements for us to buy back the assets at a later date. Following is a summary of the activities in our repurchase agreements financing:
The difference between the maximum and average daily amounts outstanding is primarily due to increasing volume and the timing of loan purchases and sales in our correspondent acquisition As discussed above, all of our repurchase agreements, The transactions relating to mortgage loans and REO under agreements to repurchase generally provide for terms of approximately one year and, in one instance, two years. The transactions relating to mortgage loans under mortgage loan participation and sale The transactions relating to assets under notes payable provide for terms of approximately one year. As of December 31, 87 Our debt financing agreements require us and certain of our subsidiaries to comply with various financial covenants. As of the filing of this Report, these financial covenants include the following: profitability at the Company for at least one (1) of the previous two consecutive fiscal quarters, as of the end of each fiscal quarter, and a minimum of $40 million in unrestricted cash and cash equivalents among the Company and/or our subsidiaries; a minimum of $40 million in unrestricted cash and cash equivalents among our Operating Partnership and its consolidated subsidiaries; a minimum of $25 million in unrestricted cash and cash equivalents between PMC and PMH; and a minimum of $10 million in unrestricted cash and cash equivalents at each of PMC and PMH; a minimum tangible net worth for the Company of $860 million; a minimum tangible net worth for our Operating Partnership of $700 million; a minimum tangible net worth for PMH of $250 million; and a minimum tangible net worth for PMC of $150 million; a maximum ratio of total liabilities to tangible net worth of less than 10:1 for PMC and PMH and 5:1 for the Company and our Operating Partnership; and at least two warehouse or repurchase facilities that finance amounts and assets similar to those being financed under our existing debt financing agreements. Although these financial covenants limit the amount of indebtedness we may incur and impact our liquidity through minimum cash reserve requirements, we believe that these covenants currently provide us with sufficient flexibility to successfully operate our business and obtain the financing necessary to achieve that purpose. PLS is also subject to various financial covenants, both as a borrower under its own financing arrangements and as our positive net income during each calendar quarter; a minimum in unrestricted cash and cash equivalents of $20 million; a minimum tangible net worth of a maximum ratio of total liabilities to tangible net worth of 10:1. In addition to the financial covenants imposed upon us and A minimum net worth of a base of $2.5 million plus 25 basis points of UPB for total 1-4 unit residential mortgage loans serviced. A tangible net worth/total assets ratio greater than or equal to 6%. Liquidity equal to or exceeding 3.5 basis points multiplied by the aggregate UPB of all mortgages secured by 1-4 unit residential properties serviced for Freddie Mac, Fannie Mae and Ginnie Mae (“Agency Mortgage Servicing”) plus 200 basis points multiplied by the sum of nonperforming (90 or more days delinquent) Agency Mortgage Servicing that exceed 6% of Agency Mortgage Servicing. In the case of PLS, liquidity equal to the greater of $1.0 million or 0.10% (10 basis points) of its outstanding Ginnie Mae single-family securities. In the case of PLS, net worth equal to $2.5 million plus 0.35% (35 basis points) of its outstanding Ginnie Mae single-family obligations. 88 Our debt financing agreements also contain margin call provisions that, upon notice from the applicable lender at its option, require us to transfer cash or, in some instances, additional assets in an amount sufficient to eliminate any margin deficit. A margin deficit will generally result from any decline in the market value (as determined by the applicable lender) of the assets subject to the related financing agreement, although in some instances we may agree with the lender upon certain thresholds (in dollar amounts or percentages based on the market value of the assets) that must be exceeded before a margin deficit will arise. Upon notice from the applicable lender, we will generally be required to satisfy the margin call on the day of such notice or within one business day thereafter, depending on the timing of the notice. Our Manager continues to explore a variety of additional means of financing our Off-Balance Sheet Arrangements and Aggregate Contractual Obligations Off-Balance Sheet Arrangements and Guarantees As of December 31, Contractual Obligations As of December 31,
commitments to purchase mortgage loans from correspondent lenders. Payment obligations under these agreements, including expected interest payments on financing agreements, are summarized below:
89 All debt financing arrangements that matured between December 31, 2016 and the date of this Report have been renewed or extended. 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 debt financing is summarized by counterparty below as of December 31,
Management Agreement. We are externally managed and advised by our Manager pursuant to a management agreement, which was amended and restated effective Pursuant to our management agreement, our Manager collects a base management fee and may collect a performance incentive fee, both payable quarterly and in arrears. The The base management fee is calculated at a defined annualized percentage of “shareholders’ equity.” Our “shareholders’ equity” is defined as the sum of the net proceeds from any issuances of our equity securities since our inception (weighted for the time outstanding during the measurement period); plus our retained earnings at the end of the quarter; less any amount that we pay for repurchases of our common shares (weighted for the time held during the measurement period); and excluding one-time events pursuant to changes in GAAP and certain other non-cash charges after discussions between our Manager and our independent trustees and approval by a majority of our independent trustees. Pursuant to the terms of our amended and restated management agreement, the base management fee is equal to the sum of (i) 1.5% per The performance incentive fee is calculated at a defined annualized percentage of the amount by which “net income,” on a rolling four-quarter basis and before deducting the incentive fee, exceeds certain levels of annualized return on our “equity.” For the purpose of determining the amount of the performance incentive fee, “net income” is defined as net income or loss computed in accordance with GAAP and adjusted to exclude one-time events pursuant to changes in GAAP and certain other non-cash charges determined after discussions between The performance incentive fee is calculated quarterly and escalates as net income (stated as a percentage of return on equity) increases over certain thresholds. On each calculation date, the threshold 90 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 Fannie Mae MBS Yield (the target yield) for such quarter.
In addition, the
We may terminate the management agreement without the payment of any termination fee under certain circumstances, including, among other circumstances, uncured material breaches by our Manager of the management agreement, upon a change in control of our Manager (defined to include a 50% change in the shareholding of our Manager in a single transaction or related series of transactions or Mr. Stanford L. Kurland’s failure to continue as chief executive officer of our Manager to the extent his suitable replacement (in our discretion) has not been retained by PCM within six months thereof) or upon the termination of our MBS agreement, our MSR recapture agreement or our servicing agreement by PLS without cause. On December 13, 2016, PFSI and our Manager announced that David A. Spector would succeed Mr. Kurland as their Chief Executive Officer, effective as of January 1, 2017, and that Mr. Kurland would continue to serve in a new capacity as their Executive Chairman. We have determined that Mr. Spector, who previously served as our Executive Managing Director, President and Chief Operating Officer, was a suitable replacement for Mr. Kurland. Accordingly, on December 13, 2016, we also announced changes to the roles of Mr. Spector and Mr. Kurland, electing Mr. Spector as our President and Chief Executive Officer and Mr. Kurland as our Executive Chairman, effective as of January 1, 2017. Our management agreement also provides that, prior to the undertaking by Servicing The base servicing 91 month per REO, an REO property lease renewal fee of $100 per lease renewal, and a property management fee in an amount equal to PLS is also entitled to certain activity-based fees for distressed whole mortgage loans that are charged based on the achievement of certain events. These fees range from 0.50% for a streamline modification to 1.50% for a liquidation and $500 for a deed-in-lieu of foreclosure. PLS is not entitled to earn more than one liquidation fee, re-performance fee or modification fee per loan in any 18-month period. The base servicing In addition, because we Except as otherwise provided in our MSR recapture agreement, when
PLS continues to be entitled to reimbursement for all customary, bona fide reasonable and necessary out‑of‑pocket expenses incurred by PLS in connection with the performance of its servicing obligations. Mortgage Banking Pursuant to
In consideration for the mortgage banking services provided by loans. We do not hold the Ginnie Mae approval required to issue Ginnie Mae MBS and act as a servicer. Accordingly, under
92 In consideration for the mortgage banking services provided by Notwithstanding any provision of MSR Recapture
Spread Acquisition and MSR Servicing To the extent On February 29, 2016, the parties terminated the 2/1/13 Spread Acquisition Agreement and all amendments thereto. In connection with the termination of the 2/1/13 Spread Acquisition Agreement, PLS reacquired from us all of its right, title and interest in and to all of the Fannie Mae ESS previously sold by PLS to us and then subject to such 2/1/13 Spread Acquisition Agreement. On December 19, 2014, we entered into a second master spread acquisition and MSR servicing agreement with To the extent On On December 19, 2016, we amended and restated a third master spread acquisition and MSR servicing agreement with 93 facilitate the continued financing of the ESS owned by us in connection with the parties’ participation in the GNMA MSR Facility (as defined below). To the extent Master Repurchase Agreement with the Issuer Trust. On December 19, 2016, we entered into a master repurchase agreement with PLS (the “PMH Repurchase Agreement”), pursuant to which we may borrow from PLS for the purpose of financing our participation certificates representing beneficial ownership in ESS. PLS then re-pledges such participation certificates to the PNMAC GMSR ISSUER TRUST (the “Issuer Trust”) under a master repurchase agreement by and among PLS, Issuer Trust and Private National Mortgage Acceptance Company, LLC, 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 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) may, from time to time pursuant to the terms of any supplemental indenture, issue to institutional investors additional term notes (“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. The principal amount paid by PLS for the participation certificates under the PMH Repurchase Agreement is based upon a percentage of the market value of the underlying ESS. Upon PMH’s repurchase of the participation certificates, PMH is required to repay PLS 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 VFN and any outstanding Term Notes) to the date of such repurchase. PLS is then required to repay the Issuer Trust the corresponding amount under the PC Repurchase Agreement. As a condition to our entry into the The
94 Commercial Mortgage Servicing Oversight Agreement. We have also entered into a
Reimbursement In the event the termination fee is payable to our Manager under our management agreement and our Manager and the underwriters have not received the full amount of the reimbursements and payments under the reimbursement agreement, such amount will be paid in full. The term of the reimbursement agreement expires on February 1, 2019. 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 real estate risk, credit risk, interest rate risk, prepayment risk, inflation risk and market value risk. Our primary trading asset is our inventory of mortgage loans acquired for sale. We believe that such assets’ fair values respond primarily to changes in the market interest rates for comparable recently-originated mortgage loans. Our other market-risk assets are Real Estate Risk Residential property values are subject to volatility and may be affected adversely by a number of factors, including, but not limited to, national, regional and local economic conditions (which may be adversely affected by industry slowdowns and other factors); local real estate conditions (such as an oversupply of housing); construction quality, age and design; demographic factors; and retroactive changes to building or similar codes. Decreases in property values reduce the value of the collateral and the potential proceeds available to a borrower to repay our loans, which could cause us to suffer losses. Credit Risk We are subject to credit risk in connection with our investments. A significant portion of our assets is comprised of residential mortgage loans. The credit risk related to these investments pertains to the ability and willingness of the borrowers to pay, which is assessed before credit is granted. We believe that residual loan credit quality is primarily determined by the borrowers’ credit profiles and loan characteristics. 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 the fair value of, interest income and net servicing income we earn from our mortgage-related investments. This effect is most pronounced with fixed-rate investments, MSRs and ESS. In general, rising interest rates negatively affect the fair value of our investments in MBS and mortgage loans, while decreasing market interest rates negatively affect the fair value of our MSRs and ESS. 95 Our operating results will depend, in part, on differences between the income from our investments and our financing costs. Presently much of 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. In the event of a significant rising interest rate environment and/or economic downturn, defaults could increase and result in credit losses to us, which could materially and adversely affect our business, financial condition, liquidity, results of operations and prospects. Furthermore, such defaults could have an adverse effect on the spread between our interest earning assets and interest bearing liabilities. We engage in interest rate risk management activities in an effort to reduce the variability of earnings caused by changes in interest rates. To manage this price risk resulting from interest rate risk, we use derivative financial instruments acquired with the intention of moderating the risk that changes in market interest rates will result in unfavorable changes in the value of our interest rate lock commitments, inventory of mortgage loans acquired for sale, MBS, ESS, mortgage loans and MSRs. We do not use derivative financial instruments for purposes other than in support of our risk management activities. Prepayment Risk To the extent that the actual prepayment rate on our mortgage loans differs from what we projected when we purchased the loans and when we measured fair value as of the end of each reporting period, our unrealized gain or loss will be affected. As we receive prepayments of principal on our MBS investments, any premiums paid for such investments will be amortized against interest income using the interest method through the expected maturity dates of the investments. In general, an increase in prepayment rates will accelerate the amortization of purchase premiums, thereby reducing the interest income earned on the MBS investments and will accelerate the amortization of MSRs and ESS thereby reducing net servicing income. Conversely, as we receive prepayments of principal on our investments, any discounts realized on the purchase of such investments will be accrued into interest income using the interest method through the expected maturity dates of the investments. In general, an increase in prepayment rates will accelerate the accrual of purchase discounts, thereby increasing the interest income earned on the MBS investments. Inflation Risk Virtually all of our assets and liabilities are interest rate sensitive in nature. As a result, interest rates and other factors will influence our performance more so than inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates. Furthermore, our consolidated financial statements are prepared in accordance with GAAP and any distributions we may make to our shareholders will be determined by our board of trustees based primarily on our taxable income and, in each case, our activities and balance sheet are measured with reference to historical cost and/or fair value without considering inflation.
Our mortgage loans and MBS are reported at their fair values. The fair value of these assets fluctuates primarily based on whether the mortgage loans are distressed or whether the MBS are backed by distressed mortgage loans. Mortgage loans (along with any related recognized IRLCs) and MBS that are backed by performing mortgage loans are more sensitive to changes in market interest rates, while mortgage loans and MBS backed by distressed mortgage loans are more sensitive to changes in real estate values and other factors such as the credit performance relating to the loans underlying our investments and the effectiveness and servicing practices of the servicers associated with the properties securing such investment. Generally, in an interest rate market where interest rates are rising or are expected to rise, the fair value of our mortgage loans would be expected to decrease, whereas in an interest rate market where interest rates are generally decreasing or are expected to decrease, mortgage loan values would be expected to increase. The fair value of MSRs, on the other hand, tends to respond generally in an opposite manner to that of mortgage loans acquired for sale. Generally, in a real estate market where values are rising or are expected to rise, the fair value of our investment in distressed mortgage loans would be expected to appreciate, whereas in a real estate market where values are generally dropping or are expected to drop, the fair values of distressed mortgage loan values would be expected to decrease. 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 assumptions 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. 96 Mortgage-backed securities at fair value The following table summarizes the estimated change in fair value of our mortgage-backed securities as of December 31, 2016, given several hypothetical (instantaneous) changes in interest rates and parallel shifts in the yield curve:
Mortgage Loans at Fair Value The following table summarizes the estimated change in fair value of our portfolio of distressed mortgage loans (comprised of mortgage loans at fair value, excluding mortgage loans at fair value held by VIE) as of December 31,
The following table summarizes the estimated change in fair value of our mortgage loans at fair value held by VIE as of December 31,
Mortgage Servicing Rights The following tables summarize the estimated change in fair value of MSRs accounted for using the amortization method as of December 31,
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The following tables summarize the estimated change in fair value of MSRs accounted for using the fair value option method as of December 31,
Excess servicing spread The following tables summarize the estimated change in fair value of our ESS as of December 31,
Accounting Developments In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Subtopic 606) (“ASU 2014-09”), which supersedes the guidance in ASC 605, Revenue Recognition. ASU 2014-09 clarifies the principles for recognizing revenue in order to improve comparability of revenue recognition practices across entities and industries with certain scope exceptions including financial instruments, leases, and guarantees. ASU 2014-09 provides guidance intended to assist in the identification of contracts with customers and separate performance obligations within those contracts, the determination and allocation of the transaction price to those identified performance obligations and the recognition of revenue when a performance obligation has been satisfied. ASU 2014-09 also requires disclosures regarding the nature, amount, timing, and uncertainty of revenues and cash flows from contracts with customers. 98 Upon adoption, ASU 2014-09 provides for transition through either a full retrospective approach requiring the restatement of all presented prior periods or a modified retrospective approach, which allows the new recognition standard to be applied to only those contracts that are not completed at the date of transition. If the modified retrospective approach is adopted, a cumulative-effect adjustment to retained earnings is performed with additional disclosures required including the amount by which each line item is affected by the transition as compared to the guidance in effect before adoption and an explanation of the reasons for significant changes in these amounts. The FASB has issued several amendments to the new revenue standard ASU 2014-09, including: In May 2014, ASU 2015-14, Revenue From Contracts With Customers (“ASU 2015-14”). This update deferred the initial effective date of ASU 2014-09. As a result of the issuance of ASU 2015-14, ASU 2014-09 is effective for annual reporting periods beginning on or after December 15, 2017, and interim periods within those annual periods. Early adoption is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. In March 2015, ASU 2016-08, Principal Versus Agent Considerations (Reporting Revenue Gross versus Net). The amendments to this update are intended to improve the implementation guidance on principal versus agent considerations in ASU 2014-09 by clarifying how an entity should identify the unit of accounting (i.e. the specified good or service) and how an entity should apply the control principle to certain types of arrangements. In May 2016, ASU 2016-12, Narrow-Scope Improvements and Practical Expedients. The amendments to this update clarify certain core recognition principles and provide practical expedients available at transition. The improvements address collectability, sales tax presentation, noncash consideration, contract modifications and completed contracts at transition. We are currently evaluating the pending adoption of ASU 2014-09 and its impact on its consolidated financial statements and have not yet identified which transition method will be applied upon adoption. In February 2015, the In
ASU 2016-01 requires that: All equity investments in unconsolidated entities (other than those accounted for using the equity method of accounting) with readily determinable fair values will generally be measured at fair value through earnings. When the fair value option has been elected for financial liabilities, changes in fair value due to instrument-specific credit risk will be recognized separately in other comprehensive income. The accumulated gains and losses due to these changes will be reclassified from accumulated other comprehensive income to earnings if the financial liability is settled before maturity. For financial instruments measured at amortized cost, public business entities will be required to use the exit price when measuring the fair value of financial instruments for disclosure purposes. Financial assets and financial liabilities shall be presented separately in the notes to the financial statements, grouped by measurement category (e.g., fair value, amortized cost, lower of cost or fair value) and form of financial asset (e.g., loans, securities). Public business entities will no longer be required to disclose the methods and significant assumptions used to estimate the fair value of financial instruments carried at amortized cost. Entities will have to assess the realizability of a deferred tax asset related to a debt security classified as 99 The classification and measurement guidance will be effective for public business entities in fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. In March 2016, the FASB issued ASU 2016-09, Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”). ASU 2016-09 simplifies several aspects of the accounting for share-based payment award transactions, including: Modifies the accounting for income taxes relating to share-based payments. All excess tax benefits and tax deficiencies (including tax benefits of dividends on share-based payment awards) will be recognized as income tax expense or benefit in the consolidated statement of income. The tax effects of exercised or vested awards will be treated as discrete items in the reporting period in which they occur. An entity will recognize excess tax benefits regardless of whether the benefit reduces taxes payable in the current period. Under current GAAP, excess tax benefits are recognized in additional paid-in capital; tax deficiencies are recognized either as an offset to accumulated excess tax benefits, if any, or in the consolidated statement of income in the period they reduce income taxes payable. Changes the classification of excess tax benefits on the consolidated statement of cash flows. In the consolidated statement of cash flows, excess tax benefits will be classified along with other income tax cash flows as an operating activity. Under current GAAP, excess tax benefits are separated from other income tax cash flows and classified as a financing activity. Changes the requirement to estimate the number of awards that are expected to vest. Under ASC 2016-09, an entity can make an entity-wide accounting policy election to either estimate the number of awards that are expected to vest as presently required or account for forfeitures when they occur. Under current GAAP, accruals of compensation cost are based on the number of awards that are expected to vest. Changes the tax withholding requirements for share-based payment awards to qualify for equity accounting. The threshold to qualify for equity classification permits withholding up to the maximum statutory tax rates in the applicable jurisdictions. Under current GAAP, for an award to qualify for equity classification, an entity cannot partially settle the award in cash in excess of the employer’s minimum statutory withholding requirements. Establishes GAAP for the classification of employee taxes paid when an employer withholds shares for tax withholding purposes. Cash paid by an employer when directly withholding shares for tax- withholding purposes should be classified as a financing activity. This guidance establishes GAAP related to the classification of withholding taxes in the statement of cash flows as there is no such guidance under current GAAP. ASU 2016-09 is effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early adoption is permitted for any organization in any interim or annual period. We do not believe that the adoption of ASU 2016-09 will have a significant effect on our consolidated financial statements. In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements—Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (“ASU 2014-15”). ASU 2014-15 is intended to define management’s responsibility to evaluate whether there is substantial doubt about an organization’s ability to continue as a going concern and to provide related footnote disclosures. Under GAAP, financial statements are prepared under the presumption that the reporting organization will continue to operate as a going concern, except in limited circumstances. Financial reporting under this presumption is commonly referred to as the going concern basis of accounting. The going concern basis of accounting establishes the fundamental basis for measuring and classifying assets and liabilities. ASU 2014-15 extends the responsibility for performing the going-concern assessment to management and contains guidance on (1) how to perform a going-concern assessment and (2) when going-concern disclosures are required under GAAP. Under ASU 2014-15, an entity would be required to evaluate its status as a going concern as part of its periodic financial statement preparation process and would be required to disclose information about its potential inability to continue as a going concern when “substantial doubt” about its ability to continue as a going concern for the period of one year from the earlier of the date its financial statements are issued or are ready to be issued. If management concludes that there is “substantial doubt about the entity’s ability to continue as a going concern,” it must disclose the principal conditions or events causing substantial doubt to be raised, management’s evaluation of the conditions and 100 management’s plans. If substantial doubt is not alleviated as a result of management’s plans, the entity is required to include a statement that there is “substantial doubt about the entity’s ability to continue as a going concern.” ASU 2014-15 also requires an entity to disclose how the substantial doubt was resolved in the period that substantial doubt no longer exists. ASU 2014-15 is effective for the annual period ending December 31, 2016. The requirements of ASU 2014-15 are not expected to have an effect on the financial statements of the Company upon adoption. In response to this Item 7A, the information set forth on pages
The information called for by this Item 8 is hereby incorporated by reference from our Financial Statements and Auditors’ Report beginning at page F-1 of this Report.
None
Disclosure Controls and Procedures We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934 (the “Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures. However, no matter how well a control system is designed and operated, it can provide only reasonable, not absolute, assurance that it will detect or uncover failures within our Company to disclose material information otherwise required to be set forth in our periodic reports. Our management has conducted an evaluation, with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Report as required by paragraph (b) of Rules 13a-15 and 15d-15 under the Exchange Act. Based on our evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective, as of the end of the period covered by this Report, to provide reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the applicable rules and forms, and that it is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. Internal Control over Financial Reporting Management’s Annual Report on Internal Control over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Exchange Act Rule 13a-15(f). Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. Management assessed the effectiveness of its internal control over financial reporting based on the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) inInternal Control—Integrated Framework (2013). Based on those criteria, management concluded that our internal control over financial reporting was effective as of December 31, The effectiveness of our internal control over financial reporting as of December 31, 101 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Trustees and Shareholders of PennyMac Mortgage Investment We have audited the internal control over financial reporting of PennyMac Mortgage Investment Trust and subsidiaries (“the Company”) as of December 31, We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of trustees, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements. Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements as of and for the year ended December 31,
Los Angeles, California February 27, 2017 102 Changes in Internal Control over Financial Reporting There has been no change in our internal control over financial reporting during the quarter ended December 31,
None.
