Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read together with our consolidated financial statements and related notes appearing elsewhere in this Report. The following discussion and analysis contains forward-looking statements that involve risks and uncertainties. When reviewing the discussion below, you should keep in mind the substantial risks and uncertainties that could impact our business. In particular, we encourage you to review the risks and uncertainties described in the section titled “Risk Factors” included elsewhere in this Report. These risks and uncertainties could cause actual results to differ materially from those projected in forward-looking statements contained in this report or implied by past results and trends.
Critical Accounting Policies
Preparation of financial statements in compliance with accounting principles generally accepted in the United States (“GAAP”) requires us to make estimates that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, and revenues and expenses during the reporting period. Certain of these estimates significantly influence the portrayal of our financial condition and results, and they require us to make difficult, subjective or complex judgments. Our critical accounting policies primarily relate to our fair value estimates.
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Fair Value
We group assets 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:
Percentage of
(in thousands)
Total stockholders' equity $ 3,538,603
At December 31, 2023, $11.7 billion or 62% of our total assets were carried at fair value on a recurring basis and $15.0 million (real estate acquired in settlement of loans (“REO”)), were carried based on fair value on a non-recurring basis when fair value indicates evidence of impairment of individual properties.
Changes in fair value of our holdings of assets carried at fair value have significant effects on our financial position and results of operations. As summarized above, changes in fair values of “Level 1” and “Level 2” fair value assets are determinable with reference to direct quotes in active markets on the measurement date in the case of “Level 1” fair value assets, or reference to publicly available pricing inputs (such as reference interest rates and credit spreads and prices of similar assets) in the case of “Level 2” fair value assets.
$7.7 billion or 41% of our total assets are measured using “Level 3” fair value inputs – significant inputs where there is difficulty observing the inputs used by market participants to establish fair value. Different approaches to valuing those assets or changes in inputs to measurement of these assets can have a significant effect on the amounts reported for these items including their reported balances and their effects on our income.
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During the three years ended December 31, 2023, we recognized significant changes in the fair value of our holdings of “Level 3” fair value assets and liabilities as shown below:
Interest Loans held Mortgage Excess Mortgage
(positive (negative) effects on net revenues in thousands)
(1) Excludes changes in fair value attributable to realization of cash flows.
The changes above primarily reflect changes attributable to our observations of changes in the markets for those assets and liabilities as opposed to changes in accounting policies or approaches to the valuation of those instruments.
As a result of the difficulty in observing certain significant valuation inputs affecting our “Level 3” fair value assets and liabilities, we are required to make judgments regarding these items’ fair values. Different persons in possession of the same facts may reasonably arrive at different conclusions as to the inputs to be applied in valuing these assets and liabilities and their fair values. Such differences may result in significantly different fair value measurements. Likewise, due to the general illiquidity of some of these assets, subsequent transactions may be at values significantly different from those reported.
Because the fair value of “Level 3” fair value assets and liabilities are difficult to estimate, our valuation process includes performance of these items’ fair value estimation by specialized staff with significant senior management oversight. We have assigned the responsibility for estimating the fair values of non-interest rate lock commitment (“IRLC”) “Level 3” fair value assets and liabilities to our capital markets valuation staff, which is responsible for valuing and monitoring these items and maintenance of our valuation policies and procedures for non- IRLC assets and liabilities. The capital markets valuation staff submits the results of its valuations to our senior management valuation committee, which oversees the valuations. Our senior management valuation committee includes the Company’s chief financial, risk, and capital markets officers as well as other senior members of the Company’s finance, capital markets and risk management staff.
The fair value of our IRLCs is developed by our capital markets risk management staff and is reviewed by our capital markets operations group.
Following is a discussion of our approach to measuring the balance sheet items that are most affected by “Level 3” fair value estimates.
Interest Rate Lock Commitments
Our net gains on loans held for sale include our estimates of the gains or losses we expect to realize upon the sale of loans we have contractually committed to fund or purchase but have not yet funded, purchased or sold. We recognize a substantial portion of our net gains on loans held for sale at fair value before we fund or purchase the loans as the result of these commitments. We call these commitments IRLCs. We recognize the fair value of IRLCs at the time we make the commitment to the correspondent seller, broker or loan applicant and adjust the fair value of such IRLCs as the loan approaches the point of funding or purchase or the prospective transaction is canceled.
We carry IRLCs as either Derivative assets or Derivative liabilities on our consolidated balance sheet. The fair value of an IRLC is transferred to Loans held for sale at fair value when the loan is funded or purchased.
An active, observable market for IRLCs does not exist. Therefore, we measure the fair value of IRLCs using methods we believe that market participants use in pricing IRLCs. We estimate the fair value of IRLCs based on observable Agency MBS prices, our estimates of the fair value of the MSRs we expect to receive in the sale of the loans and the probability that we will fund or purchase the loans (the “pull-through rate”).
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Pull-through rates and MSR fair values are based on our estimates as these inputs are difficult to observe in the marketplace. Market interest rates and our estimate of the probability that a loan will be funded are updated as the loans move through the funding or purchase process and as market interest rates change and these updates may result in significant changes in our estimates of the fair value of the IRLCs. Such changes are reflected in the change in fair value of IRLCs which is a component of our Net gains on loans held for sale at fair value in the period of the change. The financial effects of changes in these inputs are generally inversely correlated. Increasing interest rates have a positive effect on the fair value of the MSR component of IRLC fair value but increase the pull-through rate for the loan principal and interest payment cash flow component, which decreases in fair value.
A shift in our assessment of an input to the valuation of IRLCs can have a significant effect on the amount of Net gains on loans held for sale at fair value for the period. We believe that the most significant “Level 3” fair value input to the measurement of IRLCs is the pull-through rate. At December 31, 2023, we held $89.6 million of net IRLC assets at fair value. Following is a quantitative summary of the effect of changes in the pull-through rate input on the fair value of IRLCs at December 31, 2023:
(in thousands)
Loans Held for Sale
We carry loans at their fair values. We recognize changes in the fair value of loans in current period income as a component of Net gains on loans held for sale at fair value. How we estimate the fair value of loans is based on whether the loans are saleable into active markets with observable fair value inputs.
