Edgar Filing: PennyMac Mortgage Investment Trust

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10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

Form 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2013

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number: 001-34416

PennyMac Mortgage Investment Trust

(Exact name of registrant as specified in its charter)


Maryland		27-0186273
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)

6101 Condor Drive, Moorpark, California		93021
(Address of principal executive offices)		(Zip Code)

(818) 224-7442

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): Yes ¨ No x

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date.


Class		Outstanding at August 6, 2013
Common Shares of Beneficial Interest, $0.01par value		59,150,090

PENNYMAC MORTGAGE INVESTMENT TRUST

FORM 10-Q

June 30, 2013

TABLE OF CONTENTS


		Page
PART I. FINANCIAL INFORMATION			1
Item 1.	Financial Statements (Unaudited):		1
	Consolidated Balance Sheets		1
	Consolidated Statements of Income		2
	Consolidated Statements of Changes in Shareholders’ Equity		3
	Consolidated Statements of Cash Flows		4
	Notes to Consolidated Financial Statements		5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		55
	Observations on Current Market Opportunities		56
	Results of Operations		57
	Net Investment Income		58
	Expenses		73
	Balance Sheet Analysis		76
	Asset Acquisitions		77
	Investment Portfolio Composition		78
	Cash Flows		83
	Liquidity and Capital Resources		85
	Off-Balance Sheet Arrangements and Aggregate Contractual Obligations		86
	Quantitative and Qualitative Disclosures About Market Risk		90
	Factors That May Affect Our Future Results		91
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		93
Item 4.	Controls and Procedures		93
PART II. OTHER INFORMATION			95
Item 1.	Legal Proceedings		95
Item 1A.	Risk Factors		95
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		95
Item 3.	Defaults Upon Senior Securities		95
Item 4.	Mine Safety Disclosures		95
Item 5.	Other Information		95
Item 6.	Exhibits		96

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

PENNYMAC MORTGAGE INVESTMENT TRUST AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(in thousands, except per share data)


	June 30,		December 31,
	2013		2012
ASSETS
Cash	$	27,642	$	33,756
Short-term investments		73,236		39,017
Mortgage loans acquired for sale at fair value (includes $1,305,009 and $972,079 pledged to secure mortgage loans acquired for sale sold under agreements to repurchase)		1,309,830		975,184
Mortgage loans at fair value (includes $1,260,652 and $956,583 pledged to secure mortgage loans sold under agreements to repurchase)		1,309,765		1,189,971
Mortgage loans under forward purchase agreements at fair value, pledged to secure borrowings under forward purchase agreements		242,531		—
Real estate acquired in settlement of loans (includes $52,384 and $23,834 pledged to secure real estate acquired in settlement of loans sold under agreements to repurchase)		88,682		88,078
Real estate acquired in settlement of loans under forward purchase agreements, pledged to secure forward purchase agreements		89		—
Mortgage servicing rights at lower of amortized cost or fair value		225,073		125,430
Mortgage servicing rights at fair value		1,828		1,346
Principal and interest collections receivable		29,708		29,204
Interest receivable		4,296		3,029
Derivative assets		51,940		23,706
Servicing advances		39,672		32,191
Due from Private National Mortgage Acceptance Company, LLC and subsidiaries		3,063		4,829
Other assets		36,029		13,922

Total assets	$	3,443,384	$	2,559,663

LIABILITIES
Assets sold under agreements to repurchase:
Mortgage loans acquired for sale at fair value	$	1,243,949	$	894,906
Mortgage loans at fair value		313,862		353,805
Real estate acquired in settlement of loans		8,085		7,391
Borrowings under forward purchase agreements		244,047		—
Exchangeable senior notes		250,000		—
Derivative liabilities		26,619		967
Accounts payable and accrued liabilities		31,387		42,402
Due to Private National Mortgage Acceptance Company, LLC and subsidiaries		16,725		12,216
Underwriting fees payable		5,457		5,883
Income taxes payable		51,404		36,316
Recourse liability		7,668		4,441

Total liabilities		2,199,203		1,358,327

Commitments and contingencies
SHAREHOLDERS’ EQUITY
Common shares of beneficial interest—authorized, 500,000,000 common shares of $0.01 par value; issued and outstanding, 59,077,496 and 58,904,456 common shares, respectively		591		589
Additional paid-in capital		1,132,157		1,129,858
Retained earnings		111,433		70,889

Total shareholders’ equity		1,244,181		1,201,336

Total liabilities and shareholders’ equity	$	3,443,384	$	2,559,663

The accompanying notes are an integral part of these consolidated financial statements.

PENNYMAC MORTGAGE INVESTMENT TRUST AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

(in thousands, except per share data)


	Quarter ended June 30,						Six months ended June 30,
	2013			2012			2013			2012
Net Investment Income
Net gain on mortgage loans acquired for sale	$	44,438		$	18,046		$	73,717		$	31,416
Net gain (loss) on investments:
Mortgage-backed securities		—			706			—			1,063
Mortgage loans		46,834			27,286			110,814			38,417

		46,834			27,992			110,814			39,480

Interest income:
Short-term investments		57			47			88			78
Mortgage-backed securities		—			1,011			—			1,585
Mortgage loans		26,604			14,944			43,424			30,764
Other		136			—			160			—

		26,797			16,002			43,672			32,427

Loan origination fees		4,752			594			10,225			2,044
Results of real estate acquired in settlement of loans		(1,929	)		2,571			(5,182	)		6,288
Net loan servicing fees		7,892			(855	)		13,903			(658	)
Other		913			56			1,600			58

Net investment income		129,697			64,406			248,749			111,055

Expenses
Loan fulfillment fees payable to Private National Mortgage Acceptance Company, LLC and subsidiaries		22,054			7,715			50,298			13,839
Interest		14,144			6,703			25,380			13,377
Loan servicing fees payable to Private National Mortgage Acceptance Company, LLC and subsidiaries		8,787			4,438			16,513			8,563
Management fees payable to Private National Mortgage Acceptance Company, LLC and subsidiaries		8,455			2,488			14,947			4,292
Professional services		1,339			1,186			3,723			1,628
Compensation		1,438			1,744			3,527			3,045
Other		5,571			2,157			10,517			3,761

Total expenses		61,788			26,431			124,905			48,505

Income before provision for income taxes		67,909			37,975			123,844			62,550
Provision for income taxes		13,412			8,406			16,051			13,923

Net income	$	54,497		$	29,569		$	107,793		$	48,627

Earnings per share
Basic	$	0.92		$	0.80		$	1.81		$	1.46
Diluted	$	0.86		$	0.79		$	1.75		$	1.46
Weighted-average shares outstanding
Basic		59,035			36,922			58,981			32,999
Diluted		65,104			37,208			62,217			33,253
Dividends declared per share	$	0.57		$	0.55		$	1.14		$	1.10

The accompanying notes are an integral part of these consolidated financial statements.

PENNYMAC MORTGAGE INVESTMENT TRUST AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY (UNAUDITED)

(in thousands, except per share data)


	Number				Additional
	of		Par		paid-in			Retained
	shares		value		capital			earnings			Total
Balance at December 31, 2011		28,404,554	$	284	$	518,272		$	27,461		$	546,017
Net income		—		—		—			48,627			48,627
Share-based compensation		88,399		—		2,192			—			2,192
Cash dividends, $1.10 per share		—		—		—			(38,336	)		(38,336	)
Proceeds from offerings of common shares		12,973,416		131		248,266			—			248,397
Underwriting and offering costs		—		—		(1,224	)		—			(1,224	)

Balance at June 30, 2012		41,466,369	$	415	$	767,506		$	37,752		$	805,673

Balance at December 31, 2012		58,904,456	$	589	$	1,129,858		$	70,889		$	1,201,336
Net income		—		—		—			107,793			107,793
Share-based compensation		173,040		2		2,468			—			2,470
Cash dividends, $1.14 per share		—		—		—			(67,249	)		(67,249	)
Underwriting and offering costs		—		—		(169	)		—			(169	)

Balance at June 30, 2013		59,077,496	$	591	$	1,132,157		$	111,433		$	1,244,181

The accompanying notes are an integral part of these consolidated financial statements.

PENNYMAC MORTGAGE INVESTMENT TRUST AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(in thousands)


	Six months ended June 30,
	2013			2012
Cash flows from operating activities:
Net income	$	107,793		$	48,627
Adjustments to reconcile net income to net cash used by operating activities:
Net gain on mortgage loans acquired for sale at fair value		(73,717	)		(31,417	)
Net gain on mortgage-backed securities at fair value		—			(1,063	)
Net gain on mortgage loans at fair value		(110,814	)		(38,417	)
Accrual of unearned discounts on mortgage-backed securities at fair value and capitalization of interest and advances on mortgage loans at fair value		(11,814	)		(13,249	)
Results of real estate acquired in settlement of loans		5,182			(6,288	)
Change in fair value, amortization and impairment of mortgage servicing rights		9,321			3,011
Amortization of credit facility commitment fees and debt issuance costs		4,036			1,268
Accrual of costs related to forward purchase agreements		251			3,255
Share-based compensation expense		2,471			2,192
Purchases of mortgage loans acquired for sale at fair value		(17,759,140	)		(5,370,540	)
Sales of mortgage loans acquired for sale at fair value to nonaffiliates		9,044,480			2,680,649
Sales of mortgage loans acquired for sale at fair value to Private National Mortgage Acceptance Company, LLC and subsidiaries		8,282,163			2,458,243
Increase in principal and interest collections receivable		(504	)		(13,247	)
Decrease in principal and interest collections receivable under forward purchase agreements		—			2,295
Increase in interest receivable		(1,267	)		(1,511	)
Increase (decrease) in due to Private National Mortgage Acceptance Company, LLC and subsidiaries		1,766			(7,967	)
Decrease (increase) in other assets		50,631			(6,112	)
(Decrease) increase in accounts payable and accrued liabilities		(11,016	)		4,698
Increase in payable to Private National Mortgage Acceptance Company, LLC and subsidiaries		4,509			9,425
Increase in income taxes payable		15,088			8,578