103 The information required by this Item 10 is hereby incorporated by reference from our definitive proxy statement, or will be contained in an amendment to this Report, in either case to be filed by
The information required by this Item 11 is hereby incorporated by reference from our definitive proxy statement, or will be contained in an amendment to this Report, in either case to be filed by
The information required by this Item 12 is hereby incorporated by reference from our definitive proxy statement, or will be contained in an amendment to this Report, in either case to be filed by
The information required by this Item 13 is hereby incorporated by reference from our definitive proxy statement, or will be contained in an amendment to this Report, in either case to be filed by
The information required by this Item 14 is hereby incorporated by reference from our definitive proxy statement, or will be contained in an amendment to this Report, in either case to be filed by 104
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None. 115 PENNYMAC MORTGAGE INVESTMENT TRUST AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2015
REPORT OF INDEPENDENT To the Board of Trustees and Shareholders of PennyMac Mortgage Investment 3043 Townsgate Rd Westlake Village, CA 91361 We have audited the accompanying consolidated balance sheets of PennyMac Mortgage Investment Trust and subsidiaries (the “Company”) as of December 31, We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of PennyMac Mortgage Investment Trust and subsidiaries at December 31, We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, /s/ DELOITTE & TOUCHE LLP Los Angeles, California February PENNYMAC MORTGAGE INVESTMENT TRUST AND SUBSIDIARIES
The accompanying notes are an integral part of these consolidated financial statements. F-1 PENNYMAC MORTGAGE INVESTMENT TRUST AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS Assets and liabilities of consolidated variable interest entities (“VIEs”) included in total assets and liabilities (the
The accompanying notes are an integral part of these consolidated financial statements. F-2 PENNYMAC MORTGAGE INVESTMENT TRUST AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME
The accompanying notes are an integral part of these consolidated financial statements. F-3 PENNYMAC MORTGAGE INVESTMENT TRUST AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
The accompanying notes are an integral part of these consolidated financial statements. F-4 PENNYMAC MORTGAGE INVESTMENT TRUST AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these consolidated financial statements. F-5 PENNYMAC MORTGAGE INVESTMENT TRUST AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
The accompanying notes are an integral part of these consolidated financial statements. F-6 PENNYMAC MORTGAGE INVESTMENT TRUST AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Note 1—Organization PennyMac Mortgage Investment Trust (“PMT” or the “Company”) was organized in Maryland on May 18, 2009, and commenced operations on August 4, 2009, when it completed its initial offerings of common shares of beneficial interest (“common shares”). The Company is a specialty finance company, which, through its subsidiaries (all of which are wholly-owned), invests primarily in residential The Company operates in two segments, correspondent production and investment activities: The investment activities segment represents the Company’s investments in mortgage-related assets, which include distressed mortgage loans, excess servicing spread (“ESS”), credit risk transfer agreements (“CRT Agreements”), real estate acquired in settlement of loans (“REO”), real estate held for investment, mortgage servicing rights (“MSRs”), mortgage-backed securities (“MBS”); and small balance commercial real estate loans. The correspondent production segment represents the Company’s operations aimed at serving as an intermediary between mortgage lenders and the capital markets by purchasing, pooling and reselling newly originated prime credit quality mortgage loans either directly or in the form of Most of the mortgage loans the Company has acquired in its correspondent production activities have been eligible for sale to government-sponsored entities such as the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”) or through government agencies such as the Government National Mortgage Association (“Ginnie Mae”). Fannie Mae, Freddie Mac and Ginnie Mae are each referred to as an “Agency” and, collectively, as the “Agencies.”
The Company conducts substantially all of its operations and makes substantially all of its investments through its subsidiary, PennyMac Operating Partnership, L.P. (the “Operating Partnership”), and the Operating Partnership’s subsidiaries. A wholly-owned subsidiary of the Company is the sole general partner, and the Company is the sole limited partner, of the Operating Partnership. The Company believes that it qualifies, and has elected to be taxed, as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended, beginning with its taxable period ended on December 31, 2009. To maintain its tax status as a REIT, the Company has to distribute at least 90% of its taxable income in the form of qualifying distributions to shareholders. Note 2—Concentration of Risks As discussed in Note 1—Organizationabove, PMT’s operations and investing activities are centered in residential mortgage-related assets, a substantial portion of which
changes in the overall economy, unemployment rates and residential real estate values in the markets where the properties securing the Company’s mortgage loans are located; PCM’s ability to identify and PLS’ ability to execute optimal resolutions of certain mortgage loans; the accuracy of valuation information obtained during the Company’s due diligence activities; PCM’s ability to effectively model, and to develop appropriate model inputs that properly anticipate, future outcomes; F-7 regulatory, judicial and legislative support of the foreclosure process, and the resulting effect on the Company’s ability to acquire and liquidate the real estate securing its portfolio of distressed mortgage loans in a timely manner or at all. Due to these uncertainties, there can be no assurance that risk management activities identified and executed on PMT’s behalf will prevent significant losses arising from the Company’s investments in real estate-related assets. A substantial portion of the distressed mortgage loans and REO purchased by the Company in prior years has been acquired from or through one or more subsidiaries of Citigroup Inc.
Note 3—Significant Accounting Policies PMT’s significant accounting policies are summarized below. Basis of Presentation The Company’s 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”). Use of Estimates Preparation of financial statements in compliance with GAAP requires the Manager to make estimates and judgments 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. Consolidation The consolidated financial statements include the accounts of PMT and all wholly-owned subsidiaries. PMT has no significant equity method or cost-basis investments. Intercompany accounts and transactions have been eliminated upon consolidation. The Company also consolidates assets and liabilities included in Securitization Transactions The Company enters into various types of on- and off-balance sheet transactions with special purpose entities (“SPEs”), which are trusts that are established for a limited purpose. Generally, SPEs are formed in connection with securitization transactions. In a securitization transaction, the Company transfers mortgage loans on its balance sheet to an SPE, which then issues to investors various forms of beneficial interests in those assets. In a securitization transaction, the Company typically receives a combination of cash and interests in the SPE in exchange for the assets transferred by the Company. SPEs are generally F-8 PMT consolidates the assets and liabilities of VIEs of which the Company is the primary beneficiary. The primary beneficiary is the party that has both the power to direct the activities that most significantly impact the VIE and holds a variable interest that could potentially be significant to the VIE. To determine whether a variable interest the Company holds could potentially be significant to the VIE, the Company considers both qualitative and quantitative factors regarding the nature, size and form of its involvement with the VIE. The Company assesses whether it is the primary beneficiary of a VIE on an ongoing basis. The Company evaluates the securitization trust into which mortgage loans are Jumbo Mortgage Loan Financing On September 30, 2013, the Company completed a securitization transaction in which PMT Loan Trust 2013-J1, a VIE, issued $537.0 million in unpaid principal balance (“UPB”) of certificates backed by fixed-rate prime jumbo mortgage loans at a 3.9% weighted yield. The VIE The asset-backed securities issued by the consolidated VIE are backed by the expected cash flows from the underlying fixed-rate prime jumbo mortgage loans. Cash inflows from these fixed-rate prime jumbo mortgage loans are distributed to investors and service providers in accordance with the contractual priority of payments and, as such, most of these inflows must be directed first to service and repay the senior certificates. After The Company retains beneficial interests in the securitization transaction, including For financial reporting purposes, the mortgage loans owned by the consolidated VIE are included inMortgage loans at fair value on the Company’s consolidated balance sheets and are also shown under a separate statement following the Company’s consolidated balance sheets. The securities issued to third parties by the consolidated VIE are included inAsset-backed financing of a variable interest entity at fair value on the Company’s consolidated balance sheets. The Company Credit Risk Transfer The Company, through its wholly-owned subsidiary, PennyMac Corp. (“PMC”), entered into CRT Agreements with Fannie Mae, pursuant to which PMC, through subsidiary trust entities, sells pools of mortgage loans into Fannie Mae-guaranteed securitizations while retaining a portion of the credit risk underlying such mortgage loans The Manager has concluded that the Company’s subsidiary trust entities are VIEs and the Company is the primary beneficiary of the VIEs as it is the holder of the primary beneficial interests which absorb the variability of the trusts’ results of operations. Consolidation of the VIEs results in the inclusion on the Company’s consolidated balance sheet of the
PMT 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 inputs used to determine fair value. These levels are: •Level 1—Quoted prices in active markets for identical assets or liabilities. •Level 2—Prices determined or determinable using other significant observable inputs. Observable inputs are inputs that other market participants would use in pricing an asset or liability and are developed based on market data obtained from sources independent of the Company. These may include quoted prices for similar assets and liabilities, interest rates, prepayment speeds, credit risk and other inputs. •Level 3—Prices determined using significant unobservable inputs. In situations where significant observable inputs are unavailable, As a result of the difficulty in observing certain significant valuation inputs affecting “Level 3” The Manager reclassifies its Short-Term Investments Short-term investments are carried at fair value with changes in fair value recognized in current period income. Short-term investments represent deposit accounts. The Company categorizes its short-term investments as “Level 1” fair value Mortgage-Backed Securities The Company invests in Agency and non-Agency MBS. Purchases and sales of MBS Interest Income Recognition Interest income on MBS Estimating cash flows requires a number of inputs that are subject to uncertainties, including the rate and timing of principal payments (including prepayments, repurchases, defaults and liquidations), coupon interest rate, interest rate fluctuations, interest payment shortfalls due to delinquencies on the underlying mortgage loans, the likelihood of modification and the timing of the magnitude of credit losses on the mortgage loans underlying the securities. The Manager applies its judgment in developing its estimates. However, these uncertainties are difficult to predict; therefore, the outcome of future events will affect the timing and amount of interest income. Mortgage Loans Mortgage loans are carried at their fair values. Changes in the fair value of mortgage loans are recognized in current period income. Changes in fair value, other than changes in fair value attributable to accrual of unearned discounts and amortization of purchase premiums, are included inNet gain on investmentsfor mortgage loans classified as mortgage loans at fair value and mortgage loans under forward purchase agreements at fair value andNet gain on mortgage loans acquired for salefor mortgage loans classified as mortgage loans acquired for sale at fair value. Changes in fair value attributable to accrual of unearned discounts and amortization of purchase premiums are included inInterest income on the consolidated statements of income. F-10 The Company purchases from and sells mortgage loans into the secondary mortgage market without recourse for credit losses. However, the Company maintains continuing involvement with the mortgage loans in the form of servicing arrangements and the liability under the representations and warranties it makes to purchasers and insurers of the mortgage loans. The Company recognizes transfers of mortgage loans as sales based on whether the transfer is made to a VIE: For mortgage loans that are not transferred to a VIE, the Company recognizes the transfer as a sale when it surrenders control over the mortgage loans. Control over transferred mortgage loans is deemed to be surrendered when (i) the mortgage loans have been isolated from the Company, (ii) the transferee has the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred mortgage loans, and (iii) the Company does not maintain effective control over the transferred mortgage loans through either (a) an agreement that entitles and obligates the Company to repurchase or redeem them before their maturity or (b) the ability to unilaterally cause the holder to return specific mortgage loans. For mortgage loans that are transferred to a VIE, the Company recognizes the transfer as a sale when the Manager determines that the Company is not the primary beneficiary of the VIE, as the Company does not both have the power to direct the activities that will have the most significant economic impact on the VIE and does not hold a variable interest that could potentially be significant to the VIE. Interest Income Recognition The Company has the ability but not the intent to hold mortgage loans acquired for sale, mortgage loans at fair value The Company has both the ability and intent to hold mortgage loans held in a VIE for the foreseeable future. Therefore, interest income on mortgage loans held in a variable interest entity is recognized over the estimated remaining life of the mortgage loans using the interest method. Unearned discounts and purchase premiums are accrued and amortized to interest income using the effective interest rate inherent in the estimated cash flows from the mortgage loans. Income recognition is suspended and the accrued unpaid interest receivable is reversed against interest income when mortgage loans become 90 days delinquent, or when, in the Manager’s opinion, a full recovery of income and principal becomes doubtful. Income recognition is resumed when the loan becomes contractually current. Excess Servicing Spread The Company has acquired the right to receive the ESS related to MSRs owned by PFSI. ESS is carried at its fair value. Changes in fair value are recognized in current period income inNet gain on investments. Because ESS is a claim to a portion of the cash flows from MSRs, its valuation process is similar to that of MSRs. The Manager uses the same discounted cash flow approach to value the ESS as it uses to value the related 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 Company categorizes ESS as a “Level 3” Interest Income Recognition Interest income for ESS is accrued using the interest method, based upon the expected yield from the ESS through the expected life of the underlying mortgages. Changes to the expected interest yield result in a change in fair value which is recorded inInterest income. Derivative Financial Instruments In its F-11 The Company enters into CRT Agreements whereby it retains a portion of the credit risk relating to mortgage loans it sells into Fannie Mae guaranteed securitizations and retains an IO ownership interest in All other derivative financial instruments are used for risk management activities. The Company accounts for its derivative financial instruments as free-standing derivatives. The Company does not designate its derivative financial instruments for hedge accounting. All derivative financial instruments are recognized on the balance sheet at fair value with changes in fair value being reported in current period income. The fair value of the Company’s derivative financial instruments is included inDerivative assetsand Derivative liabilitiesand changes in fair value are included inNet gain on mortgage loans acquired for sale, in Net gain on investments or inNet mortgage loan servicing fees, as applicable, in the Company’s consolidated statements of income. When the Company has master netting agreements with its derivatives counterparties, the Company nets its counterparty positions along with any cash collateral received from or delivered to the counterparty. Real Estate Acquired in Settlement of Loans REO is measured at the lower of the acquisition cost of the property (as measured by Mortgage Servicing Rights MSRs arise from contractual agreements between the Company and investors (or their agents) in mortgage securities and mortgage loans. Under these contracts, the Company is obligated to provide mortgage loan servicing functions in exchange for fees and other remuneration. The servicing functions typically performed include, among other responsibilities, collecting and remitting mortgage loan payments; responding to borrower inquiries; accounting for principal and interest, holding custodial (impound) funds for payment of property taxes and insurance premiums; counseling delinquent mortgagors; and supervising the acquisition and disposition of REO. The Company has engaged PFSI to provide these services on its behalf. The Company recognizes MSRs initially at their fair values, either as proceeds from sales of mortgage loans where the Company assumes the obligation to service the mortgage loan in the sale transaction, or from the purchase of MSRs. The precise fair value of MSRs is difficult to determine because MSRs are not actively traded in observable stand-alone markets. Considerable judgment is required to estimate the fair values of these assets and the exercise of such judgment can significantly affect the Company’s earnings. Therefore, the Company categorizes its MSRs as “Level 3” fair value assets. The fair value of MSRs is derived from the net positive cash flows associated with the servicing contracts. The Company receives a servicing fee of generally The Company accounts for MSRs at either the asset’s fair value with changes in fair value recorded in current period earnings or using the amortization method with the MSRs carried at the lower of amortized cost or fair value based on the class of MSR. The Company has identified two classes of MSRs: originated MSRs backed by mortgage loans with initial interest rates of less than or equal to 4.5%; and originated MSRs backed by mortgage loans with initial interest rates of more than 4.5%. Originated MSRs backed by mortgage loans with initial interest rates of less than or equal to 4.5% are accounted for using the amortization method. Originated MSRs backed by loans with initial interest rates of more than 4.5% are accounted for at fair value with changes in fair value recorded in current period income. MSRs Accounted for Using the MSR Amortization Method The Company amortizes MSRs that are accounted for using the MSR amortization method. MSR amortization is determined by applying the ratio of the net MSR cash flows projected for the current period to the projected total remaining net MSR cash flows. The estimated total net MSR cash flows are estimated at the beginning of each month using prepayment inputs applicable at that time. F-12 The Company assesses MSRs accounted for using the amortization method for impairment monthly. Impairment occurs when the current fair value of the MSR falls below the asset’s amortized cost. If MSRs are impaired, the impairment is recognized in current-period The Company stratifies its MSRs by risk characteristic when evaluating for impairment. For purposes of performing its MSR impairment evaluation, the Company stratifies its servicing portfolio on the basis of certain risk characteristics including mortgage loan type (fixed-rate or adjustable-rate) and note interest rate. Fixed-rate mortgage loans are stratified into note interest rate pools of 50 basis points for note interest rates between 3.0% and 4.5% and a single pool for note interest rates below 3%. Adjustable rate mortgage loans with initial interest rates of 4.5% or less are evaluated in a single pool. If the fair value of MSRs in any of the note interest rate pools is below the The Manager periodically reviews the various impairment strata to determine whether the fair value of the impaired MSRs in a given stratum is likely to recover in the foreseeable future. When the Manager deems recovery of the fair value to be unlikely in the foreseeable future, a write-down of the cost of the MSRs for that stratum to its estimated recoverable value is charged to the valuation allowance. Amortization and impairment of MSRs are included in current period income as a component ofNet mortgage loan servicing fees. MSRs Accounted for at Fair Value Changes in fair value of MSRs accounted for at fair value are recognized in current period income as a component ofNet mortgage loan servicing fees. Servicing Advances Servicing advances represent advances made on behalf of borrowers and the mortgage loans’ investors to fund delinquent balances for property tax and insurance premiums and out of pocket Borrowings Borrowings, other than Asset-backed financing of a VIE at Fair Value The certificates issued to nonaffiliates by the Company relating to the asset-backed financing are recorded as borrowings. Certificates issued to nonaffiliates have the right to receive principal and interest payments of the mortgage loans held by the consolidated VIE. Asset-backed financings of the VIE are carried at fair value. Changes in fair value are recognized in current period income as a component ofNet gain on investments. The Company categorizes asset-backed financing of the VIE at fair value as a “Level 2” fair value Liability for Losses Under The Company provides for its estimate of the losses that it expects to incur in the future as a result of its breach of the representations and warranties that it provides to the purchasers and insurers of the mortgage loans it has sold. The Company’s agreements with the Agencies and other investors include representations and warranties related to the mortgage loans the Company sells to the Agencies and other investors. The representations and warranties require adherence to Agency and other investor origination and underwriting guidelines, including but not limited to the validity of the lien securing the mortgage loan, property eligibility, borrower credit, income and asset requirements, and compliance with applicable federal, state and local law. F-13 In the event of a breach of its representations and warranties, the Company may be required to either repurchase the mortgage loans with the identified defects or indemnify the investor or insurer. In such cases, the Company bears any subsequent credit loss on the mortgage loans. The Company’s credit loss may be reduced by any recourse it has to correspondent lenders that, in turn, had sold such mortgage loans to the Company and breached similar or other representations and warranties. In such event, the Company has the right to seek a recovery of related repurchase losses from that correspondent lender. The Company records a provision for losses relating to representations and warranties as part of its mortgage loan sale transactions. The method used to estimate the liability for representations and warranties is a function of the representations and warranties given and considers a combination of factors, including, but not limited to, estimated future defaults and mortgage loan repurchase rates, the estimated severity of loss in the event of default and the probability of reimbursement by the correspondent mortgage loan seller. The Company establishes a liability at the time mortgage loans are sold and periodically updates its liability estimate. The level of the liability for representations and warranties is reviewed and approved by the Manager’s management credit committee. The level of the liability for representations and warranties is difficult to estimate and requires considerable management judgment. The level of mortgage loan repurchase losses is dependent on economic factors, investor demand strategies, and other external conditions that may change over the lives of the underlying mortgage loans. The Company’s representations and warranties are generally not subject to stated limits of exposure. However, the Manager believes that the current unpaid principal balance of mortgage loans sold by the Company to date represents the maximum exposure to repurchases related to representations and warranties. The Manager believes the range of reasonably possible losses in relation to the recorded liability is not material to the Company’s financial condition or Underwriting Commissions and Offering Costs Underwriting commissions and offering costs incurred in connection with the Company’s share offerings are reflected as a reduction of additional paid-in capital. Contingent offering costs that are deemed by the Manager as probable of being paid are recorded as a reduction of additional paid-in capital. Mortgage Loan Servicing Fees Mortgage loan servicing fees and other remuneration are received by the Company for servicing mortgage loans. Mortgage loan servicing fees are recorded net of Agency guarantee fees paid by the Company. Mortgage loan servicing fees are recognized as earned over the life of the loans in the servicing portfolio. Mortgage loan servicing fees are deemed to be earned when they are collected. Share-Based Compensation The Company amortizes the fair value of previously granted share-based awards to compensation expense over the vesting period using the graded vesting method. Expense relating to share-based awards is included inCompensation expense on the consolidated statements of income. The initial cost of restricted share units awarded is established at the Company’s closing share price on the date of the award. The Company adjusts the cost of its share-based compensation awards depending on whether the awards are made to its trustees and officers or to non-employees such as officers and employees of affiliates: Compensation cost for share-based compensation awarded to employees of the Manager is adjusted to reflect changes in the fair value of awards, including changes in the Company’s share price for both restricted share units and performance share units and, in the case of performance share units, for changes in expected performance attainment in each subsequent reporting period until the award has vested or expired, the service being provided is subsequently completed, or, under certain circumstances, is likely to be completed, whichever occurs first. The Manager’s estimates of compensation costs reflect the expected portion of share-based compensation awards that are expected to vest. F-14 The Company has elected to be taxed as a REIT and the Manager believes the Company complies with the provisions of the Internal Revenue Code applicable to REITs. Accordingly, the Manager believes the Company will not be subject to federal income tax on that portion of its REIT taxable income that is distributed to shareholders as long as certain asset, income and share ownership tests are met. If PMT fails to qualify as a REIT, and does not qualify for certain statutory relief provisions, it will be subject to income taxes and may be precluded from qualifying as a REIT for the four tax years following the year of loss of the Company’s REIT qualification. The Company’s taxable REIT A valuation allowance is established if, in the Manager’s As of December 31,
Note 4—Transactions with Related Parties Operating Activities Correspondent Production Activities
Effective as of September 12, 2016, the applicable fulfillment fee percentages are (i) 0.35% for mortgage loans sold or delivered to Fannie Mae or Freddie Mac, and (ii) 0.85% for all other mortgage loans; provided however, that no fulfillment fee shall be due or payable to PLS with respect to any Ginnie Mae mortgage loans. The Company does not hold the Ginnie Mae approval required to issue securities guaranteed by Ginnie Mae MBS and act as a servicer. Accordingly, under the mortgage banking
In consideration for the mortgage banking services provided by The mortgage
F-15 Following is a summary of correspondent production activity between the Company and PLS:
Mortgage Loan Servicing Activities The Company, through its Operating Partnership, has a mortgage loan servicing agreement with PLS.