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We use a discounted cash flow model to estimate the fair value of “Level 3” fair value loans. The significant unobservable inputs used in the fair value measurement of our “Level 3” fair value loans held for sale are discount rates, home price projections and prepayment speeds. Significant changes in any of those inputs in isolation could result in a significant change to the loans’ fair value measurements.
Mortgage Servicing Rights and Mortgage Servicing Liabilities
MSRs and MSLs represent the fair value assigned to contracts that obligate us to service the mortgage loans on behalf of the owners of the mortgage loans in exchange for servicing fees and the right to collect certain ancillary income from the borrower. We recognize MSRs and MSLs at our estimate of the fair value of the contract to service the loans.
We include changes in fair value of MSRs and MSLs in current period income as a component of Net loan servicing fees—Change in fair value of mortgage servicing rights and mortgage servicing liabilities. Both our estimate of the change in fair value attributable to realization of cash flows and of other changes in fair value are affected by changes in fair value inputs. In the year ended December 31, 2023, we recognized a $605.6 million net decrease in fair value of MSRs and MSLs: $662.4 million of decrease due to realization of cash flows underlying the fair value of MSRs, partially offset by $56.8 million of increase due to changes in fair value inputs.
We estimate fair value of MSRs and MSLs using a discounted cash flow approach. We believe the most significant “Level 3” fair value inputs to the valuation of MSRs and MSLs are the pricing spread (discount rates), prepayment speed and annual per-loan cost of servicing.
A shift in the market for MSRs and MSLs or a change in our assessment of an input to the valuation of MSRs and MSLs can have a significant effect on their fair value and in our income for the period. The net fair value of MSRs and MSLs that we held at December 31, 2023 was $7.1 billion.
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Following is a summary of the effect on fair value of MSRs of various changes to these key inputs at December 31, 2023:
Effect on fair value of MSRs and MSLs of a change in input value (1)
Change in input Pricing spread Prepayment speed Servicing cost
(in thousands)
Accounting Developments
Refer to Note 3 – Significant Accounting Policies ‒ Recently Issued Accounting Pronouncements to our
consolidated financial statements for a discussion of recent accounting developments and the expected effect on the Company.
Business Trends
Due to significant inflationary pressures, the U.S. Federal Reserve raised the federal funds rates during the first three quarters of 2023, as well as reduced its overall holdings of Treasury securities and MBS. Higher interest rates are expected to contribute to reducing the size of the mortgage origination market from approximately $2.3 trillion in 2022 to an estimated $1.4 trillion in 2023. The mortgage market is expected to grow to approximately $2.0 trillion in 2024 according to mortgage industry economists, with an expectation that interest rates and mortgage rates will decline during the year.
Lower mortgage transaction volumes and higher interest rates decreased our mortgage production activities, reduced gains from the redelivery of loans bought out from Ginnie Mae securities, increased competition and lowered profit margins in our production business in 2023 as compared to the prior year. However, increased regulatory scrutiny and higher potential capital requirements on the banking sector have caused certain banks to reduce their footprint in mortgage products and business lines, leading to reduced competition in some channels. Higher interest rates also increased the costs of floating rate borrowings, increased interest income from placement fees we receive relating to custodial funds that we manage on deposits and loans held for sale and reduced prepayment speeds in our mortgage servicing portfolio in 2023 as compared to the prior year. Due to the significant contraction in the mortgage market during the year, we maintained a lower level of operating expenses than we had in prior years when then mortgage market was larger. If interest rates decrease and mortgage volumes increase in 2024 as industry economists project, certain of the trends observed in our business in 2023 may begin to soften or reverse.
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Results of Operations
Our results of operations are summarized below:
Year ended December 31,
(dollars in thousands except per share amounts)
Revenues:
Expenses:
Earnings per share
Return on average stockholders' equity 4.1% 13.8% 28.9%
Dividends declared per share $ 0.80 $ 0.80 $ 0.80
Income before provision for income taxes by segment:
Mortgage banking:
During the year:
Common stock closing per share prices:
At end of year:
Unpaid principal balance of loan servicing portfolio:
Owned:
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We define “Adjusted EBITDA” as net income plus provision for income taxes, depreciation and amortization, excluding decrease (increase) in fair value of MSRs net of MSLs, due to changes in the valuation inputs we use in our valuation models, increase (decrease) in fair value of excess servicing spread (“ESS”) payable to PMT, hedging losses (gains) associated with MSRs, stock-based compensation and interest expense on corporate debt or corporate revolving credit facilities and capital lease and non-recurring items such as significant awards of damages against us due to litigation.
We believe that the presentation of Adjusted EBITDA provides useful information to investors regarding our results of operations because each measure assists both investors and management in analyzing and benchmarking the performance and value of our business. However, other companies may define Adjusted EBITDA differently, and as a result, our measures of Adjusted EBITDA may not be directly comparable to those of other companies.
Adjusted EBITDA measures have limitations as analytical tools, and should not be considered in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are:
Because of these limitations, Adjusted EBITDA measures are not intended as alternatives to net income as an indicator of our operating performance and should not be considered as measures of discretionary cash available to us to invest in the growth of our business or as measures of cash that will be available to us to meet our obligations.