Net cash used by operating activities		(440,581	)		(267,570	)

Cash flows from investing activities
Net increase in short-term investments		(34,219	)		(2,021	)
Repayment of United States Treasury security		—			50,000
Purchases of mortgage-backed securities at fair value		—			(112,211	)
Repayments of mortgage-backed securities at fair value		—			21,257
Purchases of mortgage loans at fair value		(200,486	)		(260,595	)
Repayments of mortgage loans at fair value		135,242			84,564
Repayments of mortgage loans under forward purchase agreements at fair value		—			14,040
Purchase of real estate acquired in settlement of loans		—			(48	)
Sales of real estate acquired in settlement of loans		63,017			65,386
Sales of real estate acquired in settlement of loans under forward purchase agreements		—			9,914
Purchases of mortgage servicing rights		(185	)		(29	)
Sales of mortgage servicing rights		—			104
Increase in margin deposits and restricted cash		(13,426	)		(5,721	)

Net cash used by investing activities		(50,057	)		(135,360	)

Cash flows from financing activities
Sales of securities under agreements to repurchase		—			706,966
Repurchases of securities sold under agreements to repurchase		—			(665,170	)
Sales of mortgage loans acquired for sale at fair value under agreements to repurchase		16,490,809			4,960,026
Repurchases of mortgage loans acquired for sale at fair value sold under agreements to repurchase		(16,141,766	)		(4,754,684	)
Sales of mortgage loans at fair value under agreements to repurchase		350,661			165,395
Repurchases of mortgage loans at fair value sold under agreements to repurchase		(374,254	)		(55,122	)
Repayments of note payable secured by mortgage loans at fair value		—			(2,044	)
Sales of real estate acquired in settlement of loans financed under agreement to repurchase		—			10,753
Repayments of borrowings under forward purchase agreements		—			(140,307	)
Repurchases of real estate acquired in settlement of loans financed under agreement to repurchase		(15,656	)		(18,338	)
Proceeds from issuance of common shares		—			248,397
Payment of common share underwriting and offering costs		(169	)		(1,224	)
Payment of underwriting fees payable		(427	)		—
Issuance of exchangeable senior notes		250,000			—
Payment of exchangeable senior notes issuance costs		(7,425	)		—
Payments of dividends		(67,249	)		(38,337	)

Net cash provided by financing activities		484,524			416,311

Net (decrease) increase in cash		(6,114	)		13,381
Cash at beginning of period		33,756			14,589

Cash at end of period	$	27,642		$	27,970

The accompanying notes are an integral part of these consolidated financial statements

PENNYMAC MORTGAGE INVESTMENT TRUST AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Note 1—Organization and Basis of Presentation

PennyMac Mortgage Investment Trust (“PMT” or the “Company”) was organized in Maryland on May 18, 2009, and commenced operations on August 4, 2009, when it completed its initial offerings of common shares of beneficial interest (“shares”). The Company is a specialty finance company, which, through its subsidiaries (all of which are wholly-owned), invests primarily in residential mortgage loans and mortgage-related assets.

The Company operates in two segments: correspondent lending and investment activities:

•

The correspondent lending segment represents the Company’s operations aimed at serving as an intermediary between mortgage lenders and the capital markets by purchasing, pooling and reselling newly originated prime credit quality mortgage loans either directly or in the form of mortgage backed securities (“MBS”), using the services of PNMAC Capital Management, LLC (“PCM” or the “Manager”) and PennyMac Loan Services, LLC (“PLS” or the “Servicer”).

Most of the loans the Company has acquired in its correspondent lending activities have been eligible for sale to government-sponsored entities such as the Federal National Mortgage Association (“Fannie Mae”) and Federal Home Loan Mortgage Corporation (“Freddie Mac”) or through government agencies such as the Government National Mortgage Association (“Ginnie Mae”). Fannie Mae, Freddie Mac and Ginnie Mae are each referred to as an “Agency” and, collectively, as the “Agencies.”

•

The investment activities segment represents the Company’s investments in distressed mortgage loans, real estate acquired in settlement of loans (“REO”), MBS and mortgage servicing rights (“MSRs”). The Company seeks to maximize the value of the distressed mortgage loans that it acquires through proprietary loan modification programs, special servicing or other initiatives focused on keeping borrowers in their homes. Where this is not possible, such as in the case of many nonperforming mortgage loans, the Company seeks to effect property resolution in a timely, orderly and economically efficient manner, including through the use of resolution alternatives to foreclosure.

The Company is externally managed by PCM, an investment adviser registered with the Securities and Exchange Commission (the “SEC”) that specializes in and focuses on residential mortgage loans. Under the terms of a management agreement, PCM is paid a management fee with a base component and a performance incentive component. Determination of the amount of management fees is discussed in Note 3—Transactions with Related Parties.

The Company believes that it qualifies, and has elected to be taxed, as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”), beginning with its taxable period ended on December 31, 2009. To maintain its tax status as a REIT, the Company plans to distribute at least 90% of its taxable income in the form of qualifying distributions to shareholders.

The Company conducts substantially all of its operations and makes substantially all of its investments through its subsidiary, PennyMac Operating Partnership, L.P. (the “Operating Partnership”), and the Operating Partnership’s subsidiaries. A subsidiary of the Company is the sole general partner, and the Company is the sole limited partner, of the Operating Partnership.

The accompanying consolidated financial statements have been prepared in compliance with accounting principles generally accepted in the United States (“U.S. GAAP”) for interim financial information and with the SEC’s instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, these financial statements and notes do not include all of the information required by U.S. GAAP for complete financial statements. The interim consolidated information should be read together with the Company’s Annual Report on Form 10-K for the year ended December 31, 2012 (the “Annual Report”).

Preparation of financial statements in compliance with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, and revenues and expenses during the reporting period. Actual results will likely differ from those estimates.

In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the periods ended June 30, 2013 are not necessarily indicative of the results for the year ending December 31, 2013.

Note 2—Concentration of Risks

As discussed in Note 1—Organization and Basis of Presentation above, PMT’s operations and investing activities are centered in real estate-related assets, a substantial portion of which are distressed at acquisition. Because of the Company’s investment strategy, many of the mortgage loans in its targeted asset class are purchased at discounts reflecting their distressed state or perceived higher risk of default, as well as a greater likelihood of collateral documentation deficiencies. Before acquiring loans or other assets, PCM validates key information provided by the sellers that is necessary to determine the value of the acquired asset. A substantial portion of the distressed loans purchased by the Company has been acquired from or through one or more subsidiaries of Citigroup Inc. Because of the Company’s investment focus, PMT is exposed, to a greater extent than traditional mortgage investors, to the risks that borrowers may be in economic distress and/or may have become unemployed, bankrupt or otherwise unable or unwilling to make payments when due, and to the effects of fluctuations in the residential real estate market on the performance of its investments. Factors influencing these risks include, but are not limited to:

•

changes in the overall economy and unemployment rates and residential real estate values in the markets where the properties securing the Company’s mortgage loans are located;

•

PCM’s ability to identify and the Company’s loan servicers’ ability to execute optimal resolutions of problem mortgage loans;

•

the accuracy of valuation information obtained during the Company’s due diligence activities;

•

PCM’s ability to effectively model, and to develop appropriate model assumptions that properly anticipate, future outcomes;

•

the level of government support for problem loan resolution and the effect of current and future proposed and enacted legislative and regulatory changes on the Company’s ability to effect cures or resolutions to distressed loans; and

•

regulatory, judicial and legislative support of the foreclosure process, and the resulting effect on the Company’s ability to acquire and liquidate the real estate securing its portfolio of distressed mortgage loans in a timely manner or at all.

Due to these uncertainties, there can be no assurance that risk management activities identified and executed on PMT’s behalf will prevent significant losses arising from the Company’s investments in real estate-related assets.

On July 12, 2011, December 20, 2011, June 14, 2013 and June 28, 2013, the Company entered into forward purchase agreements with Citigroup Global Markets Realty Corp. (“CGM”), a subsidiary of Citigroup Inc., to purchase certain nonperforming residential mortgage loans and residential real property acquired in settlement of loans (collectively, the “CGM Assets”). The CGM Assets were acquired by CGM from unaffiliated money center banks. The commitment under the forward purchase agreement dated July 12, 2011 was settled during the quarter ended June 30, 2012. The commitment under the forward purchase agreement dated December 20, 2011 was settled during the quarter ended September 30, 2012. The commitments under the forward purchase agreements dated June 14, 2013 and June 28, 2013 have not yet settled and have maturity dates of June 16, 2014 and June 30, 2014, respectively.

The CGM Assets are included on the Company’s consolidated balance sheet as Mortgage loans under forward purchase agreements at fair value and Real estate acquired in settlement of loans under forward purchase agreements and the related liabilities are included as Borrowings under forward purchase agreements. The CGM Assets are held by CGM within a separate trust entity deemed a variable interest entity. The Company’s interests in the CGM Assets are deemed to be contractually segregated from all other interests in the trust. When assets are contractually segregated, they are often referred to as a “silo.” For these transactions, the silo consists of the CGM Assets and its related liability. The Company directs all of the activities that drive the economic results of the CGM Assets. All of the changes in the fair value and cash flows of the CGM Assets are attributable solely to the Company, and such cash flows can only be used to settle the related liability.