The servicing agreement was amended and restated as of September 12, 2016; however, the fee structure was not amended in any material respect. The base servicing fees for distressed mortgage loans are calculated based on a monthly per-loan dollar amount, with the actual dollar amount for each mortgage loan based on the delinquency, bankruptcy and/or foreclosure status of such mortgage loan or the related underlying real estate. Presently, the base servicing fees for distressed mortgage loans range from $30 per month for current mortgage loans up to
The base servicing fee rate for REO is $75 per month. To the extent that the Company rents its REO under an REO rental program, the Company pays PLS an REO rental fee of $30 per month per REO, an REO property lease renewal fee of $100 per lease renewal, and a property management fee in an amount equal to PLS’ cost if property management services and/or any related software costs are outsourced to a third-party property management firm or 9% of gross rental income if PLS provides property management services directly. PLS is also entitled to retain any tenant paid application fees and late rent fees and seek reimbursement for certain third party vendor fees. The base servicing fees for non-distressed mortgage loans subserviced by PLS on the Company’s behalf are also calculated through a monthly per-loan dollar amount, with the actual dollar amount for each loan based on whether the mortgage loan is a fixed-rate or adjustable-rate loan. The base servicing fees for loans subserviced on the Company’s behalf are $7.50 per month for fixed-rate loans and $8.50 per month for adjustable rate mortgage loans. To the extent that these non-distressed mortgage loans become delinquent, PLS is entitled to an additional servicing fee per mortgage loan ranging from $10 to
F-16
PLS, on behalf of the Company, currently participates in the Home Affordable Modification Program (“HAMP”) of the U.S. Department of the Treasury and U.S. Department of Housing and Urban Development (“HUD”) (and other similar mortgage loan modification programs). HAMP establishes standard loan modification guidelines for “at risk” homeowners and provides incentive payments to certain participants, including loan servicers, for achieving modifications and successfully remaining in the program. The loan servicing agreement entitles PLS to retain any incentive payments made to it and to which it is entitled under HAMP; provided, however, that with respect to any such incentive payments paid to PLS under HAMP in connection with a mortgage loan modification for which the Company previously paid PLS a modification fee, PLS shall reimburse the Company an amount equal to the incentive payments. The term of the servicing agreement, as amended, expires on Pursuant to the terms of an MSR recapture agreement, Following is a summary of mortgage loan servicing fees earned by PLS and MSR recapture income earned from PLS:
F-17
A base management fee
A performance incentive fee that is calculated at a defined annualized percentage of the amount by which “net income,” on a rolling four-quarter basis and before deducting the incentive fee, exceeds certain levels of return on “equity.” The performance incentive fee is calculated quarterly and is equal to: (a) 10% of the amount by which net income for the quarter exceeds (i) an 8% return on equity plus the high watermark, up to (ii) a 12% return on equity; plus (b) 15% of the amount by which net income for the quarter exceeds (i) a 12% return on equity plus the high watermark, up to (ii) a 16% return on equity; plus (c) 20% of the amount by which net income for the quarter exceeds a 16% return on equity plus the high watermark. For the purpose of determining the amount of the performance incentive fee: “Net income” is defined as net income or loss computed in accordance with GAAP and certain other non-cash charges determined after discussions between PCM and PMT’s independent trustees and after approval by a majority of PMT’s independent trustees. “Equity” is the weighted average of the issue price per common share of all of PMT’s public offerings, multiplied by the weighted average number of common shares outstanding (including restricted share units) in the 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 Fannie Mae MBS yield (the target yield) for such quarter. The “high watermark” starts at zero and is adjusted quarterly. 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 PCM 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 payable 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 the Company’s option. The management agreement was amended and restated as of September 12, 2016; however, the fee structure was not amended in any material respect. Following is a summary of the base management and performance incentive fees payable to PCM recorded by the Company:
In the event of termination of the management agreement between the Company and PFSI, PFSI 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 PFSI, in each case during the 24-month period before termination. Expense Reimbursement and Amounts Payable to and Receivable from PFSI F-18 Under the management agreement, PCM is entitled to reimbursement of its organizational and operating expenses, including third-party expenses, incurred on the Company’s behalf, it being understood that PCM 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 the Company. With respect to the allocation of PCM’s and its affiliates personnel, from and after September 12, 2016, PCM shall be reimbursed $120,000 per fiscal quarter, such amount to be reviewed annually and to not preclude reimbursement for any other services performed by PCM or its affiliates. The Company The Company reimbursed PCM and its affiliates for
The MSR recapture agreement was amended and restated as of September 12, 2016; however, the fee structure was not amended in any material respect. The MSR recapture agreement expires, unless terminated earlier in accordance with the agreement, on September 12, 2020, subject to automatic renewal for additional 18-month periods. Amounts
Investing Activities On February 29, 2016, the Company and PLS terminated that certain master spread acquisition and MSR servicing agreement that the parties entered into effective February 1, 2013 (the “2/1/13 Spread Acquisition Agreement”) and all amendments thereto. In connection with the termination of the 2/1/13 Spread Acquisition Agreement, PLS reacquired from the Company all of its right, title and interest in and to all of the Fannie Mae ESS previously sold by PLS to the Company under the 2/1/13 Spread Acquisition Agreement and then subject to such 2/1/13 Spread Acquisition Agreement. On February 29, 2016, PLS also reacquired from the Company all of its right, title and interest in and to all of the Freddie Mac ESS previously sold to the Company by PLS. The amount of ESS sold by the Company to PLS under these reacquisitions was $59.0 million. F-19 Following is a summary of investing activities between the Company and PFSI:
Financing Activities PFSI held 75,000 of the Company’s common shares at both December 31, 2016 and December 31, 2015. Repurchase Agreement with PLS On December 19, 2016, the Company, through a wholly-owned subsidiary, PennyMac Holdings, LLC (“PMH”), entered into a master repurchase agreement with PLS (the “PMH Repurchase Agreement”), pursuant to which PMH may borrow from PLS 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 Private National Mortgage Acceptance Company, LLC, 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 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) may, from time to time pursuant to the terms of any supplemental indenture, issue to institutional investors additional term notes (“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. The principal amount paid by PLS for the participation certificates under the PMH Repurchase Agreement is based upon a percentage of the market value of the underlying ESS. Upon PMH’s repurchase of the participation certificates, PMH is required to repay PLS 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 VFN and any outstanding Term Notes) to the date of such repurchase. PLS is then required to repay the Issuer Trust the corresponding amount under the PC Repurchase Agreement. Note Payable to PLS Before entering into the PMH Repurchase Agreement, PLS was a party to a repurchase agreement between it and Credit Suisse First Boston Mortgage Capital LLC (“CSFB”) (the “MSR Repo”), pursuant to which PLS financed Ginnie Mae MSRs and servicing advance receivables and pledged all of its rights and interests in any Ginnie Mae MSRs it owned to CSFB, and a separate acknowledgement agreement with respect thereto, by and among Ginnie Mae, CSFB and PLS. In connection with the MSR Repo, the Company was party to an underlying loan and security agreement with PLS, pursuant to which the Company was able to borrow up to $150 million from PLS for the purpose of financing its investment in ESS (the “Underlying LSA”). The principal amount of the borrowings under the Underlying LSA was based upon a percentage of the market value of the ESS pledged to PLS, subject to the $150 million sublimit described above. Pursuant to the Underlying LSA, the Company granted to PLS a security interest in all of its right, title and interest in, to and under the ESS pledged to secure the borrowings, and PLS, in turn, re-pledged such ESS to CSFB under the MSR Repo. Interest accrued on the Company’s note relating to the Underlying LSA at a rate based on CSFB’s cost of funds under the MSR Repo. The underlying LSA was terminated in connection with the execution of the PMH Agreement. F-20 In connection with its initial public offering of common shares on August 4, 2009 (“IPO”), the Company conditionally agreed to reimburse PCM up to $2.9 million for underwriting fees paid to the IPO underwriters by PCM on the Company’s behalf (the “Conditional Reimbursement”). Also in connection with its IPO, the Company agreed to pay the IPO underwriters up to $5.9 million in contingent underwriting fees. Following is a summary of financing activities between the Company and PFSI:
Note 5—Earnings Per Share The Company grants restricted share units which entitle the recipients to receive dividend equivalents during the vesting period on a basis equivalent to the dividends paid to holders of common shares. Unvested share-based compensation awards containing non-forfeitable rights to receive dividends or dividend equivalents (collectively, “dividends”) are classified as “participating securities” and are included in the basic earnings per share calculation using the two-class method. Under the two-class method, all earnings (distributed and undistributed) are allocated to common shares and participating securities, based on their respective rights to receive dividends. Basic earnings per share is determined by dividing net income, reduced by income attributable to the participating securities, by the weighted-average common shares outstanding during the period. Diluted earnings per share is determined by dividing net income attributable to diluted shareholders, which adds back to net income the interest expense, net of applicable income taxes, on the Company’s exchangeable senior notes (the “Exchangeable Notes”), by the weighted-average common shares outstanding, assuming all dilutive securities were issued. In periods in which the Company records a loss, potentially dilutive securities are excluded from the diluted loss per share calculation, as their effect on loss per share is anti-dilutive. The following table summarizes the basic and diluted earnings per share calculations:
F-21 Dividends and undistributed earnings allocated to participating securities under the basic and diluted earnings per share calculations require specific potentially dilutive shares to be included or excluded that may differ in certain circumstances. The following table summarizes the potentially dilutive shares excluded from the diluted earnings per share calculation for the periods as inclusion of such shares would have been antidilutive:
Note 6—Loan Sales and Variable Interest Entities The Company is a variable interest holder in various special purpose entities that relate to its mortgage loan transfer and financing activities. These entities are classified as VIEs for accounting purposes. The Company has segregated its involvement with VIEs between those VIEs which the Company does not consolidate and those VIEs which the Company consolidates. Unconsolidated VIEs with Continuing Involvement The following table summarizes cash flows between the Company and transferees in transfers of mortgage loans that are accounted for as sales where the Company maintains continuing involvement with the mortgage loans, as well as UPB information at period end:
F-22 Credit Risk Transfer Agreements Following is a summary of the CRT Agreements:
Jumbo Mortgage Loan Financing On September 30, 2013, the Company completed a securitization transaction in which PMT Loan Trust 2013-J1, a VIE, issued $537.0 million in UPB of certificates backed by fixed-rate prime jumbo mortgage loans, at a 3.9% weighted yield. The Company initially retained $366.8 million in fair value of such certificates. During the years ended December 31, 2015 and December 31, 2016, the Company sold $111.0 million and $208.8 million in UPB of those certificates, respectively, which reduced the fair value of the certificates retained by the Company to $8.9 million as of December 31, 2016. Note 7—Netting of Financial Instruments The Company uses derivative financial instruments to manage exposure to interest rate risk created by its MBS, interest rate lock commitments (“IRLCs”), mortgage loans acquired for sale at fair value, mortgage loans at fair value held in a VIE, ESS and MSRs. All derivative financial instruments are recorded on the consolidated balance sheets at fair value. The Company has elected to net derivative asset and liability positions, and cash collateral obtained from (or posted to) its counterparties when subject to a legally enforceable master netting arrangement. The derivative financial instruments that are not subject to master netting arrangements are IRLCs and the derivatives related to CRT Agreements. As of December 31, 2016 and December 31, 2015, the Company did not enter into reverse repurchase agreements or securities lending transactions that are required to be disclosed in the following tables. F-23 Offsetting of Derivative Assets Following is a summary of net derivative assets.
Derivative Assets and Collateral Held by Counterparty The following table summarizes by significant counterparty the amount of derivative asset positions after considering master netting arrangements and financial instruments or cash pledged that do not meet the accounting guidance qualifying for setoff accounting.
F-24 Offsetting of Derivative Liabilities and Financial Liabilities Following is a summary of net derivative liabilities and assets sold under agreements to repurchase. Assets sold under agreements to repurchase do not qualify for setoff accounting.
F-25 Derivative Liabilities, Financial Liabilities and Collateral Pledged by Counterparty The following table summarizes by significant counterparty the amount of derivative liabilities and assets sold under agreements to repurchase after considering master netting arrangements and financial instruments or cash pledged that do not meet the accounting guidance qualifying for setoff accounting. All assets sold under agreements to repurchase represent sufficient collateral or exceed the liability amount recorded on the consolidated balance sheet.
Note 8—Fair Value The Company’s consolidated financial statements include assets and liabilities that are measured based on their fair values. Measurement at fair value may be on a recurring or nonrecurring basis depending on the accounting principles applicable to the specific asset or liability and whether the Manager has elected to carry the item at its fair value as discussed in the following paragraphs. Fair Value Accounting Elections The Manager identified all of the Company’s non-cash financial assets and MSRs relating to non-commercial real estate secured mortgage loans with initial interest rates of more than 4.5%, to be accounted for at fair value. The Manager has elected to account for these assets at fair value so such changes in fair value will be reflected in income as they occur and more timely reflect the results of the Company’s performance. The Manager has also identified the Company’s CRT financing and asset-backed financing of a VIE to be accounted for at fair value to reflect the generally offsetting changes in fair value of these borrowings to changes in fair value of mortgage loans at fair value collateralizing these financings. For other borrowings, the Manager has determined that historical cost accounting is more appropriate because under this method debt issuance costs are amortized over the term of the debt, thereby matching the debt issuance cost to the periods benefiting from the availability of the debt. F-26 Financial Statement Items Measured at Fair Value on a Recurring Basis Following is a summary of financial statement items that are measured at fair value on a recurring basis:
F-27
F-28 The following is a summary of changes in items measured using Level 3 inputs on a recurring basis:
F-29
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(2) | During the year ended December 31, 2015, the Manager identified certain “Level 2” fair value mortgage loans that were not salable into the prime mortgage market and therefore transferred them to “Level 3”. |
F-30
| Year ended December 31, 2014 |
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| Mortgage |
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| loans under |
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| Mortgage |
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| forward |
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| Excess |
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| Interest |
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| Mortgage |
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| loans |
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| purchase |
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| servicing |
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| rate lock |
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| servicing |
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| at fair value |
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| agreements |
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| spread |
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| commitments (1) |
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| rights |
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| Total |
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| (in thousands) |
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Balance, December 31, 2013 |
| $ | 2,076,665 |
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| $ | 218,128 |
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| $ | 138,723 |
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| $ | 1,249 |
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| $ | 26,452 |
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| $ | 2,461,217 |
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Purchases and issuances |
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| 554,604 |
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| 1,386 |
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| 99,728 |
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|
| — |
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|
| — |
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|
| 655,718 |
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Repayments and sales |
|
| (572,586 | ) |
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| (6,413 | ) |
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| (39,257 | ) |
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| — |
|
|
| (139 | ) |
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| (618,395 | ) |
Capitalization of interest |
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| 65,050 |
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| 1,800 |
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| 13,292 |
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| — |
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| — |
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| 80,142 |
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ESS received pursuant to a recapture agreement with PFSI |
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| — |
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| — |
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| 7,342 |
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| — |
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| — |
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| 7,342 |
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Interest rate lock commitments issued, net |
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| — |
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| — |
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| — |
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| 56,367 |
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| — |
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| 56,367 |
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Sales |
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| — |
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| — |
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Servicing received as proceeds from sales of mortgage loans |
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| — |
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| — |
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| — |
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| — |
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| 47,693 |
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| 47,693 |
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Changes in fair value included in income arising from: |
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|
|
|
|
|
|
|
|
Changes in instrument-specific credit risk |
|
| 34,785 |
|
|
| 1,815 |
|
|
| — |
|
|
|
|
|
|
| — |
|
|
| 36,600 |
|
Other factors |
|
| 179,896 |
|
|
| (1,012 | ) |
|
| (28,662 | ) |
|
| 17,326 |
|
|
| (16,648 | ) |
|
| 150,900 |
|
|
|
| 214,681 |
|
|
| 803 |
|
|
| (28,662 | ) |
|
| 17,326 |
|
|
| (16,648 | ) |
|
| 187,500 |
|
Transfers of mortgage loans under forward purchase agreements to mortgage loans |
|
| 205,902 |
|
|
| (205,902 | ) |
|
| — |
|
|
|
|
|
|
|
|
|
|
|
|
|
Transfers of mortgage loans to REO |
|
| (344,733 | ) |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| (344,733 | ) |
Transfers of mortgage loans under forward purchase agreements to REO under forward purchase agreements |
|
| — |
|
|
| (9,802 | ) |
|
| — |
|
|
| — |
|
|
| — |
|
|
| (9,802 | ) |
Transfers of interest rate lock commitments to mortgage loans acquired for sale |
|
| — |
|
|
| — |
|
|
| — |
|
|
| (69,281 | ) |
|
| — |
|
|
| (69,281 | ) |
Balance, December 31, 2014 |
| $ | 2,199,583 |
|
| $ | — |
|
| $ | 191,166 |
|
| $ | 5,661 |
|
| $ | 57,358 |
|
| $ | 2,453,768 |
|
Changes in fair value recognized during the period relating to assets still held at December 31, 2014 |
| $ | 134,724 |
|
| $ | — |
|
| $ | (28,662 | ) |
| $ | 5,661 |
|
| $ | (16,648 | ) |
| $ | 95,075 |
|
(1) | For the purpose of this table, the IRLC “Level 3” fair value asset and liability positions are shown net. |
The information used in the preceding roll forwards represents activity for financial statement items measured at fair value on a recurring basis and identified as using “Level 3” significant fair value inputs at either the beginning or the end of the periods presented. The Company had transfers among the fair value levels arising from transfers of IRLCs to mortgage loans held for sale at fair value upon purchase of the respective mortgage loans.
F-31
Following are the fair values and related principal amounts due upon maturity of mortgage loans accounted for under the fair value option (including mortgage loans acquired for sale, mortgage loans held in a consolidated VIE, and distressed mortgage loans at fair value):
|
| December 31, 2016 |
|
| December 31, 2015 |
| ||||||||||||||||||
|
| Fair value |
|
| Principal amount due upon maturity |
|
| Difference |
|
| Fair value |
|
| Principal amount due upon maturity |
|
| Difference |
| ||||||
|
| (in thousands) |
| |||||||||||||||||||||
Mortgage loans acquired for sale at fair value: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current through 89 days delinquent |
| $ | 1,672,181 |
|
| $ | 1,633,569 |
|
| $ | 38,612 |
|
| $ | 1,283,275 |
|
| $ | 1,235,433 |
|
| $ | 47,842 |
|
90 or more days delinquent |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Not in foreclosure |
|
| 145 |
|
|
| 189 |
|
|
| (44 | ) |
|
| 304 |
|
|
| 333 |
|
|
| (29 | ) |
In foreclosure |
|
| 786 |
|
|
| 717 |
|
|
| 69 |
|
|
| 216 |
|
|
| 253 |
|
|
| (37 | ) |
|
|
| 931 |
|
|
| 906 |
|
|
| 25 |
|
|
| 520 |
|
|
| 586 |
|
|
| (66 | ) |
|
| $ | 1,673,112 |
|
| $ | 1,634,475 |
|
| $ | 38,637 |
|
| $ | 1,283,795 |
|
| $ | 1,236,019 |
|
| $ | 47,776 |
|
Mortgage loans at fair value: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mortgage loans held in a consolidated VIE: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current through 89 days delinquent |
| $ | 367,169 |
|
| $ | 368,524 |
|
| $ | (1,355 | ) |
| $ | 455,394 |
|
| $ | 454,935 |
|
| $ | 459 |
|
90 or more days delinquent |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Not in foreclosure |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
In foreclosure |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
|
| 367,169 |
|
|
| 368,524 |
|
|
| (1,355 | ) |
|
| 455,394 |
|
|
| 454,935 |
|
|
| 459 |
|
Distressed mortgage loans at fair value: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Current through 89 days delinquent |
|
| 611,584 |
|
|
| 818,665 |
|
|
| (207,081 | ) |
|
| 877,438 |
|
|
| 1,134,560 |
|
|
| (257,122 | ) |
90 or more days delinquent |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Not in foreclosure |
|
| 305,431 |
|
|
| 425,460 |
|
|
| (120,029 | ) |
|
| 459,060 |
|
|
| 640,343 |
|
|
| (181,283 | ) |
In foreclosure |
|
| 437,557 |
|
|
| 595,534 |
|
|
| (157,977 | ) |
|
| 763,896 |
|
|
| 1,062,205 |
|
|
| (298,309 | ) |
|
|
| 742,988 |
|
|
| 1,020,994 |
|
|
| (278,006 | ) |
|
| 1,222,956 |
|
|
| 1,702,548 |
|
|
| (479,592 | ) |
|
|
| 1,354,572 |
|
|
| 1,839,659 |
|
|
| (485,087 | ) |
|
| 2,100,394 |
|
|
| 2,837,108 |
|
|
| (736,714 | ) |
|
| $ | 1,721,741 |
|
| $ | 2,208,183 |
|
| $ | (486,442 | ) |
| $ | 2,555,788 |
|
| $ | 3,292,043 |
|
| $ | (736,255 | ) |
Following are the changes in fair value included in current period income by consolidated statement of income line item for financial statement items accounted for under the fair value option:
|
| Year ended December 31, 2016 |
| |||||||||||||||||
|
| Net gain on |
|
|
|
|
|
| Net |
|
|
|
|
|
|
|
|
| ||
|
| mortgage |
|
|
|
|
|
| mortgage |
|
|
|
|
|
|
|
|
| ||
|
| loans |
|
| Net |
|
| loan |
|
| Net gain |
|
|
|
|
| ||||
|
| acquired |
|
| interest |
|
| servicing |
|
| on |
|
|
|
|
| ||||
|
| for sale |
|
| income |
|
| fees |
|
| investments |
|
| Total |
| |||||
|
| (in thousands) |
| |||||||||||||||||
Assets: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Short-term investments |
| $ | — |
|
| $ | — |
|
| $ | — |
|
| $ | — |
|
| $ | — |
|
Mortgage-backed securities at fair value |
|
| — |
|
|
| (2,391 | ) |
|
| — |
|
|
| (13,168 | ) |
|
| (15,559 | ) |
Mortgage loans acquired for sale at fair value |
|
| 55,350 |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| 55,350 |
|
Mortgage loans at fair value |
|
| — |
|
|
| 1,294 |
|
|
| — |
|
|
| (5,252 | ) |
|
| (3,958 | ) |
ESS at fair value |
|
| — |
|
|
| — |
|
|
| — |
|
|
| (23,923 | ) |
|
| (23,923 | ) |
MSRs at fair value |
|
| — |
|
|
| — |
|
|
| (12,524 | ) |
|
| — |
|
|
| (12,524 | ) |
|
| $ | 55,350 |
|
| $ | (1,097 | ) |
| $ | (12,524 | ) |
| $ | (42,343 | ) |
| $ | (614 | ) |
Liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Asset-backed financing of a VIE at fair value |
| $ | — |
|
| $ | (669 | ) |
| $ | — |
|
| $ | 3,238 |
|
| $ | 2,569 |
|
|
| $ | — |
|
| $ | (669 | ) |
| $ | — |
|
| $ | 3,238 |
|
| $ | 2,569 |
|
F-32
| Year ended December 31, 2015 |
| ||||||||||||||||||
|
| Net gain on |
|
|
|
|
|
| Net |
|
|
|
|
|
|
|
|
| ||
|
| mortgage |
|
|
|
|
|
| mortgage |
|
|
|
|
|
|
|
|
| ||
|
| loans |
|
| Net |
|
| loan |
|
| Net gain |
|
|
|
|
| ||||
|
| acquired |
|
| interest |
|
| servicing |
|
| on |
|
|
|
|
| ||||
|
| for sale |
|
| income |
|
| fees |
|
| investments |
|
| Total |
| |||||
|
| (in thousands) |
| |||||||||||||||||
Assets: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Short-term investments |
| $ | — |
|
| $ | — |
|
| $ | — |
|
| $ | — |
|
| $ | — |
|
Mortgage-backed securities at fair value |
|
| — |
|
|
| (35 | ) |
|
| — |
|
|
| (5,224 | ) |
|
| (5,259 | ) |
Mortgage loans acquired for sale at fair value |
|
| 71,880 |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| 71,880 |
|
Mortgage loans at fair value |
|
| — |
|
|
| 1,253 |
|
|
| — |
|
|
| 70,470 |
|
|
| 71,723 |
|
ESS at fair value |
|
| — |
|
|
| — |
|
|
| — |
|
|
| 3,239 |
|
|
| 3,239 |
|
MSRs at fair value |
|
| — |
|
|
| — |
|
|
| (7,072 | ) |
|
| — |
|
|
| (7,072 | ) |
|
| $ | 71,880 |
|
| $ | 1,218 |
|
| $ | (7,072 | ) |
| $ | 68,485 |
|
| $ | 134,511 |
|
Liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Asset-backed financing of a VIE at fair value |
| $ | — |
|
| $ | (499 | ) |
| $ | — |
|
| $ | 4,260 |
|
| $ | 3,761 |
|
|
| $ | — |
|
| $ | (499 | ) |
| $ | — |
|
| $ | 4,260 |
|
| $ | 3,761 |
|
|
| Year ended December 31, 2014 |
| |||||||||||||||||
|
| Net gain on |
|
|
|
|
|
| Net |
|
|
|
|
|
|
|
|
| ||
|
| mortgage |
|
|
|
|
|
| mortgage |
|
|
|
|
|
|
|
|
| ||
|
| loans |
|
| Net |
|
| loan |
|
| Net gain |
|
|
|
|
| ||||
|
| acquired |
|
| interest |
|
| servicing |
|
| on |
|
|
|
|
| ||||
|
| for sale |
|
| income |
|
| fees |
|
| investments |
|
| Total |
| |||||
|
| (in thousands) |
| |||||||||||||||||
Assets: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Short-term investments |
| $ | — |
|
| $ | — |
|
| $ | — |
|
| $ | — |
|
| $ | — |
|
Mortgage-backed securities at fair value |
|
| — |
|
|
| 357 |
|
|
| — |
|
|
| 10,416 |
|
|
| 10,773 |
|
Mortgage loans acquired for sale at fair value |
|
| 100,213 |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| 100,213 |
|
Mortgage loans at fair value |
|
| — |
|
|
| 1,848 |
|
|
| — |
|
|
| 242,449 |
|
|
| 244,297 |
|
Mortgage loans under forward purchase agreements at fair value |
|
|
|
|
|
|
|
|
|
|
|
|
|
| 803 |
|
|
| 803 |
|
ESS at fair value |
|
| — |
|
|
| — |
|
|
| — |
|
|
| (20,834 | ) |
|
| (20,834 | ) |
MSRs at fair value |
|
| — |
|
|
| — |
|
|
| (16,648 | ) |
|
| — |
|
|
| (16,648 | ) |
|
| $ | 100,213 |
|
| $ | 2,205 |
|
| $ | (16,648 | ) |
| $ | 232,834 |
|
| $ | 318,604 |
|
Liabilities: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Asset-backed financing of a VIE at fair value |
| $ | — |
|
| $ | (617 | ) |
| $ | — |
|
| $ | (8,459 | ) |
| $ | (9,076 | ) |
|
| $ | — |
|
| $ | (617 | ) |
| $ | — |
|
| $ | (8,459 | ) |
| $ | (9,076 | ) |
Financial Statement Items Measured at Fair Value on a Nonrecurring Basis
Following is a summary of financial statement items that were re-measured at fair value on a nonrecurring basis during the periods presented:
|
| December 31, 2016 |
| |||||||||||||
|
| Level 1 |
|
| Level 2 |
|
| Level 3 |
|
| Total |
| ||||
|
| (in thousands) |
| |||||||||||||
Real estate acquired in settlement of loans |
| $ | — |
|
| $ | — |
|
| $ | 125,683 |
|
| $ | 125,683 |
|
MSRs at lower of amortized cost or fair value |
|
| — |
|
|
| — |
|
|
| 173,765 |
|
|
| 173,765 |
|
|
| $ | — |
|
| $ | — |
|
| $ | 299,448 |
|
| $ | 299,448 |
|
|
| December 31, 2015 |
| |||||||||||||
|
| Level 1 |
|
| Level 2 |
|
| Level 3 |
|
| Total |
| ||||
|
| (in thousands) |
| |||||||||||||
Real estate acquired in settlement of loans |
| $ | — |
|
| $ | — |
|
| $ | 173,662 |
|
| $ | 173,662 |
|
MSRs at lower of amortized cost or fair value |
|
| — |
|
|
| — |
|
|
| 145,187 |
|
|
| 145,187 |
|
|
| $ | — |
|
| $ | — |
|
| $ | 318,849 |
|
| $ | 318,849 |
|
F-33
The following table summarizes the fair value changes recognized during the period on assets held at period end that were measured at fair value on a nonrecurring basis:
|
| Year ended December 31, |
| |||||||||
|
| 2016 |
|
| 2015 |
|
| 2014 |
| |||
|
| (in thousands) |
| |||||||||
Real estate asset acquired in settlement of loans |
| $ | (17,561 | ) |
| $ | (24,546 | ) |
| $ | (24,896 | ) |
MSRs at lower of amortized cost or fair value |
|
| (2,728 | ) |
|
| (3,229 | ) |
|
| (5,138 | ) |
|
| $ | (20,289 | ) |
| $ | (27,775 | ) |
| $ | (30,034 | ) |
Real Estate Acquired in Settlement of Loans
The Company evaluates its REO for impairment with reference to the respective properties’ fair values less cost to sell on a nonrecurring basis. The initial carrying value of the REO is measured at cost as indicated by the purchase price in the case of purchased REO or as measured by the fair value of the mortgage loan immediately before REO acquisition in the case of acquisition in settlement of a loan. REO may be subsequently revalued due to the Company receiving greater access to the property, the property being held for an extended period or receiving indications that the property’s value may not be supported by developing market conditions. Any subsequent change in fair value to a level that is less than or equal to the property’s cost is recognized in Results of real estate acquired in settlement of loans in the Company’s consolidated statements of income.