The following table presents a reconciliation of Adjusted EBITDA to our net income, the most directly comparable financial measure calculated and presented in accordance with GAAP, for each of the years indicated:
Year ended December 31,
(in thousands)
Effect of fourth quarter arbitration accrual 158,368 — —
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Comparison of the years ended December 31, 2023, 2022 and 2021
Income Before Provisions for Income Taxes
In the year ended December 31, 2023, we recorded income before provision for income taxes of $183.6 million, a decrease of $481.6 million or 72% from 2022. The decrease was due to a $309.6 million decrease in production revenues (net gains on sales of loans, loan origination fees and fulfillment fees) primarily due to lower production volume and a shift in the mix of production to lower margin channels and a $308.7 million decrease in Net loan servicing fees reflecting decreased valuation of our MSRs, net of hedging results, partially offset by a $102.5 million decrease in total expenses. The decrease in the total expense was primarily due to a $246.5 million reduction in compensation, loan origination and marketing and advertising expenses, partially offset by a $158.1 million increase in legal settlements. The increase in legal settlements expense reflects an arbitrator’s finding in a claim made against us by Black Knight Servicing Technologies, LLC. This claim, which is discussed in detail in Note 18–Commitments and Contingencies to the consolidated financial statements included in this Report, resulted in a charge to our results of operations of $115.8 million net of income taxes or a reduction to earnings per diluted share of common stock of $2.20.
In the year ended December 31, 2022, we recorded income before provision for income taxes of $665.2 million, a decrease of $693.9 million or 51% from 2021. The decrease was primarily due to a $2.0 billion decrease in production revenues primarily due to lower production volume and gain on sale margins across all channels, partially offset by a $768.4 million increase in Net loan servicing fees reflecting improved valuation results in our MSRs, net of hedging results, and a $487.7 million decrease in total expenses, primarily due to reductions in compensation, loan origination and servicing expenses.
Net gains on loans held for sale at fair value
In our production segment, revenues reflect the effects of increasing interest rates on both demand for mortgage loans and gain on sale margins during the years ended December 31, 2023 and 2022, compared to the strong demand due to the historically low interest rate environment that prevailed during 2021.
In the year ended December 31, 2023, we recognized Net gains on loans held for sale at fair value totaling $545.9 million, as compared to $791.6 million and $2.5 billion in 2022 and 2021, respectively. The decrease was primarily due to lower gains from production due to decreased production volumes and gain on sale margins and lower EBO loan redelivery gains due to reduced reperformance and modifications and diminished redelivery margins in the year ended December 31, 2023 compared to 2022 and 2021.
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Our net gains on loans held for sale are summarized below:
Year ended December 31,
(in thousands)
From non-affiliates:
Cash (losses) gains:
Non-cash gains (losses):
During the year:
Interest rate lock commitments issued:
By loan type:
Closed-end second lien mortgage loans 1,020,995 102,215 —
By production channel:
At end of year:
Non-Cash Elements of Gain on Sale of Loans Held for Sale
Our gains on loans held for sale include both cash and non-cash elements. We recognize a significant portion of our gains on loans held for sale when we make commitments to purchase or fund mortgage loans. We recognize this gain in the form of IRLCs. We adjust our initial gain estimate as the loan purchase or origination process progresses until the loan is either funded or cancelled. We also receive non-cash proceeds on sale that include our estimate of the fair value of MSRs and we incur liabilities for MSLs (which represent the fair value of the costs we expect to incur in excess of the fees we receive to service the EBO loans we have resold) and for the fair value of our estimate of the losses we expect to incur relating to the representations and warranties we provide in our loan sale transactions.
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The MSRs, MSLs, and liability for representations and warranties we recognize represent our estimate of the fair value of future benefits and costs we will realize for years in the future. These estimates represented approximately 338% of our gain on sale of loans at fair value for the year ended December 31, 2023, as compared to 217% and 71% in 2022 and 2021, respectively. These estimates change as circumstances change and changes in these estimates are recognized in income in subsequent periods.
Interest Rate Lock Commitments, Mortgage Servicing Rights and Mortgage Servicing Liabilities
The methods and key inputs we use to measure and update our measurements of IRLCs, MSRs and MSLs is detailed in Note 6 – Fair value – Valuation Techniques and Inputs to the consolidated financial statements included in this Annual Report.
Representations and Warranties – Loan Repurchases
Our agreements with the purchasers and insurers include representations and warranties related to the loans we sell. The representations and warranties require adherence to purchaser and insurer origination and underwriting guidelines, including but not limited to the validity of the lien securing the loan, property eligibility, borrower credit, income and asset requirements, and compliance with applicable federal, state and local law.
In the event of a breach of our representations and warranties, we may be required to either repurchase the loans with the identified defects or indemnify the purchaser or insurer. In such cases, we bear any subsequent credit loss on the loans. Our credit loss may be reduced by any recourse we have to correspondent originators that sold such loans to us and breached similar or other representations and warranties. In such event, we have the right to seek a recovery of related repurchase losses from that correspondent seller.
Our representations and warranties are generally not subject to stated limits of exposure. However, we believe that the current UPB of loans sold by us and subject to representation and warranty liability to date represents the maximum exposure to repurchases related to representations and warranties.
The level of the liability for losses under representations and warranties is difficult to estimate and requires considerable judgment. The level of loan repurchase losses is dependent on economic factors, purchaser or insurer loss mitigation strategies, and other external conditions that may change over the lives of the underlying loans. Our estimate of the liability for representations and warranties is developed by our credit administration staff and approved by our senior management credit committee which includes our senior executives and senior management in our loan production, loan servicing and credit risk management areas.
The method used to estimate our losses on representations and warranties is a function of our estimate of future defaults, loan repurchase rates, the severity of loss in the event of default, if applicable, and the probability of reimbursement by the correspondent loan seller. We establish a liability at the time loans are sold and periodically assess the adequacy of our recorded liability.
In the years ended December 31, 2023, 2022, and 2021 we recorded provisions for losses under representations and warranties relating to current loan sales as a component of Net gains on loans held for sale at fair value totaling $13.0 million, $9.6 million, and $31.6 million, respectively. The increase in the provision relating to current loan sales in the year ended December 31, 2023 compared to 2022 was primarily attributable to an increase in loans sold and a change in the mix between government guaranteed or insured loans and conventional loans during 2023. The decrease in provision relating to current loan sales from the year ended December 31, 2021 compared to the year ended December 31, 2022 reflects the decrease in our loan production in 2022.