As a result of consolidating the silo, the Company’s consolidated statements of income and cash flows for the periods presented include the following amounts related to the silo:


	Quarter ended June 30,					Six months ended June 30,
	2013			2012		2013			2012
				(in thousands)
Net income:
Net gain on mortgage loans	$	(690	)	$	2,488	$	(690	)	$	9,188
Interest income on mortgage loans	$	814		$	348	$	814		$	850
Interest expense	$	251		$	781	$	251		$	2,296
Loan servicing fees	$	—		$	521	$	—		$	960
Cash flows:
Repayments of mortgage loans	$	—		$	5,340	$	—		$	14,040
Repayments of borrowings under forward purchase agreements	$	—		$	113,178	$	—		$	140,307

The Company has no other variable interests in the trust entity or other exposure to the creditors of the trust entity that could expose the Company to loss.

The following tables present the fair value of mortgage loans and REO purchased (including purchases under forward purchase agreements) for the Company’s investment portfolio, and the portion thereof representing assets purchased from or through one or more subsidiaries of Citigroup Inc., for the periods presented:


	Quarter ended June 30,				Six months ended June 30,
	2013		2012		2013		2012
	(in thousands)
Investment portfolio purchases:
Loans	$	243,109	$	261,379	$	443,582	$	261,665
REO		89		243		89		296

	$	243,198	$	261,622	$	443,671	$	261,961

Investment portfolio purchases above through one or more subsidiaries of Citigroup Inc.:
Loans	$	242,886	$	260,309	$	443,183	$	260,595
REO		89		195		89		248

	$	242,975	$	260,504	$	443,272	$	260,843

Note 3—Transactions with Related Parties

Management Fees

Before February 1, 2013, under a management agreement, PMT paid PCM a base management fee. The management agreement also provided for a performance incentive, which was calculated at 1.5% per year of shareholders’ equity. The performance incentive fee was calculated at 20% per year of the amount by which “core earnings,” on a rolling four-quarter basis and before the incentive fee, exceeded an 8% “hurdle rate” as defined in the management agreement. The Company did not pay a performance incentive fee prior to February 1, 2013.

Effective February 1, 2013, the management agreement was amended to provide that:

•

The base management fee is calculated quarterly and is equal to the sum of (i) 1.5% per year of shareholders’ equity up to $2 billion, (ii) 1.375% per year of shareholders’ equity in excess of $2 billion and up to $5 billion, and (iii) 1.25% per year of shareholders’ equity in excess of $5 billion.

•

The performance incentive fee is calculated at a defined annualized percentage of the amount by which “net income,” on a rolling four-quarter basis and before deducting the incentive fee, exceeds certain levels of return on “equity.”

The performance incentive fee is calculated quarterly and is equal to: (a) 10% of the amount by which net income for the quarter exceeds (i) an 8% return on equity plus the high watermark, up to (ii) a 12% return on equity; plus (b) 15% of the amount by which net income for the quarter exceeds (i) a 12% return on equity plus the high watermark, up to (ii) a 16% return on equity; plus (c) 20% of the amount by which net income for the quarter exceeds a 16% return on equity plus the high watermark.

For the purpose of determining the amount of the performance incentive fee:

“Net income” is defined as net income or loss computed in accordance with U.S. GAAP and certain other non-cash charges determined after discussions between the Company’s Manager and our independent trustees and after approval by a majority of our independent trustees.

“Equity” is the weighted average of the issue price per common share of all of our public offerings, multiplied by the weighted average number of common shares outstanding (including restricted share units) in the four-quarter period.

The “high watermark” starts at zero and is adjusted quarterly. The quarterly adjustment reflects the amount by which the net income (stated as a percentage of return on equity) in that quarter exceeds or falls short of the lesser of 8% and the Fannie Mae MBS yield (the target yield) for such quarter. If the net income is lower than the target yield, the high watermark is increased by the difference. If the net income is higher than the target yield, the high watermark is reduced by the difference. Each time a performance incentive fee is earned, the high watermark returns to zero. As a result, the threshold amounts required for our Manager to earn a performance incentive fee are adjusted cumulatively based on the performance of our net income over (or under) the target yield, until the net income in excess of the target yield exceeds the then-current cumulative high watermark amount, and a performance incentive fee is earned.

The base management fee and the performance incentive fee are both payable quarterly in arrears. The performance incentive fee may be paid in cash or in our common shares (subject to a limit of no more than 50% paid in common shares), at the Company’s option.

Following is a summary of the base management and performance incentive fees recorded by the Company for the periods presented:


	Quarter ended June 30,				Six months ended June 30,
	2013		2012		2013		2012
	(in thousands)
Base management fee	$	4,575	$	2,488	$	8,940	$	4,292
Performance incentive fee		3,880		—		6,007		—

Total management fee incurred during the period	$	8,455	$	2,488	$	14,947	$	4,292

In the event of termination, PCM may be entitled to a termination fee in certain circumstances. The termination fee is equal to three times the sum of (a) the average annual base management fee, and (b) the average annual (or, if the period is than 24 months, annualized) performance incentive fee earned by PCM, in each case during the 24-month period before termination.

Mortgage Loan Servicing

The Company, through its Operating Partnership, has a loan servicing agreement with PLS. Before February 1, 2013, the servicing fee rates were based on the risk characteristics of the mortgage loans serviced and total servicing compensation was established at levels that management believed were competitive with those charged by other servicers or specialty servicers, as applicable.

•

Servicing fee rates for nonperforming loans ranged between 50 and 100 basis points per year on the unpaid principal balance of the mortgage loans serviced on the Company’s behalf. PLS was also entitled to certain customary market-based fees and charges, including boarding and deboarding fees, liquidation and disposition fees, assumption, modification and origination fees and late charges, as well as interest on funds on deposit in custodial accounts. In the event PLS either effected a refinancing of a loan on the Company’s behalf and not through a third party lender and the resulting loan was readily saleable, or originated a loan to facilitate the disposition of real estate that the Company had acquired in settlement of a loan, PLS was entitled to receive from the Company market-based fees and compensation.

•

For mortgage loans serviced by the Company as a result of acquisitions and sales with servicing rights retained in connection with the Company’s correspondent lending business, PLS was entitled to base subservicing fees and other customary market-based fees and charges as described above.

Effective February 1, 2013, the servicing agreement was amended to provide for servicing fees payable to PLS that changed from being based on a percentage of the loan’s unpaid principal balance to fixed per-loan monthly amounts based on the delinquency, bankruptcy and/or foreclosure status of the serviced loan or the REO. PLS also remains entitled to market-based fees and charges including boarding and deboarding, liquidation and disposition fees, assumption, modification and origination fees and late charges relating to loans it services for the Company.

•

The base servicing fees for distressed whole loans are calculated based on a monthly per-loan dollar amount, with the actual dollar amount for each loan based on the delinquency, bankruptcy and/or foreclosure status of such loan or the related underlying real estate. Presently, the base servicing fees for distressed whole loans range from $30 per month for current loans up to $125 per month for loans that are severely delinquent and in foreclosure.

•

The base servicing fees for loans subserviced by PLS on the Company’s behalf are also calculated through a monthly per-loan dollar amount, with the actual dollar amount for each loan based on whether the mortgage loan is a fixed-rate or adjustable-rate loan. The base servicing fees for loans subserviced on the Company’s behalf are $7.50 per month for fixed-rate loans and $8.50 per month for adjustable rate mortgage loans. To the extent that these loans become delinquent, PLS is entitled to an additional servicing fee per loan falling within a range of $10 to $75 per month based on the delinquency, bankruptcy and foreclosure status of the loan or the related underlying real estate. PLS is also entitled to customary ancillary income and certain market-based fees and charges, including boarding and deboarding fees, liquidation and disposition fees, assumption, modification and origination fees.

•

PLS is required to provide a range of services and activities significantly greater in scope than the services provided in connection with a customary servicing arrangement because the Company does not have any employees or infrastructure. For these services, PLS receives a supplemental fee of $25 per month for each distressed whole loan and $3.25 per month for each subserviced loan. PLS is entitled to reimbursement for all customary, good faith reasonable and necessary out-of-pocket expenses incurred in performance of its servicing obligations.

•

PLS, on behalf of PMT, currently participates in the U.S. Department of the Treasury and U.S. Department of Housing and Urban Development’s (“HUD”) Home Affordable Modification Program (“HAMP”) (and other similar mortgage loan modification programs), which establishes standard loan modification guidelines for “at risk” homeowners and provides incentive payments to certain participants, including loan servicers, for achieving modifications and successfully remaining in the program. The loan servicing agreement entitles PLS to retain any incentive payments made to it and to which it is entitled under HAMP; provided, however, that with respect to any such incentive payments paid to PLS under HAMP in connection with a mortgage loan modification for which the Company previously paid PLS a modification fee, PLS shall reimburse the Company an amount equal to the incentive payments.

Following is a summary of mortgage loan servicing fees payable to PLS for the periods presented:


	Quarter ended June 30,				Six months ended June 30,
	2013		2012		2013		2012
	(in thousands)
Loan servicing fees to PLS:
Base	$	6,150	$	3,110	$	11,866	$	6,138
Activity-based		2,637		1,328		4,647		2,425

	$	8,787	$	4,438	$	16,513	$	8,563

The term of the servicing agreement, as amended, expires on February 1, 2017, subject to automatic renewal for additional 18-month periods, unless terminated earlier in accordance with the terms of the servicing agreement.

Correspondent Lending

Before February 1, 2013, the Company paid PLS a fulfillment fee of 50 basis points of the unpaid principal balance of mortgage loans sold to non-affiliates where the Company is approved or licensed to sell to such non-affiliate. Effective February 1, 2013, the mortgage banking and warehouse services agreement provides for a fulfillment fee paid to PLS based on the type of mortgage loan that the Company acquires. The fulfillment fee is equal to a percentage of the unpaid principal balance of mortgage loans purchased by the Company, with the addition of potential fee rate discounts applicable to the Company’s monthly purchase volume in excess of designated thresholds. PLS has also agreed to provide such services exclusively for the Company’s benefit, and PLS and its affiliates are prohibited from providing such services for any other third party.