Mortgage Servicing Rights at Lower of Amortized Cost or Fair Value
The Company evaluates its MSRs at lower of amortized cost or fair value for impairment with reference to the asset’s fair value. For purposes of performing its MSR impairment evaluation, the Company stratifies its MSRs at lower of amortized cost or fair value based on the interest rates borne by the mortgage loans underlying the MSRs. Mortgage loans are grouped into pools with 50 basis point interest rate ranges for fixed-rate mortgage loans with interest rates between 3.0% and 4.5% and a single pool for mortgage loans with interest rates below 3.0%. MSRs relating to adjustable rate mortgage loans with initial interest rates of 4.5% or less are evaluated in a single pool. If the fair value of MSRs in any of the interest rate pools is below the amortized cost of the MSRs, those MSRs are impaired.
When MSRs are impaired, the impairment is recognized in current-period income and the carrying value of the MSRs is adjusted using a valuation allowance. If the fair value of the MSRs subsequently increases, the increase in fair value is recognized in current period income only to the extent of the valuation allowance for the respective impairment stratum.
The Manager periodically reviews the various impairment strata to determine whether the fair value of the impaired MSRs in a given stratum is likely to recover. When the Manager deems recovery of fair value to be unlikely in the foreseeable future, a write-down of the cost of the MSRs for that stratum to its estimated recoverable value is charged to the valuation allowance.
Fair Value of Financial Instruments Carried at Amortized Cost
The Company’s Cash as well as certain of its borrowings are carried at amortized cost. Cash is measured using a “Level 1” fair value input. The Company’s Assets sold under agreements to repurchase, Mortgage loan participation and sale agreements, Notes payable, Exchangeable senior notes and Federal Home Loan Bank advances are classified as “Level 3” fair value liabilities due to the Company’s reliance on unobservable inputs to estimate these instruments’ fair values.
The Manager has concluded that the fair values of Cash, Assets sold under agreements to repurchase, Mortgage loan participation and sale agreements, Notes payable and Federal Home Loan Bank advances approximate the agreements’ carrying values due to the immediate realizability of Cash at its carrying amount and to the borrowing agreements’ short terms and variable interest rates. The fair value of the Exchangeable senior notes at December 31, 2016 and December 31, 2015 was $240.7 million and $230.0 million, respectively. The fair value of the Exchangeable senior notes is estimated using a broker indication of value.
Valuation Techniques and Inputs
Most of the Company’s assets, and the Asset-backed financing of a VIE, the Interest-only security payable and Derivative liabilities are carried at fair value with changes in fair value recognized in current period income. A substantial portion of these items are “Level 3” fair value assets and liabilities which require the 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.
F-34
Due to the difficulty in estimating the fair values of “Level 3” fair value assets and liabilities, the Manager has assigned responsibility for estimating fair value of these items to specialized staff and subjects the valuation process to significant executive management oversight. The Manager’s Financial Analysis and Valuation group (the “FAV group”) is responsible for estimating the fair values of “Level 3” fair value assets and liabilities other than IRLCs and maintaining its valuation policies and procedures.
With respect to the Company’s non-IRLC “Level 3” fair value assets and liabilities, the FAV group reports to PCM’s valuation committee, which oversees and approves the valuations. The FAV group monitors the models used for valuation of the Company’s non-IRLC “Level 3” fair value assets and liabilities, including the models’ performance versus actual results, and reports those results to PCM’s valuation committee. During 2016, PCM’s valuation committee included PFSI’s chief executive, financial, risk, business development and asset/liability management officers.
The FAV group is responsible for reporting to PCM’s valuation committee on a monthly basis 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 fair value of the Company’s IRLCs is developed by the Manager’s Capital Markets Risk Management staff and is reviewed by the Manager’s Capital Markets Operations group.
The 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:
Mortgage-Backed Securities
The Company categorizes its current holdings of MBS as “Level 2” fair value assets. Fair value of MBS is established based on quoted market prices. Changes in the fair value of MBS are included in Net gain (loss) on investments in the consolidated statements of income.
Mortgage Loans
Fair value of mortgage loans is estimated based on whether the mortgage loans are saleable into active markets:
Mortgage loans that are saleable into active markets, comprised of the Company’s mortgage loans acquired for sale at fair value and mortgage loans at fair value held in a VIE, are categorized as “Level 2” fair value assets. The fair values of mortgage loans acquired for sale at fair value are established using their quoted market or contracted price or market price equivalent. For the mortgage loans at fair value held in a VIE, the quoted fair values of all of the individual securities issued by the securitization trust are used to derive a fair value for the mortgage loans. The Company obtains indications of fair value from nonaffiliated brokers based on comparable securities and validates the brokers’ indications of fair value using pricing models and inputs the Manager believes are similar to the models and inputs used by other market participants.
Mortgage loans that are not saleable into active markets, comprised of distressed mortgage loans, are categorized as “Level 3” fair value assets and their fair values are estimated using a discounted cash flow approach. Inputs to the discounted cash flow model include current interest rates, loan amount, payment status, property type, discount rates and forecasts of future interest rates, home prices, prepayment speeds, default speeds, loss severities and contracted selling price where applicable.
The valuation process includes the computation by stratum of the mortgage loans’ fair values and a review for reasonableness of various measures such as weighted average life, projected prepayment and default speeds, and projected default and loss percentages. The FAV group computes the effect on the valuation of changes in inputs such as interest rates, home prices, and delinquency status to assess the reasonableness of changes in the mortgage loan valuation.
Changes in fair value attributable to changes in instrument-specific credit risk are measured by the effect on fair value of the change in the respective mortgage loan’s delinquency status and performance history at year-end from the later of the beginning of the year or acquisition date.
F-35
The significant unobservable inputs used in the fair value measurement of the Company’s mortgage loans at fair value are discount rate, home price projections, voluntary prepayment speeds and default speeds. Significant changes in any of those inputs in isolation could result in a significant change to the mortgage loans’ fair value measurement. Increases in home price projections are generally accompanied by an increase in voluntary prepayment speeds. Changes in the fair value of mortgage loans at fair value are included in Net gain (loss) on investments in the consolidated statements of income.
Following is a quantitative summary of key inputs used in the valuation of mortgage loans at fair value:
Key inputs |
| December 31, 2016 |
|
| December 31, 2015 |
| ||
Discount rate |
|
|
|
|
|
|
|
|
Range |
| 2.6% – 15.0% |
|
| 2.5% – 15.0% |
| ||
Weighted average |
|
| 7.1% |
|
|
| 7.1% |
|
Twelve-month projected housing price index change |
|
|
|
|
|
|
|
|
Range |
| 2.5% – 4.8% |
|
| 1.5% – 5.1% |
| ||
Weighted average |
|
| 3.7% |
|
|
| 3.6% |
|
Prepayment speed (1) |
|
|
|
|
|
|
|
|
Range |
| 0.1% – 10.9% |
|
| 0.1% – 9.6% |
| ||
Weighted average |
|
| 4.0% |
|
|
| 3.7% |
|
Total prepayment speed (2) |
|
|
|
|
|
|
|
|
Range |
| 2.9% – 24.6% |
|
| 0.5% – 27.2% |
| ||
Weighted average |
|
| 17.7% |
|
|
| 19.6% |
|
(1) | Prepayment speed is measured using Life Voluntary Conditional Prepayment Rate (“CPR”). |
(2) | Total prepayment speed is measured using Life Total CPR. |
Excess Servicing Spread Purchased from PFSI
The Company categorizes ESS as a “Level 3” fair value asset. The Company uses a discounted cash flow approach to estimate the fair value of ESS. The key inputs used in the estimation of the fair value of ESS include prepayment speed and discount rate. Significant changes to those inputs in isolation may result in a significant change in the ESS fair value measurement. Changes in these key inputs are not necessarily directly related.
ESS is generally subject to loss in fair value when interest rates decrease. Decreasing mortgage market interest rates normally encourage increased mortgage refinancing activity. Increased refinancing activity reduces the expected life of the mortgage loans underlying the ESS, thereby reducing the cash flows expected to accrue to ESS. Reductions in the fair value of ESS affect income primarily through change in fair value. Changes in the fair value of ESS are included in Net gain (loss) on investments in the consolidated statements of income.
Following are the key inputs used in determining the fair value of ESS:
Key inputs |
| December 31, 2016 |
|
| December 31, 2015 |
| ||
UPB of underlying mortgage loans (in thousands) |
| $32,376,359 |
|
| $51,966,405 |
| ||
Average servicing fee rate (in basis points) |
|
| 34 |
|
|
| 32 |
|
Average ESS rate (in basis points) |
|
| 19 |
|
|
| 17 |
|
Pricing spread (1) |
|
|
|
|
|
|
|
|
Range |
| 3.8% - 4.8% |
|
| 4.8% - 6.5% |
| ||
Weighted average |
|
| 4.4% |
|
|
| 5.7% |
|
Life (in years) |
|
|
|
|
|
|
|
|
Range |
| 1.4 - 8.6 |
|
| 1.4 - 9.0 |
| ||
Weighted average |
| 6.8 |
|
|
| 6.9 |
| |
Annual total prepayment speed (2) |
|
|
|
|
|
|
|
|
Range |
| 7.0% - 41.3% |
|
| 5.2% - 52.4% |
| ||
Weighted average |
|
| 10.5% |
|
|
| 9.6% |
|
(1) | Pricing spread represents a margin that is applied to a reference interest rate’s forward rate curve to develop periodic discount rates. The Company |
(2) | Prepayment speed is measured using Life Total CPR. |
F-36
Derivative Financial Instruments
Interest Rate Lock Commitments
The Company categorizes IRLCs as “Level 3” fair value assets and 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 mortgage loan and the probability that the mortgage loans will be purchased under the commitment (the “pull-through rate”).
The significant unobservable inputs used in the fair value measurement of the Company’s IRLCs are the pull-through rate and the MSR component of the Company’s estimate of the fair value of the mortgage loans it has committed to purchase. Significant changes in the pull-through rate or the MSR component of the IRLCs, in isolation, may result in a significant change in fair value. 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 value, but increase the pull-through rate for mortgage loan principal and interest payment cash flows that have decreased in fair value. Changes in fair value of IRLCs are included in Net gain on mortgage loans acquired for sale in the consolidated statements of income.
Following is a quantitative summary of key unobservable inputs used in the valuation of IRLCs:
Key inputs |
| December 31, 2016 |
|
| December 31, 2015 |
| ||
Pull-through rate |
|
|
|
|
|
|
|
|
Range |
| 60.7% - 100.0% |
|
| 60.2% - 100.0% |
| ||
Weighted average |
|
| 88.5% |
|
|
| 92.4% |
|
MSR value expressed as: |
|
|
|
|
|
|
|
|
Servicing fee multiple |
|
|
|
|
|
|
|
|
Range |
| 2.6 - 6.0 |
|
| 2.1 - 6.2 |
| ||
Weighted average |
|
| 5.0 |
|
|
| 4.9 |
|
Percentage of UPB |
|
|
|
|
|
|
|
|
Range |
| 0.7% - 1.5% |
|
| 0.5% - 3.8% |
| ||
Weighted average |
|
| 1.3% |
|
|
| 1.2% |
|
Hedging Derivatives
The Company estimates the fair value of commitments to sell mortgage loans based on quoted MBS prices. These derivative financial instruments are categorized by the Company as “Level 1” fair value assets and liabilities for those based on exchange traded market prices or as “Level 2” fair value assets and liabilities for those based on observable interest rate volatilities in the MBS market. Changes in the fair value of hedging derivatives are included in Net gain on mortgage loans acquired for sale, Net mortgage loan servicing fees, Net gain on investments or, as applicable, in the consolidated statements of income.
Real Estate Acquired in Settlement of Loans
REO is measured based on its fair value on a nonrecurring basis and is categorized as a “Level 3” fair value asset. Fair value of REO is established by using a current estimate of fair value from a broker’s price opinion, a full appraisal, or the price given in a current contract of sale.
REO fair values are reviewed by the Manager’s staff appraisers when the Company obtains multiple indications of fair value and there is a significant difference between the fair values received. PCM’s staff appraisers will attempt to resolve the difference between the indications of fair value. In circumstances where the appraisers are not able to generate adequate data to support a fair value conclusion, the staff appraisers will order an additional appraisal to determine fair value. Changes in the fair value of REO are included in Results of real estate acquired in settlement of loans 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, prepayment and default rates of the underlying mortgage loans, and annual per-loan cost to service mortgage 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 necessarily directly related. Changes in the fair value of MSRs are included in Net mortgage loan servicing fees in the consolidated statements of income.
F-37
MSRs are generally subject to loss in fair value when mortgage interest rates decrease. Decreasing mortgage interest rates normally encourage increased mortgage refinancing activity. Increased refinancing activity reduces the expected life of the underlying mortgage loans, thereby reducing the cash flows expected to accrue to the MSRs. Reductions in the fair value of MSRs affect income primarily through change in fair value and change in impairment. For MSRs backed by mortgage loans with historically low interest rates, factors other than interest rates (such as housing price changes) take on increasing influence on prepayment behavior of the underlying mortgage loans.
Following are the key inputs used in determining the fair value of MSRs at the time of initial recognition:
|
| Year ended December 31, |
| |||||||||||||||||||||
|
| 2016 |
|
| 2015 |
|
| 2014 |
| |||||||||||||||
|
| Amortized cost |
|
| Fair value |
|
| Amortized cost |
|
| Fair value |
|
| Amortized cost |
|
| Fair value |
| ||||||
|
| (MSR recognized and UPB of underlying mortgage loan amounts in thousands) |
| |||||||||||||||||||||
MSR recognized |
| $ | 267,755 |
|
| $ | 7,337 |
|
| $ | 140,511 |
|
| $ | 13,963 |
|
| $ | 73,640 |
|
| $ | 47,693 |
|
Key inputs |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
UPB of underlying mortgage loans |
| $ | 22,068,577 |
|
| $ | 752,850 |
|
| $ | 12,195,574 |
|
| $ | 1,430,795 |
|
| $ | 6,800,637 |
|
| $ | 4,573,369 |
|
Weighted-average annual servicing fee rate (in basis points) |
| 25 |
|
| 26 |
|
| 25 |
|
| 25 |
|
| 25 |
|
| 25 |
| ||||||
Pricing spread (1) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Range |
| 7.2% – 12.6% |
|
| 7.2% – 7.6% |
|
| 6.5% –17.5% |
|
| 7.2% – 16.3% |
|
| 6.3% – 17.5% |
|
| 8.5% – 14.3% |
| ||||||
Weighted average |
|
| 7.5% |
|
|
| 7.3% |
|
|
| 7.9% |
|
|
| 8.5% |
|
|
| 8.6% |
|
|
| 9.1% |
|
Life (in years) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Range |
| 1.4 – 12.3 |
|
| 2.0 – 9.4 |
|
| 1.3 – 12.0 |
|
| 2.2 – 9.4 |
|
| 1.1 – 7.3 |
|
| 1.6 – 7.3 |
| ||||||
Weighted average |
|
| 8.0 |
|
| 5.9 |
|
|
| 6.9 |
|
|
| 6.4 |
|
|
| 6.4 |
|
|
| 7.1 |
| |
Annual total prepayment speed (2) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Range |
| 3.3% – 49.2% |
|
| 7.2% – 38.0% |
|
| 3.5% – 51.0% |
|
| 6.8% – 34.2% |
|
| 7.6% – 56.4% |
|
| 8.0% – 42.7% |
| ||||||
Weighted average |
|
| 8.3% |
|
|
| 14.5% |
|
|
| 9.0% |
|
|
| 12.3% |
|
|
| 9.6% |
|
|
| 9.7% |
|
Annual per-loan cost of servicing |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Range |
| $68 – $79 |
|
| $68 – $82 |
|
| $62 – $134 |
|
| $62 – $68 |
|
| $59 – $140 |
|
| $59 – $140 |
| ||||||
Weighted average |
| $77 |
|
| $73 |
|
| $64 |
|
| $65 |
|
| $69 |
|
| $68 |
|
(1) | The Company applies a pricing spread to the United States Dollar LIBOR curve for purposes of discounting cash flows relating to MSRs acquired as proceeds from the sale of mortgage loans. |
(2) | Prepayment speed is measured using Life Total CPR. |
F-38
Following is a quantitative summary of key inputs used in the valuation of MSRs as of the dates presented, and the effect on the fair value from adverse changes in those inputs:
|
| December 31, 2016 |
|
| December 31, 2015 |
| ||||||||||
|
| Amortized cost |
|
| Fair value |
|
| Amortized cost |
|
| Fair value |
| ||||
|
| (Carrying value, UPB of underlying mortgage loans and effect on fair value amounts in thousands) |
| |||||||||||||
Carrying value |
| $ | 592,431 |
|
| $ | 64,136 |
|
| $ | 393,157 |
|
| $ | 66,584 |
|
Key inputs: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
UPB of underlying mortgage loans |
| $ | 50,539,707 |
|
| $ | 5,763,957 |
|
| $ | 35,841,654 |
|
| $ | 6,458,684 |
|
Weighted-average annual servicing fee rate (in basis points) |
|
| 25 |
|
|
| 25 |
|
|
| 26 |
|
|
| 25 |
|
Weighted-average note interest rate |
|
| 3.8% |
|
|
| 4.7% |
|
|
| 3.9% |
|
|
| 4.7% |
|
Pricing spread (1) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Range |
| 7.6% – 13.0% |
|
| 7.6% – 12.6% |
|
| 7.2% – 10.7% |
|
| 7.2% – 10.2% |
| ||||
Weighted average |
|
| 7.6% |
|
|
| 7.6% |
|
|
| 7.3% |
|
|
| 7.2% |
|
Effect on fair value of (2): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5% adverse change |
| $(10,018) |
|
| $(979) |
|
| $(6,411) |
|
| $(944) |
| ||||
10% adverse change |
| $(19,738) |
|
| $(1,929) |
|
| $(12,635) |
|
| $(1,862) |
| ||||
20% adverse change |
| $(38,330) |
|
| $(3,748) |
|
| $(24,553) |
|
| $(3,621) |
| ||||
Weighted average life (in years) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Range |
| 3.1 - 8.5 |
|
| 3.2 - 7.0 |
|
| 1.3 - 7.7 |
|
| 2.5 - 6.1 |
| ||||
Weighted average |
|
| 8.0 |
|
|
| 7.0 |
|
|
| 7.2 |
|
|
| 6.1 |
|
Prepayment speed (3) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Range |
| 6.7% – 25.7% |
|
| 6.8% – 24.2% |
|
| 8.1% – 51.5% |
|
| 9.2% – 32.5% |
| ||||
Weighted average |
|
| 7.7% |
|
|
| 10.7% |
|
|
| 9.6% |
|
|
| 13.2% |
|
Effect on fair value of (2): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5% adverse change |
| $(9,436) |
|
| $(1,379) |
|
| $(8,159) |
|
| $(1,793) |
| ||||
10% adverse change |
| $(18,578) |
|
| $(2,704) |
|
| $(16,024) |
|
| $(3,502) |
| ||||
20% adverse change |
| $(36,037) |
|
| $(5,202) |
|
| $(30,938) |
|
| $(6,692) |
| ||||
Annual per-loan cost of servicing |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Range |
| $78 – $79 |
|
| $77 – $79 |
|
| $68 – $68 |
|
| $68 – $68 |
| ||||
Weighted average |
| $79 |
|
| $79 |
|
| $68 |
|
| $68 |
| ||||
Effect on fair value of (2): |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5% adverse change |
| $(4,650) |
|
| $(555) |
|
| $(2,742) |
|
| $(470) |
| ||||
10% adverse change |
| $(9,300) |
|
| $(1,110) |
|
| $(5,484) |
|
| $(940) |
| ||||
20% adverse change |
| $(18,600) |
|
| $(2,220) |
|
| $(10,968) |
|
| $(1,880) |
|
(1) | The Company applies a pricing spread to the United States Dollar LIBOR curve for purposes of discounting cash flows relating to MSRs. |
(2) | For MSRs carried at fair value, an |
(3) | Prepayment speed is measured using Life Total CPR. |
The preceding sensitivity analyses are limited in that they were performed at a particular point in time; only account for the estimated effect of the movements in the indicated inputs; do not incorporate changes in the inputs in relation to other inputs; are subject to the accuracy of various 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 the Manager to account for changing circumstances. For these reasons, the preceding estimates should not be viewed as earnings forecasts.
Securities Sold Under Agreements to Repurchase
Fair value of securities sold under agreements to repurchase is based on the accrued cost of the agreements, which approximates the fair values of the agreements, due to the short maturities of such agreements.
F-39
The Company’s short-term investments are comprised of deposit accounts with U.S. commercial banks.
Note 10—Mortgage Loans Acquired for Sale at Fair Value
Mortgage loans acquired for sale at fair value is comprised of recently originated mortgage loans purchased by the Company for resale. Following is a summary of the distribution of the Company’s mortgage loans acquired for sale at fair value:
Mortgage loan type |
| December 31, 2016 |
|
| December 31, 2015 |
| ||
|
| (in thousands) |
| |||||
Conventional: |
|
|
|
|
|
|
|
|
Agency-eligible |
| $ | 847,810 |
|
| $ | 540,947 |
|
Jumbo |
|
| 6,042 |
|
|
| 54,613 |
|
Held for sale to PLS — Government insured or guaranteed |
|
| 804,616 |
|
|
| 669,288 |
|
Commercial real estate |
|
| 8,961 |
|
|
| 14,590 |
|
Repurchased pursuant to representations and warranties |
|
| 5,683 |
|
|
| 4,357 |
|
|
| $ | 1,673,112 |
|
| $ | 1,283,795 |
|
Mortgage loans pledged to secure: |
|
|
|
|
|
|
|
|
Assets sold under agreements to repurchase |
| $ | 1,627,010 |
|
| $ | 1,204,462 |
|
Mortgage loan participation and sale agreements |
|
| 26,738 |
|
|
| — |
|
Federal Home Loan Bank (“FHLB”) advances |
|
| — |
|
|
| 63,993 |
|
|
| $ | 1,653,748 |
|
| $ | 1,268,455 |
|
The Company is not approved by Ginnie Mae as an issuer of Ginnie Mae-guaranteed securities which are backed by government-insured or guaranteed mortgage loans. The Company transfers government-insured or guaranteed mortgage loans that it purchases from correspondent lenders to PLS, which is a Ginnie Mae-approved issuer, and earns a sourcing fee ranging from two to three and one-half basis points, generally based on the average number of calendar days that mortgage loans are held prior to purchase by PLS.
Note 11—Derivative Financial Instruments
The Company’s activities involving derivative financial instruments are summarized below:
The Company generates IRLCs in the normal course of business when it commits to purchase mortgage loans acquired for sale.
The Company enters into CRT Agreements whereby it retains a portion of the credit risk relating to certain mortgage loans it sells into Fannie Mae guaranteed securitizations and an IO ownership interest in such mortgage loans. The fair values of the Recourse Obligations and the Company’s retention of the IO ownership interest are accounted for as a derivative financial instrument.
The Company engages in interest rate risk management activities in an effort to reduce the variability of earnings caused by the effects of changes in interest rates on the fair value of certain of its assets and liabilities. To manage the price risk resulting from interest rate risk, the Company uses derivative financial instruments acquired with the intention of moderating the risk that changes in market interest rates will result in unfavorable changes in the fair value of the Company’s MBS, inventory of mortgage loans acquired for sale, mortgage loans held by VIE, ESS, IRLCs and MSRs.
The Company records all derivative financial instruments at fair value and records changes in fair value in current period income.
The Company is exposed to price risk relative to the IRLCs it issues to correspondent sellers and to the mortgage loans it purchases as a result of issuing the IRLCs. The Company bears price risk from the time an IRLC is issued to a correspondent seller to the time the purchased mortgage loan is sold. The Company is exposed to loss if market mortgage interest rates increase, because market interest rate increases generally cause the fair value of the purchase commitment or mortgage loan acquired for sale to decrease.