We also recorded reductions in the liability relating to previously sold loans of $9.1 million, $8.5 million, and $16.0 million, for the years ended December 31, 2023, 2022 and 2021, respectively. The reductions in the liability relating to previously sold loans resulted from those loans meeting performance criteria established by the Agencies which significantly limits the likelihood of certain repurchase or indemnification claims.
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Following is a summary of mortgage loan repurchase activity and the unpaid balance of mortgage loans subject to representations and warranties:
Year ended December 31,
(in thousands)
During the year:
Indemnification activity:
Less indemnified loans sold, repaid or refinanced 3,706 3,134 8,253
Repurchase activity:
Less:
At end of year:
Liability for representations and warranties $ 30,788 $ 32,421 $ 43,521
In the year ended December 31, 2023, we repurchased loans with unpaid principal balances totaling $50.3 million and charged $5.5 million in net incurred losses relating to repurchases against our liability for representations and warranties. Our losses arising from representations and warranties have historically been reduced by our ability to either recover most of the losses from our correspondent sellers or from our ability to profitably refinance and resell repurchased loans.
If the outstanding balance of loans we purchase and sell subject to representations and warranties increases, the loans sold continue to season, economic conditions change, correspondent lenders become unwilling or unable to repurchase defective loans, or investor and insurer loss mitigation strategies are adjusted, the level of repurchase and loss activity may increase. Furthermore, as expected economic conditions, such as interest rates, home values and borrower default rates change, our realized loss rates may increase. Such increases may require us to adjust our estimate of future losses relating to loans previously sold. Such increased loss estimates, if recognized, would be reflected in Net gains on loans held for sale at fair value in the period we recognize the change.
The increases in market interest rates in recent years have affected certain of our correspondent sellers’ ability to honor their obligations to repurchase defective loans. Furthermore, these market factors and a potential future economic slowdown may increase the level of borrower defaults, increasing the level of repurchases we are required to make, and may make it more difficult to minimize losses on repurchased loans due to reduced opportunities to refinance loans and decreasing fair values for resales of loans. We expect these developments will increase the losses we incur in relation to our representations and warranties compared to our historical experience. However, we believe our recorded liability is presently adequate to absorb such losses.
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Loan origination fees
Following is a summary of our loan origination fees:
Year ended December 31,
(in thousands)
Loan origination fees decreased $23.7 million in the year ended December 31, 2023 compared to 2022, primarily due to a decrease in the volume of consumer direct loans we produced. Loan origination fees decreased $214.3 million in the year ended December 31, 2022 compared to 2021, primarily due to a decrease in loan production volumes.
Fulfillment fees from PennyMac Mortgage Investment Trust
Following is a summary of our fulfillment fees:
Year ended December 31,
(in thousands)
Average fulfillment fee rate (in basis points) 19 18 16
Fulfillment fees from PMT represent fees we collect for services we perform on behalf of PMT in connection with the acquisition, packaging and sale of loans. We charge fulfillment fees based on the number of loans we lock and fulfill for PMT.
Fulfillment fees decreased $40.2 million and $110.9 million in the years ended December 31, 2023 and 2022, respectively, compared to 2022 and 2021, respectively, primarily due to decreases in correspondent loan production volumes for PMT’s account which reflects our purchases of conventional correspondent loans from PMT.
Net loan servicing fees
Our net loan servicing fee income has two primary components: fees earned for servicing the loans and the effects of MSR and MSL valuation changes, net of hedging results as summarized below:
Year ended December 31,
(in thousands)
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Loan Servicing Fees
Following is a summary of our loan servicing fees:
Year ended December 31,
(in thousands)
Other:
Average loan servicing portfolio:
Loan servicing fees from non-affiliates generally relate to our MSRs which are primarily related to servicing we provide for loans included in Agency securitizations. These fees are contractually established at an annualized percentage of the unpaid principal balance of the loan serviced and we collect these fees from borrower payments. Loan servicing fees from PMT are primarily related to PMT’s MSRs and are established at monthly per-loan amounts based on whether the loan is a fixed-rate or adjustable-rate loan and the loan’s delinquency or foreclosure status as detailed in Note 4 – Transactions with Related Parties to the consolidated financial statements included in this Annual Report. Other loan servicing fees are comprised primarily of borrower-contracted fees such as late charges and reconveyance fees and fees charged to correspondent lenders relating to loans that are repaid shortly after we purchase them.
The increases in loan servicing fees from non-affiliates for the year ended December 31, 2023, compared to 2022 and 2021, were primarily due to growth of our loan servicing portfolio. The increase in other loan servicing fees for the year ended December 31, 2023 compared to 2022 is primarily due to growth in incentive fees we receive for effecting modifications of non-performing loans, partially offset by reduced property reconveyance fees, reflecting reduced loan prepayment activity. The decrease in other loan servicing fees for the year ended December 31, 2022 compared to 2021 was primarily due to a decrease in fees charged to correspondent lenders related to borrower early loan payoffs and decreased recording and release fees charged to borrowers due to the lower prepayment activity we experienced in the then rising interest rate environment compared to 2021.
Effects of Mortgage Servicing Rights and Mortgage Servicing Liabilities Net of Hedging Results
We have elected to carry our servicing assets and liabilities at fair value. Changes in fair value have two components: changes due to realization of the contractual servicing fees and changes due to changes in market inputs used to estimate the fair value of MSRs and MSLs. We endeavor to moderate the effects of changes in fair value by entering into derivatives transactions and, until March of 2021, by financing certain of our purchases of MSRs with the sale of a portion of the MSR assets’ cash flows to PMT in the form of ESS.
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Change in fair value of MSR, MSL and ESS and the related hedging results are summarized below:
Year ended December 31,
(in thousands)
MSR and MSL valuation changes and hedging results:
Change in fair value of excess servicing spread — — (1,037)
Average balances:
Excess servicing spread financing $ — $ — $ 21,563
At end of year:
Changes in fair value of MSRs and MSLs attributable to changes in fair value inputs decreased in the year ended December 31, 2023 compared to 2022 primarily due to the smaller increase in interest rates in 2023 as compared to 2022. Changes in fair value of MSRs attributable to changes in fair value inputs increased in the year ended December 31, 2022 compared to 2021 primarily due to significant increases in interest rates and resulting decreases in expected future prepayment speeds in 2022. Increasing interest rates reduce the rate of prepayments of the underlying loans associated with the servicing rights, which increases the cash flows expected from the servicing rights, while decreasing interest rates have the opposite effect.