PLS is entitled to a fulfillment fee based on the type of mortgage loan that the Company acquires and equal to a percentage of the unpaid principal balance of such mortgage loan. Presently, the applicable percentages are (i) 0.50% for conventional mortgage loans, (ii) 0.88% for loans underwritten in accordance with the Ginnie Mae Mortgage-Backed Securities Guide, (iii) 0.80% for the U.S. Department of the Treasury and HUD’s Home Affordable Refinance Program (“HARP”) mortgage loans with a loan-to-value ratio of 105% or less, (iv) 1.20% for HARP mortgage loans with a loan-to-value ratio of greater than 105%, and (v) 0.50% for all other mortgage loans not contemplated above. At this time, the Company does not hold the Ginnie Mae approval required to issue

securities guaranteed by Ginnie Mae MBS and act as a servicer. Accordingly, under the mortgage banking and warehouse services agreement, PLS currently purchases loans underwritten in accordance with the Ginnie Mae Mortgage-Backed Securities Guide “as is” and without recourse of any kind from us at our cost less an administrative fee plus accrued interest and a sourcing fee of three basis points.

In the event that the Company purchases mortgage loans with an aggregate unpaid principal balance in any month greater than $2.5 billion and less than $5 billion, PLS has agreed to discount the amount of such fulfillment fees by reimbursing PMT an amount equal to the product of (i) 0.025%, (ii) the amount of unpaid principal balance in excess of $2.5 billion and (iii) the percentage of the aggregate unpaid principal balance relating to mortgage loans for which PLS collected fulfillment fees in such month. In the event the Company purchases mortgage loans with an aggregate unpaid principal balance in any month greater than $5 billion, PLS has agreed to further discount the amount of fulfillment fees by reimbursing us an amount equal to the product of (i) 0.05%, (ii) the amount of unpaid principal balance in excess of $5 billion and (iii) the percentage of the aggregate unpaid principal balance relating to mortgage loans for which PLS collected fulfillment fees in such month.

In consideration for the mortgage banking services provided by PLS with respect to the Company’s acquisition of mortgage loans under PLS’s early purchase program, PLS is entitled to fees accruing (i) at a rate equal to $25,000 per year, and (ii) in the amount of $50 for each mortgage loan the Company acquires. In consideration for the warehouse services provided by PLS with respect to mortgage loans that the Company finances for its warehouse lending clients, with respect to each facility, PLS is entitled to fees accruing (i) at a rate equal to $25,000 per year, and (ii) in the amount of $50 for each mortgage loan that the Company finances thereunder. Where we have entered into both an early purchase agreement and a warehouse lending agreement with the same client, PLS shall only be entitled to one $25,000 per annum fee and, with respect to any mortgage loan that becomes subject to both such agreements, only one $50 per loan fee.

The term of our mortgage banking and warehouse services agreement expires on February 1, 2017, subject to automatic renewal for additional 18-month periods, unless terminated earlier in accordance with the terms of the agreement.

Following is a summary of correspondent lending activity between the Company and PLS for the periods presented:


	Quarter ended June 30,				Six months ended June 30,
	2013		2012		2013		2012
	(in thousands)
Sourcing fees received	$	1,349	$	461	$	2,359	$	701
Fulfillment fees expense	$	22,054	$	7,715	$	50,298	$	13,839
Unpaid principal balance of loans fulfilled	$	4,323,885	$	1,537,636	$	9,110,711	$	2,336,843
Fair value of loans source to PLS	$	4,733,767	$	1,620,123	$	8,282,163	$	2,458,243
At period end:
Mortgage loans included in mortgage loans acquired for sale pending sale to PLS at period end	$	290,567	$	102,176	$	290,567	$	102,176

Investment Activities

Pursuant to the terms of a mortgage servicing rights (“MSR”) recapture agreement, effective February 1, 2013, if PLS refinances through its retail lending business loans for which the Company previously held the MSRs, PLS is generally required to transfer and convey to one of the Company’s wholly-owned subsidiaries without cost to the Company, the MSRs with respect to new mortgage loans originated in those refinancings (or, under certain circumstances, other mortgage loans) that have an aggregate unpaid principal balance that is not less than 30% of the aggregate unpaid principal balance of all the loans so originated. MSR recapture amounts are shown in Note 24—Net loan servicing fees. The MSR recapture agreement expires, unless terminated earlier in accordance with the agreement, on February 1, 2017, subject to automatic renewal for additional 18-month periods.

Pursuant to a spread acquisition and MSR servicing agreement, PMT may acquire from PLS the rights to receive certain excess servicing spread arising from MSRs acquired by PLS, in which case PLS generally would be required to service or subservice the related mortgage loans. The terms of each transaction under the spread acquisition and MSR servicing agreement will be subject to the terms of such agreement as modified and supplemented by the terms of a confirmation executed in connection with such transaction.

Other Transactions

In connection with the initial public offering of PMT’s common shares (“IPO”) on August 4, 2009, the Company entered into an agreement with PCM pursuant to which the Company agreed to reimburse PCM for the $2.9 million payment that it made to the IPO

underwriters (the “Conditional Reimbursement”) if the Company satisfied certain performance measures over a specified period of time. Effective February 1, 2013, the Company amended the terms of the reimbursement agreement to provide for the reimbursement of PCM of the Conditional Reimbursement if the Company is required to pay PCM performance incentive fees under the management agreement at a rate of $10 in reimbursement for every $100 of performance incentive fees earned. The reimbursement of the Conditional Reimbursement is subject to a maximum reimbursement in any particular 12-month period of $1.0 million and the maximum amount that may be reimbursed under the agreement is $2.9 million. The reimbursement agreement also provides for the payment to the underwriters in such offering of the payment that the Company agreed to make to them at the time of the offering if the Company satisfied certain performance measures over a specified period of time. As PCM earns performance incentive fees under the management agreement, such underwriters will be paid at a rate of $20 of payments for every $100 of performance incentive fees earned by PCM. The payment to the underwriters is subject to a maximum reimbursement in any particular 12-month period of $2.0 million and the maximum amount that may be paid under the agreement is $5.9 million.

In the event the termination fee is payable to PCM under the management agreement and PCM and the underwriters have not received the full amount of the reimbursements and payments under the reimbursement agreement, such amount will be paid in full. The term of the reimbursement agreement expires on February 1, 2019.

The Company reimburses PCM and its affiliates for other expenses, including common overhead expenses incurred on its behalf by PCM and its affiliates, in accordance with the terms of its management agreement as summarized below:


	Quarter ended June 30,				Six months ended June 30,
	2013		2012		2013		2012
	(in thousands)
Reimbursement of expenses incurred on PMT’s behalf	$	585	$	2,055	$	1,834	$	3,261
Reimbursement of common overhead incurred by PCM and its affiliates		3,201		882		5,807		1,268

	$	3,786	$	2,937	$	7,641	$	4,529

Payments and settlements during the period (1)	$	32,616	$	11,014	$	65,290	$	16,859

(1)	Payments and settlements include payments for management fees and correspondent lending activities itemized in the preceding tables and netting settlements made pursuant to master netting agreements between the Company and PCM and its affiliates.

Amounts due to affiliates are summarized below as of the dates presented:


	June 30, 2013		December 31, 2012
	(in thousands)
Underwriting fees payable	$	2,519	$	2,941
Management fees		8,455		4,499
Servicing fees expense		4,319		3,670
Allocated expenses		1,432		1,106

	$	16,725	$	12,216

Amounts due from affiliates totaling $3.1 million and $4.8 million at June 30, 2013 and December 31, 2012, respectively, represent amounts receivable pursuant to loan sales to PLS and reimbursable expenses paid on the affiliates’ behalf by the Company.

PCM’s parent company, Private National Mortgage Acceptance Company, LLC, held 75,000 of the Company’s common shares of beneficial interest at both June 30, 2013 and December 31, 2012.

Note 4—Earnings Per Share

Basic earnings per share is determined using net income divided by the weighted-average common shares outstanding during the period. Diluted earnings per share is determined by dividing net income attributable to common shareholders, which adds back to net income the interest expense, net of applicable income taxes, on exchangeable senior notes for periods presented, by the weighted-average common shares outstanding, assuming all potentially dilutive common shares were issued. In periods in which the Company records a loss, potentially dilutive common shares are excluded from the diluted loss per share calculation, as their effect on loss per share is anti-dilutive.

The Company grants restricted share units which entitle the recipients to receive dividend equivalents during the vesting period on a basis equivalent to the dividends paid to holders of common shares. For purposes of calculating earnings per share, unvested share-based compensation awards containing non-forfeitable rights to receive dividends or dividend equivalents (collectively, “dividends”) are classified as “participating securities” and are included in the basic earnings per share calculation using the two-class method. Under the two-class method, all earnings (distributed and undistributed) are allocated to each class of common shares and participating securities, based on their respective rights to receive dividends.

The following table summarizes the basic and diluted earnings per share calculations:


	Quarter ended June 30,						Six months ended June 30,
	2013			2012			2013			2012
	(in thousands, except per share amounts)
Basic earnings per share:
Net income	$	54,497		$	29,569		$	107,793		$	48,627
Effect of participating securities—share-based compensation instruments		(444	)		(213	)		(961	)		(424	)

Net income attributable to common shareholders	$	54,053		$	29,356		$	106,832		$	48,203

Weighted-average shares outstanding		59,035			36,922			58,981			32,999
Basic earnings per share	$	0.92		$	0.80		$	1.81		$	1.46
Diluted earnings per share:
Net income	$	54,497		$	29,569		$	107,793		$	48,627
Interest on exchangeable senior notes, net of income taxes		1,382			—			1,382			—

Net income available to diluted shareholders	$	55,879		$	29,569		$	109,175		$	48,627

Weighted-average shares outstanding		59,035			36,922			58,981			32,999
Dilutive potential common shares:
Shares issuable pursuant to conversion of exchangeable senior notes		5,709			—			2,870			—
Shares issuable under share-based compensation plan		360			286			366			254

Diluted weighted-average number of common shares outstanding		65,104			37,208			62,217			33,253

Diluted earnings per common share	$	0.86		$	0.79		$	1.75		$	1.46

Note 5—Loan Sales

The Company purchases and sells mortgage loans into the secondary mortgage market without recourse for credit losses. However the Company maintains continuing involvement with the loans in the form of servicing arrangements and the potential liability under representations and warranties it makes to purchasers and insurers of the loans.