F-40
The Company had the following derivative assets and liabilities recorded within Derivative assets and Derivative liabilities and related margin deposits recorded in Other assets on the consolidated balance sheets:
|
| December 31, 2016 |
|
| December 31, 2015 |
| ||||||||||||||||||
|
|
|
|
|
| Fair value |
|
|
|
|
|
| Fair value |
| ||||||||||
|
| Notional |
|
| Derivative |
|
| Derivative |
|
| Notional |
|
| Derivative |
|
| Derivative |
| ||||||
Instrument |
| amount |
|
| assets |
|
| liabilities |
|
| amount |
|
| assets |
|
| liabilities |
| ||||||
|
| (in thousands) |
| |||||||||||||||||||||
Derivatives not designated as hedging instruments: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Not subject to master netting arrangements: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest rate lock commitments |
|
| 1,420,468 |
|
| $ | 7,069 |
|
| $ | 3,292 |
|
|
| 970,067 |
|
| $ | 4,983 |
|
| $ | 337 |
|
CRT Agreements |
|
| 14,379,850 |
|
|
| 15,610 |
|
|
| — |
|
|
| 4,546,265 |
|
|
| 593 |
|
|
| — |
|
Subject to master netting arrangements: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Forward sale contracts |
|
| 6,148,242 |
|
|
| 13,164 |
|
|
| 17,974 |
|
|
| 2,450,642 |
|
|
| 2,604 |
|
|
| 2,680 |
|
Forward purchase contracts |
|
| 4,840,707 |
|
|
| 30,879 |
|
|
| 7,619 |
|
|
| 2,469,550 |
|
|
| 2,444 |
|
|
| 3,774 |
|
MBS put options |
|
| 925,000 |
|
|
| 1,697 |
|
|
| — |
|
|
| 375,000 |
|
|
| 93 |
|
|
| — |
|
MBS call options |
|
| 750,000 |
|
|
| 142 |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
Swap futures |
|
| 150,000 |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
Eurodollar future sales contracts |
|
| 1,351,000 |
|
|
| — |
|
|
| — |
|
|
| 1,755,000 |
|
|
| — |
|
|
| — |
|
Call options on interest rate futures |
|
| 200,000 |
|
|
| 63 |
|
|
| — |
|
|
| 50,000 |
|
|
| 1,156 |
|
|
| 305 |
|
Put options on interest rate futures |
|
| 550,000 |
|
|
| 2,469 |
|
|
| — |
|
|
| 1,600,000 |
|
|
| 1,512 |
|
|
| 39 |
|
Total derivative instruments before netting |
|
|
|
|
|
| 71,093 |
|
|
| 28,885 |
|
|
|
|
|
|
| 13,385 |
|
|
| 7,135 |
|
Netting |
|
|
|
|
|
| (37,384 | ) |
|
| (19,312 | ) |
|
|
|
|
|
| (3,300 | ) |
|
| (3,978 | ) |
|
|
|
|
|
| $ | 33,709 |
|
| $ | 9,573 |
|
|
|
|
|
| $ | 10,085 |
|
| $ | 3,157 |
|
Margin deposits (received from) placed with derivatives counterparties included in Other assets |
|
|
|
|
| $ | (18,071 | ) |
|
|
|
|
|
|
|
|
| $ | 679 |
|
|
|
|
|
The following tables summarize the notional amount activity for derivative contracts used to hedge the Company’s MBS, mortgage loans acquired for sale, mortgage loans at fair value held in a VIE, IRLCs and MSRs and for derivatives arising from CRT Agreements.
|
| Year ended December 31, 2016 |
| |||||||||||||
|
| Balance, |
|
|
|
|
|
|
|
|
|
| Balance, |
| ||
|
| beginning |
|
|
|
|
|
| Dispositions/ |
|
| end |
| |||
Instrument |
| of period |
|
| Additions |
|
| expirations |
|
| of period |
| ||||
| (in thousands) |
| ||||||||||||||
CRT Agreements |
|
| 4,546,265 |
|
|
| 11,190,933 |
|
|
| (1,357,348 | ) |
|
| 14,379,850 |
|
Forward sales contracts |
|
| 2,450,642 |
|
|
| 99,737,855 |
|
|
| (96,040,255 | ) |
|
| 6,148,242 |
|
Forward purchase contracts |
|
| 2,469,550 |
|
|
| 73,269,440 |
|
|
| (70,898,283 | ) |
|
| 4,840,707 |
|
MBS put options |
|
| 375,000 |
|
|
| 12,400,000 |
|
|
| (11,850,000 | ) |
|
| 925,000 |
|
MBS call options |
|
| — |
|
|
| 750,000 |
|
|
| — |
|
|
| 750,000 |
|
Swap futures |
|
| — |
|
|
| 175,000 |
|
|
| (25,000 | ) |
|
| 150,000 |
|
Eurodollar future sale contracts |
|
| 1,755,000 |
|
|
| 282,000 |
|
|
| (686,000 | ) |
|
| 1,351,000 |
|
Treasury future buy contracts |
|
| — |
|
|
| 558,700 |
|
|
| (558,700 | ) |
|
| — |
|
Treasury future sale contracts |
|
| — |
|
|
| 558,700 |
|
|
| (558,700 | ) |
|
| — |
|
Call options on interest rate futures |
|
| 50,000 |
|
|
| 4,425,000 |
|
|
| (4,275,000 | ) |
|
| 200,000 |
|
Put options on interest rate futures |
|
| 1,600,000 |
|
|
| 7,445,000 |
|
|
| (8,495,000 | ) |
|
| 550,000 |
|
F-41
| Year ended December 31, 2015 |
| ||||||||||||||
|
| Balance, |
|
|
|
|
|
|
|
|
|
| Balance, |
| ||
|
| beginning |
|
|
|
|
|
| Dispositions/ |
|
| end |
| |||
Instrument |
| of period |
|
| Additions |
|
| expirations |
|
| of period |
| ||||
|
| (in thousands) |
| |||||||||||||
CRT Agreements |
|
| — |
|
|
| 4,602,507 |
|
|
| (56,242 | ) |
|
| 4,546,265 |
|
Forward sales contracts |
|
| 1,601,283 |
|
|
| 51,449,971 |
|
|
| (50,600,612 | ) |
|
| 2,450,642 |
|
Forward purchase contracts |
|
| 1,100,700 |
|
|
| 37,757,703 |
|
|
| (36,388,853 | ) |
|
| 2,469,550 |
|
MBS put option |
|
| 340,000 |
|
|
| 2,177,500 |
|
|
| (2,142,500 | ) |
|
| 375,000 |
|
MBS call option |
|
| — |
|
|
| 140,000 |
|
|
| (140,000 | ) |
|
| — |
|
Eurodollar future sale contracts |
|
| 7,426,000 |
|
|
| 385,000 |
|
|
| (6,056,000 | ) |
|
| 1,755,000 |
|
Eurodollar future purchase contracts |
|
| 800,000 |
|
|
| — |
|
|
| (800,000 | ) |
|
| — |
|
Treasury future sale contracts |
|
| 85,000 |
|
|
| 161,500 |
|
|
| (246,500 | ) |
|
| — |
|
Call options on interest rate futures |
|
| 1,030,000 |
|
|
| 4,510,000 |
|
|
| (5,490,000 | ) |
|
| 50,000 |
|
Put options on interest rate futures |
|
| 275,000 |
|
|
| 5,743,000 |
|
|
| (4,418,000 | ) |
|
| 1,600,000 |
|
|
| Year ended December 31, 2014 |
| |||||||||||||
|
| Balance, |
|
|
|
|
|
|
|
|
|
| Balance, |
| ||
|
| beginning |
|
|
|
|
|
| Dispositions/ |
|
| end |
| |||
Instrument |
| of period |
|
| Additions |
|
| expirations |
|
| of period |
| ||||
|
| (in thousands) |
| |||||||||||||
Forward sales contracts |
|
| 3,588,027 |
|
|
| 45,904,253 |
|
|
| (47,890,997 | ) |
|
| 1,601,283 |
|
Forward purchase contracts |
|
| 2,781,066 |
|
|
| 33,418,838 |
|
|
| (35,099,204 | ) |
|
| 1,100,700 |
|
MBS put option |
|
| 55,000 |
|
|
| 2,087,500 |
|
|
| (1,802,500 | ) |
|
| 340,000 |
|
MBS call option |
|
| 110,000 |
|
|
| 230,000 |
|
|
| (340,000 | ) |
|
| — |
|
Eurodollar future sale contracts |
|
| 8,779,000 |
|
|
| 3,032,000 |
|
|
| (4,385,000 | ) |
|
| 7,426,000 |
|
Eurodollar future purchase contracts |
|
| — |
|
|
| 4,087,000 |
|
|
| (3,287,000 | ) |
|
| 800,000 |
|
Treasury future sale contracts |
|
| 105,000 |
|
|
| 482,600 |
|
|
| (502,600 | ) |
|
| 85,000 |
|
Treasury future purchase contracts |
|
| — |
|
|
| 439,200 |
|
|
| (439,200 | ) |
|
| — |
|
Call options on interest rate futures |
|
| — |
|
|
| 3,530,000 |
|
|
| (2,500,000 | ) |
|
| 1,030,000 |
|
Put options on interest rate futures |
|
| 52,500 |
|
|
| 1,687,500 |
|
|
| (1,465,000 | ) |
|
| 275,000 |
|
Following are the net gains (losses) recognized by the Company on derivative financial instruments and the consolidated statements of income line items where such gains and losses are included:
|
|
|
| Year ended December 31, |
| |||||||||
Derivative activity |
| Income statement line |
| 2016 |
|
| 2015 |
|
| 2014 |
| |||
|
|
|
| (in thousands) |
| |||||||||
CRT agreements |
| Net gain on investments |
| $ | 32,500 |
|
| $ | 593 |
|
| $ | — |
|
Interest rate lock commitments |
| Net gain on mortgage loans acquired for sale |
| $ | 87,836 |
|
| $ | 37,725 |
|
| $ | 73,693 |
|
Hedged item: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest rate lock commitments and mortgage loans acquired for sale |
| Net gain on mortgage loans acquired for sale |
| $ | 50,274 |
|
| $ | (16,781 | ) |
| $ | (68,679 | ) |
Mortgage servicing rights |
| Net loan servicing fees |
| $ | 2,271 |
|
| $ | 481 |
|
| $ | 11,527 |
|
Fixed-rate assets and LIBOR- indexed repurchase agreements |
| Net gain on investments |
| $ | 7,251 |
|
| $ | (19,353 | ) |
| $ | (22,565 | ) |
F-42
Note 12—Mortgage Loans at Fair Value
Mortgage loans at fair value are comprised of mortgage loans that are not acquired for sale and, to the extent they are not held in a VIE securing an asset-backed financing, may be sold at a later date pursuant to a management determination that such a sale represents the most advantageous liquidation strategy for the identified mortgage loan.
Following is a summary of the distribution of the Company’s mortgage loans at fair value:
|
| December 31, 2016 |
|
| December 31, 2015 |
| ||||||||||
Loan type |
| Fair value |
|
| Unpaid principal balance |
|
| Fair value |
|
| Unpaid principal balance |
| ||||
|
| (in thousands) |
| |||||||||||||
Distressed mortgage loans |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nonperforming mortgage loans |
| $ | 742,988 |
|
| $ | 1,020,994 |
|
| $ | 1,222,956 |
|
| $ | 1,702,548 |
|
Performing mortgage loans: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed interest rate |
|
| 296,901 |
|
|
| 408,943 |
|
|
| 417,658 |
|
|
| 535,610 |
|
Interest rate step-up |
|
| 232,700 |
|
|
| 317,409 |
|
|
| 299,569 |
|
|
| 412,749 |
|
Adjustable-rate/hybrid |
|
| 81,983 |
|
|
| 92,313 |
|
|
| 160,051 |
|
|
| 185,997 |
|
Balloon |
|
| — |
|
|
| — |
|
|
| 160 |
|
|
| 204 |
|
|
|
| 611,584 |
|
|
| 818,665 |
|
|
| 877,438 |
|
|
| 1,134,560 |
|
|
|
| 1,354,572 |
|
|
| 1,839,659 |
|
|
| 2,100,394 |
|
|
| 2,837,108 |
|
Fixed interest rate jumbo mortgage loans held in a VIE |
|
| 367,169 |
|
|
| 368,524 |
|
|
| 455,394 |
|
|
| 454,935 |
|
|
| $ | 1,721,741 |
|
| $ | 2,208,183 |
|
| $ | 2,555,788 |
|
| $ | 3,292,043 |
|
Mortgage loans at fair value pledged to secure: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets sold under agreements to repurchase |
| $ | 1,345,021 |
|
|
|
|
|
| $ | 2,067,341 |
|
|
|
|
|
Asset-backed financing of a VIE at fair value and FHLB advances |
| $ | 367,169 |
|
|
|
|
|
| $ | 455,394 |
|
|
|
|
|
FHLB advances |
| $ | — |
|
|
|
|
|
| $ | 134,172 |
|
|
|
|
|
Following is a summary of certain concentrations of credit risk in the portfolio of distressed mortgage loans at fair value:
Concentration |
| December 31, 2016 |
|
| December 31, 2015 |
| ||
|
| (percentages are of fair value) |
| |||||
Portion of mortgage loans originated between 2005 and 2007 |
|
| 72% |
|
|
| 72% |
|
Percentage of fair value of mortgage loans with unpaid-principal balance-to-current-property-value in excess of 100% |
|
| 41% |
|
|
| 48% |
|
States contributing 5% or more of mortgage loans |
| New York California New Jersey Florida Massachusetts |
|
| New York California New Jersey Florida |
|
F-43
Note 13—Real Estate Acquired in Settlement of Loans
Following is a summary of financial information relating to REO:
|
| Year ended December 31, |
| |||||||||
|
| 2016 |
|
| 2015 |
|
| 2014 |
| |||
| (in thousands) |
| ||||||||||
Balance at beginning of year |
| $ | 341,846 |
|
| $ | 303,228 |
|
| $ | 138,942 |
|
Purchases |
|
| — |
|
|
| — |
|
|
| 3,049 |
|
Transfers from mortgage loans at fair value and advances |
|
| 207,431 |
|
|
| 307,455 |
|
|
| 364,945 |
|
Transfer of real estate acquired in settlement of mortgage loans to real estate held for investment |
|
| (21,406 | ) |
|
| (8,827 | ) |
|
| — |
|
Transfers from REO under forward purchase agreements |
|
| — |
|
|
| — |
|
|
| 12,737 |
|
Results of REO: |
|
|
|
|
|
|
|
|
|
|
|
|
Valuation adjustments, net |
|
| (36,193 | ) |
|
| (40,432 | ) |
|
| (45,476 | ) |
Gain on sale, net |
|
| 17,075 |
|
|
| 21,255 |
|
|
| 13,498 |
|
|
|
| (19,118 | ) |
|
| (19,177 | ) |
|
| (31,978 | ) |
Proceeds from sales |
|
| (234,684 | ) |
|
| (240,833 | ) |
|
| (184,467 | ) |
Balance at end of year |
| $ | 274,069 |
|
| $ | 341,846 |
|
| $ | 303,228 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At the end of year: |
|
|
|
|
|
|
|
|
|
|
|
|
REO pledged to secure assets sold under agreements to repurchase |
| $ | 167,430 |
|
| $ | 245,647 |
|
|
|
|
|
REO held in a consolidated subsidiary whose stock is pledged to secure financings of such properties |
|
| 48,283 |
|
|
| 37,696 |
|
|
|
|
|
|
| $ | 215,713 |
|
| $ | 283,343 |
|
|
|
|
|
Note 14—Mortgage Servicing Rights
Carried at Fair Value:
Following is a summary of MSRs carried at fair value:
|
| Year ended December 31, |
| |||||||||
|
| 2016 |
|
| 2015 |
|
| 2014 |
| |||
| (in thousands) |
| ||||||||||
Balance at beginning of year |
| $ | 66,584 |
|
| $ | 57,358 |
|
| $ | 26,452 |
|
Purchases |
|
| 2,739 |
|
|
| 2,335 |
|
|
| — |
|
MSRs resulting from mortgage loan sales |
|
| 7,337 |
|
|
| 13,963 |
|
|
| 47,693 |
|
Changes in fair value: |
|
|
|
|
|
|
|
|
|
|
|
|
Due to changes in valuation inputs used in valuation model (1) |
|
| (3,210 | ) |
|
| 312 |
|
|
| (11,455 | ) |
Other changes in fair value (2) |
|
| (9,314 | ) |
|
| (7,384 | ) |
|
| (5,193 | ) |
|
|
| (12,524 | ) |
|
| (7,072 | ) |
|
| (16,648 | ) |
Sales |
|
| — |
|
|
| — |
|
|
| (139 | ) |
Balance at year end |
| $ | 64,136 |
|
| $ | 66,584 |
|
| $ | 57,358 |
|
MSRs carried at fair value pledged to secure notes payable at year end |
| $ | 64,136 |
|
| $ | 66,584 |
|
|
|
|
|
(1) | Principally reflects changes in pricing spread (discount rate) and prepayment speed inputs, primarily due to changes in market interest rates. |
(2) | Represents changes due to realization of expected cash flows. |
F-44
Carried at Lower of Amortized Cost or Fair Value:
Following is a summary of MSRs carried at lower of amortized cost or fair value:
|
| Year ended December 31, |
| |||||||||
|
| 2016 |
|
| 2015 |
|
| 2014 |
| |||
|
| (in thousands) |
| |||||||||
Amortized cost: |
|
|
|
|
|
|
|
|
|
|
|
|
Balance at beginning of year |
| $ | 404,101 |
|
| $ | 308,137 |
|
| $ | 266,697 |
|
MSRs resulting from mortgage loan sales |
|
| 267,755 |
|
|
| 140,511 |
|
|
| 73,640 |
|
Amortization |
|
| (65,647 | ) |
|
| (43,982 | ) |
|
| (31,911 | ) |
Sales |
|
| (106 | ) |
|
| (565 | ) |
|
| (289 | ) |
Balance at end of year |
|
| 606,103 |
|
|
| 404,101 |
|
|
| 308,137 |
|
Valuation allowance: |
|
|
|
|
|
|
|
|
|
|
|
|
Balance at beginning of year |
|
| (10,944 | ) |
|
| (7,715 | ) |
|
| (2,577 | ) |
Additions |
|
| (2,728 | ) |
|
| (3,229 | ) |
|
| (5,138 | ) |
Balance at end of year |
|
| (13,672 | ) |
|
| (10,944 | ) |
|
| (7,715 | ) |
MSRs, net |
| $ | 592,431 |
|
| $ | 393,157 |
|
| $ | 300,422 |
|
Fair value at beginning of year |
| $ | 424,154 |
|
| $ | 322,230 |
|
| $ | 289,737 |
|
Fair value at year end |
| $ | 626,334 |
|
| $ | 424,154 |
|
| $ | 322,230 |
|
MSRs carried at lower of cost or fair value pledged to secure notes payable at year end |
| $ | 592,431 |
|
| $ | 393,157 |
|
|
|
|
|
The following table summarizes the Company’s estimate of future amortization of its existing MSRs carried at amortized cost. This estimate was developed with the inputs used in the December 31, 2016 valuation of MSRs. The inputs underlying the following estimate will change as market conditions and portfolio composition and behavior change, causing both actual and projected amortization levels to change over time.
|
| Estimated MSR |
| |
Year ended December 31, |
| amortization |
| |
|
| (in thousands) |
| |
2017 |
| $ | 67,814 |
|
2018 |
|
| 63,283 |
|
2019 |
|
| 58,297 |
|
2020 |
|
| 53,184 |
|
2021 |
|
| 48,204 |
|
Thereafter |
|
| 315,321 |
|
Total |
| $ | 606,103 |
|
Servicing fees relating to MSRs are recorded in Net mortgage loan servicing fees on the Company’s consolidated statements of income and are summarized below:
|
| Year ended December 31, |
| |||||||||
|
| 2016 |
|
| 2015 |
|
| 2014 |
| |||
| (in thousands) |
| ||||||||||
Contractually-specified servicing fees |
| $ | 125,961 |
|
| $ | 97,633 |
|
| $ | 76,300 |
|
Ancillary and other fees: |
|
|
|
|
|
|
|
|
|
|
|
|
Late charges |
|
| 570 |
|
|
| 328 |
|
|
| — |
|
Other |
|
| 5,302 |
|
|
| 4,186 |
|
|
| 3,708 |
|
|
| $ | 131,833 |
|
| $ | 102,147 |
|
| $ | 80,008 |
|
F-45
Note 15—Assets Sold Under Agreements to Repurchase
Following is a summary of financial information relating to assets sold under agreements to repurchase:
|
| Year ended December 31, |
| |||||||||
|
| 2016 |
|
| 2015 |
|
| 2014 |
| |||
|
| (dollars in thousands) |
| |||||||||
Weighted-average interest rate (1) |
|
| 2.44 | % |
|
| 2.33 | % |
|
| 2.12 | % |
Average balance |
| $ | 3,382,528 |
|
| $ | 3,046,963 |
|
| $ | 2,311,273 |
|
Total interest expense |
| $ | 92,838 |
|
| $ | 79,869 |
|
| $ | 58,304 |
|
Maximum daily amount outstanding |
| $ | 5,573,021 |
|
| $ | 4,710,412 |
|
| $ | 3,203,989 |
|
|
| December 31, |
| |||||
|
| 2016 |
|
| 2015 |
| ||
|
| (dollars in thousands) |
| |||||
Carrying value: |
|
|
|
|
|
|
|
|
Unpaid principal balance |
| $ | 3,784,685 |
|
| $ | 3,130,328 |
|
Unamortized debt issuance costs |
|
| (684 | ) |
|
| (1,548 | ) |
|
| $ | 3,784,001 |
|
| $ | 3,128,780 |
|
Weighted-average interest rate |
|
| 2.70 | % |
|
| 2.33 | % |
Available borrowing capacity: |
|
|
|
|
|
|
|
|
Committed |
| $ | 518,932 |
|
| $ | 231,913 |
|
Uncommitted |
|
| 1,092,253 |
|
|
| 661,756 |
|
|
| $ | 1,611,185 |
|
| $ | 893,669 |
|
Margin deposits placed with counterparties included in Other assets |
| $ | 29,634 |
|
| $ | 7,268 |
|
Fair value of assets securing agreements to repurchase: |
|
|
|
|
|
|
|
|
Mortgage-backed securities |
| $ | 863,802 |
|
| $ | 313,753 |
|
Mortgage loans acquired for sale at fair value |
| $ | 1,627,010 |
|
| $ | 1,204,462 |
|
Mortgage loans at fair value |
| $ | 1,345,021 |
|
| $ | 2,067,341 |
|
Real estate acquired in settlement of loans |
| $ | 215,713 |
|
| $ | 283,343 |
|
CRT Agreements: |
|
|
|
|
|
|
|
|
Deposits securing CRT agreements |
| $ | 414,610 |
|
| $ | — |
|
Derivative assets |
| $ | 9,078 |
|
| $ | — |
|
(1) | Excludes the effect of amortization of debt issuance costs of $8.8 million |
Following is a summary of maturities of outstanding assets sold under agreements to repurchase by facility maturity date:
Remaining Maturity at December 31, 2016 |
| Unpaid principal balance |
| |
|
| (in thousands) |
| |
Within 30 days |
| $ | 1,185,874 |
|
Over 30 to 90 days |
|
| 1,874,899 |
|
Over 90 days to 180 days |
|
| — |
|
Over 180 days to 1 year |
|
| 506,120 |
|
Over 1 year to 2 years |
|
| 217,792 |
|
|
| $ | 3,784,685 |
|
Weighted average maturity (in months) |
|
| 3.7 |
|
The Company is subject to margin calls during the period the agreements are outstanding and therefore may be required to repay a portion of the borrowings before the respective agreements mature if the fair value (as determined by the applicable lender) of the assets securing those agreements decreases.