Hedging results reflect valuation losses attributable to the effects of interest rate increases on the fair value of the hedging instruments in the years ended December 31, 2023 and 2022 compared to lesser or opposite circumstances and effects in 2021.
Changes in realization of cash flows are influenced by changes in the level of servicing assets and liabilities and changes in estimates of the remaining cash flows to be realized. Realization of cash flows increased in the year ended December 31, 2023 compared to 2022 and 2021 primarily due to the growth in our investment in MSRs.
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Following is a summary of our loan servicing portfolio:
December 31,
(in thousands)
Loans serviced
Prime servicing:
Owned:
Mortgage servicing rights and liabilities
Special servicing subserviced for PMT 9,925 20,797
Delinquencies:
Owned servicing:
Subserviced for PMT:
Following is a summary of characteristics of our MSR and MSL servicing portfolio as of December 31, 2023:
Average
(Dollars and loan count in thousands)
Government (2):
Government-sponsored entities:
(1) Loan-to-Value
(3) Represents MSRs on conventional loans sold to private investors.
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Net Interest Expense
Net interest expense is summarized below:
Year ended December 31,
(in thousands)
Interest income:
From Townsgate Closing Services, LLC 84 — —
From PennyMac Mortgage Investment Trust — — 387
Interest expense:
Interest on mortgage loan impound deposits 9,795 7,066 5,545
Other 1,545 — —
Net interest expense decreased $36.5 million in the year ended December 31, 2023 compared to 2022. The decrease was primarily due to:
Net interest expense decreased $49.2 million in the year ended December 31, 2022 compared to 2021. The decrease was primarily due to:
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Management fees
Management fees are summarized below:
Year ended December 31,
(in thousands)
Performance incentive — — 3,007
Management fees decreased $2.3 million in the year ended December 31, 2023 compared to 2022, reflecting the decrease in PMT’s average shareholders’ equity upon which its base management fees are based. Management fees decreased $6.7 million in the year ended December 31, 2022 compared to 2021, reflecting the decrease in PMT’s average shareholders’ equity upon which its base management fees are based and a decrease in performance incentive fees.
Change in Fair Value of Investment in and Dividends Received from PMT
The results of our holdings of common shares of PMT, which is included in Changes in fair value of investment in, and dividends received from PMT are summarized below:
Year ended December 31,
(in thousands)
Dividends from PennyMac Mortgage Investment Trust $ 120 $ 136 $ 141
Dividends received and change in fair value $ 312 $ (235) $ 336
Change in fair value of investment in and dividends received from PMT increased $547,000 in the year ended December 31, 2023 compared to 2022 and decreased $571,000 in the year ended December 31, 2022 compared to 2021, primarily due to changes in the fair value of our investment in PMT. We held 75,000 common shares of PMT during each of the three years ended December 31, 2023.
Expenses
Compensation
Our compensation expense is summarized below:
Year ended December 31,
(dollars in thousands)
Head count:
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Compensation expense decreased $158.3 million and $264.6 million in the year ended December 31, 2023, and 2022, respectively, compared to 2022 and 2021, respectively, primarily due to work force reductions necessitated by reductions in loan production and decreased incentive compensation accruals due to reduced staffing levels and lower achievement of profitability targets.
Legal settlements
Legal settlement expenses increased $158.1 million for the year ended December 31, 2023 compared to 2022. The increase in legal settlements expense is attributable to the arbitration ruling in a claim made against us by Black Knight Servicing Technologies, LLC and is discussed in detail in Note 18–Commitments and Contingencies to the consolidated financial statements included in this Report.
Loan origination
Loan origination expense decreased $59.1 million and $157.2 million in the year ended December 31, 2023 and 2022, respectively, compared to 2022, and 2021, respectively, due to decreased lending activities.
Servicing
Servicing expense increased $9.8 million in the year ended December 31, 2023 compared to 2022 primarily due to the non-recurrence in 2023 of the reversal of the provision for estimated servicing advance losses that was recognized during 2022 as COVID-19 related delinquencies decreased significantly. Servicing expense decreased $50.2 million in the year ended December 31, 2022 compared to 2021, primarily due to a larger reversal of the provision for estimated servicing advance losses recorded in prior years. The reduction also reflects the improvements in the performance of our servicing portfolio due to the resolution of delinquent loans relating to the COVID-19 pandemic.
Provision for income taxes
For the years ended December 31, 2023, 2022 and 2021, our effective income tax rates were 21.2%, 28.5%, and 26.2%, respectively. The lower effective tax rate for 2023 is primarily due to the permanent differences impact of an increase in deductible compensation along with the reduction in the future tax rate for some states. The decrease in the 2023 effective tax rate is further emphasized by the decrease in income before income taxes. The higher effective income tax rate for 2022 as compared to 2021 is primarily due to the effect of the repricing of the net deferred tax liability resulting from the higher booking tax rate partially offset by the effect of the reduction in the future tax rates for some states as well as the effect of an increase in non-deductible compensation.
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Balance Sheet Analysis
Following is a summary of key balance sheet items as of the dates presented:
December 31,
(in thousands)
ASSETS
Investments in and advances to affiliates 30,383 37,301
LIABILITIES AND STOCKHOLDERS' EQUITY
Liability for loans eligible for repurchase 4,889,925 4,702,103
Leverage ratios:
Total debt / Stockholders' equity 2.4 2.0
Total debt / Tangible stockholders' equity (1) 2.5 2.1
Total assets increased $2.0 billion from $16.8 billion at December 31, 2022 to $18.8 billion at December 31, 2023. The increase was primarily due to a $1.1 billion increase in MSRs and a $911.4 million increase in loans held for sale at fair value.