The following table summarizes cash flows between the Company and transferees upon sale of loans in transactions whereby the Company maintains continuing involvement with the mortgage loans as well as unpaid principal balance information at period end:


	Quarter ended June 30,				Six months ended June 30,
	2013		2012		2013		2012
	(in thousands)
Cash flows:
Proceeds from sales	$	3,960,798	$	1,819,393	$	9,074,367	$	2,912,297
Service fees received	$	21,712	$	1,757	$	38,677	$	2,409
Period-end information:
Unpaid principal balance of loans outstanding	$	19,850,609	$	2,932,967
Delinquencies:
30-89 days	$	44,436	$	3,897
90 or more days or in foreclosure or bankruptcy	$	5,648	$	175

Note 6—Netting of Financial Instruments

The Company uses derivative instruments to manage exposure to interest rate risk created by the commitments it makes to correspondent lenders to purchase loans at specified interest rates, also called interest rate lock commitments (“IRLCs”), mortgage loans acquired for sale at fair value and MSRs. All derivative financial instruments are recorded on the balance sheet at fair value. The Company has elected to net derivative asset and liability positions, and cash collateral obtained (or posted) by (or to) its counterparties when subject to a master netting arrangement. In the event of default, all counterparties are subject to legally enforceable master netting agreements. The derivatives that are not subject to a master netting arrangement are IRLCs. As of June 30, 2013 and December 31, 2012, the Company did not enter into reverse repurchase agreements or securities lending transactions that are required to be disclosed in the following table.

Offsetting of Derivative Assets


	June 30, 2013								December 31, 2012
	Gross amounts of recognized assets		Gross amounts offset in the balance sheet			Net amounts of assets presented in the balance sheet			Gross amounts of recognized assets		Gross amounts offset in the balance sheet			Net amounts of assets presented in the balance sheet
	(in thousands)
Derivatives:
MBS put options	$	9,214	$	—		$	9,214		$	977	$	—		$	977
MBS call options		1,776		—			1,776			—		—			—
Forward purchase contracts		16,249		—			16,249			2,617		—			2,617
Forward sale contracts		158,274		—			158,274			3,458		—			3,458
Netting		—		(140,026	)		(140,026	)		—		(2,825	)		(2,825	)

Total derivatives, subject to a master netting arrangement		185,513		(140,026	)		45,487			7,052		(2,825	)		4,227
Total derivatives, not subject to a master netting arrangement		6,453		—			6,453			19,479		—			19,479

Total	$	191,966	$	(140,026	)	$	51,940		$	26,531	$	(2,825	)	$	23,706

Derivative Assets and Collateral Held by Counterparty

The following table summarizes by significant counterparty the amount of derivative asset positions after considering master netting arrangements and financial instruments or cash pledged that do not meet the accounting guidance qualifying for netting.


	June 30, 2013								December 31, 2012
			Gross amounts not offset in the balance sheet								Gross amounts not offset in the balance sheet
	Net amount of assets in the balance sheet		Financial instruments		Cash collateral received		Net amount		Net amount of assets in the balance sheet		Financial instruments		Cash collateral received		Net amount
	(in thousands)
Interest rate lock commitments	$	6,453	$	—	$	—	$	6,453	$	19,479		—		—	$	19,479
Bank of America, N.A.		17,418		—		—		17,418		1,219		—		—		1,219
Daiwa Capital Markets		6,789						6,789		—		—		—		—
Barclays		4,620		—		—		4,620		15		—		—		15
Citibank		4,577		—		—		4,577		1,009		—		—		1,009
Fannie Mae Capital Markets		3,835		—		—		3,835		—		—		—		—
Jefferies & Co		2,012						2,012		21		—		—		21
Credit Suisse First Boston Mortgage Capital LLC		1,720		—		—		1,720		820		—		—		820
Morgan Stanley Bank, N.A.		—		—		—		—		316		—		—		316
Wells Fargo		1,433						1,433		99						99
Cantor Fitzgerald LP		742		—		—		742		581		—		—		581
Other		2,341		—		—		2,341		147		—		—		147

Total	$	51,940	$	—	$	—	$	51,940	$	23,706	$	—	$	—	$	23,706

Offsetting of Derivative Liabilities and Financial Liabilities

Following is a summary of net derivative liabilities and assets sold under agreements to repurchase. As discussed above, all derivatives with the exception of IRLCs are subject to master netting arrangements. Assets sold under agreements to repurchase do not qualify for offset.


	June 30, 2013								December 31, 2012
	Gross amounts of recognized liabilities		Gross amounts offset in the balance sheet			Net amounts of liabilities presented in the balance sheet			Gross amounts of recognized liabilities		Gross amounts offset in the balance sheet			Net amounts of liabilities presented in the balance sheet
	(in thousands)
Derivatives:
Forward purchase contracts	$	72,016	$	—		$	72,016		$	1,741	$	—		$	1,741
Forward sale contracts		10,724		—			10,724			4,520		—			4,520
Netting		—		(79,541	)		(79,541	)		—		(5,294	)		(5,294	)

Total derivatives, subject to a master netting arrangement		82,740		(79,541	)		3,199			6,261		(5,294	)		967
Total derivatives, not subject to a master netting arrangement		23,420		—			23,420			—		—			—

Total derivatives		106,160		(79,541	)		26,619			6,261		(5,294	)		967

Assets sold under agreements to repurchase:
Mortgage loans acquired for sale at fair value		1,243,949		—			1,243,949			894,906		—			894,906
Mortgage loans at fair value		313,862		—			313,862			353,805		—			353,805
Real estate acquired in settlement of loans		8,085		—			8,085			7,391		—			7,391

Total assets sold under agreements to repurchase		1,565,896		—			1,565,896			1,256,102		—			1,256,102

Total	$	1,672,056	$	(79,541	)	$	1,592,515		$	1,262,363	$	(5,294	)	$	1,257,069

Derivative Liabilities, Financial Liabilities and Collateral Held by Counterparty

The following table summarizes by significant counterparty the amount of derivative liabilities and assets sold under agreements to repurchase after considering master netting arrangements and financial instruments or cash pledged that does not meet the accounting guidance qualifying for offset. All assets sold under agreements to repurchase have sufficient collateral or exceed the liability amount recorded on the consolidated balance sheet.


	June 30, 2013									December 31, 2012
			Gross amounts not offset in the consolidated balance sheet									Gross amounts not offset in the consolidated balance sheet
	Net liabilities in the balance sheet		Financial instruments			Cash collateral pledged		Net amount		Net liabilities in the balance sheet		Financial instruments			Cash collateral pledged		Net amount
	(in thousands)
Citibank	$	619,976	$	(619,976	)	$	—	$	—	$	474,625	$	(474,625	)	$	—	$	—
Credit Suisse First Boston Mortgage Capital LLC		580,848		(580,848	)		—		—		243,525		(243,525	)		—		—
Bank of America, N.A.		447,063		(447,063	)		—		—		256,711		(256,711	)		—		—
Morgan Stanley Bank, N.A.		135,993		(135,922	)		—		71		155,321		(155,321	)		—		—
Barclays		26,134		(26,134	)		—		—		79,253		(78,780	)		—		473
Interest rate lock commitments		23,420		—			—		23,420		—		—			—		—
Wells Fargo Bank, N.A.		—		—			—		—		47,140		(47,140	)		—		—
Bank of NY Mellon		2,667		—			—		2,667		—		—			—		—
Other		461		—			—		461		494		—			—		494

Total	$	1,836,562	$	(1,809,943	)	$	—	$	26,619	$	1,257,069	$	(1,256,102	)	$	—	$	967

Note 7—Fair Value

The Company’s consolidated financial statements include assets and liabilities that are measured based on their estimated fair values. The application of fair value estimates may be on a recurring or nonrecurring basis depending on the accounting principles applicable to the specific asset or liability and whether management has elected to carry the item at its estimated fair value as discussed in the following paragraphs.

Fair Value Accounting Elections

Management identified all of its non-cash financial assets, including short-term investments and mortgage loans, as well as its MSRs relating to loans with initial interest rates of more than 4.5% that were acquired as a result of its correspondent lending operations, to be accounted for at estimated fair value so such changes in fair value will be reflected in income as they occur and more timely reflect the results of the Company’s performance.

For MSRs relating to mortgage loans with initial interest rates of less than or equal to 4.5% that were acquired as a result of the Company’s correspondent lending operations, management has concluded that such assets present different risks to the Company than MSRs relating to mortgage loans with initial interest rates of more than 4.5% and therefore require a different risk management approach. Management’s risk management efforts relating to these assets are aimed at moderating the effects of non-interest rate risks on fair value, such as the effect of changes in home prices on the assets’ values. Management has identified these assets for accounting at the lower of amortized cost or fair value.

The Company’s risk management efforts in connection with MSRs relating to mortgage loans with initial interest rates of more than 4.5% are generally aimed at moderating the effects of changes in interest rates on the assets’ values. During the six month period ended June 30, 2013, a portion of the IRLCs, the fair value of which typically increases when prepayment speeds increase, were used to mitigate the effect of changes in fair value of the servicing assets, which typically decreases as prepayment speeds increase.