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) and maturity information relating to the Company’s assets sold under agreements to repurchase is summarized by counterparty below as of December 31, 2016:
F-46
Mortgage loans acquired for sale, Mortgage loans and REO sold under agreements to repurchase
|
|
|
|
|
| Weighted-average |
|
|
Counterparty |
| Amount at risk |
|
| repurchase agreement maturity |
| Facility maturity | |
|
| (in thousands) |
|
|
|
|
| |
Citibank, N.A. |
| $ | 249,493 |
|
| January 21, 2017 |
| March 3, 2017 |
JPMorgan Chase & Co. |
| $ | 116,225 |
|
| October 13, 2017 |
| October 13, 2017 |
JPMorgan Chase & Co. |
| $ | 1,854 |
|
| January 26, 2017 |
| January 26, 2017 |
Credit Suisse First Boston Mortgage Capital LLC |
| $ | 149,984 |
|
| March 21, 2017 |
| March 30, 2017 |
Bank of America, N.A. |
| $ | 23,156 |
|
| March 22, 2017 |
| March 29, 2017 |
Barclays Bank PLC |
| $ | 4,590 |
|
| March 21, 2017 |
| December 1, 2017 |
Morgan Stanley |
| $ | 6,622 |
|
| February 17, 2017 |
| August 25, 2017 |
Securities sold under agreements to repurchase
Counterparty |
| Amount at risk |
|
| Weighted average maturity | |
|
| (in thousands) |
|
|
| |
JPMorgan Chase & Co. |
| $ | 4,539 |
|
| January 20, 2017 |
Bank of America, N.A. |
| $ | 15,526 |
|
| January 17, 2017 |
Daiwa Capital Markets America Inc. |
| $ | 8,218 |
|
| January 14, 2017 |
Wells Fargo, N.A. |
| $ | 7,116 |
|
| January 9, 2017 |
Royal Bank of Canada |
| $ | 2,590 |
|
| January 19, 2017 |
CRT Agreements
Counterparty |
| Amount at risk |
|
| Weighted average maturity | |
|
| (in thousands) |
|
|
| |
JPMorgan Chase & Co. |
| $ | 72,670 |
|
| January 13, 2017 |
Bank of America, N.A. |
| $ | 33,731 |
|
| January 16, 2017 |
BNP Paribas Corporate & Institutional Banking |
| $ | 19,498 |
|
| January 13, 2017 |
Note 16—Mortgage Loan Participation and Sale Agreements
Two of the borrowing facilities secured by mortgage loans acquired for sale are in the form of mortgage loan participation and sale agreements. Participation certificates, each of which represents an undivided beneficial ownership interest in a pool of mortgage loans that have been pooled with Fannie Mae or Freddie Mac, are sold to a lender pending the securitization of such mortgage loans and the sale of the resulting security. A commitment between the Company and a nonaffiliate to sell such security 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 is not required to be paid to the Company until the settlement of the security and its delivery to the lender.
Mortgage loan participation and sale agreements are summarized below:
|
| Year ended December 31, |
| |||||||||
|
| 2016 |
|
| 2015 |
|
| 2014 |
| |||
|
| (dollars in thousands) |
| |||||||||
Weighted-average interest rate (1) |
|
| 1.74 | % |
|
| 1.62 | % |
|
| 1.42 | % |
Average balance |
| $ | 70,391 |
|
| $ | 49,318 |
|
| $ | 44,770 |
|
Total interest expense |
| $ | 1,376 |
|
| $ | 1,001 |
|
| $ | 912 |
|
Maximum daily amount outstanding |
| $ | 99,469 |
|
| $ | 148,032 |
|
| $ | 116,363 |
|
(1) | Excludes the effect of |
F-47
|
| December 31, |
| |||||
|
| 2016 |
|
| 2015 |
| ||
|
| (dollars in thousands) |
| |||||
Carrying value: |
|
|
|
|
|
|
|
|
Amount outstanding |
| $ | 25,917 |
|
| $ | — |
|
Unamortized debt issuance costs |
|
| — |
|
|
| — |
|
|
| $ | 25,917 |
|
| $ | — |
|
Weighted-average interest rate |
|
| 2.02 | % |
|
| — |
|
Mortgage loans acquired for sale pledged to secure mortgage loan participation and sale agreements |
| $ | 26,738 |
|
| $ | — |
|
Note 17—Notes Payable
On January 22, 2016, the Company, through PMC, entered into an Amended and Restated Loan and Security Agreement with Barclays Bank PLC (“Barclays”), pursuant to which PMC may finance certain of its MSRs relating to mortgage loans pooled into Fannie Mae MBS in an aggregate loan amount not to exceed $220 million. The note matures on December 1, 2017, subject to a wind down period of up to one year following such maturity date.
On September 15, 2016, the Company, through PMC, entered into an Amended and Restated Loan and Security Agreement with Citibank, N.A., pursuant to which PMC may finance certain of its MSRs relating to mortgage loans pooled into Freddie Mac MBS in an aggregate loan amount not to exceed $125 million. The note matures on March 31, 2017.
Following is a summary of financial information relating to the notes payable:
|
| Year ended December 31, |
| |||||
|
| 2016 |
|
| 2015 |
| ||
| (dollars in thousands) |
| ||||||
Weighted-average interest rate (1) |
|
| 4.73 | % |
|
| 4.31 | % |
Average balance |
| $ | 202,293 |
|
| $ | 119,307 |
|
Total interest expense |
| $ | 12,892 |
|
| $ | 6,826 |
|
Maximum daily amount outstanding |
| $ | 275,106 |
|
| $ | 236,107 |
|
(1) | Excludes the effect of amortization of debt issuance costs of $3.2 million for the year ended December 31, 2016, and $1.6 million for the year ended December 31, 2015. |
|
| Year ended December 31, |
| |||||
|
| 2016 |
|
| 2015 |
| ||
|
| (dollars in thousands) |
| |||||
Carrying value: |
|
|
|
|
|
|
|
|
Amount outstanding |
| $ | 275,106 |
|
| $ | 236,107 |
|
Unamortized debt issuance costs |
|
| — |
|
|
| (92 | ) |
|
| $ | 275,106 |
|
| $ | 236,015 |
|
Weighted-average interest rate |
|
| 4.73 | % |
|
| 4.53 | % |
MSRs pledged to secure notes payable |
| $ | 656,567 |
|
| $ | 459,741 |
|
Note 18—Exchangeable Senior Notes
PMC issued in a private offering $250 million aggregate principal amount of Exchangeable Notes due May 1, 2020. The Exchangeable Notes bear interest at a rate of 5.375% per year, payable semiannually. The Exchangeable Notes are exchangeable into common shares of the Company at a rate of 33.8667 common shares per $1,000 principal amount of the Exchangeable Notes as of December 31, 2016, which is an increase over the initial exchange rate of 33.5149. The increase in the calculated exchange rate was the result of quarterly cash dividends exceeding the quarterly dividend threshold amount of $0.57 per share in prior reporting periods, as provided in the related indenture.
F-48
Following is financial information relating to the Exchangeable Notes:
|
| Year ended December 31, |
| |||||||||
|
| 2016 |
|
| 2015 |
|
| 2014 |
| |||
| (in thousands) |
| ||||||||||
Weighted-average UPB |
| $ | 250,000 |
|
| $ | 250,000 |
|
| $ | 250,000 |
|
Interest expense (1) |
| $ | 14,473 |
|
| $ | 14,413 |
|
| $ | 14,358 |
|
(1) | Total interest expense includes amortization of debt issuance costs of $1.0 million, $975,000, and $920,000 for the years ended December 31, 2016, 2015 and 2014, respectively. |
|
| December 31, |
| |||||
|
| 2016 |
|
| 2015 |
| ||
|
| (in thousands) |
| |||||
Carrying value: |
|
|
|
|
|
|
|
|
UPB |
| $ | 250,000 |
|
| $ | 250,000 |
|
Unamortized debt issuance costs |
|
| (3,911 | ) |
|
| (4,946 | ) |
|
| $ | 246,089 |
|
| $ | 245,054 |
|
Note 19—Asset-Backed Financing of a Variable Interest Entity at Fair Value
Following is a summary of financial information relating to the asset-backed financing of a VIE:
|
| Year ended December 31, |
| |||||||||
|
| 2016 |
|
| 2015 |
|
| 2014 |
| |||
| (dollars in thousands) |
| ||||||||||
Weighted-average fair value |
| $ | 338,582 |
|
| $ | 186,430 |
|
| $ | 167,752 |
|
Interest expense |
| $ | 12,091 |
|
| $ | 6,840 |
|
| $ | 6,490 |
|
Weighted-average effective interest rate |
|
| 3.32 | % |
|
| 3.35 | % |
|
| 3.82 | % |
|
| December 31, |
| |||||
|
| 2016 |
|
| 2015 |
| ||
|
| (dollars in thousands) |
| |||||
Carrying value |
| $ | 353,898 |
|
| $ | 247,690 |
|
UPB |
| $ | 355,494 |
|
| $ | 248,284 |
|
Weighted-average interest rate |
|
| 3.50 | % |
|
| 3.50 | % |
The asset-backed financing of a VIE is a non-recourse liability and secured solely by the assets of a consolidated VIE and not by any other assets of the Company. The assets of the VIE are the only source of funds for repayment of the asset-backed financing.
Note 20—Federal Home Loan Bank Advances
On January 12, 2016, the Federal Housing Finance Agency (“FHFA”) issued a final rule establishing new requirements for membership in the Federal Home Loan Banks. The final rule excludes captive insurance companies such as the Company’s insurance subsidiary, Copper Insurance, LLC, from membership.
For captive insurance companies that became members since the rule was proposed in 2014, including Copper Insurance, LLC, membership must be terminated within one year, and no additional advances may be made. Accordingly, the Company has repaid all of the advances outstanding as of December 31, 2016.
The FHLB advances are summarized below:
|
| Year ended December 31, |
| |||||
|
| 2016 |
|
| 2015 |
| ||
| (dollars in thousands) |
| ||||||
Weighted-average interest rate |
|
| 0.49 | % |
|
| 0.30 | % |
Average balance |
| $ | 24,375 |
|
| $ | 89,512 |
|
Total interest expense |
| $ | 122 |
|
| $ | 275 |
|
Maximum daily amount outstanding |
| $ | 201,130 |
|
| $ | 196,100 |
|
F-49
|
| December 31, |
| |||||
|
| 2016 |
|
| 2015 |
| ||
|
| (dollars in thousands) |
| |||||
Carrying value |
| $ | — |
|
| $ | 183,000 |
|
Weighted-average interest rate |
|
| — |
|
|
| 0.30 | % |
Fair value of assets securing FHLB advances: |
|
|
|
|
|
|
|
|
Mortgage-backed securities |
| $ | — |
|
| $ | 8,720 |
|
Mortgage loans acquired for sale at fair value |
| $ | — |
|
| $ | 63,993 |
|
Mortgage loans at fair value |
| $ | — |
|
| $ | 134,172 |
|
Note 21—Liability for Losses Under Representations and Warranties
Following is a summary of the Company’s liability for losses under representations and warranties:
|
| Year ended December 31, |
| |||||||||
|
| 2016 |
|
| 2015 |
|
| 2014 |
| |||
| (in thousands) |
| ||||||||||
Balance, beginning of period |
| $ | 20,171 |
|
| $ | 14,242 |
|
| $ | 10,110 |
|
Provision for losses |
|
|
|
|
|
|
|
|
|
|
|
|
Pursuant to mortgage loan sales |
|
| 3,254 |
|
|
| 5,771 |
|
|
| 4,255 |
|
Reduction in liability due to change in estimate |
|
| (7,564 | ) |
|
| — |
|
|
| — |
|
Losses incurred |
|
| (511 | ) |
|
| (176 | ) |
|
| (123 | ) |
Recoveries |
|
| — |
|
|
| 334 |
|
|
| — |
|
Balance, end of period |
| $ | 15,350 |
|
| $ | 20,171 |
|
| $ | 14,242 |
|
UPB of mortgage loans subject to representations and warranties at period end |
| $ | 56,114,162 |
|
| $ | 41,842,601 |
|
| $ | 34,673,414 |
|
Note 22—Commitments and Contingencies
Litigation
From time to time, the Company may be involved in various proceedings, claims and legal actions arising in the ordinary course of business. As of December 31, 2016, the Company was not involved in any such proceedings, claims or legal actions that in management’s view would reasonably be likely to have a material adverse effect on the Company.
Commitments
The following table summarizes the Company’s outstanding contractual commitments:
|
| December 31, 2016 |
| |
|
| (in thousands) |
| |
Commitments to purchase mortgage loans acquired for sale |
| $ | 1,420,468 |
|
Commitments to fund Deposits securing credit risk transfer agreements (1) |
| $ | 92,109 |
|
(1) | Certain deposits of cash collateral on CRT Agreements are made upon the first to |
F-50
Common Share Repurchases
During August 2015, the Company’s board of trustees authorized a common share repurchase program under which the Company may repurchase up to $150 million of its outstanding common shares. During February 2016, the Company’s board of trustees approved an increase to its share repurchase program pursuant to which the Company is now authorized to repurchase up to $200 million of its common shares.
The following table summarizes the Company’s share repurchase activity:
|
| Year ended December 31, |
|
| Cumulative |
| ||||||
|
| 2016 |
|
| 2015 |
|
| Total (1) |
| |||
|
| (in thousands) |
| |||||||||
Common shares repurchased |
|
| 7,368 |
|
|
| 1,045 |
|
|
| 8,413 |
|
Cost of common shares repurchased |
| $ | 98,370 |
|
| $ | 16,338 |
|
| $ | 114,708 |
|
(1) | Amounts represent the share repurchase program total through December 31, 2016. |
The repurchased common shares were canceled upon settlement of the repurchase transactions and returned to the authorized but unissued common share pool.
Common Share Issuances
The Company has entered into an ATM Equity Offering Sales AgreementSM. Unless terminated earlier, the agreement automatically terminates upon issuance and sale of all common shares under the agreement. During the year ended December 31, 2016, the Company did not sell any common shares under the agreement. At December 31, 2016, the Company had approximately $85.3 million of common shares available for issuance under the agreement.
As more fully described in Note 4—Transactions with Related Parties, on February 1, 2013, the Company entered into a Reimbursement Agreement, by and among the Company, the Operating Partnership and PCM. The Reimbursement Agreement provides that, to the extent the Company is required to pay PCM performance incentive fees under the management agreement, the Company will reimburse PCM for underwriting costs it paid on the IPO offering date at a rate of $10 in reimbursement for every $100 of performance incentive fees earned. The reimbursement is subject to a maximum reimbursement in any particular 12-month period of $1.0 million, and the maximum amount that may be reimbursed under the agreement is $2.9 million. No payments were made during the year ended December 31, 2016. During the years ended December 31, 2015 and 2014, $237,000 and $651,000 was paid to PCM.
The Reimbursement Agreement also provides for the payment to the IPO underwriters of the amount that the Company agreed to pay to them at the time of the IPO if the Company satisfied certain performance measures over a specified period of time. As PCM earns performance incentive fees under the management agreement, the IPO underwriters will be paid at a rate of $20 of payments for every $100 of performance incentive fees earned by PCM. The payment to the underwriters is subject to a maximum reimbursement in any particular 12-month period of $2.0 million and the maximum amount that may be paid under the agreement is $5.9 million. No payments were made during the year ended December 31, 2016. During the years ended December 31, 2015 and 2014, $473,000 and $1.7 million, respectively was paid to the underwriters. The Reimbursement Agreement expires on February 1, 2019.
F-51
Net interest income is summarized below:
|
| Year ended December 31, |
| |||||||||
|
| 2016 |
|
| 2015 |
|
| 2014 |
| |||
| (in thousands) |
| ||||||||||
Interest income: |
|
|
|
|
|
|
|
|
|
|
|
|
From nonaffiliates: |
|
|
|
|
|
|
|
|
|
|
|
|
Short-term investments |
| $ | 923 |
|
| $ | 815 |
|
| $ | 604 |
|
Mortgage-backed securities |
|
| 14,663 |
|
|
| 10,267 |
|
|
| 8,226 |
|
Mortgage loans acquired for sale at fair value |
|
| 54,750 |
|
|
| 48,281 |
|
|
| 23,974 |
|
Mortgage loans at fair value: |
|
|
|
|
|
|
|
|
|
|
|
|
Distressed |
|
| 107,044 |
|
|
| 96,536 |
|
|
| 100,340 |
|
Under forward purchase agreements |
|
| — |
|
|
| — |
|
|
| 3,584 |
|
Held in a VIE |
|
| 17,042 |
|
|
| 19,903 |
|
|
| 22,280 |
|
Placement fees relating to custodial funds |
|
| 4,058 |
|
|
| — |
|
|
| — |
|
Deposits securing CRT Agreements |
|
| 930 |
|
|
| — |
|
|
| — |
|
Other |
|
| 111 |
|
|
| 178 |
|
|
| 48 |
|
|
|
| 199,521 |
|
|
| 175,980 |
|
|
| 159,056 |
|
From PFSI—ESS purchased from PFSI at fair value |
|
| 22,601 |
|
|
| 25,365 |
|
|
| 13,292 |
|
|
|
| 222,122 |
|
|
| 201,345 |
|
|
| 172,348 |
|
Interest expense: |
|
|
|
|
|
|
|
|
|
|
|
|
To nonaffiliates: | �� |
|
|
|
|
|
|
|
|
|
|
|
Assets sold under agreements to repurchase |
|
| 92,838 |
|
|
| 79,869 |
|
|
| 58,304 |
|
Mortgage loan participation and sale agreements |
|
| 1,376 |
|
|
| 1,001 |
|
|
| 912 |
|
Notes payable |
|
| 12,892 |
|
|
| 6,826 |
|
|
| — |
|
Exchangeable Notes |
|
| 14,473 |
|
|
| 14,413 |
|
|
| 14,358 |
|
Asset-backed financings of VIEs at fair value (1) |
|
| 12,091 |
|
|
| 13,754 |
|
|
| 6,490 |
|
FHLB advances |
|
| 122 |
|
|
| 275 |
|
|
| — |
|
Borrowings under forward purchase agreements |
|
| — |
|
|
| — |
|
|
| 2,363 |
|
Interest shortfall on repayments of mortgage loans serviced for Agency securitizations |
|
| 6,812 |
|
|
| 4,207 |
|
|
| 2,004 |
|
Placement fees on mortgage loan impound deposits |
|
| 1,334 |
|
|
| 1,020 |
|
|
| 1,158 |
|
|
|
| 141,938 |
|
|
| 121,365 |
|
|
| 85,589 |
|
To PFSI—financings payable |
|
| 7,830 |
|
|
| 3,343 |
|
|
| — |
|
|
|
| 149,768 |
|
|
| 124,708 |
|
|
| 85,589 |
|
Net interest income |
| $ | 72,354 |
|
| $ | 76,637 |
|
| $ | 86,759 |
|
(1) | The results for the year ended December 31, 2016 include interest expense from Asset-backed financing of a VIE at fair value and CRT Agreements financing at fair value. |
F-52
Note 25—Net Gain on Mortgage Loans Acquired for Sale
Net gain on mortgage loans acquired for sale is summarized below:
|
| Year ended December 31, |
| |||||||||
|
| 2016 |
|
| 2015 |
|
| 2014 |
| |||
| (in thousands) |
| ||||||||||
From non-affiliates: |
|
|
|
|
|
|
|
|
|
|
|
|
Cash loss: |
|
|
|
|
|
|
|
|
|
|
|
|
Mortgage loans |
| $ | (229,743 | ) |
| $ | (84,489 | ) |
| $ | (25,241 | ) |
Hedging activities |
|
| 30,927 |
|
|
| (17,742 | ) |
|
| (57,161 | ) |
|
|
| (198,816 | ) |
|
| (102,231 | ) |
|
| (82,402 | ) |
Non cash gain: |
|
|
|
|
|
|
|
|
|
|
|
|
Receipt of MSRs in mortgage loan sale transactions |
|
| 275,092 |
|
|
| 154,474 |
|
|
| 121,333 |
|
Provision for losses relating to representations and warranties provided in mortgage loan sales |
|
|
|
|
|
|
|
|
|
|
|
|
Pursuant to mortgage loans sales |
|
| (3,254 | ) |
|
| (5,771 | ) |
|
| (4,255 | ) |
Reduction in liability due to change in estimate |
|
| 7,564 |
|
|
| — |
|
|
| — |
|
Change in fair value of financial instruments held at period end: |
|
|
|
|
|
|
|
|
|
|
|
|
IRLCs |
|
| (869 | ) |
|
| (1,015 | ) |
|
| 4,412 |
|
Mortgage loans |
|
| (1,846 | ) |
|
| (2,977 | ) |
|
| 3,825 |
|
Hedging derivatives |
|
| 19,347 |
|
|
| 961 |
|
|
| (11,518 | ) |
|
|
| 16,632 |
|
|
| (3,031 | ) |
|
| (3,281 | ) |
Total from non-affiliates |
|
| 97,218 |
|
|
| 43,441 |
|
|
| 31,395 |
|
From PFSI—cash gain |
|
| 9,224 |
|
|
| 7,575 |
|
|
| 4,252 |
|
|
| $ | 106,442 |
|
| $ | 51,016 |
|
| $ | 35,647 |
|
Note 26—Net Gain on Investments
Net gain (loss) on investments is summarized below:
|
| Year ended December 31, |
| |||||||||
|
| 2016 |
|
| 2015 |
|
| 2014 |
| |||
|
| (in thousands) |
| |||||||||
Net gain (loss) on investments: |
|
|
|
|
|
|
|
|
|
|
|
|
From non-affiliates: |
|
|
|
|
|
|
|
|
|
|
|
|
Mortgage-backed securities |
| $ | (13,168 | ) |
| $ | (5,224 | ) |
| $ | 10,416 |
|
Mortgage loans at fair value: |
|
|
|
|
|
|
|
|
|
|
|
|
Distressed mortgage loans |
|
| (3,504 | ) |
|
| 81,133 |
|
|
| 215,483 |
|
Mortgage loans held in a VIE |
|
| (1,748 | ) |
|
| (10,663 | ) |
|
| 27,768 |
|
CRT Agreements |
|
| 32,500 |
|
|
| 593 |
|
|
| — |
|
Asset-backed financing of a VIE at fair value |
|
| 3,238 |
|
|
| 4,260 |
|
|
| (8,459 | ) |
Hedging derivatives |
|
| 7,251 |
|
|
| (19,353 | ) |
|
| (22,565 | ) |
|
|
| 24,569 |
|
|
| 50,746 |
|
|
| 222,643 |
|
From PFSI—ESS |
|
| (17,394 | ) |
|
| 3,239 |
|
|
| (20,834 | ) |
|
| $ | 7,175 |
|
| $ | 53,985 |
|
| $ | 201,809 |
|
F-53
Note 27—Net Mortgage Loan Servicing Fees
Net mortgage loan servicing fees are summarized below:
|
| Year ended December 31, |
| |||||||||
|
| 2016 |
|
| 2015 |
|
| 2014 |
| |||
| (in thousands) |
| ||||||||||
From non-affiliates: |
|
|
|
|
|
|
|
|
|
|
|
|
Servicing fees (1) |
| $ | 131,833 |
|
| $ | 102,147 |
|
| $ | 80,008 |
|
Effect of MSRs: |
|
|
|
|
|
|
|
|
|
|
|
|
Carried at lower of amortized cost or fair value: |
|
|
|
|
|
|
|
|
|
|
|
|
Amortization |
|
| (65,647 | ) |
|
| (43,982 | ) |
|
| (31,911 | ) |
Provision for impairment |
|
| (2,728 | ) |
|
| (3,229 | ) |
|
| (5,138 | ) |
Gain on sale |
|
| 11 |
|
|
| 187 |
|
|
| 46 |
|
Carried at fair value—change in fair value |
|
| (12,524 | ) |
|
| (7,072 | ) |
|
| (16,648 | ) |
Gains on hedging derivatives |
|
| 2,271 |
|
|
| 481 |
|
|
| 11,527 |
|
|
|
| (78,617 | ) |
|
| (53,615 | ) |
|
| (42,124 | ) |
|
|
| 53,216 |
|
|
| 48,532 |
|
|
| 37,884 |
|
From PFSI-MSR recapture income |
|
| 1,573 |
|
|
| 787 |
|
|
| 9 |
|
Net mortgage loan servicing fees |
| $ | 54,789 |
|
| $ | 49,319 |
|
| $ | 37,893 |
|
Average servicing portfolio |
| $ | 49,626,758 |
|
| $ | 38,450,379 |
|
| $ | 30,720,168 |
|
(1) | Includes contractually specified servicing and ancillary fees. |
Note 28—Share-Based Compensation Plans
The Company has adopted an equity incentive plan which provides for the issuance of equity based awards, including share options, restricted shares, restricted share units, unrestricted common share awards, LTIP units (a special class of partnership interests in the Operating Partnership) and other awards based on PMT’s common shares that may be made by the Company directly to its officers and trustees, and the members, officers, trustees, directors and employees of PCM, PFSI, or their affiliates and to PCM, PFSI and other entities that provide services to PMT and the employees of such other entities.
The equity incentive plan is administered by the Company’s compensation committee, pursuant to authority delegated by the board of trustees, which has the authority to make awards to the eligible participants referenced above, and to determine what form the awards will take, and the terms and conditions of the awards.
The Company’s equity incentive plan allows for grants of share-based awards up to an aggregate of 8% of PMT’s issued and outstanding shares on a diluted basis at the time of the award.
The shares underlying award grants will again be available for award under the equity incentive plan if:
any shares subject to an award granted under the equity incentive plan are forfeited, canceled, exchanged or surrendered;
an award terminates or expires without a distribution of shares to the participant; or
shares are surrendered or withheld by PMT as payment of either the exercise price of an award and/or withholding taxes for an award.
Restricted share units have been awarded to trustees and officers of the Company and to employees of PFSI at no cost to the grantees. Such awards generally vest over a one- to three-year period.