Total liabilities increased by $1.9 billion from $13.4 billion as of December 31, 2022 to $15.3 billion at December 31, 2023. The increase was primarily due to a $1.6 billion increase in borrowings to fund our inventory of loans held for sale and MSRs and a $187.8 million increase in liability for loans eligible for repurchase.
Cash Flows
Our cash flows for the three years ended December 31, 2023 are summarized below:
Year ended December 31,
(in thousands)
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Operating activities
Net cash (used in) provided by operating activities totaled $(1.6) billion, $6.0 billion, and $2.6 billion in the years ended December 31, 2023, 2022, and 2021, respectively. Our cash flows from operating activities are primarily influenced by changes in the levels of our inventory of loans held for sale as shown below:
Year ended December 31,
(in thousands)
Cash flows from:
Investing activities
Net cash used in investing activities was $273.3 million in the year ended December 31, 2023, primarily comprised of $242.0 million in net settlement of derivative financial instruments used to hedge our investment in MSRs, a $96.5 million increase in margin deposits and $31.2 million used in acquisition of capitalized software, partially offset by $98.1 million received from the sale of interest-only stripped securities.
Net cash used in investing activities was $721.6 million in the year ended December 31, 2022, primarily comprised of $871.9 million in net settlement of derivative financial instruments used to hedge our investment in MSRs and $71.9 million used in acquisition of capitalized software, partially offset by a $238.7 million decrease in margin deposits.
Net cash used in investing activities was $304.4 million in the year ended December 31, 2021, primarily comprised of $434.4 million in net settlement of derivative financial instruments used to hedge our investment in MSRs, partially offset by a $97.7 million decrease in margin deposits.
Financing activities
Net cash provided by financing activities was $1.5 billion in the year ended December 31, 2023, primarily due to a $923.3 million increase in short-term borrowings and a $680 million increase in long-term borrowings. The increase in borrowings reflects the increase in inventory of loans held for sale and our investment in MSRs.
Net cash used in financing activities was $4.3 billion in the year ended December 31, 2022, primarily due to a $4.5 billion decrease in short-term borrowings, which reflects decreased borrowing requirements relating to our reduced inventory of loans held for sale, and $406.1 million in repurchases of common stock, partially offset by issuance of a $650 million note payable secured by mortgage servicing rights.
Net cash used in financing activities was $2.5 billion in the year ended December 31, 2021, primarily due to a $2.4 billion decrease in short-term borrowings, which reflects decreased borrowing requirements relating to our inventory of loans held for sale, and a $958.2 million repurchase of common stock, partially offset by issuance of $1.2 billion of unsecured senior notes.
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Liquidity and Capital Resources
Our liquidity reflects our ability to meet our current obligations (including our operating expenses and, when applicable, the retirement of, and margin calls relating to, our debt, and margin calls relating to hedges on our commitments to purchase or originate mortgage loans and on our MSR investments), fund new originations and purchases, and make investments as we identify them. We expect our primary sources of liquidity to be through cash flows from business activities, proceeds from bank borrowings, proceeds from and issuance of equity or debt offerings. We believe that our liquidity is sufficient to meet our current liquidity needs.
Our current borrowing strategy is to finance our assets where we believe such borrowing is prudent, appropriate and available. Our borrowing activities are in the form of sales of assets under agreements to repurchase, sales of mortgage loan participation purchase and sale certificates, notes payable, a capital lease and unsecured senior notes. A significant amount of our borrowings have short-term maturities and provide for advances with terms ranging from 30 days to 364 days. Because a significant portion of our current debt facilities consist of short-term borrowings, we expect to renew these facilities in advance of maturity in order to ensure our ongoing liquidity and access to capital or otherwise allow ourselves sufficient time to replace any necessary financing.
Secured debt facilities for MSRs and servicing advances take various forms. Fannie Mae MSRs and Ginnie Mae MSRs and servicing advances are pledged to special purpose entities, each of which issues variable funding notes (“VFNs”) and may issue term notes and term loans that are secured by such Ginnie Mae or Fannie Mae assets. Term notes are issued to qualified institutional buyers under Rule 144A of the Securities Act and term loans are syndicated to banking entities, while the VFNs are sold to bank partners under agreements to repurchase. Freddie Mac MSRs are pledged to a single lender under a bi-lateral loan and security agreement.
On February 7, 2023, the Company, PNMAC GMSR ISSUER TRUST (the “Issuer Trust”), PLS and PNMAC entered into two VFN repurchase agreements as part of the structured finance transaction that PLS uses to finance Ginnie Mae mortgage servicing rights and related excess servicing spread and servicing advance receivables: a Series 2023-MSRVF1 Master Repurchase Agreement by and among PLS, as seller, Goldman Sachs Bank USA, as administrative agent and as a buyer, and PNMAC, as a guarantor, related to the excess servicing spread, and a Series 2020-SPIADVF1 Master Repurchase Agreement by and among PLS, as seller, and Goldman Sachs Bank USA, as administrative agent and buyer, related to the servicing advance receivables. The maximum purchase under each repurchase agreement is $300 million and each agreement is set to expire on February 7, 2025. On December 20, 2023, the repurchase agreement was amended and restructured to make PNMAC GMSR VFN Funding, LLC (“GMSR SPV”), the seller with PLS contributing the Ginnie Mae Mortgage servicing rights to GMSR SPV under a contribution, sale and security agreement.
On February 28, 2023, the Company, the Issuer Trust and PLS entered into a syndicated series of term loans (the “Series 2023-GTL1 Loan”) as part of the structured finance transaction that PLS uses to finance Ginnie Mae mortgage servicing rights and related excess servicing spread and servicing advance receivables. The initial 5-year term of the Series 2023-GTL1 Loan is set to expire on February 28, 2028, unless the Company exercises a one-year optional extension. The initial loan balance of the Series 2023-GTL1 Loan was $680 million.