For loans sold under agreements to repurchase, REO financed through agreements to repurchase and borrowings under forward purchase agreements, management has determined that historical cost accounting is more appropriate because under this method debt issuance costs are amortized over the term of the debt, thereby matching the debt issuance cost to the periods benefiting from the usage of the debt.

Financial Statement Items Measured at Fair Value on a Recurring Basis

Following is a summary of financial statement items that are measured at estimated fair value on a recurring basis:


	June 30, 2013
	Level 1		Level 2			Level 3		Total
	(in thousands)
Assets:
Short-term investments	$	73,236	$	—		$	—	$	73,236
Mortgage loans acquired for sale at fair value		—		1,309,830			—		1,309,830
Mortgage loans at fair value		—		—			1,309,765		1,309,765
Mortgage loans under forward purchase agreements at fair value		—		—			242,531		242,531
Mortgage servicing rights at fair value		—		—			1,828		1,828
Derivative assets:
Interest rate lock commitments		—		—			6,453		6,453
MBS put options		—		9,214			—		9,214
MBS call options		—		1,776			—		1,776
Forward purchase contracts		—		16,249			—		16,249
Forward sales contracts		—		158,274			—		158,274

Total derivative assets before netting		—		185,513			6,453		191,966
Netting (1)		—		(140,026	)		—		(140,026	)

Total derivative assets before netting		—		45,487			6,453		51,940

	$	73,236	$	1,355,317		$	1,560,577	$	2,989,130

Liabilities:
Derivative liabilities:
Interest rate lock commitments		—		—			23,420		23,420
Forward purchase contracts		—		72,016			—		72,016
Forward sales contracts		—		10,724			—		10,724

Total derivative liabilities before netting		—		82,740			23,420		106,160
Netting (1)		—		(79,541	)		—		(79,541	)

Total derivative liabilities	$	—	$	3,199		$	23,420	$	26,619

(1)

Derivatives are reported net of cash collateral received and paid and, to the extent that the criteria of the accounting guidance covering the offsetting of amounts related to certain contracts are met, positions with the same counterparty are netted as part of a legally enforceable master netting agreement.


	December 31, 2012
	Level 1		Level 2		Level 3		Total
	(in thousands)
Assets:
Short-term investments	$	39,017	$	—	$	—	$	39,017
Mortgage loans acquired for sale at fair value		—		975,184		—		975,184
Mortgage loans at fair value		—		—		1,189,971		1,189,971
Mortgage servicing rights at fair value		—		—		1,346		1,346
Derivative assets:
Interest rate lock commitments		—		—		19,479		19,479
MBS put options		—		977		—		977
Forward purchase contracts		—		2,617		—		2,617
Forward sales contracts		—		3,458		—		3,458

Total derivative assets before netting		—		7,052		19,479		26,531
Netting (1)		—		—		—		(2,825	)

Total derivative assets		—		7,052		19,479		23,706

	$	39,017	$	982,236	$	1,210,796	$	2,229,224

Liabilities:
Derivative liabilities:
Forward purchase contracts		—		1,741		—		1,741
Forward sales contracts		—		4,520		—		4,520

Total derivative liabilities before netting		—		6,261		—		6,261
Netting (1)		—		—		—		(5,294	)

Total derivative liabilities	$	—	$	6,261	$	—	$	967

(1)

The Company’s MBS, mortgage loans at fair value, mortgage loans under forward purchase agreements, MSRs, IRLCs and securities sold under agreements to repurchase were measured using Level 3 inputs on a recurring basis. The following is a summary of changes in those items for the periods presented:


	Three months ended June 30, 2013
	Mortgage loans at fair value			Mortgage loans under forward purchase agreements			Mortgage servicing rights		Net interest rate lock commitments (1)			Total
	(in thousands)
Assets:
Balance, March 31, 2013	$	1,366,922		$	—		$	1,305	$	11,052		$	1,379,279
Purchases		13			243,309			186		—			243,508
Repayments		(73,820	)		—			—		—			(73,820	)
Interest rate lock commitments issued, net		—			—			—		22,240			22,240
Capitalization of interest		6,584			—			—		—			6,584
Servicing received as proceeds from sales of mortgage loans		—			—			77		—			77
Changes in fair value included in income arising from:
Changes in instrument-specific credit risk		11,050			—					—			11,050
Other factors		36,473			(689	)		260		(20,678	)		15,366

		47,523			(689	)		260		(20,678	)		26,416

Transfers of mortgage loans to REO		(37,457	)		(89	)		—		—			(37,546	)
Transfers of interest rate lock commitments (asset) liability to mortgage loans acquired for sale		—			—			—		(29,581	)		(29,581	)

Balance, June 30, 2013	$	1,309,765		$	242,531		$	1,828	$	(16,967	)	$	1,537,157

Changes in fair value recognized during the period relating to assets still held at June 30, 2013	$	33,292		$	—		$	260	$	(16,967	)	$	16,585

Accumulated changes in fair value relating to assets still held at June 30, 2013	$	165,960		$	(688	)			$	(16,967	)

(1)	For the purpose of this table, the interest rate lock asset and liability positions are shown net.


	Three Months ended June 30, 2012
	Mortgage- backed securities			Mortgage loans at fair value			Mortgage loans under forward purchase agreements			Mortgage servicing rights			Total
	(in thousands)
Assets:
Balance, March 31, 2012	$	62,425		$	667,542		$	105,030		$	1,188		$	836,185
Purchases		—			260,683			784			—			261,467
Repayments		(9,804	)		(49,865	)		(5,340	)		—			(65,009	)
Sales		—			—			—			(30	)		(30	)
Addition of unpaid interest, impound advances and fees to unpaid balance of mortgage loans		—			4,416			—			—			4,416
Accrual of unearned discounts		29			—			—			—			29
Servicing received as proceeds from sales of mortgage loans		—			—			—			568			568
Changes in fair value included in income arising from:
Changes in instrument-specific credit risk		—			8,227			312			—			8,539
Other factors		511			16,571			2,177			(441	)		18,818

		511			24,798			2,489			(441	)		27,357

Transfer of mortgage loans to REO		—			(21,485	)		—			—			(21,485	)
Transfer of mortgage loans under forward purchase agreements to REO under forward purchase agreements		—			—			(2,217	)		—			(2,217	)
Transfer of mortgage loans under forward purchase agreements to mortgage loans		—			83,865			(83,865	)		—			—

Balance, June 30, 2012	$	53,161		$	969,954		$	16,881		$	1,285		$	1,041,281

Changes in fair value recognized during the period relating to assets still held at June 30, 2012	$	511		$	15,845		$	1,044		$	(441	)	$	16,959

Accumulated changes in fair value relating to assets still held at June 30, 2012	$	(1,777	)	$	75,797		$	1,523


	Six months ended June 30, 2013
	Mortgage loans at fair value			Mortgage loans under forward purchase agreements			Mortgage servicing rights		Net interest rate lock commitments (1)			Total
	(in thousands)
Assets:
Balance, December 31, 2012	$	1,189,971		$	—		$	1,346	$	19,479		$	1,210,796
Purchases		200,486			243,309			186		—			443,981
Repayments		(135,242	)		—			—		—			(135,242	)
Interest rate lock commitments issued, net		—			—			—		57,654			57,654
Capitalization of interest		11,814			—			—		—			11,814
Servicing received as proceeds from sales of mortgage loans		—			—			104		—			104
Changes in fair value included in income arising from:
Changes in instrument-specific credit risk		19,495			—					—			19,495
Other factors		92,008			(689	)		192		(20,678	)		70,833

		111,503			(689	)		192		(20,678	)		90,328

Transfers of mortgage loans to REO		(68,767	)		(89	)		—		—			(68,856	)
Transfers of interest rate lock commitments (asset) liability to mortgage loans acquired for sale		—			—			—		(73,422	)		(73,422	)

Balance, June 30, 2013	$	1,309,765		$	242,531		$	1,828	$	(16,967	)	$	1,537,157

Changes in fair value recognized during the period relating to assets still held at June 30, 2013	$	77,771		$	—		$	192	$	(16,967	)	$	60,996

Accumulated changes in fair value relating to assets still held at June 30, 2013	$	165,960		$	(688	)			$	(16,967	)

(1)	For the purpose of this table, the interest rate lock asset and liability positions are shown net.


