PMT US Equity☆

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

We are a specialty finance company that invests in 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. A significant portion of our investment portfolio is comprised of mortgage-related assets that we have created through our correspondent production activities, including mortgage servicing rights (“MSRs”), subordinate mortgage-backed securities (“MBS”), and credit risk transfer (“CRT”) arrangements, which include CRT Agreements (“CRT Agreements”) and CRT strips that absorb credit losses on certain of the loans we have sold. We also invest in Agency and senior non-Agency MBS, subordinate credit-linked MBS and interest-only ("IO") and principal-only ("PO") stripped MBS. We have also historically invested in distressed mortgage assets (distressed loans and real estate acquired in settlement of loans (“REO”)), which we have substantially liquidated.

We are externally managed by PNMAC Capital Management, LLC (“PCM”), an investment adviser that specializes in and focuses on U.S. mortgage assets. Our loans and MSRs are serviced by PennyMac Loan Services, LLC (“PLS”). PCM and PLS are both indirect controlled subsidiaries of PennyMac Financial Services, Inc. (“PFSI”), a publicly-traded mortgage banking and investment management company separately listed on the New York Stock Exchange.

During the year ended December 31, 2023, we purchased newly originated prime credit quality residential loans with fair values totaling $87.5 billion as compared to $88.1 billion and $181.4 billion for the years ended December 31, 2022 and December 31, 2021, respectively, in our correspondent production business. To the extent that we purchase loans that are insured by the U.S. Department of Housing and Urban Development through the Federal Housing Administration, or insured or guaranteed by the U.S. Department of Veterans Affairs or U.S. Department of Agriculture, we and PLS have agreed that PLS will fulfill and purchase such 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 loans. During the year ended December 31, 2023, our sales of loans to PLS also included $31.1 billion in in unpaid principal balance (“UPB”) of conventional loans in order to allow us to optimize our use and allocation of capital.

Our loan sales volume included $72.4 billion, $50.6 billion and $67.9 billion of loans we sold to PLS during the years ended December 31, 2023, 2022 and 2021, respectively. We receive a sourcing fee from PLS based on the UPB of each loan that we sell to PLS under such arrangement, and earn interest income on the loan for the period we hold it before the sale to PLS. During the years ended December 31, 2023, 2022 and 2021 we received sourcing fees totaling $7.2 million, $5.0 million and $6.5 million, respectively.

We operate our business in four segments: Credit sensitive strategies, Interest rate sensitive strategies, Correspondent production and our Corporate operations, as described below.

Our Investment Activities

Credit Sensitive Investments

CRT Arrangements

We have not entered into any CRT arrangements since 2020. We held net CRT-related investments (comprised of deposits securing CRT arrangements, CRT derivatives, CRT strips and an interest-only security payable) totaling approximately $1.1 billion at December 31, 2023.

Subordinate Credit-Linked Mortgage-Backed Securities

Subordinate credit-linked MBS provide us with a higher yield than senior securities. However, we retain credit risk in the subordinate credit-linked MBS since they are the first securities to absorb credit losses relating to the underlying loans. We purchased approximately $87.3 million of subordinate credit-linked MBS during the year ended December 31, 2023. We held subordinate credit-linked MBS with fair values totaling approximately $301.2 million at December 31, 2023.

As the result of the Company’s consolidation of the variable interest entities that issued certain subordinate MBS as described in Note 6 – Variable Interest Entities – Subordinate Mortgage-Backed Securities to the consolidated financial statements included in this Report, we include the loans underlying these transactions with UPB totaling approximately $1.7 billion on our consolidated balance sheet as of December 31, 2023.

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Interest Rate Sensitive Investments

Our interest rate sensitive investments include:

•

Mortgage servicing rights. During the year ended December 31, 2023, we purchased $16.3 million of MSRs and received approximately $292.5 million of MSRs as proceeds from sales of loans acquired for sale. We held approximately $3.9 billion of MSRs at fair value at December 31, 2023.

•

REIT-eligible Agency, senior non-Agency, IO and PO stripped MBS. We purchased approximately $559.0 million of Agency fixed-rate pass-through securities and senior non-Agency MBS, net of sales during the year ended December 31, 2023. We held Agency fixed-rate pass-through, senior non-Agency, IO stripped and PO stripped MBS with fair values totaling approximately $4.5 billion at December 31, 2023.

Correspondent Production

Our correspondent production activities involve the acquisition and sale of newly originated prime credit quality residential loans. Correspondent production has served as the source of most of our investments in MSRs, non-Agency securitizations and CRT arrangements. Our correspondent production and resulting investment activity are summarized below:

Year ended December 31,

(in thousands)

Sales of loans acquired for sale:

Investment activities resulting from correspondent production:

(1)

The trusts issuing the securities are consolidated on our consolidated balance sheets. Therefore, our investments in these securities are shown as their underlying assets, Loans at fair value, with the securities held by non-affiliates being shown as Asset-backed financings of variable interest entities at fair value.

Taxation

We believe that we qualify to be taxed as a REIT and as such will not be subject to federal income tax on that portion of our income that is distributed to shareholders as long as we meet applicable REIT asset, income and share ownership tests. If we fail to qualify as a REIT, and do not qualify for certain statutory relief provisions, our profits will be subject to income taxes and we may be precluded from qualifying as a REIT for the four tax years following the year that we lose our REIT qualification.

A portion of our activities, including our correspondent production business, is conducted in our taxable REIT subsidiary (“TRS”), which is subject to corporate federal and state income taxes. Accordingly, we make a provision for income taxes with respect to the operations of our TRS. We expect that the effective rate for the provision for income taxes may be volatile in future periods. Our goal is to manage the business to take full advantage of the tax benefits afforded to us as a REIT.

We evaluate our deferred tax assets quarterly to determine if valuation allowances are required based on the consideration of all available positive and negative evidence using a “more-likely-than-not” standard with respect to whether deferred tax assets will be realized. Our evaluation considers, among other factors, taxable loss carryback availability, expectations of sufficient future taxable income, trends in earnings, existence of taxable income in recent years, the future reversal of temporary differences, and available tax planning strategies that could be implemented, if required. The ultimate

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realization of our deferred tax assets depends primarily on our ability to generate future taxable income during the periods in which the related deferred tax assets become deductible.

Critical Accounting Policies

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 us to make difficult, subjective or complex judgments. Our critical accounting policies primarily relate to our fair value estimates.

Fair value

Our consolidated balance sheet is substantially comprised of assets that are measured at or 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 we have elected to carry them at 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.

The fair value level assigned to an asset or liability is identified based on the lowest level of inputs that are significant to determining the respective asset's or liability’s fair value. These levels are:

Percentage of

(in thousands)

Total assets measured at or based on fair value (3) $ 12,290,205 94 % 628 %

Total shareholders’ equity $ 1,957,090

(1)

Includes assets measured on both a recurring and nonrecurring basis based on the accounting principles applicable to the specific asset or liability and whether we have elected to carry the item at its fair value.

(2)

For purposes of this discussion, includes Deposits securing credit risk transfer arrangements which are carried at amortized cost. These deposits along with the related CRT derivatives and CRT strips are held in the form of securities which are the basis for valuation of the CRT derivatives and strips.

(3)

Percentages may not sum to total due to rounding.

At December 31, 2023, $12.3 billion, or 94%, of our total assets were carried at fair value on a recurring basis and $4.5 million, or less than 1% (consisting of REO), were carried based on fair value on a non-recurring basis. Of these assets, $5.3 billion, or 40%, of total assets are measured using “Level 3” fair value inputs-significant inputs where there is difficulty observing the inputs used by the market participants to establish fair value. Different approaches to valuing or changes in inputs used to measure these assets can have a significant effect on the amounts reported for these items and their effects on our results of operations.