F-54
The following table summarizes the Company’s share-based compensation activity:
|
| Year ended December 31, |
| |||||||||
|
| 2016 |
|
| 2015 |
|
| 2014 |
| |||
| (in thousands except per share amounts) |
| ||||||||||
Number of units: |
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at beginning of year |
|
| 734 |
|
|
| 725 |
|
|
| 661 |
|
Granted |
|
| 330 |
|
|
| 312 |
|
|
| 300 |
|
Vested |
|
| (299 | ) |
|
| (302 | ) |
|
| (234 | ) |
Canceled or forfeited |
|
| — |
|
|
| (1 | ) |
|
| (2 | ) |
Outstanding at end of year |
|
| 765 |
|
|
| 734 |
|
|
| 725 |
|
Weighted Average Grant Date Fair Value: |
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at beginning of year |
| $ | 21.26 |
|
| $ | 21.00 |
|
| $ | 19.95 |
|
Granted |
| $ | 10.46 |
|
| $ | 21.06 |
|
| $ | 21.05 |
|
Vested |
| $ | 18.46 |
|
| $ | 19.65 |
|
| $ | 19.68 |
|
Expired or canceled |
| $ | — |
|
| $ | 21.29 |
|
| $ | 18.74 |
|
Outstanding at end of year |
| $ | 16.19 |
|
| $ | 21.26 |
|
| $ | 21.00 |
|
Compensation expense recorded during the year |
| $ | 5,748 |
|
| $ | 6,346 |
|
| $ | 7,107 |
|
Fair value of vested units during the year |
| $ | 5,510 |
|
| $ | 5,929 |
|
| $ | 4,615 |
|
Year end: |
|
|
|
|
|
|
|
|
|
|
|
|
Units available for future awards(1) |
|
| 4,632 |
|
|
|
|
|
|
|
|
|
Unamortized compensation cost |
| $ | 4,118 |
|
|
|
|
|
|
|
|
|
(1) | Based on shares outstanding as of December 31,
|
As of December 31, 2016, 653,210 restricted share units with a weighted average grant date fair value of $17.34 per share unit are expected to vest over their average remaining vesting period of 12 months. The grant date fair values of share unit awards are based on the market value of the Company’s stock at the date of grant.
As of December 31, 2016, 112,079 performance units with a weighted average grant date fair value of $9.50 per share unit are expected to vest over their average remaining vesting period of 12 months. The grant date fair values of share unit awards are based on the market value of the Company’s stock at the date of grant.
Note 29—Other Expenses
Other expenses are summarized below:
|
| Year ended December 31, |
| |||||||||
|
| 2016 |
|
| 2015 |
|
| 2014 |
| |||
|
| (in thousands) |
| |||||||||
Common overhead allocation from PFSI |
| $ | 7,898 |
|
| $ | 10,742 |
|
| $ | 10,477 |
|
Real estate held for investment |
|
| 3,213 |
|
|
| 604 |
|
|
| — |
|
Technology |
|
| 1,448 |
|
|
| 1,279 |
|
|
| 984 |
|
Insurance |
|
| 1,326 |
|
|
| 1,304 |
|
|
| 989 |
|
Other |
|
| 4,340 |
|
|
| 2,542 |
|
|
| 2,313 |
|
|
| $ | 18,225 |
|
| $ | 16,471 |
|
| $ | 14,763 |
|
Note 30—Income Taxes
The Company has elected to be taxed as a REIT for U.S. federal income tax purposes under Sections 856 through 860 of the Internal Revenue Code. Therefore, PMT generally will not be subject to corporate federal or state income tax to the extent that qualifying distributions are made to shareholders and the Company meets REIT requirements including certain asset, income, distribution and share ownership tests. The Company believes that it has met the distribution requirements, as it has declared dividends sufficient to distribute substantially all of its taxable income. Taxable income will generally differ from net income. The primary differences between net income and the REIT taxable income (before deduction for qualifying distributions) are the taxable income of the taxable REIT subsidiary (“TRS”) and the method of determining the income or loss related to valuation of the mortgage loans owned by the qualified REIT subsidiary (“QRS”).
F-55
In general, cash dividends declared by the Company will be considered ordinary income to the shareholders for income tax purposes. Some portion of the dividends may be characterized as capital gain distributions or a return of capital. The approximate tax characterization of the Company’s distributions is as follows:
Year ended December 31, |
| Ordinary income |
|
| Long term capital gain |
|
| Return of capital |
| |||
2016 |
|
| 60 | % |
|
| 40 | % |
|
| 0 | % |
2015 |
|
| 41 | % |
|
| 25 | % |
|
| 34 | % |
2014 |
|
| 86 | % |
|
| 14 | % |
|
| 0 | % |
The Company had elected to treat two of its subsidiaries as TRSs. In the quarter ended September 30, 2012, the Company revoked the election to treat its wholly owned subsidiary that is the sole general partner of the Operating Partnership as a TRS. As a result, beginning September 1, 2012, only one subsidiary, PMC, is treated as a TRS. Income from a TRS is only included as a component of REIT taxable income to the extent that the TRS makes dividend distributions of income to the REIT. No such dividend distributions have been made to date. A TRS is subject to corporate federal and state income tax. Accordingly, a provision for income taxes for PMC and, for the periods for which TRS treatment had been elected, the sole general partner of the Operating Partnership is included in the Consolidated Statements of Income.
The Company files U.S. federal and state income tax returns for both the REIT and TRSs. These federal income tax returns for 2013 and forward are subject to examination. The Company’s state income tax returns are generally subject to examination for 2012 and forward. No returns are currently under examination.
The following table details the Company’s income tax benefit which relates primarily to the TRSs for the years presented:
|
| Year ended December 31, |
| |||||||||
|
| 2016 |
|
| 2015 |
|
| 2014 |
| |||
| (in thousands) |
| ||||||||||
Current expense: |
|
|
|
|
|
|
|
|
|
|
|
|
Federal |
| $ | 361 |
|
| $ | 671 |
|
| $ | 352 |
|
State |
|
| 81 |
|
|
| 204 |
|
|
| 104 |
|
Total current expense |
|
| 442 |
|
|
| 875 |
|
|
| 456 |
|
Deferred benefit: |
|
|
|
|
|
|
|
|
|
|
|
|
Federal |
|
| (8,790 | ) |
|
| (13,124 | ) |
|
| (10,232 | ) |
State |
|
| (5,699 | ) |
|
| (4,547 | ) |
|
| (5,304 | ) |
Total deferred benefit |
|
| (14,489 | ) |
|
| (17,671 | ) |
|
| (15,536 | ) |
Total benefit from income taxes |
| $ | (14,047 | ) |
| $ | (16,796 | ) |
| $ | (15,080 | ) |
The following table is a reconciliation of the Company’s provision for income taxes at statutory rates to the provision for income taxes at the Company’s effective rate for the years presented:
|
| Year ended December 31, |
| |||||||||||||||||||||
|
| 2016 |
|
| 2015 |
|
| 2014 |
| |||||||||||||||
|
| Amount |
|
| Rate |
|
| Amount |
|
| Rate |
|
| Amount |
|
| Rate |
| ||||||
| (in thousands) |
| ||||||||||||||||||||||
Federal income tax expense at statutory tax rate |
| $ | 21,617 |
|
|
| 35.0 | % |
| $ | 25,656 |
|
|
| 35.0 | % |
| $ | 62,812 |
|
|
| 35.0 | % |
Effect of non-taxable REIT income |
|
| (32,501 | ) |
|
| (52.6 | )% |
|
| (40,366 | ) |
|
| (55.1 | )% |
|
| (74,480 | ) |
|
| (41.5 | )% |
State income taxes, net of federal benefit |
|
| (3,652 | ) |
|
| (5.9 | )% |
|
| (2,823 | ) |
|
| (3.9 | )% |
|
| (3,380 | ) |
|
| (1.9 | )% |
Other |
|
| 489 |
|
|
| 0.8 | % |
|
| 737 |
|
|
| 1.1 | % |
|
| (32 | ) |
|
| 0 | % |
Valuation allowance |
|
| — |
|
|
| 0 | % |
|
| — |
|
|
| 0 | % |
|
| — |
|
|
| 0 | % |
Benefit from income taxes |
| $ | (14,047 | ) |
|
| (22.7 | )% |
| $ | (16,796 | ) |
|
| (22.9 | )% |
| $ | (15,080 | ) |
|
| (8.4 | )% |
F-56
The Company’s components of the provision for deferred income taxes are as follows:
|
| Year ended December 31, |
| |||||||||
|
| 2016 |
|
| 2015 |
|
| 2014 |
| |||
| (in thousands) |
| ||||||||||
Real estate valuation loss |
| $ | 2,732 |
|
| $ | (1,577 | ) |
| $ | (5,079 | ) |
Mortgage servicing rights |
|
| 10,597 |
|
|
| (31,324 | ) |
|
| 27,996 |
|
Net operating loss carryforward |
|
| (19,863 | ) |
|
| 33,297 |
|
|
| (35,963 | ) |
Liability for losses under representations and warranties |
|
| 2,222 |
|
|
| (2,467 | ) |
|
| (5,944 | ) |
Excess interest expense disallowance |
|
| (8,721 | ) |
|
| (15,384 | ) |
|
| — |
|
Other |
|
| (1,456 | ) |
|
| (216 | ) |
|
| 3,454 |
|
Valuation allowance |
|
| — |
|
|
| — |
|
|
| — |
|
Total (benefit) provision for deferred income taxes |
| $ | (14,489 | ) |
| $ | (17,671 | ) |
| $ | (15,536 | ) |
The components of income taxes payable are as follows:
|
| December 31, 2016 |
|
| December 31, 2015 |
| ||
|
| (in thousands) |
| |||||
Taxes currently receivable |
|
| 2,519 |
|
|
| 1,669 |
|
Deferred income taxes payable |
| $ | (20,685 | ) |
| $ | (35,174 | ) |
Income taxes payable |
| $ | (18,166 | ) |
| $ | (33,505 | ) |
The tax effects of temporary differences that gave rise to deferred income tax assets and liabilities are presented below:
|
| December 31, 2016 |
|
| December 31, 2015 |
| ||
|
| (in thousands) |
| |||||
Deferred income tax assets: |
|
|
|
|
|
|
|
|
REO valuation loss |
| $ | 9,542 |
|
| $ | 12,274 |
|
Net operating loss carryforward |
|
| 60,435 |
|
|
| 40,572 |
|
Liability for losses under representations and warranties |
|
| 6,189 |
|
|
| 8,411 |
|
Excess interest expense disallowance |
|
| 24,105 |
|
|
| 15,384 |
|
Other |
|
| 1,882 |
|
|
| 426 |
|
Gross deferred tax assets |
|
| 102,153 |
|
|
| 77,067 |
|
Deferred income tax liabilities: |
|
|
|
|
|
|
|
|
Mortgage servicing rights |
|
| (122,838 | ) |
|
| (112,241 | ) |
Other |
|
| — |
|
|
| — |
|
Gross deferred tax liabilities |
|
| (122,838 | ) |
|
| (112,241 | ) |
Net deferred income tax liability |
| $ | (20,685 | ) |
| $ | (35,174 | ) |
The net deferred income tax liability is recorded in Income taxes payable in the consolidated balance sheets as of December 31, 2016 and December 31, 2015.
The Company has net operating loss carryforwards of $152 million and $96.7 million for the years ended December 31, 2016 and December 31, 2015, respectively, that expire between 2033 and 2036.
At December 31, 2016 and December 31, 2015, the Company had no unrecognized tax benefits and does not anticipate any increase in unrecognized tax benefits. Should the accrual of any interest or penalties relative to unrecognized tax benefits be necessary, it is the Company’s policy to record such accruals in the Company’s income tax accounts. No such accruals existed at December 31, 2016 and December 31, 2015.
F-57
The Company has two segments: correspondent production and investment activities.
The correspondent production segment represents the Company’s operations aimed at serving as an intermediary between mortgage lenders and the capital markets by purchasing, pooling and reselling newly originated prime credit quality mortgage loans either directly or in the form of MBS, using the services of PFSI.
Most of the loans the Company has acquired in its correspondent production activities have been eligible for sale to government-sponsored entities such as Fannie Mae and Freddie Mac or through government agencies such as Ginnie Mae.
The investment activities segment represents the Company’s investments in mortgage-related assets, which include distressed mortgage loans, REO, MBS, MSRs, ESS, small balance commercial real estate loans and CRT Agreements. The Company seeks to maximize the value of the distressed mortgage loans that it acquires through proprietary loan modification programs, special servicing or other initiatives focused on keeping borrowers in their homes. Where this is not possible, such as in the case of many nonperforming mortgage loans, the Company seeks to effect property resolution in a timely, orderly and economically efficient manner, including through the use of resolution alternatives to foreclosure.
Financial highlights by operating segment are summarized below:
|
| Correspondent |
|
| Investment |
|
|
|
|
| ||
Year ended December 31, 2016 |
| production |
|
| activities |
|
| Total |
| |||
|
| (in thousands) |
| |||||||||
Net gain on mortgage loans acquired for sale |
| $ | 106,442 |
|
| $ | — |
|
| $ | 106,442 |
|
Net investment income: |
|
|
|
|
|
|
|
|
|
|
|
|
Interest income |
|
| 53,998 |
|
|
| 168,124 |
|
|
| 222,122 |
|
Interest expense |
|
| (33,701 | ) |
|
| (116,067 | ) |
|
| (149,768 | ) |
|
|
| 20,297 |
|
|
| 52,057 |
|
|
| 72,354 |
|
Net mortgage loan servicing fees |
|
| — |
|
|
| 54,789 |
|
|
| 54,789 |
|
Net gain on investments |
|
| — |
|
|
| 7,175 |
|
|
| 7,175 |
|
Other income (loss) |
|
| 41,998 |
|
|
| (10,670 | ) |
|
| 31,328 |
|
|
|
| 168,737 |
|
|
| 103,351 |
|
|
| 272,088 |
|
Expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
Mortgage loan fulfillment, servicing and management fees payable to PFSI |
|
| 88,978 |
|
|
| 68,759 |
|
|
| 157,737 |
|
Other |
|
| 9,292 |
|
|
| 43,296 |
|
|
| 52,588 |
|
|
|
| 98,270 |
|
|
| 112,055 |
|
|
| 210,325 |
|
Pre-tax income (loss) |
| $ | 70,467 |
|
| $ | (8,704 | ) |
| $ | 61,763 |
|
Total assets at period end |
| $ | 1,715,145 |
|
| $ | 4,642,357 |
|
| $ | 6,357,502 |
|
|
| Correspondent |
|
| Investment |
|
|
|
|
| ||
Year ended December 31, 2015 |
| production |
|
| activities |
|
| Total |
| |||
|
| (in thousands) |
| |||||||||
Net gain on mortgage loans acquired for sale |
| $ | 51,016 |
|
| $ | — |
|
| $ | 51,016 |
|
Net investment income: |
|
|
|
|
|
|
|
|
|
|
|
|
Interest income |
|
| 39,976 |
|
|
| 161,369 |
|
|
| 201,345 |
|
Interest expense |
|
| (19,843 | ) |
|
| (104,865 | ) |
|
| (124,708 | ) |
|
|
| 20,133 |
|
|
| 56,504 |
|
|
| 76,637 |
|
Net mortgage loan servicing fees |
|
| — |
|
|
| 49,319 |
|
|
| 49,319 |
|
Net gain on investments |
|
| — |
|
|
| 53,985 |
|
|
| 53,985 |
|
Other income (loss) |
|
| 28,822 |
|
|
| (11,014 | ) |
|
| 17,808 |
|
|
|
| 99,971 |
|
|
| 148,794 |
|
|
| 248,765 |
|
Expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
Mortgage loan fulfillment, servicing and management fees payable to PFSI |
|
| 60,619 |
|
|
| 68,605 |
|
|
| 129,224 |
|
Other |
|
| 6,450 |
|
|
| 39,787 |
|
|
| 46,237 |
|
|
|
| 67,069 |
|
|
| 108,392 |
|
|
| 175,461 |
|
Pre-tax income |
| $ | 32,902 |
|
| $ | 40,402 |
|
| $ | 73,304 |
|
Total assets at period end |
| $ | 1,286,138 |
|
| $ | 4,540,786 |
|
| $ | 5,826,924 |
|
F-58
| Correspondent |
|
| Investment |
|
| Intersegment |
|
|
|
|
| ||||
Year ended December 31, 2014 |
| production |
|
| activities |
|
| elimination & other |
|
| Total |
| ||||
|
| (in thousands) |
| |||||||||||||
Net gain on mortgage loans acquired for sale |
| $ | 35,647 |
|
| $ | — |
|
|
| — |
|
| $ | 35,647 |
|
Net investment income: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest income |
|
| 24,022 |
|
|
| 150,714 |
|
|
| (2,388 | ) |
|
| 172,348 |
|
Interest expense |
|
| (15,899 | ) |
|
| (72,078 | ) |
|
| 2,388 |
|
|
| (85,589 | ) |
|
|
| 8,123 |
|
|
| 78,636 |
|
|
| — |
|
|
| 86,759 |
|
Net mortgage loan servicing fees |
|
| — |
|
|
| 37,893 |
|
|
| — |
|
|
| 37,893 |
|
Net gain on investments |
|
| — |
|
|
| 201,809 |
|
|
| — |
|
|
| 201,809 |
|
Other income |
|
| 18,290 |
|
|
| (23,657 | ) |
|
| — |
|
|
| (5,367 | ) |
|
|
| 62,060 |
|
|
| 294,681 |
|
|
| — |
|
|
| 356,741 |
|
Expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Mortgage loan fulfillment, servicing and management fees payable to PFSI |
|
| 49,872 |
|
|
| 86,404 |
|
|
| — |
|
|
| 136,276 |
|
Other |
|
| 3,357 |
|
|
| 37,644 |
|
|
| — |
| �� |
| 41,001 |
|
|
|
| 53,229 |
|
|
| 124,048 |
|
|
| — |
|
|
| 177,277 |
|
Pre-tax income |
| $ | 8,831 |
|
| $ | 170,633 |
|
| $ | — |
|
| $ | 179,464 |
|
Total assets at period end |
| $ | 654,476 |
|
| $ | 4,242,782 |
|
| $ | — |
|
| $ | 4,897,258 |
|
F-59
Note 32—Selected Quarterly Results (Unaudited)
Following is a presentation of selected quarterly financial data:
|
| Quarter ended |
| |||||||||||||||||||||||||||||
|
| 2016 |
|
| 2015 |
| ||||||||||||||||||||||||||
|
| Dec. 31 |
|
| Sept. 30 |
|
| June 30 |
|
| Mar. 31 |
|
| Dec. 31 |
|
| Sept. 30 |
|
| June 30 |
|
| Mar. 31 |
| ||||||||
|
| (dollars in thousands, except per share data) |
| |||||||||||||||||||||||||||||
For the quarter ended: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net investment income |
| $ | 68,928 |
|
| $ | 103,326 |
|
| $ | 47,618 |
|
| $ | 52,216 |
|
| $ | 50,569 |
|
| $ | 90,774 |
|
| $ | 69,765 |
|
| $ | 37,657 |
|
Net income |
| $ | 31,174 |
|
| $ | 35,408 |
|
| $ | (5,267 | ) |
| $ | 14,496 |
|
| $ | 15,709 |
|
| $ | 38,812 |
|
| $ | 28,071 |
|
| $ | 7,508 |
|
Earnings per share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic |
| $ | 0.46 |
|
| $ | 0.52 |
|
| $ | (0.08 | ) |
| $ | 0.20 |
|
| $ | 0.21 |
|
| $ | 0.51 |
|
| $ | 0.37 |
|
| $ | 0.09 |
|
Diluted |
| $ | 0.44 |
|
| $ | 0.49 |
|
| $ | (0.08 | ) |
| $ | 0.20 |
|
| $ | 0.21 |
|
| $ | 0.49 |
|
| $ | 0.36 |
|
| $ | 0.09 |
|
Cash dividends declared per share |
| $ | 0.47 |
|
| $ | 0.47 |
|
| $ | 0.47 |
|
| $ | 0.47 |
|
| $ | 0.47 |
|
| $ | 0.47 |
|
| $ | 0.61 |
|
| $ | 0.61 |
|
At period end: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Short-term investments at fair value |
| $ | 122,088 |
|
| $ | 33,353 |
|
| $ | 16,877 |
|
| $ | 47,500 |
|
| $ | 41,865 |
|
| $ | 31,518 |
|
| $ | 32,417 |
|
| $ | 44,949 |
|
Mortgage-backed securities at fair value |
|
| 865,061 |
|
|
| 708,862 |
|
|
| 531,612 |
|
|
| 364,439 |
|
|
| 322,473 |
|
|
| 315,599 |
|
|
| 287,626 |
|
|
| 316,292 |
|
Mortgage loans at fair value (1) |
|
| 3,394,853 |
|
|
| 4,000,570 |
|
|
| 3,497,026 |
|
|
| 3,836,411 |
|
|
| 3,839,583 |
|
|
| 3,688,026 |
|
|
| 4,944,694 |
|
|
| 4,226,290 |
|
Excess servicing spread |
|
| 288,669 |
|
|
| 280,367 |
|
|
| 294,551 |
|
|
| 321,976 |
|
|
| 412,425 |
|
|
| 418,573 |
|
|
| 359,102 |
|
|
| 222,309 |
|
Real estate acquired in settlement of loans (2) |
|
| 303,393 |
|
|
| 314,056 |
|
|
| 320,120 |
|
|
| 339,970 |
|
|
| 350,642 |
|
|
| 358,011 |
|
|
| 325,822 |
|
|
| 317,536 |
|
Mortgage servicing rights (3) |
|
| 656,567 |
|
|
| 524,529 |
|
|
| 471,458 |
|
|
| 455,097 |
|
|
| 459,741 |
|
|
| 423,095 |
|
|
| 394,737 |
|
|
| 359,160 |
|
Other assets |
|
| 726,871 |
|
|
| 757,164 |
|
|
| 635,918 |
|
|
| 455,047 |
|
|
| 400,195 |
|
|
| 357,409 |
|
|
| 332,976 |
|
|
| 243,991 |
|
Total assets |
| $ | 6,357,502 |
|
| $ | 6,618,901 |
|
| $ | 5,767,562 |
|
| $ | 5,820,440 |
|
| $ | 5,826,924 |
|
| $ | 5,592,231 |
|
| $ | 6,677,374 |
|
| $ | 5,730,527 |
|
Assets sold under agreements to repurchase and mortgage loan participation and sale agreement |
| $ | 3,809,918 |
|
| $ | 4,129,543 |
|
| $ | 3,372,026 |
|
| $ | 3,307,414 |
|
| $ | 3,128,780 |
|
| $ | 2,925,110 |
|
| $ | 3,571,181 |
|
| $ | 3,633,922 |
|
Federal Home Loan Bank advances |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| 183,000 |
|
|
| 183,000 |
|
|
| 138,400 |
|
|
| — |
|
Credit risk transfer financing at fair value |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| 649,120 |
|
|
| — |
|
Notes payable |
|
| 425,106 |
|
|
| 346,132 |
|
|
| 313,976 |
|
|
| 356,191 |
|
|
| 386,015 |
|
|
| 342,332 |
|
|
| 297,404 |
|
|
| — |
|
Borrowings under forward purchase agreements |
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
|
| — |
|
Asset-backed financing of a VIE at fair value |
|
| 353,898 |
|
|
| 384,407 |
|
|
| 325,939 |
|
|
| 344,693 |
|
|
| 247,690 |
|
|
| 234,287 |
|
|
| 151,489 |
|
|
| 162,222 |
|
Exchangeable senior notes |
|
| 246,089 |
|
|
| 245,824 |
|
|
| 245,564 |
|
|
| 245,307 |
|
|
| 245,054 |
|
|
| 244,805 |
|
|
| 244,559 |
|
|
| 244,317 |
|
Other liabilities |
|
| 171,377 |
|
|
| 158,077 |
|
|
| 149,230 |
|
|
| 152,332 |
|
|
| 140,272 |
|
|
| 148,267 |
|
|
| 99,924 |
|
|
| 147,907 |
|
Total liabilities |
|
| 5,006,388 |
|
|
| 5,263,983 |
|
|
| 4,406,735 |
|
|
| 4,405,937 |
|
|
| 4,330,811 |
|
|
| 4,077,801 |
|
|
| 5,152,077 |
|
|
| 4,188,368 |
|
Shareholders’ equity |
|
| 1,351,114 |
|
|
| 1,354,918 |
|
|
| 1,360,827 |
|
|
| 1,414,503 |
|
|
| 1,496,113 |
|
|
| 1,514,430 |
|
|
| 1,525,297 |
|
|
| 1,542,159 |
|
Total liabilities and shareholders’ equity |
| $ | 6,357,502 |
|
| $ | 6,618,901 |
|
| $ | 5,767,562 |
|
| $ | 5,820,440 |
|
| $ | 5,826,924 |
|
| $ | 5,592,231 |
|
| $ | 6,677,374 |
|
| $ | 5,730,527 |
|
|
Assets: Short-term investments Mortgage-backed securities at fair value Mortgage loans acquired for sale at fair value Mortgage loans at fair value Excess servicing spread purchased from PFSI Derivative assets: Interest rate lock commitments MBS put options Forward purchase contracts Forward sales contracts Put options on interest rate futures Call options on interest rate futures Total derivative assets Netting Total derivative assets after netting Mortgage servicing rights at fair value Liabilities: Asset-backed financing of the VIE at fair value Derivative liabilities: Interest rate lock commitments MBS call options Forward purchase contracts Forward sales contracts Total derivative liabilities Netting Total derivative liabilities after netting
Assets: Balance, December 31, 2012 Purchases Repayments and sales Capitalization of interest ESS received pursuant to a recapture agreement with PFSI Interest rate lock commitments issued, net Servicing received as proceeds from sales of mortgage loans Changes in fair value included in income arising from: Changes in instrument-specific credit risk Other factors Transfers of mortgage loans under forward purchase agreements to mortgage loans Transfers of mortgage loans to REO Transfers of mortgage loans under forward purchase agreements to REO under forward purchase agreements Transfers of interest rate lock commitments to mortgage loans acquired for sale Balance, December 31, 2013 Changes in fair value recognized during the period relating to assets still held at December 31, 2013
Assets: Short-term investments Mortgage-backed securities at fair value Mortgage loans acquired for sale at fair value Mortgage loans at fair value Agency debt security Mortgage loans under forward purchase agreements at fair value Excess servicing spread at fair value Mortgage servicing rights at fair value Liabilities: Asset-backed financing of a VIE at fair value
|
Includes REO,
Instrument Forward sales contracts Forward purchase contracts MBS put option MBS call option Eurodollar future sale contracts Eurodollar future purchase contracts Treasury future sale contracts Treasury future purchase contracts Put options on interest rate futures Call options on interest rate futures Instrument Forward sales contracts Forward purchase contracts MBS put option MBS call option Eurodollar future sale contracts Eurodollar future purchase contracts Treasury future sale contracts Treasury future purchase contracts Put options on interest rate futures Call options on interest rate futures
|
Year ended December 31, 2013 Net investment income: Interest income Interest expense Net gain on mortgage loans acquired for sale Net gain on investments Net loan servicing fees Other income (loss) Expenses: Loan fulfillment, servicing and management fees payable to PFSI Other Pre-tax (loss) income Total assets at year end
|
F-60
Note 33—Supplemental Cash Flow Information
|
| Year ended December 31, |
| |||||||||
|
| 2016 |
|
| 2015 |
|
| 2014 |
| |||
|
| (in thousands) |
| |||||||||
Cash paid for interest |
| $ | 157,686 |
|
| $ | 117,223 |
|
| $ | 94,116 |
|
Income taxes paid, net |
| $ | 1,294 |
|
| $ | 1,116 |
|
| $ | (6,562 | ) |
Non-cash investing activities: |
|
|
|
|
|
|
|
|
|
|
|
|
Receipt of MSRs as proceeds from sales of mortgage loans |
| $ | 275,092 |
|
| $ | 154,474 |
|
| $ | 121,333 |
|
Transfer of mortgage loans and advances to real estate acquired in settlement of loans |
| $ | 207,431 |
|
| $ | 307,455 |
|
| $ | 364,945 |
|
Transfer of real estate acquired in settlement of mortgage loans to real estate held for investment |
| $ | 21,406 |
|
| $ | 8,827 |
|
| $ | — |
|
Receipt of ESS pursuant to recapture agreement with PFSI |
| $ | 6,603 |
|
| $ | 6,728 |
|
| $ | 7,343 |
|
Transfers of mortgage loans acquired for sale to mortgage loans at fair value |
| $ | — |
|
| $ | 23,859 |
|
| $ | — |
|
Purchase of mortgage loans financed through forward purchase agreements |
| $ | — |
|
| $ | — |
|
| $ | 2,828 |
|
Transfer of mortgage loans under forward purchase agreements to mortgage loans at fair value |
| $ | — |
|
| $ | — |
|
| $ | 205,902 |
|
Transfer of mortgage loans under forward purchase agreements and advances to REO under forward purchase agreements |
| $ | — |
|
| $ | — |
|
| $ | 9,369 |
|
Purchase of REO financed through forward purchase agreements |
| $ | — |
|
| $ | — |
|
| $ | 68 |
|
Transfer of REO under forward purchase agreements to REO |
| $ | — |
|
| $ | — |
|
| $ | 12,737 |
|
Non-cash financing activities: |
|
|
|
|
|
|
|
|
|
|
|
|
Dividends payable |
| $ | 31,655 |
|
| $ | 35,069 |
|
| $ | 45,894 |
|
Transfer of mortgage loans at fair value financed through agreements to repurchase to REO financed under agreements to repurchase |
| $ | — |
|
| $ | 85,134 |
|
| $ | 2,731 |
|
Purchase of mortgage loans financed through forward purchase agreements |
| $ | — |
|
| $ | — |
|
| $ | 2,828 |
|
Purchase of REO financed through forward purchase agreements |
| $ | — |
|
| $ | — |
|
| $ | 68 |
|
Note 34—Regulatory Capital and Liquidity Requirements
PMC is a seller-servicer for Fannie Mae and Freddie Mac. The Company is required to comply with the following minimum capital and liquidity eligibility requirements to remain in good standing with each Agency:
A minimum net worth of a base of $2.5 million plus 25 basis points of UPB for total 1-4 unit residential mortgage loans serviced;
A tangible net worth/total assets ratio greater than or equal to 6%; and
Liquidity equal to or exceeding 3.5 basis points multiplied by the aggregate UPB of all mortgages secured by 1-4 unit residential properties serviced for Freddie Mac and Fannie Mae (“Agency Mortgage Servicing”) plus 200 basis points multiplied by the sum of nonperforming (90 or more days delinquent) Agency Mortgage Servicing that exceeds 6% of Agency Mortgage Servicing.