	Six Months ended June 30, 2012
	Mortgage- backed securities			Mortgage loans at fair value			Mortgage loans under forward purchase agreements			Mortgage servicing rights			Total
	(in thousands)
Assets:
Balance, December 31, 2011	$	72,813		$	696,266		$	129,310		$	749		$	899,138
Purchases		—			260,595			1,070			20			261,685
Repayments		(20,890	)		(84,564	)		(14,040	)		—			(119,494	)
Sales		—			—			—			(30	)		(30	)
Accrual of unearned discounts		363			—			—			—			363
Capitalization of interest		—			13,016			—			—			13,016
Sales		—			—			—			—			—
Servicing received as proceeds from sales of mortgage loans		—			—			—			1,088			1,088
Changes in fair value included in income arising from:
Changes in instrument-specific credit risk		—			17,307			705			—			18,012
Other factors		875			11,828			8,483			(542	)		20,644

		875			29,135			9,188			(542	)		38,656

Transfer of mortgage loans to REO		—			(45,686	)		—			—			(45,686	)
Transfer from mortgage loans acquired for sale		—			18			—			—			18
Transfer of mortgage loans under forward purchase agreements to REO under forward purchase agreements		—			—			(7,473	)		—			(7,473	)
Transfer of mortgage loans under forward purchase agreements to mortgage loans		—			101,174			(101,174	)		—			—

Balance, June 30, 2012	$	53,161		$	969,954		$	16,881		$	1,285		$	1,041,281

Changes in fair value recognized during the period relating to assets still held at June 30, 2012	$	838		$	17,888		$	1,635		$	(542	)	$	19,819

Accumulated changes in fair value relating to assets still held at June 30, 2012	$	(1,777	)	$	75,797		$	1,523


	Securities sold under agreements to repurchase
	(in thousands)
Liabilities:
Balance, December 31, 2011	$	115,493
Changes in fair value included in income		—
Sales		706,966
Repurchases		(665,170	)

Balance, June 30, 2012	$	157,289

Changes in fair value recognized during the period relating to liabilities still outstanding at June 30, 2012	$	—

Following are the fair values and related principal amounts due upon maturity of mortgage loans accounted for under the fair value option (including mortgage loans acquired for sale, mortgage loans at fair value and mortgage loans under forward purchase agreements at fair value):


	June 30, 2013
	Fair value		Principal amount due upon maturity		Difference
	(in thousands)
Mortgage loans acquired for sale:
Current through 89 days delinquent	$	1,309,830	$	1,317,135	$	(7,305	)
90 or more days delinquent (1)		—		—		—

		1,309,830		1,317,135		(7,305	)

Other mortgage loans at fair value:
Current through 89 days delinquent	$	506,964		768,666		(261,702	)
90 or more days delinquent (1)		1,045,332		1,816,434		(771,102	)

		1,552,296		2,585,100		(1,032,804	)

	$	2,862,126	$	3,902,235	$	(1,040,109	)


	December 31, 2012
	Fair value		Principal amount due upon maturity		Difference
	(in thousands)
Mortgage loans acquired for sale:
Current through 89 days delinquent	$	975,184	$	931,787	$	43,397
90 or more days delinquent (1)		—		—		—

		975,184		931,787		43,397

Other mortgage loans at fair value:
Current through 89 days delinquent	$	404,016		640,722		(236,706	)
90 or more days delinquent (1)		785,955		1,483,311		(697,356	)

		1,189,971		2,124,033		(934,062	)

	$	2,165,155	$	3,055,820	$	(890,665	)

(1)	Loans delinquent 90 or more days are placed on nonaccrual status and previously accrued interest is reversed.

Following are the changes in fair value included in current period income by consolidated statement of income line item for financial statement items accounted for under the fair value option:


	Changes in fair value included in current period income
	Quarter ended June 30, 2013
	Net gain (loss) on investments			Interest income		Net loss on mortgage loans acquired for sale			Net loan servicing fees		Total
	(in thousands)
Assets:
Short-term investments	$	—		$	—	$	—		$	—	$	—
Mortgage-backed securities at fair value		—			—		—			—		—
Mortgage loans acquired for sale at fair value		—			—		(56,951	)		—		(56,951	)
Mortgage loans at fair value		47,523			—		—			—		47,523
Mortgage loans under forward purchase agreements at fair value		(689	)		—		—			—		(689	)
Mortgage servicing rights at fair value		—			—		—			260		260

	$	46,834		$	—	$	(56,951	)	$	260	$	(9,857	)


	Changes in fair value included in current period income
	Quarter ended June 30, 2012
	Net gain on investments			Interest income			Net gain on mortgage loans acquired for sale			Net loan servicing fees			Total
	(in thousands)
Assets:
Short-term investments	$	—		$	—		$	—		$	—		$	—
Mortgage-backed securities at fair value		706			(101	)		—			—			605
Mortgage loans acquired for sale at fair value		—			—			18,046			—			18,046
Mortgage loans at fair value		24,798			—			—			—			24,798
Mortgage loans under forward purchase agreements at fair value		2,488			—			—			—			2,488
Mortgage servicing rights at fair value		—			—			—			(441	)		(441	)

	$	27,992		$	(101	)	$	18,046		$	(441	)	$	45,496

Liabilities:
Securities sold under agreements to repurchase at fair value	$	—		$	—		$	—		$	—		$	—

	$	—		$	—		$	—		$	—		$	—


	Changes in fair value included in current period income
	Six months ended June 30, 2013
	Net gain (loss) on investments			Interest income			Net loss on mortgage loans acquired for sale			Net loan servicing fees			Total
	(in thousands)
Assets:
Short-term investments	$	—		$	—		$	—		$	—		$	—
Mortgage-backed securities at fair value		—			—			—			—			—
Mortgage loans acquired for sale at fair value		—			—			(32,180	)		—			(32,180	)
Mortgage loans at fair value		111,503			—			—			—			111,503
Mortgage loans under forward purchase agreements at fair value		(689	)		—			—			—			(689	)
Mortgage servicing rights at fair value		—			—			—			192			192

	$	110,814		$	—		$	(32,180	)	$	192		$	78,826


	Changes in fair value included in current period income
	Six months ended June 30, 2012
	Net gain on investments		Interest income		Net gain on mortgage loans acquired for sale		Net loan servicing fees			Total
	(in thousands)
Assets:
Short-term investments	$	—	$	—	$	—	$	—		$	—
Mortgage-backed securities at fair value		1,063		233		—		—			1,296
Mortgage loans acquired for sale at fair value		—		—		31,416		—			31,416
Mortgage loans at fair value		29,229		—		—		—			29,229
Mortgage loans under forward purchase agreements at fair value		9,188		—		—		—			9,188
Mortgage servicing rights at fair value		—		—		—		(542	)		(542	)

	$	39,480	$	233	$	31,416	$	(542	)	$	70,587

Liabilities:
Securities sold under agreements to repurchase at fair value	$	—	$	—	$	—	$	—		$	—

	$	—	$	—	$	—	$	—		$	—

Financial Statement Items Measured at Fair Value on a Nonrecurring Basis

Following is a summary of financial statement items that are measured at estimated fair value on a nonrecurring basis:


	June 30, 2013
	Level 1		Level 2		Level 3		Total
	(in thousands)
Assets:
Real estate asset acquired in settlement of loans	$	—	$	—	$	42,493	$	42,493
Mortgage servicing assets at lower of amortized cost or fair value		—		—		149,000		149,000

	$	—	$	—	$	191,493	$	191,493


	December 31, 2012
	Level 1		Level 2		Level 3		Total
	(in thousands)
Assets:
Real estate asset acquired in settlement of loans	$	—	$	—	$	56,156	$	56,156
Mortgage servicing rights at lower of amortized cost or fair value		—		—		86,215		86,215

	$	—	$	—	$	142,371	$	142,371

The following table summarizes the total gains (losses) on assets measured at estimated fair values on a nonrecurring basis:


	Net gains (losses) recognized during the period
	Quarter ended June 30,						Six months ended June 30,
	2013			2012			2013			2012
	(in thousands)
Real estate asset acquired in settlement of loans	$	(4,095	)	$	(2,963	)	$	(6,594	)	$	(5,273	)
Real estate asset acquired in settlement of loans under forward purchase agreements		—			—			—			—
Mortgage servicing assets at lower of amortized cost or fair value		1,222			(1,518	)		3,708			(1,624	)

	$	(2,873	)	$	(4,481	)	$	(2,886	)	$	(6,897	)

Real Estate Acquired in Settlement of Loans

The Company measures its investment in REO at the respective properties’ estimated fair values less cost to sell on a nonrecurring basis. The initial carrying value of the REO is established as the lesser of (a) either the fair value of the loan at the date of transfer, (b) the fair value of the real estate less estimated costs to sell as of the date of transfer or (c) the purchase price of the property. REO may be subsequently revalued due to the Company receiving greater access to the property, the property being held for an extended period or management receiving indications that the property’s value may not be supported by developing market conditions. Any subsequent change in fair value to a level that is less than or equal to the value at which the property was initially recorded is recognized in Results of real estate acquired in settlement of loans in the consolidated statements of income.

Mortgage Servicing Rights at Lower of Amortized Cost or Fair Value

The Company evaluates its MSRs at lower of amortized cost or fair value for impairment with reference to the assets’ fair value. For purposes of performing its MSR impairment evaluation, the Company stratifies its MSRs at lower of amortized cost or fair value based on the interest rates borne by the mortgage loans underlying the MSRs. Mortgage loans are grouped into note rate pools of 50 basis point ranges for fixed-rate mortgage loans with note rates between 3% and 4.5% and a single pool for note rates below 3%. MSRs relating to adjustable rate mortgage loans with initial interest rates of 4.5% or less are evaluated in a single pool. If the fair value of MSRs in any of the note rate pools is below the carrying value of the MSRs for that pool reduced by the existing valuation allowance, those MSRs are impaired.

When MSRs are impaired, the impairment is recognized in current-period income and the carrying value of the MSRs is adjusted using a valuation allowance. If the value of the MSRs subsequently increases, the increase of value is recognized in current period earnings only to the extent of the valuation allowance for the respective stratum.

Management periodically reviews the various impairment strata to determine whether the value of the impaired MSRs in a given stratum is likely to recover. When management deems recovery of the value to be unlikely in the foreseeable future, a write-down of the cost of the MSRs for that stratum to its estimated fair value is charged to the valuation allowance.

Fair Value of Financial Instruments Carried at Amortized Cost

The Company’s cash balances as well as its borrowings secured by its inventory of mortgage loans acquired for sale and by its investments in nonperforming loans and REO in the form of repurchase agreements are carried at amortized cost.

Management has concluded that the estimated fair values of Cash, Mortgage loans acquired for sale at fair value sold under agreements to repurchase, Mortgage loans at fair value sold under agreements to repurchase, Real estate acquired in settlement of loans financed under agreements to repurchase and Borrowings under forward purchase agreements approximate the agreements’ carrying values due to the immediate realizability of cash at its carrying amount and to the borrowing agreements’ short terms and variable interest rates.