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Changes in inputs to measurement of Level 3 fair value financial statement items have a significant effect on the amounts reported for these items including their reported balances and their effects on our pre-tax income as summarized below:

Change in fair value

(in thousands)

(1)

Includes loans held for sale and loans at fair value.

(2)

Excluding changes in fair value attributable to realization of cash flows.

As a result of the difficulty in observing certain significant valuation inputs affecting “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 estimating the fair value of these assets and liabilities. Such differences may result in significantly different fair value measurements. Likewise, due to the general illiquidity of some of these fair value assets and liabilities, subsequent transactions may be at values significantly different from those reported.

Because the fair value of “Level 3” fair value assets and liabilities is difficult to estimate, our valuation process is conducted by specialized staff and receives significant management oversight. We have assigned the responsibility for estimating the fair values of our “Level 3” fair value assets and liabilities, except for interest rate lock commitments (“IRLCs”), to specialized staff within PFSI's capital markets group. With respect to those valuations, PFSI’s capital markets valuation staff reports to PFSI’s valuation committee, which oversees the valuations. PFSI’s valuation committee includes the Company’s chief financialand investment officers as well as other senior members of PFSI’s finance, capital markets and risk management staffs.

The fair value of our IRLCs is developed by PFSI's capital markets risk management staff and is reviewed by PFSI's capital markets operations group in the exercise of their internal control responsibilities.

Following is a discussion relating to our approach to measuring the assets and liabilities that are most affected by “Level 3” fair value estimates.

Loans

We carry loans at their fair values. We recognize changes in the fair value of loans in current period results of operations as a component of either Net gains on loans acquired for sale or Net gains (losses) on investments and financings. We estimate fair value of loans based on whether the loans are saleable into active markets with observable pricing.

•

We categorize loans that are saleable into active markets with observable pricing inputs as “Level 2” fair value assets. Such loans include substantially all of our loans acquired for sale and our loans held in VIEs. We estimate such loans’ fair values using their quoted market price or market price equivalent. We held $2.1 billion of such loans at fair value at December 31, 2023.

•

We categorize loans that are not saleable into active markets with observable pricing inputs as “Level 3” fair value assets. Such loans include our investments in distressed loans, home equity and commercial loans held for sale and certain of the loans acquired for sale which we subsequently repurchased pursuant to representations and warranties or that we identified as non-salable to the Agencies. We held $8.4 million of such loans at fair value at December 31, 2023.

We estimate the fair value of our “Level 3” fair value loans based on the expected resolution of individual loans for distressed loans and using a discounted cash flow valuation model for loans held for sale. Inputs to the discounted cash flow 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.

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Derivative Assets

Interest Rate Lock Commitments

Our net gains on loans acquired for sale include our estimates of gains or losses we expect to realize upon the sale of loans we have committed to purchase but have not yet purchased or sold. Therefore, we recognize a substantial portion of our net gains on loans acquired for sale at fair value before we purchase the loans. In the course of our correspondent production activities, we make contractual commitments to correspondent sellers to purchase loans at specified terms. We call these commitments IRLCs. We recognize the fair values of IRLCs at the time we make the commitment to the correspondent seller and adjust the fair value of such IRLCs during the time the commitment is outstanding.

We carry IRLCs as either derivative assets or derivative liabilities on our consolidated balance sheet. The fair value of an IRLC is transferred to the fair value of Loans acquired for sale at fair value when the 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 estimate of the fair value of the MSRs we expect to receive in the sale of the loan and the probability that the 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 loan will fund and changes in mortgage market interest rates are recognized as IRLCs move through the purchase process and may result in significant changes in the 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 acquiredfor sale and may be included in Net loan servicing fees – From nonaffiliates – Mortgage servicing rights hedging results when we include the IRLCs in our MSR hedging activities in the period of the change. The financial effects of changes in the pull-through rates and MSR fair values generally move in different directions. 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 principal and interest payment portion of the loans that decrease in fair value.

A shift in the market for IRLCs or a change in our assessment of an input to the valuation of IRLCs can have an effect on the amount of Net gains on loans acquired for sale for the period. We believe that the fair value of IRLCs is most sensitive to changes in pull-through rate inputs. We held $7.5 million of net IRLC assets at December 31, 2023. Following is a quantitative summary of the effect of changes in pull-through inputs on the fair value of IRLCs at December 31, 2023:

Effect on fair value of a change in pull-through rate

Change in input (1) Effect on fair value

(in thousands)

(1)

Pull-through rate adjustments for individual loans are limited to adjustments that will increase the individual loan’s pull-through rate to 100%.

Credit Risk Transfer Arrangements

We hold CRT arrangements with Fannie Mae, pursuant to which we sold pools of loans into Fannie Mae-guaranteed securitizations while retaining recourse obligations as part of the retention of an interest-only ownership interest in such loans. We carry the strips or derivative assets or liabilities relating to these transactions at fair value and recognize changes in the respective asset's or liability’s fair values in Net gains (losses) on investments and financings in the consolidated statements of operations.

A shift in the market for CRT arrangements or a change in our assessment of an input to the valuation of CRT arrangements can have a significant effect on the fair value of CRT arrangements and in our results of operations for the period. We believe that the most significant “Level 3” fair value inputs to the valuation of CRT arrangements are the pricing spread (discount rate) and the remaining loss expectation, which is influenced by the changes in the fair value of the properties securing the loans in the reference pool.

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We held $1.1 billion of net CRT arrangement assets at December 31, 2023. Following is a summary of the effect on fair value of various changes to the pricing spread and property value shifts (which is used in the determination of estimated remaining credit losses) inputs used to estimate the fair value of our CRT arrangements as of December 31, 2023:

Change in input Effect on fair value Change in input Effect on fair value

(in basis points) (in thousands) (in thousands)

Mortgage Servicing Rights

MSRs represent the value of a contract that obligates us to service the 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 carry all of our investments in MSRs at fair value and recognize changes in fair value in current period results of operations. Changes in fair value of MSRs are recognized as a component of Net loan servicing fees – From nonaffiliates – Change in fair value of mortgage servicing rights in our consolidated statements of operations.

A shift in the market for MSRs or a change in our assessment of an input to the valuation of MSRs can have a significant effect on the fair value of MSRs and in our results of operations 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. We held $3.9 billion of MSRs at December 31, 2023. Following is a summary of the effect on fair value of various changes to these key inputs that we use in making our fair value estimates as of December 31, 2023:

Effect on fair value of a change in input

Change in input Pricing spread Prepayment speed Servicing cost

(in thousands)

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. Therefore, the preceding analyses are not projections of the effects of a shock event or a change in our estimate of an input and should not be relied upon as earnings projections.

Critical Accounting Policies Not Tied to Fair Value

Consolidation—Variable Interest Entities

We enter into various types of transactions with special purpose entities (“SPEs”), which are trusts that are established for limited purposes. Generally, SPEs are formed in connection with securitization transactions. In a securitization transaction, we transfer assets on our balance sheet to an SPE, which then issues various forms of interests in those assets to investors. In a securitization transaction, we typically receive cash and/or beneficial interests in the 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 activities that most significantly impact the economic performance of the VIE. 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. Expected residual returns represent the expected positive variability in the fair value of a VIE’s net assets.

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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 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. The primary beneficiary of a VIE must include the assets and liabilities of the VIE on its consolidated balance sheet. Therefore, our evaluation of a securitization as a VIE and our status as the VIE’s primary beneficiary can have a significant effect on our consolidated balance sheet.