On August 4, 2023, the Company, the Issuer Trust and PLS entered into two VFN repurchase agreements, as part of the structured finance transaction that PLS uses to finance Ginnie Mae mortgage servicing rights and related excess servicing spread and servicing advance receivables. The Series 2023-MSRVF2 Master Repurchase Agreement by and between PLS, as seller, and Nomura Corporate Funding Americas, LLC (“Nomura”), as administrative agent and as a buyer, is related to the servicing spread. The Series 2020-SPIADVF1 Master Repurchase Agreement by and between PLS, as seller, and Nomura, as administrative agent and buyer, is related to the servicing advance receivables. The maximum amount outstanding under both repurchase agreements is $350 million and each agreement is set to expire on August 5, 2024.
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On October 25, 2023, the Company, PNMAC, the Issuer Trust and PLS entered into a syndicated series of term loans (the “Series 2023-GTL2 Loan”), as part of the structured finance transaction that PLS uses to finance Ginnie Mae mortgage servicing rights, related excess servicing spread and servicing advance receivables. The initial 5-year term of the Series 2023-GTL2 Loan is set to expire on October 25, 2028. The initial note balance of the Series 2023-GTL2 Loan is $125 million.
On December 11, 2023, the Company, together with its subsidiaries, issued $750 million in 7.875% unsecured senior notes due 2029 in a private placement to “qualified institutional buyers”.
Our repurchase agreements represent the sales of assets together with agreements for us to buy back the assets at a later date. The table below presents the average outstanding, maximum and ending balances:
Year ended December 31,
(in thousands)
The differences between the average and maximum daily balances on our repurchase agreements reflect the fluctuations throughout the years of our inventory as we fund and pool mortgage loans for sale in guaranteed mortgage securitizations.
Our debt repurchase 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 a decrease in the market value (as determined by the applicable lender) of the assets subject to the related financing agreement. Upon notice from the applicable lender, we will generally be required to satisfy the margin call on the day of such notice or within one business day thereafter, depending on the timing of the notice.
Our secured financing agreements at PLS require us to comply with various financial covenants. The most significant financial covenants currently include the following:
● a minimum in unrestricted cash and cash equivalents of $100 million;
● a minimum tangible net worth of $1.25 billion;
● a maximum ratio of total liabilities to tangible net worth of 10:1; and
With respect to servicing performed for PMT, PLS is also subject to certain covenants under PMT’s debt agreements. Covenants in PMT’s debt agreements are equally, or sometimes less, restrictive than the covenants described above.
PFSI has issued unsecured senior notes (the “Unsecured Notes”) to qualified institutional buyers under Rule 144A of the Securities Act of 1933, as amended. The Unsecured Notes are fully and unconditionally guaranteed, jointly and severally, on a senior unsecured basis by the Company’s existing and future wholly-owned domestic subsidiaries (other than certain excluded subsidiaries defined in the indentures under which the Unsecured Notes were issued).
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Our Unsecured Notes contain covenants that limit our and our restricted subsidiaries’ ability to engage in specified types of transactions, including, but not limited to, the following:
● incur, assume or guarantee additional debt or issue preferred stock;
● incur liens on assets;
● enter into transactions with affiliates; and
Although these financial covenants limit the amount of indebtedness that we may incur and affect our liquidity through minimum cash reserve requirements, we believe that these covenants currently provide us with sufficient flexibility to successfully operate our business and obtain the financing necessary to achieve that purpose.
We are also subject to liquidity and net worth requirements established by FHFA for Agency seller/servicers and Ginnie Mae for single-family issuers. FHFA and Ginnie Mae have established minimum liquidity requirements and revised their net worth requirements for their approved non-depository single-family sellers/servicers or issuers
In August 2022, the Agencies issued revised capital and liquidity requirements. Most of the requirements became effective on or before December 31, 2023, for issuers of securities guaranteed by Ginnie Mae and seller/servicers of mortgage loans to Fannie Mae and Freddie Mac. We believe that we are in compliance with Agencies’ revised requirements. The risk-based capital requirements issued by Ginnie Mae will be effective on December 31, 2024. We believe that we are in compliance with those pending requirements as of December 31, 2023.
On August 4, 2021, our Board of Directors increased our common stock repurchase program from $1 billion to $2 billion. Share repurchases may be effected through open market purchases or privately negotiated transactions in accordance with applicable rules and regulations. The stock repurchase program does not have an expiration date and the authorization does not obligate us to acquire any particular amount of common stock. From inception through December 31, 2023, we have repurchased approximately $1.8 billion of common shares under our stock repurchase program.
We continue to explore a variety of means of financing our business, including debt financing through bank warehouse lines of credit, bank loans, repurchase agreements, securitization transactions and corporate debt. However, there can be no assurance as to how much additional financing capacity such efforts will produce, what form the financing will take or whether such efforts will be successful.
Debt Obligations
As described further above in “Liquidity and Capital Resources,” we currently finance certain of our assets through short-term borrowings with major financial institutions in the form of sales of assets under agreements to repurchase and mortgage loan participation purchase and sale agreements. We access the capital market for long-term debt through the issuance of secured notes payable and Unsecured Notes. The issuer under our secured term note facilities is PLS or a wholly-owned issuer trust guaranteed by PNMAC. In addition, we have issued Unsecured Notes guaranteed by certain of our restricted wholly-owned subsidiaries.
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Under the terms of these financing agreements, PLS is required to comply with certain financial covenants, as described further above in “Liquidity and Capital Resources,” and various non-financial covenants customary for transactions of this nature. As of December 31, 2023, we believe we were in compliance in all material respects with these covenants.
Many of our debt financing agreements contain a condition precedent to obtaining additional funding that requires PLS to maintain positive net income for at least one of the previous two consecutive quarters, or other similar measures. PLS is compliant with all such conditions.
The financing agreements also contain margin call provisions that, upon notice from the applicable lender, require us to transfer cash or, in some instances, additional assets in an amount sufficient to eliminate any margin deficit. Upon notice from the applicable lender, we will generally be required to satisfy the margin call on the day of such notice or within one business day thereafter, depending on the timing of the notice.