As discussed in Note 20, the Company, during the quarter, issued Exchangeable Senior Notes, which are carried at amortized cost. The fair value of the Exchangeable Senior Notes at June 30, 2013 was $238.6 million.

Cash is measured using Level 1 inputs. The Company’s borrowings carried at amortized cost do not have active markets or observable inputs and the fair value is measured using management’s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation. The Company has classified these financial instruments as “Level 3” financial statement items as of June 30, 2013 due to the lack of current market activity and the Company’s reliance on unobservable inputs to estimate these instruments’ fair value.

Valuation Techniques and Assumptions

Most of the Company’s assets are carried at fair value with changes in fair value recognized in current period income. A substantial portion of those assets are “Level 3” financial statement items which require the use of significant unobservable inputs in the estimation of the assets’ values. Unobservable inputs reflect the Company’s own assumptions about the factors that market participants use in pricing an asset or liability, and are based on the best information available under the circumstances.

The Manager has assigned the responsibility for estimating the fair values of “Level 3” financial statement items to its Financial Analysis and Valuation group (the “FAV group”), which is responsible for valuing and monitoring the Company’s investment portfolios and maintenance of its valuation policies and procedures.

The FAV group reports to the Manager’s senior management valuation committee, which oversees and approves the valuations. The valuation committee includes the chief executive, financial, investment and credit officers of the Manager. The FAV group monitors the models used for valuation of the Company’s “Level 3” financial statement items, including the models’ performance versus actual results and reports those results to the valuation committee. The results developed in the FAV group’s monitoring activities are used to calibrate subsequent projections used for valuation.

The FAV group is responsible for reporting to the Company’s senior management valuation committee on a monthly basis on the changes in the valuation of the portfolio, including major factors affecting the valuation and any changes in model methods and assumptions. To assess the reasonableness of its valuations, the FAV group presents an analysis of the effect on the valuation of each of the changes to the significant inputs to the models.

The following describes the valuation techniques and assumptions used in estimating the fair values of Level 2 and Level 3 financial statement items:

Mortgage Loans

Fair value of mortgage loans is estimated based on whether the mortgage loans are saleable into active markets:

•

Mortgage loans that are saleable into active markets, comprised of the Company’s mortgage loans acquired for sale at fair value, are categorized as “Level 2” financial statement items and their fair values are estimated using their quoted market or contracted price or market price equivalent.

•

Loans that are not saleable into active markets, comprised of the Company’s mortgage loans at fair value and mortgage loans under forward purchase agreements at fair value, are categorized as “Level 3” financial statement items, and their fair values are estimated using a discounted cash flow approach. Inputs to the discounted cash flow model include current interest rates, loan amount, payment status and property type, and forecasts of future interest rates, home prices, prepayment speeds, default speeds and loss severities. The valuation process includes the computation by stratum of loan population and a review for reasonableness of various measures such as weighted average life, projected prepayment and default speeds, and projected default and loss percentages. The FAV group computes the effect on the valuation of changes in input variables such as interest rates, home prices, and delinquency status to assess the reasonableness of changes in the loan valuation. The results of the estimates of fair value of “Level 3” mortgage loans are reported to PCM’s valuation committee as part of its review and approval of monthly valuation results.

Changes in fair value attributable to changes in instrument-specific credit risk are measured by the change in the respective loan’s delinquency status at period-end from the later of the beginning of the period or acquisition date.

The significant unobservable inputs used in the fair value measurement of the Company’s mortgage loans at fair value and mortgage loans under forward purchase agreements at fair value are discount rate, home price projections, voluntary prepayment speeds and default speeds. Significant changes in any of those inputs in isolation could result in a significant change to the loans’ fair value measurement. Increases in home price projections are generally accompanied by an increase in voluntary prepayment speeds.

Following is a quantitative summary of key inputs used in the valuation of mortgage loans at fair value:


	Range
	(Weighted Average)
Key Inputs	June 30, 2013	December 31, 2012
Mortgage loans at fair value
Discount rate	8.3% – 19.0%	8.8% – 20.7%
	(12.4%)	(13.1%)
Twelve-month projected housing price index change	3.7% – 6.0%	0.4% – 1.5%
	(4.8%)	(1.1%)
Prepayment speed(1)	0.0% – 4.4%	0.4% – 4.4%
	(2.4%)	(2.2%)
Total prepayment speed (2)	0.0% – 33.3%	5.9% – 31.2%
	(21.7%)	(20.6%)
Mortgage loans under forward purchase agreements
Discount rate	9.5% – 13.4%	—
	(12.6%)	—
Twelve-month projected housing price index change	4.5% – 5.6%	—
	(5.2%)	—
Prepayment speed (1)	1.1% – 2.4%	—
	(1.7%)	—
Total prepayment speed (2)	13.1% – 31.4%	—
	(25.3%)	—

(1)	Prepayment speed is measured using Life Voluntary Conditional Prepayment Rate (“CPR”).

(2)	Total prepayment speed is measured using Life Total CPR.

Derivative Financial Instruments

The Company estimates the fair value of IRLCs based on quoted Agency MBS prices, its estimate of the fair value of the MSRs it expects to receive in the sale of the loans and the probability that the mortgage loan will fund or be purchased as a percentage of the commitments it has made (the “pull-through rate”). The Company categorized IRLCs as a “Level 3” financial statement item.

The significant unobservable inputs used in the fair value measurement of the Company’s IRLCs are the pull-through rate and the MSR component of the Company’s estimate of the value of the mortgage loans it has committed to purchase. Significant changes in the pull-through rate and the MSR component of the IRLCs, in isolation, could result in a significant change in fair value measurement. The financial effects of changes in these assumptions are generally inversely correlated as increasing interest rates have a positive effect on the fair value of the MSR component of IRLC value, but increase the pull-through rate for loans that have decreased in fair value in comparison to the agreed-upon purchase price.

Following is a quantitative summary of key unobservable inputs used in the valuation of IRLCs:


	June 30, 2013	December 31, 2012
Key Inputs	Range (Weighted average)
Pull-through rate	55.3% - 98.0%	44.2% - 98.0%
	(87.6)%	(80.6%)
MSR value expressed as:
Servicing fee multiple	1.6 - 5.2	1.8 - 4.8
	(4.5)	(4.5)
Percentage of unpaid principal balance	0.4% - 1.3%	0.4% - 1.2%
	(1.1%)	(1.1%)

The Company estimates the fair value of commitments to sell loans based on quoted MBS prices. The Company estimates the fair value of the interest rate options and futures it purchases and sells based on observed interest rate volatilities in the MBS market. The Company estimates the fair value of its MBS interest rate swaptions based on quoted market prices.

Real Estate Acquired in Settlement of Loans

REO is measured based on its fair value on a nonrecurring basis and is categorized as a “Level 3” financial statement item. Fair value of REO is determined by using a current estimate of value from a broker’s price opinion or a full appraisal, or the price given in a current contract of sale.

REO values are reviewed by PCM’s staff appraisers when the Company obtains multiple indications of value and there is a significant discrepancy between the values received. PCM’s staff appraisers will attempt to resolve the discrepancy between the indications of value. In circumstances where the appraisers are not able to generate adequate data to support a value conclusion, the staff appraisers will order an additional appraisal to resolve the property’s value.

Mortgage Servicing Rights

MSRs are categorized as “Level 3” financial statement items. The Company uses a discounted cash flow approach to estimate the fair value of MSRs. The key assumptions used in the estimation of the fair value of MSRs include prepayment and default rates of the underlying loans, the applicable discount rate, and cost to service loans. The key assumptions used in the Company’s discounted cash flow model are based on market factors which management believes are consistent with assumptions and data used by market participants valuing similar MSRs. The results of the estimates of fair value of MSRs are reported to PCM’s valuation committee as part of their review and approval of monthly valuation results.

The significant unobservable inputs used in the fair value measurement of the Company’s MSRs are pricing spreads, prepayment speeds (or life) and annual per-loan cost of servicing. Significant changes to any of those inputs in isolation could result in a significant change in the MSR fair value measurement. Changes in these key assumptions are not necessarily directly related.

MSRs are generally subject to loss in value when mortgage rates decrease. Decreasing mortgage rates normally encourage increased mortgage refinancing activity. Increased refinancing activity reduces the life of the loans underlying the MSRs, thereby reducing MSR value. Reductions in the value of MSRs affect income primarily through change in fair value and impairment charges. For MSRs backed by mortgage loans with historically low interest rates, factors other than interest rates (such as housing price changes) take on increasing influence on prepayment behavior of the underlying mortgage loans.

Following are the key inputs used in determining the fair value of MSRs at the time of initial recognition:


	Quarter ended June 30,
	2013				2012
	Range (Weighted average)
Key Inputs	Amortized cost		Fair value		Amortized cost		Fair value
Unpaid principal balance of underlying loans	$	3,840,110	$	27,346	$	1,486,109	$	56,193
Average servicing fee rate (in basis points)		28		27		25		25

Pricing spread (1)		5.4% – 13.5%		6.6% – 11.9%		7.5% – 22.8%		7.5% – 14.3%
		(6.5%)		(7.5%)		(8.2%)		(8.5%)
Life (in years)		2.6 - 6.9		6.3 - 6.9		2.5 - 6.4		2.5 - 6.4
		(6.4)		(6.8)		(6.4)		(6.3)
Annual total prepayment speed (2)		8.5% – 23.6%		8.8% – 13.6%		7.9% – 36.9%		7.9% – 36.9%
		(9.1%)		(9.3%)		(9.0%)		(9.7%)
Annual per-loan cost of servicing		$68 – $140		$68 – $68		$68 – $140		$68 – $140
		($68)		($68)		($68)		($70)

Six months ended June 30,

2013

2012

Range
(Weighted average)

Key Inputs

Amortized cost

Fair value

Large accelerated filer

Accelerated filer

Non-accelerated filer

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Smaller reporting company