We evaluate the securitization trust into which assets are transferred to determine whether the entity is a VIE. To determine whether a variable interest we hold could potentially be significant to the VIE, we consider both qualitative and quantitative factors regarding the nature, size and form of our involvement with the VIE. We assess whether we are the primary beneficiary of a VIE on an ongoing basis.

For our financial reporting purposes, the underlying assets owned by the securitization VIEs that we presently consolidate are shown under Loans at fair value, Derivative assets, Derivative and credit risk transfer strip liabilities and Deposits securing credit risk transfer agreements on our consolidated balance sheets:

•

The VIEs that hold loans we have securitized are shown as their constituent assets and liabilities- Loans at fair value, and the securities issued to third parties by the consolidated VIE are shown as Asset-backed financings of variable interest entities at fair value on our consolidated balance sheets. We include the interest earned on the loans held by the VIEs in Interest income and interest attributable to the asset-backed securities issued by the VIEs in Interest expense in our consolidated statements of operations. Changes in the fair value of loans held in the VIEs and the associated asset-backed financings are included in Net gains (losses) on investments and financings in our consolidated statements of operations.

•

The VIEs that hold assets relating to our CRT arrangements are shown as their constituent assets and liabilities – the Deposit securing credit risk transfer agreements, Derivative assets and Derivative and credit risk liabilities which represent our IO ownership interest and obligation to absorb credit losses arising from the reference loans, and Interest-only security payable at fair value. We include the income we receive from the IO ownership interests and changes in fair value of the Derivative assets, Derivative and credit risk liabilities and Interest-only security payable at fair value in Net gains (losses) on investments and financings in our consolidated statements of operations.

Income Taxes

We have elected to be taxed as a REIT and believe we comply with the provisions of the Internal Revenue Code applicable to REITs. Accordingly, we believe that we will not be subject to federal income tax on that portion of our REIT taxable income that is distributed to shareholders as long as we meet the requirements of certain asset, income and share ownership tests. If we fail to qualify as a REIT, and do not qualify for certain statutory relief provisions, we 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 our REIT qualification.

Our TRS is subject to federal and state income taxes. We provide for income taxes using the asset and liability method. We recognize deferred tax assets and liabilities for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. We measure deferred tax assets and liabilities using enacted rates expected to apply to taxable income in the years in which we expect those temporary differences to be recovered or settled.

We recognize the effect on deferred taxes of a change in tax rates in income in the period in which the change occurs. We establish a valuation allowance 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. We recognize a tax position that meets this standard as the largest amount that in our judgment exceeds 50 percent likelihood of being realized upon settlement. We will classify any penalties and interest as a component of income tax expense.

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 effect of these developments on us.

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Non-Cash Investment Income

A substantial portion of our net investment income is comprised of non-cash items, including fair value adjustments and recognition of the fair value of assets created and liabilities incurred in loan sale transactions. Because we have elected, or are required by GAAP, to record certain of our financial assets (comprised of MBS, loans acquired for sale at fair value, loans at fair value and Excess Servicing Spread ("ESS")), our derivatives and CRT strips, our MSRs, and our asset-backed financings and interest-only security payable at fair value, a substantial portion of the income or loss we record with respect to such assets and liabilities results from non-cash changes in fair value.

The amounts of net non-cash investment income items included in net investment income are as follows:

Year ended December 31,

(dollars in thousands)

Net gains (losses) on investments and financings:

Loans:

Excess servicing spread purchased from PFSI — — 1,651

Interest-only security payable at fair value (10,742 ) (11,332 ) 164

Non-cash items as a percentage of net investment income 95 % 217 % 340 %

(1)

Amount represents MSRs received, liability for representations and warranties incurred in loan sales transactions and changes in fair value of loans, IRLCs and hedging derivatives held at year end.

(2)

Includes fair value changes due to changes in fair value inputs and fair value changes related to MSR derivative hedging instruments.

We receive or pay cash relating to:

•

Our investment in mortgage-backed securities through monthly principal and interest payments from the issuer of such securities or from the sale of the investment;

•

Loan investments when the investments are paid down, paid off or sold, when payments of principal and interest occur on such loans or when the properties acquired in settlement of loans are sold;

•

ESS investments through a portion of the monthly interest payments collected on the loans in the ESS reference pool or from sales of the investment;

•

CRT arrangements through a portion of the interest payments collected on loans in the CRT arrangements’ reference pools, interest payments from the investment of the deposits securing the arrangement in short-term investments and the release to us of the deposits securing the arrangements as principal on such loans is repaid;

•

Hedging instruments when we receive or make margin deposits as the fair value of respective instruments change, when the instruments mature or when we effectively cancel the transactions through offsetting trades;

•

Our liability for representations and warranties when we repurchase loans or settle loss claims from investors; and

•

MSRs in the form of loan servicing fees and placement fees on the deposits we manage on behalf of the borrowers and investors in the loans we service.

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Results of Operations

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 $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 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 the correspondent channel. 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. We have also increased our sales of conventional loans to PLS during the year ended December 31, 2023, and we intend to continue to sell a portion of our conventional loans to PLS in 2024 to optimize our use and allocation of capital.

Elevated interest rates may also lead to a reduction in economic activity and slowing home price growth or depreciation, which could lead to increasing mortgage delinquencies or defaults and increased losses. If these effects are realized, they could negatively affect the performance of our credit-sensitive assets such as CRT or subordinate credit-linked notes and increase losses from our representations and warranties. However, many of the loans underlying our assets have favorable credit characteristics including low loan-to-value ratios, which are likely to help offset the negative effects of credit performance in an economic downturn.

The competitive landscape for our correspondent business has also been affected by the exit or reduction in activity of several large entities, which has reduced and may continue to reduce competition in that business compared to previous years.

The following is a summary of our key performance measures:

Year ended December 31,

(dollar amounts in thousands, except per common share amounts)

Pretax income (loss) by segment:

Annualized return on average common shareholders' equity 11.1 % (7.2 )% 1.3 %

Earnings (loss) per common share

Dividends per common share $ 1.60 $ 1.81 $ 1.88

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Book value per common share $ 16.13 $ 15.78

Closing price per common share $ 14.95 $ 12.39

(1)

Include net gains on sales of loans and loan origination fees.

Our results of operations increased by $272.9 million during the year ended December 31, 2023, as compared to the year ended December 31, 2022, reflecting the effect of decreased losses on MBS, increased valuation of CRT-related investments and a reduced provision for income taxes, offset by the fair value performance of our MSR investments.

The increase in pretax results is summarized below:

•

Our credit sensitive strategies segment recognized a $247.7 million increase in net gains on our CRT arrangements as credit spreads tightened due to supply and demand dynamics and an improving macroeconomic outlook compared to the year ended December 31, 2022, in which the macroeconomic outlook was worsening.

•

Our interest rate sensitive strategies segment benefited less from the slower rise in interest rates and reduced interest rate sensitivity of our assets during the year ended December 31, 2023, as compared to the year ended December 31, 2022, resulting in a $651.7 million increase in valuation gains on MBS, offset by a $620.9 million decrease in net servicing fees caused by lower valuations net of hedge impact in MSRs.

•

Our correspondent production segment recognized a $14.2 million increase in gains on sales of loans during the year ended December 31, 2023, reflecting a reduction of our liability for representations and warranties and improved gain on sale margins partially offset by reduced volume of sales to nonaffiliates.