In addition, the financing agreements contain events of default (subject to certain materiality thresholds and grace periods), including payment defaults, breaches of covenants and/or certain representations and warranties, cross-defaults, guarantor defaults, servicer termination events and defaults, material adverse changes, bankruptcy or insolvency proceedings and other events of default customary for these types of transactions. The remedies for such events of default are also customary for these types of transactions and include the acceleration of the principal amount outstanding under the agreements and the liquidation by our lenders of the mortgage loans or other collateral then subject to the agreements.
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Our borrowings have maturities as follows:
Outstanding Total Committed Facility
Lender indebtedness (1) facility size (2) facility (2) Maturity date (2)
(dollar amounts in thousands)
Assets sold under agreements to repurchase
Mortgage loan participation purchase and sale agreements
Notes payable
(1) Outstanding indebtedness as of December 31, 2023.
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The amount at risk (the fair value of the assets pledged plus the related margin deposit, less the amount advanced by the counterparty and accrued interest) relating to our assets sold under agreements to repurchase is summarized by counterparty below as of December 31, 2023:
Weighted average
maturity of
advances under
Counterparty Amount at risk repurchase agreement Facility maturity
(in thousands)
On March 16, 2023, the Company, PNMAC, the Issuer Trust, and PLS, consented to assignments of all of the credit facilities provided to the Company by Credit Suisse First Boston Mortgage Capital LLC, as administrative agent, and Credit Suisse AG, Cayman Islands Branch, as a buyer or purchaser, and Alpine Securitization LTD, as a buyer or purchaser. All of the credit facilities were assigned to Atlas Securitized Products, L.P. (“Atlas SP”), Atlas Securitized Products Investments 3, L.P., Atlas Securitized Products Funding 2, L.P., and Nexera Holding LLC.
All debt financing arrangements that matured between December 31, 2023 and the date of this Annual Report have been renewed or extended and are described in Note 14—Short-TermBorrowings to the accompanying consolidated financial statements.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Market risk is the exposure to loss resulting from changes in interest rates, foreign currency exchange rates, commodity prices, equity prices, real estate values and other market-based risks. The primary market risks that we are exposed to are fair value risk, interest rate and prepayment risk.
Fair Value Risk
Our IRLCs, mortgage loans held for sale, MSRs, MSLs and ESS financing are reported at their fair values. The fair value of these assets fluctuates primarily due to changes in interest rates. The fair value risk we face is primarily attributable to interest rate risk and prepayment risk.
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Interest Rate Risk
Interest rate risk is highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations, and other factors beyond our control. Changes in interest rates affect both the fair value of, and interest income we earn from, our mortgage-related investments and our derivative financial instruments. This effect is most pronounced with fixed-rate mortgage assets.
In general, rising interest rates negatively affect the fair value of our IRLCs and inventory of mortgage loans held for sale and positively affect the fair value of our MSRs. Changes in interest rates significantly influence the prepayment speeds of the loans underlying our investments in MSRs, which can have a significant effect on their fair values. Changes in interest rate are most prominently reflected in the prepayment speeds of the loans underlying our investments in MSRs and the discount rate used in their valuation.
Our operating results will depend, in part, on differences between the income from our investments and our financing costs. Presently most of our secured debt financing is based on a floating rate of interest calculated on a fixed spread over the relevant index, as determined by the particular financing arrangement.
Prepayment Risk
To the extent that the actual prepayment rate on the mortgage loans underlying our MSRs differs from what we projected when we initially recognized these assets and liabilities when we measure fair value as of the end of each reporting period, the carrying value of these assets and liabilities will be affected. In general, a decrease in the principal balances of the mortgage loans underlying our MSRs or an increase in prepayment expectations will decrease our estimates of the fair value of the MSRs, thereby reducing net servicing income, partially offset by the beneficial effect on net servicing income of a corresponding reduction in the fair value of our MSLs.
Risk Management Activities
We engage in risk management activities primarily in an effort to mitigate the effect of changes in interest rates on the fair value of our assets. To manage this price risk, we use derivative financial instruments acquired with the intention of moderating the risk that changes in market interest rates will result in unfavorable changes in the fair value of our assets, primarily prepayment exposure on our MSR investments as well as IRLCs and our inventory of loans held for sale. Our objective is to minimize our hedging expense and maximize our loss coverage based on a given hedge expense target. We do not use derivative financial instruments other than IRLCs for purposes other than in support of our risk management activities.
Our strategies are reviewed daily within a disciplined risk management framework. We use a variety of interest rate and spread shifts and scenarios and define target limits for market value and liquidity loss in those scenarios. With respect to our IRLCs and inventory of loans held for sale, we use MBS forward sale contracts to lock in the price at which we will sell the mortgage loans or resulting MBS, and further use MBS put options to mitigate the risk of our IRLCs not closing at the rate we expect. With respect to our MSRs, we seek to mitigate mortgage-based loss exposure utilizing MBS forward purchase and sale contracts, address exposures to smaller interest rate shifts with Treasury and interest rate swap futures, and use options and swaptions to achieve target coverage levels for larger interest rate shocks.
Fair Value Sensitivities
The following sensitivity analyses are limited in that they were performed at a particular point in time; only contemplate the movements in the indicated variables; do not incorporate changes to other variables; are subject to the accuracy of various models and inputs used; and do not incorporate other factors that would affect our overall financial performance in such scenarios, including operational adjustments made by management to account for changing circumstances. For these reasons, the following estimates should not be viewed as earnings forecasts.
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Mortgage Servicing Rights
The following tables summarize the estimated change in fair value of MSRs as of December 31, 2023, given
several shifts in pricing spreads, prepayment speed and annual per loan cost of servicing:
Change in fair value attributable to shift in: -20% -10% -5% +5% +10% +20%
(in thousands)
Item 8. Financial Statements and Supplementary Data
The information called for by this Item 8 is hereby incorporated by reference from our Financial Statements and Auditors’ Report in Part IV of this Report.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A. Controls and Procedures