Such Agencies’ capital and liquidity requirements, the calculations of which are defined by each entity, are summarized below:
|
| December 31, 2016 |
| |||||||||||||||||||||
|
| Net Worth (1) |
|
| Tangible Net Worth / Total Assets Ratio (1) |
|
| Liquidity (1) |
| |||||||||||||||
Fannie Mae and Freddie Mac |
| Actual |
|
| Required |
|
| Actual |
|
| Required |
|
| Actual |
|
| Required |
| ||||||
|
| (in thousands) |
| |||||||||||||||||||||
December 31, 2016 |
| $ | 392,056 |
|
| $ | 143,259 |
|
|
| 12 | % |
|
| 6 | % |
| $ | 26,670 |
|
| $ | 19,706 |
|
December 31, 2015 |
| $ | 409,930 |
|
| $ | 107,405 |
|
|
| 13 | % |
|
| 6 | % |
| $ | 46,030 |
|
| $ | 16,481 |
|
(1) | Calculated in
|
F-61
Noncompliance with the respective Agency’s capital and liquidity requirements can result in the respective Agency taking various remedial actions up to and including removing the Company’s ability to sell loans to and service loans on behalf of the respective Agency.
Note 35—Recently Issued Accounting Pronouncements
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Subtopic 606) (“ASU 2014-09”), which supersedes the guidance in ASC 605, Revenue Recognition. ASU 2014-09 clarifies the principles for recognizing revenue in order to improve comparability of revenue recognition practices across entities and industries with certain scope exceptions including financial instruments, leases, and guarantees. ASU 2014-09 provides guidance intended to assist in the identification of contracts with customers and separate performance obligations within those contracts, the determination and allocation of the transaction price to those identified performance obligations and the recognition of revenue when a performance obligation has been satisfied. ASU 2014-09 also requires disclosures regarding the nature, amount, timing, and uncertainty of revenues and cash flows from contracts with customers.
Upon adoption, ASU 2014-09 provides for transition through either a full retrospective approach requiring the restatement of all presented prior periods or a modified retrospective approach, which allows the new recognition standard to be applied to only those contracts that are not completed at the date of transition. If the modified retrospective approach is adopted, a cumulative-effect adjustment to retained earnings is performed with additional disclosures required including the amount by which each line item is affected by the transition as compared to the guidance in effect before adoption and an explanation of the reasons for significant changes in these amounts.
The FASB has issued several amendments to the new revenue standard ASU 2014-09, including:
In May 2014, ASU 2015-14, Revenue From Contracts With Customers (“ASU 2015-14”). This update deferred the initial effective date of ASU 2014-09. As a result of the issuance of ASU 2015-14, ASU 2014-09 is effective for annual reporting periods beginning on or after December 15, 2017, and interim periods within those annual periods. Early adoption is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period.
In March 2015, ASU 2016-08, Principal Versus Agent Considerations (Reporting Revenue Gross versus Net). The amendments to this update are intended to improve the implementation guidance on principal versus agent considerations in ASU 2014-09 by clarifying how an entity should identify the unit of accounting (i.e. the specified good or service) and how an entity should apply the control principle to certain types of arrangements.
In May 2016, ASU 2016-12, Narrow-Scope Improvements and Practical Expedients. The amendments to this update clarify certain core recognition principles and provide practical expedients available at transition. The improvements address collectability, sales tax presentation, noncash consideration, contract modifications and completed contracts at transition.
The Company is currently evaluating the pending adoption of ASU 2014-09 and its impact on its consolidated financial statements and has not yet identified which transition method will be applied upon adoption.
In February 2015, the FASB issued ASU 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis (“ASU 2015-02”). ASU 2015-02 affects reporting entities that are required to evaluate whether they should consolidate certain legal entities. ASU 2015-02 modifies the evaluation of whether limited partnerships and similar legal entities are VIEs or voting interest entities, eliminates the presumption that a general partner should consolidate a limited partnership and affects the consolidation analysis of reporting entities that are involved with VIEs, particularly those that have fee arrangements and related party relationships. ASU 2015-02 is effective for fiscal years, and for interim periods within those fiscal years, beginning after December 15, 2015. The Company adopted ASU 2015-02 effective January 1, 2016. The adoption of ASU 2015-02 had no effect on the Company’s consolidated financial statements.
In January 2016, the FASB issued ASU 2016-01, Financial Instruments–Overall: Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU 2016-01”). ASU 2016-01 affects the accounting for equity investments, financial liabilities under the fair value option, the presentation and disclosure requirements for financial instruments, and the valuation allowance assessment when recognizing deferred tax assets resulting from unrealized losses on available-for-sale debt securities.
F-62
All equity investments in unconsolidated entities (other than those accounted for using the equity method of accounting) with readily determinable fair values will generally be measured at fair value through earnings.
When the fair value option has been elected for financial liabilities, changes in fair value due to instrument-specific credit risk will be recognized separately in other comprehensive income. The accumulated gains and losses due to these changes will be reclassified from accumulated other comprehensive income to earnings if the financial liability is settled before maturity.
For financial instruments measured at amortized cost, public business entities will be required to use the exit price when measuring the fair value of financial instruments for disclosure purposes.
Financial assets and financial liabilities shall be presented separately in the notes to the financial statements, grouped by measurement category (e.g., fair value, amortized cost, lower of cost or fair value) and form of financial asset (e.g., loans, securities).
Public business entities will no longer be required to disclose the methods and significant assumptions used to estimate the fair value of financial instruments carried at amortized cost.
Entities will have to assess the realizability of a deferred tax asset related to a debt security classified as available for sale in combination with the entity’s other deferred tax assets.
The classification and measurement guidance will be effective for public business entities in fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption of the provision to record fair value changes for financial liabilities under the fair value option resulting from instrument-specific credit risk in other comprehensive income is permitted and can be elected for all financial statements of fiscal years and interim periods that have not yet been issued or that have not yet been made available for issuance. The Company does not believe that the adoption of ASU 2016-01 will have a significant effect on its consolidated financial statements.
In March 2016, the FASB issued ASU 2016-09, Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”). ASU 2016-09 simplifies several aspects of the accounting for share-based payment award transactions, including:
Modifies the accounting for income taxes relating to share-based payments. All excess tax benefits and tax deficiencies (including tax benefits of dividends on share-based payment awards) will be recognized as income tax expense or benefit in the consolidated statement of income. The tax effects of exercised or vested awards will be treated as discrete items in the reporting period in which they occur. An entity will recognize excess tax benefits regardless of whether the benefit reduces taxes payable in the current period. Under current GAAP, excess tax benefits are recognized in additional paid-in capital; tax deficiencies are recognized either as an offset to accumulated excess tax benefits, if any, or in the consolidated statement of income in the period they reduce income taxes payable.
Changes the classification of excess tax benefits on the consolidated statement of cash flows. In the consolidated statement of cash flows, excess tax benefits will be classified along with other income tax cash flows as an operating activity. Under current GAAP, excess tax benefits are separated from other income tax cash flows and classified as a financing activity.
Changes the requirement to estimate the number of awards that are expected to vest. Under ASC 2016-09, an entity can make an entity-wide accounting policy election to either estimate the number of awards that are expected to vest as presently required or account for forfeitures when they occur. Under current GAAP, accruals of compensation cost are based on the number of awards that are expected to vest.
Changes the tax withholding requirements for share-based payment awards to qualify for equity accounting. The threshold to qualify for equity classification permits withholding up to the maximum statutory tax rates in the applicable jurisdictions. Under current GAAP, for an award to qualify for equity classification is that an entity cannot partially settle the award in cash in excess of the employer’s minimum statutory withholding requirements.
Establishes GAAP for the classification of employee taxes paid when an employer withholds shares for tax withholding purposes. Cash paid by an employer when directly withholding shares for tax- withholding purposes should be classified as a financing activity. This guidance establishes GAAP related to the classification of withholding taxes in the statement of cash flows as there is no such guidance under current GAAP.
ASU 2016-09 is effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early adoption is permitted for any organization in any interim or annual period. The Company does not believe that the adoption of ASU 2016-09 will have a significant effect on its consolidated financial statements.
F-63
In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements—Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (“ASU 2014-15”). ASU 2014-15 is intended to define management’s responsibility to evaluate whether there is substantial doubt about an organization’s ability to continue as a going concern and to provide related footnote disclosures.
Under GAAP, financial statements are prepared under the presumption that the reporting organization will continue to operate as a going concern, except in limited circumstances. Financial reporting under this presumption is commonly referred to as the going concern basis of accounting. The going concern basis of accounting establishes the fundamental basis for measuring and classifying assets and liabilities.
ASU 2014-15 extends the responsibility for performing the going-concern assessment to management and contains guidance on (1) how to perform a going-concern assessment and (2) when going-concern disclosures are required under GAAP.
Under ASU 2014-15, an entity would be required to evaluate its status as a going concern as part of its periodic financial statement preparation process and would be required to disclose information about its potential inability to continue as a going concern when “substantial doubt” about its ability to continue as a going concern for the period of one year from the earlier of the date its financial statements are issued or are ready to be issued.
If management concludes that there is “substantial doubt about the entity’s ability to continue as a going concern,” it must disclose the principal conditions or events causing substantial doubt to be raised, management’s evaluation of the conditions and management’s plans. If substantial doubt is not alleviated as a result of management’s plans, the entity is required to include a statement that there is “substantial doubt about the entity’s ability to continue as a going concern.” ASU 2014-15 also requires an entity to disclose how the substantial doubt was resolved in the period that substantial doubt no longer exists.
ASU 2014-15 is effective for the annual period ending December 31, 2016. The requirements of ASU 2014-15 are not expected to have an effect on the financial statements of the Company upon adoption.
Note 36—Parent Company Information
The Company’s debt financing agreements require PMT and certain of its subsidiaries to comply with financial covenants that include a minimum tangible net worth for the Company of $860 million; a minimum tangible net worth for the Company’s subsidiaries including the Operating Partnership of $700 million (net worth was $1.4 billion, which includes PMH and PMC); a minimum tangible net worth for PMH of $250 million (net worth was $835 million); and a minimum tangible net worth for PMC of $150 million (net worth was $1.1 billion). The Company’s subsidiaries are limited from transferring funds to the Parent by these minimum tangible net worth requirements.
F-64
PENNYMAC MORTGAGE INVESTMENT TRUST
CONDENSED BALANCE SHEETS
|
| December 31, |
| |||||
|
| 2016 |
|
| 2015 |
| ||
|
| (in thousands) |
| |||||
Assets |
|
|
|
|
|
|
|
|
Short-term investment |
| $ | 1,035 |
|
| $ | 2,606 |
|
Investments in subsidiaries |
|
| 1,408,979 |
|
|
| 1,558,728 |
|
Due from affiliates |
|
| 100 |
|
|
| 168 |
|
Due from PennyMac Financial Services, Inc. |
|
| 54 |
|
|
| — |
|
Other assets |
|
| 610 |
|
|
| 806 |
|
Total assets |
|
| 1,410,778 |
|
|
| 1,562,308 |
|
|
|
|
|
|
|
|
|
|
Liabilities |
|
|
|
|
|
|
|
|
Dividends payable |
|
| 31,385 |
|
|
| 34,720 |
|
Accounts payable and accrued liabilities |
|
| 2,765 |
|
|
| 2,708 |
|
Capital notes due to subsidiaries |
|
| 18,409 |
|
|
| 20,379 |
|
Due to PennyMac Financial Services, Inc. |
|
| 1,185 |
|
|
| 1,247 |
|
Due to affiliates |
|
| 42 |
|
|
| 219 |
|
Income taxes payable |
|
| — |
|
|
| — |
|
Total liabilities |
|
| 53,786 |
|
|
| 59,273 |
|
Shareholders' equity |
|
| 1,356,992 |
|
|
| 1,503,035 |
|
Total liabilities and shareholders' equity |
|
| 1,410,778 |
|
|
| 1,562,308 |
|
F-65
PENNYMAC MORTGAGE INVESTMENT TRUST
CONDENSED STATEMENTS OF INCOME
|
| Year ended December 31, |
| |||||||||
|
| 2016 |
|
| 2015 |
|
| 2014 |
| |||
|
| (in thousands) |
| |||||||||
Income |
|
|
|
|
|
|
|
|
|
|
|
|
Dividends from subsidiaries |
| $ | 230,091 |
|
| $ | 171,254 |
|
| $ | 174,192 |
|
Intercompany interest |
|
| 6 |
|
|
| 8 |
|
|
| 15 |
|
Interest |
|
| — |
|
|
| — |
|
|
| 4 |
|
Other |
|
| 1,250 |
|
|
| 1,250 |
|
|
| 1,250 |
|
Total income |
|
| 231,347 |
|
|
| 172,512 |
|
|
| 175,461 |
|
Expenses |
|
|
|
|
|
|
|
|
|
|
|
|
Intercompany interest |
|
| 1,382 |
|
|
| 441 |
|
|
| 26 |
|
Other |
|
| (114 | ) |
|
| 14 |
|
|
| — |
|
Total expenses |
|
| 1,268 |
|
|
| 455 |
|
|
| 26 |
|
Income before provision for income taxes and equity in undistributed earnings in subsidiaries |
|
| 230,079 |
|
|
| 172,057 |
|
|
| 175,435 |
|
Provision for income taxes |
|
| 442 |
|
|
| 875 |
|
|
| 372 |
|
Income before equity in undistributed earnings of subsidiaries |
|
| 229,637 |
|
|
| 171,182 |
|
|
| 175,063 |
|
Equity in undistributed earnings of subsidiaries |
|
| (155,093 | ) |
|
| (78,704 | ) |
|
| 23,288 |
|
Net income |
| $ | 74,544 |
|
| $ | 92,478 |
|
| $ | 198,351 |
|
F-66
PENNYMAC MORTGAGE INVESTMENT TRUST
CONDENSED STATEMENTS OF CASH FLOWS
|
| Year ended December 31, |
| |||||||||
|
| 2016 |
|
| 2015 |
|
| 2014 |
| |||
|
| (in thousands, except share data) |
| |||||||||
Cash flows from operating activities: |
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
| $ | 74,544 |
|
| $ | 92,478 |
|
| $ | 198,351 |
|
Equity in undistributed earnings of subsidiaries |
|
| 155,093 |
|
|
| 78,704 |
|
|
| (23,288 | ) |
Decrease in due from affiliates |
|
| 693 |
|
|
| 915 |
|
|
| 107 |
|
Decrease (increase) in other assets |
|
| 196 |
|
|
| (284 | ) |
|
| (1 | ) |
Increase (decrease) in accounts payable and accrued liabilities |
|
| 93 |
|
|
| (257 | ) |
|
| (837 | ) |
Increase in due from affiliates |
|
| (116 | ) |
|
| (238 | ) |
|
| (652 | ) |
Decrease due to affiliates |
|
| (174 | ) |
|
| (119 | ) |
|
| (40 | ) |
Increase in income taxes payable |
|
| — |
|
|
| (126 | ) |
|
| 59 |
|
Net cash provided by operating activities |
|
| 230,329 |
|
|
| 171,073 |
|
|
| 173,699 |
|
Cash flows from investing activities: |
|
|
|
|
|
|
|
|
|
|
|
|
Increase in investment in subsidiaries |
|
| — |
|
|
| — |
|
|
| (89,618 | ) |
Net decrease in short-term investments |
|
| 1,571 |
|
|
| (2,100 | ) |
|
| 834 |
|
Net cash used by investing activities |
|
| 1,571 |
|
|
| (2,100 | ) |
|
| (88,784 | ) |
Cash flows from financing activities: |
|
|
|
|
|
|
|
|
|
|
|
|
Issuance of common shares |
|
| — |
|
|
| 8 |
|
|
| 90,588 |
|
Net increase in intercompany unsecured note payable to PMT subsidiary |
|
| (1,970 | ) |
|
| 20,379 |
|
|
| — |
|
Repurchases of common shares |
|
| (98,370 | ) |
|
| (16,338 | ) |
|
| — |
|
Payment of common share underwriting and offering costs |
|
| — |
|
|
| — |
|
|
| (1,070 | ) |
Payment of dividends |
|
| (131,560 | ) |
|
| (173,022 | ) |
|
| (174,433 | ) |
Net cash provided (used) by financing activities |
|
| (231,900 | ) |
|
| (168,973 | ) |
|
| (84,915 | ) |
Net change in cash |
|
| — |
|
|
| — |
|
|
| — |
|
Cash at beginning of year |
|
| — |
|
|
| — |
|
|
| — |
|
Cash at end of year |
| $ | — |
|
| $ | — |
|
| $ | — |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-cash financing activity — dividends payable |
| $ | 31,655 |
|
| $ | 35,069 |
|
| $ | 45,894 |
|
Note 37—Subsequent Events
Management has evaluated all events and transactions through the date the Company issued these consolidated financial statements. During this period:
On January 26, 2017, the Company entered into an agreement to sell $89 million in UPB of performing loans from the distressed portfolio. The sale is scheduled to settle in March 2017. Although definitive documentation has been executed, this transaction is subject to continuing due diligence and customary closing conditions. There can be no assurance regarding the size of the transaction or that the transaction will be completed at all.
F-67
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
PENNYMAC MORTGAGE INVESTMENT TRUST
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|
Dated: February 27, 2017
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the registrant in the capacities and on the dates indicated.
Signatures | Title |
| Date | ||||
/s/ David A. Spector | President and Chief Executive Officer (Principal Executive Officer) | ||||||
David A. Spector | February 27, 2017 | ||||||
/s/ Andrew S. Chang | |||||||
Andrew S. Chang | Chief Financial Officer (Principal Financial Officer) | February 27, 2017 | |||||
/s/ Gregory L. Hendry | |||||||
Gregory L. Hendry | Chief Accounting Officer (Principal Accounting Officer) | February 27, 2017 | |||||
/s/ Stanford L. Kurland | |||||||
Stanford L. Kurland | Executive Chairman | February 27, 2017 | |||||
/s/ Scott W. Carnahan | |||||||
Trustee | February 27, 2017 | ||||||
/s/ Preston DuFauchard | |||||||
Preston DuFauchard | Trustee | February 27, 2017 | |||||
/s/ Randall D. Hadley | |||||||
Randall D. Hadley | Trustee | February 27, 2017 | |||||
Clay A. Halvorsen | Trustee | ||||||
/s/ Nancy McAllister | |||||||
Nancy McAllister | Trustee | February 27, 2017 | |||||
/s/ Stacey D. Stewart | |||||||
Stacey D. Stewart | Trustee | February 27, 2017 | |||||
/s/ Frank P. Willey | |||||||
Frank P. Willey | Trustee | February 27, 2017 | |||||
|
F-68
Stanford L. Kurland
Chairman of the Board of Trustees and Chief Executive Officer (Principal Executive Officer)
/s/ Anne D. McCallion
Anne D. McCallion
Chief Financial Officer (Principal Financial Officer)
/s/ Gregory L. Hendry
Gregory L. Hendry
Chief Accounting Officer (Principal Accounting Officer)
/s/ Scott W. Carnahan
Scott W. Carnahan
Trustee
/s/ Preston DuFauchard
Preston DuFauchard
Trustee
/s/ Randall D. Hadley
Randall D. Hadley
Trustee
/s/ Clay A. Halvorsen
Clay A. Halvorsen
Trustee
/s/ Nancy McAllister
Nancy McAllister
Trustee
/s/ David A. Spector
David A. Spector
Trustee
/s/ Stacey D. Stewart
Stacey D. Stewart
Trustee
/s/ Frank P. Willey
Frank P. Willey
Trustee