Our consolidated net income decreased by $130.1 million during the year ended December 31, 2022, reflecting the income tax effects of shifts in our net investment income from one of our disregarded entity subsidiaries of the Operating Partnership to our taxable REIT subsidiary; the decreases in CRT-related investment fair valuation, gains on loans held for sale and loan origination fees; partially offset by the improved fair value performance of our MSR investments during the year ended December 31, 2022, as compared to the same period in 2021.

The decrease in pretax results is summarized below:

•

Our credit sensitive strategies segment recognized a $434.1 million decrease in net gains on our CRT arrangements as compared to 2021, due to the effect of credit spread widening due to increasing macroeconomic uncertainty during 2022 as compared to the continuing recovery from the market disruption caused by the COVID-19 pandemic during 2021.

•

Our interest rate sensitive strategies segment was positively affected by a $945.6 million increase in net servicing fees caused by positive fair value changes in our investment in MSRs and hedging results and a $49.2 million decrease in net interest expense, reflecting increased earnings on placement fees and reduced interest shortfall on repayments relating to Agency securitizations, partially offset by a $502.4 million increase in losses on MBS, reflecting the effect of increasing interest rates.

•

Our correspondent production segment recognized a $180.2 million decrease in gains on sales of the loans and origination fees, reflecting decreases in both production volume and gain on sale margins during the year ended December 31, 2022, resulting from the effect of increasing interest rates on loan demand.

•

We recorded income tax provision of $136.4 million due to fair value gains on MSRs held in our TRS.

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Net Investment Income

Our net investment income is summarized below:

Year ended December 31,

(in thousands)

Net Loan Servicing Fees

Our net loan servicing fees have two primary components: fees earned for servicing loans and the effects of MSR valuation changes, net of hedging results, as summarized below:

Year ended December 31,

(in thousands)

Following is a summary of our loan servicing fees:

Year ended December 31,

(in thousands)

Ancillary and other fees:

Loan servicing fees 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 UPB of the loans serviced and we collect these fees from borrower payments. Other loan servicing fees are comprised primarily of borrower-contracted fees, such as late charges and reconveyance fees, and fees charged to correspondent lenders for loans repaid by the borrower shortly after purchase.

The change in contractually-specified fees during the years ended December 31, 2023 and 2022, as compared to the prior years is due primarily to increased servicing fees resulting from the growth in our loan servicing portfolio.

We have elected to carry our servicing assets 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 inputs used to estimate fair value. We endeavor to moderate the effects of changes in fair value attributable to changes in fair value inputs (market conditions) primarily by entering into derivatives transactions.

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Changes in fair value of MSRs and hedging results are summarized below:

Year ended December 31,

(in thousands)

Change in fair value of MSRs

Changes in fair value due to changes in valuation inputs used in our valuation model during the year ended December 31, 2023 reflect the effects of continued increases in interest rates. The magnitude of the change in fair value of the MSRs compared to the same period in 2022 is impacted by both the magnitude of the interest rate changes and the interest rate and prepayment sensitivity of the MSRs in each period, which changes are based on the relationship of the interest rates of the underlying mortgages and the level of market interest rates. Changes in fair value due to changes in valuation inputs used in our valuation model during the year ended December 31, 2022, as compared to 2021, reflect the effects of expectations for slower future prepayments of the underlying loans as a result of interest rates increasing more significantly during the year ended December 31, 2022, as compared to the year ended December 31, 2021.

The decrease in loan recapture income from PFSI reflects the decrease in refinancing activity in our MSR portfolio during the year ended December 31, 2023, as compared to the same periods in 2022 and 2021. We have an agreement with PFSI that requires that when PFSI refinances a loan for which we held the MSRs, we receive a recapture fee. The MSR recapture agreement is summarized in Note 4 ‒ Transactions with Related Parties – Operating Activities to the consolidated financial statements included in this Report.

Hedging results reflect valuation losses in hedges against interest rates during the year ended December 31, 2023, during which interest rates increased, as do the hedging results from the years ended December 31, 2022 and December 31, 2021. The loss from hedging activities decreased during the year ended December 31, 2023, as compared to the same period in 2022, due to a smaller increase in interest rates during the period as well as decreased prepayment sensitivity of the hedged MSRs resulting from higher interest rate levels leading to a reduced amount of required hedges. The loss from hedging activities decreased during the year ended December 31, 2022, as compared to the same period in 2021, due to decreased prepayment sensitivity of the hedged MSRs due to higher interest rate levels leading to a reduced amount of required hedges as well as lower target hedge coverage for fluctuations in MSR value due to the growth in fair value and interest rate sensitivity of our MBS portfolio, which also serves to offset the fair value changes of our MSRs.

Changes in realization of cash flows are influenced by changes in the level of servicing assets and liabilities and changes in estimates of remaining cash flows to be realized. During the year ended December 31, 2023, realization of cash flows increased primarily due to growth of our average investment in MSRs over the year as compared to 2022. Likewise, the increase in realization of cash flows during the year ended December 31, 2022, as compared to 2021, was primarily due to the significant growth of our investment in MSRs as compared to the year ended December 31, 2021, partially offset by the effect of reduced prepayment speeds on the rate of realization of expected cash flows.

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Following is a summary of our loan servicing portfolio:

(in thousands)

Collection status (UPB)

Delinquency:

90 or more days delinquent:

(1)

Custodial funds include borrower and investor custodial cash accounts relating to loans serviced under mortgage servicing agreements and are not included on the Company’s consolidated balance sheets. The Company earns placement fees on certain of the custodial funds it manages on behalf of the loans’ borrowers and investors, which are included in Interest income in the Company’s consolidated statements of operations.

Following is a summary of characteristics of our MSR servicing portfolio as of December 31, 2023:

Average

(Dollars and loan count in thousands)

Agency:

(1)

Loan-to-value.

(2)

Represents MSRs on conventional loans sold to private investors.

Net gains (losses) on investments and financings

Net gains (losses) on investments and financings are summarized below:

Year ended December 31,

(in thousands)

From nonaffiliates:

Loans at fair value:

Hedging derivatives (83,201 ) — —

From PFSI‒Excess servicing spread — — 1,651

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The increase in net gains on investments for the year ended December 31, 2023, as compared to the same period in 2022, was primarily due to improved performance from our investments in MBS and CRT arrangements as interest rates increased at a slower rate during 2023 as compared to 2022, reducing losses on MBS, and credit spreads tightened (a decrease in the interest rate premium demanded by investors for instruments over those that are considered “risk free”), in 2023 as compared to widening in 2022, which benefited the fair value of our investment in CRT arrangements.

The decrease in net gains on investments for the year ended December 31, 2022, as compared to the year ended December 31, 2021, was caused primarily by increased losses from our investments in MBS and CRT arrangements as interest rates increased and credit spreads widened.

Mortgage-Backed Securities

During the year ended December 31, 2023, we recognized net valuation gains of $75.0 million compared to valuation losses of $576.8 million and $74.4 million, respectively, for the same periods in 2022 and 2021. The changes recognized reflect a slower rate of increase in interest rates during the year ended December 31, 2023, as compared to the effect of significantly increasing interest rates on fair value during the same periods in 2022 and increasing interest rates somewhat offset by tightening credit spreads in 2021.

Loans at Fair Value – Held in VIEs and Asset-backed Financings at Fair Value

Loans at fair value held in VIEs and Asset-backed financings at fair value recorded combined net valuation gains of $4.2 million during the year ended December 31, 2023, as compared to a net loss of $17.6 million during 2022. The net gain during the year ended December 31, 2023, reflects the effect of credit spread tightening during the year compared to the year ended 2022 when interest rates increased significantly and credit spreads widened. The net losses during the year ended December 31, 2022 reflect the effects of increasing interest rates and widening credit spreads during that year compared to the year ended December 31, 2021.

CRT Arrangements

The activity in and balances relating to our CRT arrangements are summarized below:

Year ended December 31,

(in thousands)

Net investment income:

Net gains (losses) on investments and financings:

CRT Derivatives and strips:

CRT derivatives

CRT strips

Interest-only security payable at fair value (10,742 ) (11,332 ) 164

Interest income — Deposits securing CRT arrangements 62,713 21,324 559

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(in thousands)

Carrying value of CRT arrangements:

Derivative assets - CRT derivatives $ 16,160 $ 1,262

Derivative and credit risk transfer strip liabilities:

CRT derivatives — (23,360 )

Interest-only security payable at fair value (32,667 ) (21,925 )

CRT arrangement assets pledged to secure borrowings:

Collection status (UPB):

Delinquency

(1)

Deposits securing credit risk transfer strip liabilities also secure $46.7 million and $160.6 million in CRT strip and CRT derivative liabilitiesat December 31, 2023, and December 31, 2022, respectively.

The performance of our investments in CRT arrangements during the year ended December 31, 2023 reflects credit spread tightening for CRT securities in the credit markets. This contrasts with CRT investments' fair value losses during the same period in 2022, when credit spreads widened.

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Net Gains on Loans Acquired for Sale

Our net gains on loans acquired for sale are summarized below:

Year ended December 31,

(in thousands)

From non-affiliates:

Cash losses:

Non-cash gains:

Reduction in liability due to change in estimate 15,228 4,227 5,812

Changes in fair value of financial instruments during the year:

Interest rate lock commitments issued on loans acquired for sale:

Acquisition of loans for sale (UPB):

The changes in Net gains on loans acquired for sale during the year ended December 31, 2023, as compared to the same periods in 2022 and 2021, reflect the effect of a reduction in our liability for representations and warranties and increased gain on sale margins for mortgage loans partially offset by reduced volume of sales to nonaffiliates.

Non-cash elements of gain on sale of loans:

Interest Rate Lock Commitments

Our Net gains on 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 gains before we purchase the loans. These gains are reflected on our balance sheet as IRLC derivative assets and liabilities. We adjust the fair value of our IRLCs as the loan acquisition process progresses until we complete the acquisition or the commitment is canceled. Such adjustments are included in our Netgains on loans acquired for sale. The fair value of our IRLCs becomes part of the carrying value of our loans when we complete the purchase of the loans. The methods and key inputs we use to measure the fair value of IRLCs are summarized in Note 7 – Fair value – Valuation Techniques and Inputs to the consolidated financial statements included in this Report.

The MSRs 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 change as circumstances change, and changes in these estimates are recognized in our results of operations in subsequent periods. Subsequent changes in the fair value of our MSRs significantly affect our results of operations.

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Mortgage Servicing Rights

The methods we use to measure and update the measurements of our MSRs as well as the effect of changes in valuation inputs on MSR fair value are detailed in Note 7 – Fair value – Valuation Techniques and Inputs to the consolidated financial statements included in this Report.

Liability for Losses Under Representations and Warranties

We recognize a liability for losses we expect to incur relating to the representations and warranties we provide to purchasers in our loan sales transactions. 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.

We recorded a provision at fair value for losses relating to representations and warranties relating to current loan sales of $2.4 million, $4.4 million and $25.0 million as part of our loan sales in each of the years ended December 31, 2023, 2022 and 2021, respectively. The decrease in the provision relating to current loan sales reflects the decrease of our loan sales volume to nonaffiliates and reduced default and loss-given default assumptions.

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 investor or insurer against credit losses attributable to the loans with indemnified defects. 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 sellers that, in turn, had 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 those repurchase losses from that correspondent seller.

Following is a summary of the indemnification, repurchase and loss activity and loans subject to representations and warranties:

Year ended December 31,

(in thousands)

Indemnification activity (UPB):

Loans indemnified at beginning of year $ 8,108 $ 2,782 $ 4,583

Less: indemnified loans sold, repaid or refinanced 3,047 683 2,146

Repurchase activity (UPB):

Less:

Losses charged to liability for representations and warranties $ 549 $ 993 $ 861

At end of year:

The losses on representations and warranties we have recorded to date have been moderated by our ability to recover most of the losses inherent in the repurchased loans from the correspondent sellers. As the outstanding balance of loans we purchase and sell subject to representations and warranties increases, as the loans outstanding season, as our investors’ and guarantors’ loss mitigation strategies change and as our correspondent sellers’ ability and willingness to repurchase loans change, we expect that the level of repurchase activity and associated losses may increase.

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The method we use to estimate the liability for representations and warranties is a function of our estimates of future defaults, loan repurchase rates, severity of loss in the event of default and the probability of reimbursement by the correspondent loan seller. We establish a liability at our estimate of its fair value at the time loans are sold and review our liability estimate on a periodic basis and adjust the liability for estimated losses in excess of the recorded liability.

The amount of the liability for representations and warranties is difficult to estimate and requires considerable judgment. The level of loan repurchase losses is dependent on economic factors, investor loss mitigation strategies, our ability to recover any losses inherent in the repurchased loan from the correspondent seller and other external conditions that change over the lives of the underlying loans. We may be required to incur losses related to such representations and warranties for several periods after the loans are sold or liquidated.

We record adjustments to our liability for losses on representations and warranties as economic fundamentals change, 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. Such adjustments may be material to our financial position and results of operations in future periods.

Adjustments to our liability for representations and warranties are included as a component of our Net gains on loans acquired for sale at fair value. We recorded $15.2 million, $4.2 million and $5.8 million reduction in liability for representations and warranties during the years ended December 31, 2023, 2022 and 2021, respectively, due to the effects of certain loans reaching specified performance histories identified by the Agencies as sufficient to limit repurchase claims relating to such loans.

Loan Origination Fees

Loan origination fees represent fees we charge correspondent sellers relating to our purchase of loans from those sellers. The decrease in fees during the year ended December 31, 2023, as compared to the same periods in 2022 and 2021, reflects a decrease in our purchases of loans with delivery fees.

Net interest expense

Net interest expense is summarized below:

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Interest Interest Interest Interest Interest Interest

income/ Average yield/ income/ Average yield/ income/ Average yield/

expense balance cost % expense balance cost % expense balance cost %

(dollars in thousands)

Assets:

Loans at fair value:

Excess servicing spread from PFSI — — — — 1,280 21,563 5.94 %

Liabilities:

Assets sold to PFSI under agreement to repurchase — — — 387 13,020 2.97 %

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The effects of changes in the yields and costs and composition of our investments on our net interest expense are summarized below:

vs. vs.

Increase (decrease)due to changes in Increase (decrease)due to changes in

Rate Volume Total Rate Volume Total

(in thousands)

Assets:

Loans at fair value:

Excess servicing spread from PFSI — — — (1,280 ) (1,280 )

Placement fees relating to custodial funds 91,523 44,595

Liabilities:

Assets sold to PFSI under agreement to repurchase — — — — (387 ) (387 )

Interest on loan impound deposits 2,157 625

The increase in net interest expense during the year ended December 31, 2023, as compared to the same period in 2022 is due to an increase in interest costs attributable to financing non-interest earning MSR assets, partially offset by an increase in placement fees relating to custodial funds we manage on behalf of borrowers and investors in our MSR portfolio and reduced interest shortfall on repayments of loans serviced from Agency securitization.

The decrease in net interest expense during the year ended December 31, 2022, as compared to 2021, is due to an increase in the yields we earn on our investments in MBS and loans acquired for sale and an increase in placement fee income, partially offset by a decrease in the interest shortfall on repayments of loans serviced for the Agency securitizations due to decreased prepayment activity in our MSR portfolio as a result of increasing interest rates reducing the incentive of borrowers to refinance their loans.

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Expenses

Our expenses are summarized below:

Year ended December 31,

(in thousands)

Earned by PennyMac Financial Services, Inc.:

Expenses decreased by $56.1 million, or 23%, during the year ended December 31, 2023, as compared to the year ended December 31, 2022, and $135.0 million, or 36%, during the year ended December 31, 2022, as compared to the year ended December 31, 2021, as discussed below.

Loan Servicing Fees

Loan servicing fees payable to PLS are summarized below:

Year ended December 31,

(in thousands)

Loan servicing fees:

Loans acquired for sale at fair value $ 680 $ 1,018 $ 2,363

Average investment in loans:

Loan servicing fees decreased by $568,000 during the year ended December 31, 2023, as compared to the same period in 2022 due to the decreases in the size of our investment in loans held for sale, along with reduced COVID-19 related fees relating primarily to our MSR portfolio, and increased $1.3 million during the year ended December 31, 2022, as compared to the same period in 2021.

Management Fees

Management fees payable to PCM are summarized below:

Year ended December 31,

(in thousands)

Performance incentive — — 3,007

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Management fees decreased by $2.3 million during the year ended December 31, 2023, compared to the same period in 2022, and by $6.7 million during the year ended December 31, 2022, as compared to the same period in 2021. This decrease reflects the nonrecurrence of a performance incentive fee during the years ended December 31, 2023 and 2022, along with the effect of the decrease in our average shareholders’ equity on our base management fee during the years ended December 31, 2023 and 2022, as compared to the year ended December 31, 2021.

Loan Fulfillment Fees

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 loans. Fulfillment fees decreased by $40.2 million during the year ended December 31, 2023, compared to the same period in 2022, and by $110.9 million during the year ended 2022, as compared to the same period in 2021. The decrease was due to a decrease in loan production volume sold to non-affiliates. Our loan fulfillment fee structure is described in Note 4 – Transactions with Related Parties to the consolidated financial statements included in this Report.

Compensation

Compensation expense increased $1.2 million during the year ended December 31, 2023, as compared to the same period in 2022, and $1.9 million during the year ended December 31, 2022, as compared to the same period in 2021, respectively, primarily due to increased expectations in achieving performance targets included in certain performance-based restricted share awards.

Loan origination

Loan origination expenses decreased by $7.4 million during the year ended December 31, 2023, as compared to the same period in 2022, and $16.8 million during 2022, as compared to the same period in 2021, primarily reflecting a decrease in our loan originations purchased for sale to non-affiliates.

Loan collection and liquidation

Loan collection and liquidation expenses decreased by $834,000 during the year ended December 31, 2023, as compared to the same period in 2022, and $5.9 million during the year ended December 31, 2022, as compared to the same period in 2021, respectively, due to the reduction in our portfolio of nonperforming mortgage loans and the borrower assistance expenses we incurred relating to loans in our CRT reference pools.

Other Expenses

Other expenses are summarized below:

Year ended December 31,

(in thousands)

Income Taxes

We have elected to treat our subsidiary, PennyMac Corp. (“PMC”), as a taxable REIT subsidiary (“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 us. A TRS is subject to corporate federal and state income tax. Accordingly, a provision for income taxes for PMC is included in the accompanying consolidated statements of income.

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The Company’s effective tax rate was 18.3% for the year ended December 31, 2023 and 216.2% for the year ended December 31, 2022. The Company’s TRS recognized a tax expense of $41.9 million on pretax income of $155.0 million while the Company’s consolidated pretax income was $244.4 million for the year ended December 31, 2023. For 2022, the TRS recognized tax expense of $141.9 million on pretax income of $712.9 million while the Company’s reported consolidated pretax income was $63.1 million. The primary difference between the Company’s effective tax rate and the statutory tax rate is generally attributable to nontaxable REIT income resulting from the dividends paid deduction.

The Company assesses the available positive and negative evidence to estimate whether sufficient future taxable income will be generated to permit use of the existing deferred tax assets. On the basis of this evaluation, as of December 31, 2023, the valuation allowance remains zero as a result of cumulative GAAP income at the TRS for the three-year period ended December 31, 2023. The amount of deferred tax assets considered realizable could be adjusted in future periods based on future income.

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. For tax years beginning after December 31, 2017, the 2017 Tax Cuts and Jobs Act (subject to certain limitations) provides a 20% deduction from taxable income for ordinary REIT dividends.

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:

Taxable income (loss)

Year ended December 31, 2023 (in thousands)

Net investment income

Provision for (benefit from) income taxes 44,741 (44,735 ) 6 — 6

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Balance Sheet Analysis

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

December 31, December 31,

(in thousands)

Assets

Investments:

Deposits securing credit risk transfer arrangements 1,209,498 1,325,294

Liabilities

Debt:

Total assets decreased by approximately $807.7 million, or 6%, from December 31, 2022 to December 31, 2023, primarily due to a decrease of $1.2 billion in Loans acquired for sale at fair value, a decrease of $79.6 million in Loans at fair value, a decrease in Deposits securing credit risk transfer arrangements of $115.8 million and a $93.6 million decrease in MSRs, partially offset by a $373.7 million increase in Mortgage-backed securities at fair value.

Asset Acquisitions

Our asset acquisitions are summarized below.

Correspondent Production

Following is a summary of our correspondent production acquisitions at fair value:

Year ended December 31,

(in thousands)

Correspondent loan purchases:

Advances to home equity lines of credit 102 132 —

(1)

GSE eligibility refers to the eligibility of loans for sale to Fannie Mae or Freddie Mac. The Company sells or finances a portion of its GSE eligible loan production to other investors, including PLS.

(2)

The Company sells all of its loans eligible for inclusion in Ginnie Mae securities to PLS. The Company is not approved by Ginnie Mae as an issuer of Ginnie Mae-guaranteed securities which are backed by government-insured or guaranteed loans. The Company earns a sourcing fee for all loans that it purchases from correspondent sellers and subsequently sells to PLS as described in Note 4 – Transactions with Related Parties – Operating activities – Correspondent Production Activities.

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During the year ended December 31, 2023, we purchased for sale $87.5 billion in fair value of correspondent production loans as compared to $88.1 billion and $181.4 billion during the same periods in 2022 and 2021, respectively.

Other Investment Activities

Following is a summary of our acquisitions of mortgage-related investments held in our credit and interest rate sensitive strategies segments:

Year ended December 31,

(in thousands)

Credit sensitive assets:

Subordinate credit-linked securities $ 87,346 $ 184,670 $ —

Interest rate sensitive assets:

Interest-only and principal-only stripped mortgage-backed securities 150,310 — —

Excess servicing spread received pursuant to a recapture agreement — — 557

Mortgage servicing rights:

(1)

Net of exchange of servicing spread for IO stripped MBS and interest receivable.

Our acquisitions during the years ended December 31, 2023, 2022 and 2021 were financed through the use of a combination of proceeds from borrowings and liquidations of existing investments. We continue to identify additional means of increasing our investment portfolio through cash flow from our business activities, existing investments, borrowings, and transactions that minimize current cash outlays. However, we expect that, over time, our ability to continue our investment portfolio growth will depend on our ability to raise additional equity capital.

Investment Portfolio Composition

Mortgage-Backed Securities

Following is a summary of our MBS holdings:

Average Average

Fair Principal/ Life Fair Life

value notional (in years) Coupon value Principal (in years) Coupon

(dollars in thousands)

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Credit Risk Transfer Arrangements

Following is a summary of our investment in CRT arrangements:

(in thousands)

Carrying value of CRT arrangements:

Derivative assets - CRT derivatives $ 16,160 $ 1,262

Derivative and credit risk transfer strip liabilities:

CRT derivatives — (23,360 )

Interest-only security payable at fair value (32,667 ) (21,925 )

Following is a summary of the composition of the loans underlying our investment in CRT arrangements as of December 31, 2023:

Year of origination

(in millions)

UPB:

Liquidations:

Modifications:

Year of origination

(in millions)

Year of origination

(in millions)

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Year of origination

(in millions)

Year of origination

(in millions)

(1)

Based on current UPB compared to estimated fair value of the property securing the loan.

Year of origination

(in millions)

Year of origination

(in millions)

(1)

Northeast consists of CT, DE, ME, MA, NH, NJ, NY, PA, PR, RI, VT, VI; Southeast consists of AL, DC, FL, GA, KY, MD, MS, NC, SC, TN, VA, WV; Midwest consists of IL, IN, IA, MI, MN, NE, ND, OH, SD, WI; Southwest consists of AZ, AR, CO, KS, LA, MO, NM, OK, TX, UT; and West consists of AK, CA, GU, HI, ID, MT, NV, OR, WA and WY.

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Year of origination

(in millions)

Delinquency

Cash Flows

Our cash flows for the years ended December 31, 2023, 2022 and 2021 are summarized below:

Year ended December 31,

(in thousands)

Our cash flows resulted in a net increase in cash of $169.2 million during the year ended December 31, 2023, as discussed below.

Operating activities

Cash provided by operating activities totaled $1.3 billion during the year ended December 31, 2023, as compared to cash provided by our operating activities of $1.8 billion during the year ended December 31, 2022 and net cash used in operating activities of $2.8 billion during 2021. Cash flows from operating activities are most influenced by cash flows from loans acquired for sale as shown below:

Year ended December 31,

(in thousands)

Operating cash flows from:

Cash flows from loans acquired for sale primarily reflect changes in the level of production inventory from the beginning to end of the periods presented as well as cash flows relating to associated hedging activities. Our inventory of loans held for sale decreased during the years ended December 31, 2023 and December 31, 2022, compared to the year ended 2021.

Investing activities

Net cash used in our investing activities was $21.7 million and $1.9 billion for the years ended December 31, 2023 and December 31, 2022, respectively, as compared to net cash provided by investing activities of $1.1 billion during 2021, primarily due to a decrease in net purchases of MBS.

Financing activities

Net cash used in our financing activities was $1.1 billion for the year ended December 31, 2023, as compared to net cash provided by our financing activities of $135.9 million for the year ended December 31, 2022. This change primarily reflects decreased financing requirements relating to loans acquired for sale.

Net cash provided by our financing activities was $135.9 million during 2022, as compared to net cash provided by financing activities of $1.7 billion for the year ended December 31,2021. The change during 2022 reflects the relative

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stability in the level of our investments during the year, as compared to the growth experienced during 2021. The change during 2021 reflects the increased borrowings to finance our investment activities.

As discussed below in Liquidity and Capital Resources, our Manager continually evaluates and pursues 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 earnings are adequate to fund our operating expenses and dividend payment requirements. However, we manage our liquidity in the aggregate and are reinvesting our cash flows in new investments as well as using such cash to fund our dividend requirements.

Liquidity and Capital Resources

Our liquidity reflects our ability to meet our current obligations (including the purchase of loans from correspondent sellers, our operating expenses and, when applicable, retirement of, and margin calls relating to, our debt and derivatives positions), make investments as our Manager identifies them, pursue our share repurchase program and make distributions to our shareholders. We generally need to distribute at least 90% of our taxable income each year (subject to certain adjustments) to our shareholders to qualify as a REIT under the Internal Revenue Code. This distribution requirement limits our ability to retain earnings and thereby replenish or increase capital to support our activities.

We expect our primary sources of liquidity to be cash flows from our investment portfolio, including cash earnings on our investments, cash flows from business activities, liquidation of existing investments and proceeds from borrowings and/or additional equity offerings. When we finance a particular asset, the amount borrowed is less than the asset’s fair value and we must provide the cash in the amount of such difference. Our ability to continue making investments is dependent on our ability to invest the cash representing such difference.

Debt Financing

Our current debt financing strategy is to finance our assets where we believe such borrowing is prudent, appropriate and available. We make collateralized borrowings in the form of sales of assets under agreements to repurchase, loan participation purchase and sale agreements and notes payable, including secured term financing for our MSRs and our CRT arrangements that has allowed us to match the term of our borrowings more closely to the expected lives of the assets securing those borrowings. We have also borrowed money by issuing unsecured senior notes.

Sales of Assets Under Agreements to Repurchase

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:

Year ended December 31,

(in thousands)

The difference between the maximum and average daily amounts outstanding is primarily due to timing of loan purchases and sales in our correspondent production business. The total facility size of our assets sold under agreements to repurchase was approximately $11.5 billion at December 31, 2023.

Because a significant portion of our current debt facilities consists of short-term borrowings, we expect to either 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.

As discussed above, all of our repurchase agreements, and mortgage loan participation purchase and sale agreements have short-term maturities:

•

The transactions relating to loans and REO under agreements to repurchase generally provide for terms of approximately one to two years;

•

The transactions relating to loans under mortgage loan participation purchase and sale agreements provide for terms of approximately one year;

•

The transactions relating to assets under notes payable provide for terms ranging from two to five years; and

•

All repurchase agreements that matured between December 31, 2023 and the date of this Report have been renewed, extended or replaced.

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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:

Counterparty Amount at risk

(in thousands)

Atlas Securitized Products, L.P. $ 102,864

Goldman Sachs & Co. LLC 55,245

Barclays Capital Inc. 53,634

JPMorgan Chase & Co. 45,285

Bank of America, N.A. 30,519

Wells Fargo Securities, LLC 20,805

Santander US Capital 10,091

Daiwa Capital Markets America Inc. 8,475

RBC Capital Markets, L.P. 6,204

Nomura Holdings America, Inc. 3,573

Morgan Stanley & Co. LLC 2,279

Mizuho Financial Group 1,960

All debt financing arrangements that matured between December 31, 2023 and the date of this Report have been renewed, extended or replaced.

Unsecured Senior Notes

In September 2023, we issued $53.5 million principal amount of our unsecured 8.50% senior notes due September 30, 2028 (the “2023 Senior Notes”) during September 2023. The 2023 Senior Notes bear interest at a rate of 8.50% per year payable quarterly.

On or after September 30, 2025, we may redeem for cash all or any portion of the 2023 Senior Notes, at our option, at a redemption price equal to 100% of the principal amount of the notes to be redeemed, plus accrued and unpaid interest to, but excluding, the redemption date. No “sinking fund” will be provided for the 2023 Senior Notes.

The 2023 Senior Notes are fully and unconditionally guaranteed on a senior unsecured basis by PMC, including the due and punctual payment of principal of and interest on the Unsecured Senior Notes, whether at stated maturity, upon acceleration, call for redemption or otherwise (the “PMC Guarantee”). PMC’s operations and investing activities are centered in residential mortgage-related assets, including the creation of and investment in MSRs.

Under the terms of the PMC Guarantee, holders of the 2023 Senior Notes will not be required to exercise their remedies against us before they proceed directly against PMC. PMC’s obligations under the guarantee are limited to the maximum amount that will not, after giving effect to all other contingent and fixed liabilities of PMC, result in the guarantee constituting a fraudulent transfer or conveyance. The PMC Guarantee will:

•

rank equal in right of payment to any of PMC’s existing and future unsecured and unsubordinated indebtedness and guarantees of PMC;

•

be effectively subordinated in right of payment to any of PMC’s existing and future secured indebtedness and secured guarantees to the extent of the value of the assets securing such indebtedness or guarantees; and

•

be structurally subordinated to all existing and future indebtedness and other liabilities (including trade payables) and (to the extent not held by PMC) preferred stock, if any, of PMC’s subsidiaries and of any entity PMC accounts for using the equity method of accounting.

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The following summarized financial information for PMT and PMC is presented on a combined basis. Intercompany balances and transactions between PMT and PMC have been eliminated:

(in thousands)

Loans acquired for sale at fair value $ 669,018

Mortgage servicing rights at fair value 3,928,608

Other assets

From PFSI 56

From non-issuer or non-guarantor subsidiaries 628,726

Total liabilities

Payable to nonaffiliates $ 2,082,300

Payable to non-issuer or non-guarantor subsidiaries 3,553,166

(in thousands)

Net investment income

From non-issuer or non-guarantor subsidiaries (1) (293,975 )

Expenses

Provision for income taxes 17,785

(1)

Excludes equity in earnings of non-guarantor subsidiaries.

Debt Covenants

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:

•

a minimum of $75 million in unrestricted cash and cash equivalents among the Company and/or our subsidiaries; a minimum of $75 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 PennyMac Holdings, LLC (“PMH”); a minimum of $25 million in unrestricted cash and cash equivalents at PMC; and a minimum of $10 million in unrestricted cash and cash equivalents at PMH;

•

a minimum tangible net worth for the Company of $1.25 billion; a minimum tangible net worth for our Operating Partnership of $1.25 billion; a minimum tangible net worth for PMH of $250 million; and a minimum tangible net worth for PMC of $300 million;

•

a maximum ratio of total indebtedness to tangible net worth of less than 10:1 for PMC and PMH and 8.5:1 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.

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PLS is also subject to various financial covenants, both as a borrower under its own financing arrangements and as our servicer under certain of our debt financing agreements. The most significant of these financial covenants currently include the following:

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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 indebtedness to tangible net worth of 10:1; and

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

Many of our debt financing agreements contain a condition precedent to obtaining additional funding that requires us to maintain positive net income for at least one (1) of the previous two consecutive quarters, or other similar measures. For the most recent fiscal quarter, the Company is compliant with all such conditions. However, we may be required to obtain waivers from certain lenders in the future if this condition precedent is not met.

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.

Regulatory Capital and Liquidity Requirements

In addition to the financial covenants imposed upon us and PLS as our servicer under our debt financing agreements, we, through PMC and/or PLS, as applicable, are also subject to liquidity and net worth requirements established by the Federal Housing Finance Agency (“FHFA”) for Agency sellers/servicers and Ginnie Mae for single-family issuers. FHFA and Ginnie Mae have established minimum liquidity and net worth requirements for approved non-depository single-family sellers/servicers in the case of FHFA, and for approved single-family issuers in the case of Ginnie Mae.

In August 2022, the FHFA and Ginnie Mae issued revised capital and liquidity requirements. Most of the requirements became effective on December 31, 2023, for issuers of securities guaranteed by Ginnie Mae and seller/servicers of mortgage loans to Fannie Mae and Freddie Mac. The origination liquidity requirements issued by the FHFA became effective on December 31, 2023 and risk-based capital requirements issued by Ginnie Mae will be effective on December 31, 2024. We believe that we and PLS are in compliance with the applicable and pending requirements as of December 31, 2023.

Our Manager continues to explore a variety of additional means of financing our business, including debt financing through bank warehouse lines of credit, repurchase agreements, term financing, securitization transactions and unsecured debt and equity offerings. However, there can be no assurance as to how much additional financing capacity such efforts will produce, what form the financing will take or that such efforts will be successful.

Off-Balance Sheet Arrangements and Aggregate Contractual Obligations

Off-Balance Sheet Arrangements

As of December 31, 2023, we have not entered into any off-balance sheet arrangements.

Our management, servicing, and loan fulfillment fee agreements are described in Note 4 – Transactions with Related Parties to the consolidated financial statements included in this Report.

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 real estate risk, credit risk, interest rate risk, prepayment risk, inflation risk and market value risk. Our primary trading asset is our inventory of loans acquired for sale. We believe that such assets’ fair values respond primarily to changes in the market interest rates for comparable recently-originated loans. Our other market-risk assets are a substantial portion of our investments and are primarily comprised of MSRs, CRT arrangements and MBS. We believe that the fair values of MSRs and MBS also respond primarily to changes in the market interest rates for comparable loans or yields on MBS. Changes in

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interest rates are reflected in the prepayment speeds underlying these investments and in the pricing spread (an element of the discount rate) used in their valuation. We believe that the primary market risks to the fair values of our investment in CRT arrangements are changes in market credit spreads and the fair value of the real estate securing the loans underlying such arrangements.

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 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 or dependent upon the performance of residential 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. We have entered into CRT arrangements which involve the absorption on our part of losses relating to certain loans we sell that subsequently default. The fair value of the assets we carry related to these arrangements are sensitive to credit market conditions generally, perceptions of the performance of the loans in our CRT arrangements’ reference pools specifically and to the actual performance of such loans.

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.

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. Changes in interest rates significantly influence the prepayment speed of the loans underlying our investment in MSRs and ESS which affects those assets’ estimated lives. In general, rising interest rates negatively affect the fair value of our investments in MBS and loans, while decreasing market interest rates negatively affect the fair value of our MSRs and ESS.

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.

We engage in interest rate risk management activities in an effort to reduce the variability of earnings and book value 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 loans acquired for sale, MBS, ESS, 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 rates on our mortgage-based investments 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 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 such MBS investments and will accelerate the fair value decline 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 such MBS investments.

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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.

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 and its impact on our profitability, book value, and available liquidity, 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 on our MSR investments as well as IRLCs and our inventory of loans held for sale. Our objective is to maintain our loss coverage levels within established thresholds while minimizing our hedging expense. We do not use derivative financial instruments other than IRLCs and repurchase agreement derivatives (both of which arise from our operations) for purposes other than in support of our risk management activities.

Our strategies are reviewed daily within a disciplined risk management framework. We use a variety of interest rate and spread shifts and scenarios and define target limits for market value and liquidity loss in those scenarios. With respect to our IRLCs and inventory of loans held for sale, we use MBS forward sale contracts to lock in the price at which we will sell the mortgage loans or resulting MBS, and further use MBS put options to mitigate the risk of our IRLCs not closing at the rate we expect. With respect to our MSRs and other interest rate sensitive assets and liabilities, 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 Risk

Our loans, MBS, MSRs, ESS and CRT arrangements are reported at their fair values. The fair value of these assets fluctuates primarily based on the exposure of the underlying investment. Performing prime loans (along with any related recognized IRLCs), MBS, MSRs and ESS are more sensitive to changes in market interest rates, while CRT arrangements are more sensitive to changes in the market credit spreads, underlying real estate values relating to the loans underlying our investments, and other factors such as 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 loans and MBS would be expected to decrease, whereas in an interest rate market where interest rates are generally decreasing or are expected to decrease, loan and MBS values would be expected to increase. The fair value of MSRs and ESS, on the other hand, tends to respond generally in an opposite manner to that of loans acquired for sale and MBS.

Generally, in a real estate market where values are rising or are expected to rise, the fair value of our investment in CRT arrangements 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 CRT arrangements 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.

Mortgage-backed securities at fair value