Edgar Filing: PennyMac Mortgage Investment Trust

Large accelerated filer

Accelerated filer

Non-accelerated filer

¨ (Do not check if a smaller reporting company)

Smaller reporting company

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 March 31, 2014

¨	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 May 6, 2014
Common Shares of Beneficial Interest, $0.01 par value		73,989,941

PENNYMAC MORTGAGE INVESTMENT TRUST

FORM 10-Q

March 31, 2014

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		6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		52
	Observations on Current Market Opportunities		53
	Results of Operations		54
	Net Investment Income		55
	Expenses		72
	Balance Sheet Analysis		75
	Asset Acquisitions		76
	Investment Portfolio Composition		77
	Cash Flows		84
	Liquidity and Capital Resources		85
	Off-Balance Sheet Arrangements and Aggregate Contractual Obligations		87
	Quantitative and Qualitative Disclosures About Market Risk		92
	Factors That May Affect Our Future Results		94
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		96
Item 4.	Controls and Procedures		96
PART II. OTHER INFORMATION			97
Item 1.	Legal Proceedings		97
Item 1A.	Risk Factors		97
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		97
Item 3.	Defaults Upon Senior Securities		97
Item 4.	Mine Safety Disclosures		97
Item 5.	Other Information		97
Item 6.	Exhibits		98

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

PENNYMAC MORTGAGE INVESTMENT TRUST AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (UNAUDITED)


	March 31,		December 31,
	2014		2013
	(in thousands, except share data)
ASSETS
Cash	$	11,871	$	27,411
Short-term investments		91,338		92,398
Mortgage-backed securities at fair value pledged to secure securities sold under agreements to repurchase		198,110		197,401
Mortgage loans acquired for sale at fair value (includes $339,153 and $454,210 pledged to secure mortgage loans acquired for sale under agreements to repurchase)		344,680		458,137
Mortgage loans at fair value (includes $1,913,828 and $1,963,266 pledged to secure mortgage loans sold under agreements to repurchase)		2,079,020		2,076,665
Mortgage loans under forward purchase agreements at fair value pledged to secure borrowings under forward purchase agreements		202,661		218,128
Mortgage loans at fair value held by variable interest entity (includes $522,684 and $516,473 pledged to secure agreement to repurchase and asset-backed secured financing of the variable interest entity at fair value)		529,680		523,652
Excess servicing spread purchased from PennyMac Financial Services, Inc. at fair value		151,019		138,723
Derivative assets		7,928		7,976
Real estate acquired in settlement of loans (includes $81,615 and $89,404 pledged to secure real estate acquired in settlement of loans sold under agreements to repurchase)		172,987		138,942
Real estate acquired in settlement of loans under forward purchase agreements pledged to secure forward purchase agreements		13,890		9,138
Mortgage servicing rights (includes $36,181 and $26,452 carried at fair value)		301,427		290,572
Servicing advances		60,024		59,573
Due from PennyMac Financial Services, Inc.		3,590		6,009
Other assets		59,312		66,192

Total assets	$	4,227,537	$	4,310,917

LIABILITIES
Assets sold under agreements to repurchase	$	1,887,778	$	2,039,605
Borrowings under forward purchase agreements		216,614		226,580
Asset-backed secured financing of the variable interest entity at fair value		166,514		165,415
Exchangeable senior notes		250,000		250,000
Derivative liabilities		961		1,961
Accounts payable and accrued liabilities		72,413		71,561
Due to PennyMac Financial Services, Inc.		20,812		18,636
Income taxes payable		58,309		59,935
Liability for losses under representations and warranties		10,854		10,110

Total liabilities		2,684,255		2,843,803

Commitments and contingencies
SHAREHOLDERS’ EQUITY
Common shares of beneficial interest—authorized, 500,000,000 common shares of $0.01 par value; issued and outstanding, 73,929,541 and 70,458,082 common shares, respectively		739		705
Additional paid-in capital		1,466,347		1,384,468
Retained earnings		76,196		81,941

Total shareholders’ equity		1,543,282		1,467,114

Total liabilities and shareholders’ equity	$	4,227,537	$	4,310,917

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

PENNYMAC MORTGAGE INVESTMENT TRUST AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)


	Quarter ended March 31,
	2014			2013
	(in thousands, except share data)
Net investment income
Net gain on mortgage loans acquired for sale	$	9,971		$	29,279
Loan origination fees		2,356			5,473
Net interest income:
Interest income		39,346			16,875
Interest expense		19,775			11,236

		19,571			5,639

Net gain on investments		42,585			63,980
Net loan servicing fees		7,421			6,011
Results of real estate acquired in settlement of loans		(6,626	)		(3,253	)
Other		1,317			687

Net investment income		76,595			107,816

Expenses
Expenses payable to PennyMac Financial Services, Inc.:
Loan fulfillment fees		8,902			28,244
Loan servicing fees		14,591			7,726
Management fees		8,074			6,492
Professional services		1,731			2,384
Compensation		2,942			2,089
Other		4,066			4,946

Total expenses		40,306			51,881

Income before provision for income taxes		36,289			55,935
(Benefit from) provision for income taxes		(1,584	)		2,639

Net income	$	37,873		$	53,296

Earnings per share
Basic	$	0.52		$	0.90
Diluted	$	0.50		$	0.90
Weighted-average shares outstanding
Basic		71,527			58,927
Diluted		80,289			59,319
Dividends declared per share	$	0.59		$	0.57

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)


	Number				Additional
	of		Par		paid-in			Retained
	shares		value		capital			earnings			Total
	(in thousands)
Balance at December 31, 2012		58,904	$	589	$	1,129,858		$	70,889		$	1,201,336
Net income		—		—		—			53,296			53,296
Share-based compensation		86		1		1,451			—			1,452
Cash dividends, $0.57 per share		—		—		—			(33,577	)		(33,577	)
Underwriting and offering costs		—		—		(78	)		—			(78	)

Balance at March 31, 2013		58,990	$	590	$	1,131,231		$	90,608		$	1,222,429

Balance at December 31, 2013		70,458	$	705	$	1,384,468		$	81,941		$	1,467,114
Net income		—		—		—			37,873			37,873
Share-based compensation		85		—		1,814			—			1,814
Cash dividends, $0.59 per share		—		—		—			(43,618	)		(43,618	)
Proceeds from offerings of common shares		3,387		34		80,983			—			81,017
Underwriting and offering costs		—		—		(918	)		—			(918	)

Balance at March 31, 2014		73,930	$	739	$	1,466,347		$	76,196		$	1,543,282

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

PENNYMAC MORTGAGE INVESTMENT TRUST AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)


	Quarter ended March 31,
	2014			2013
	(in thousands)
Cash flows from operating activities
Net income	$	37,873		$	53,296
Adjustments to reconcile net income to net cash used by operating activities:
Net gain on mortgage loans acquired for sale at fair value		(9,971	)		(29,279	)
Accrual of unearned discounts on mortgage-backed securities at fair value		(240	)		—
Capitalization of interest and advances on mortgage loans at fair value		(12,470	)		(5,230	)
Accrual of interest on excess servicing spread		(2,862	)		—
Amortization of credit facility commitment fees and debt issuance costs		2,360			1,143
Accrual of costs related to forward purchase agreements		2,200			—
Net gain on investments		(46,727	)		(63,980	)
Change in fair value, amortization and impairment of mortgage servicing rights		10,020			4,539
Results of real estate acquired in settlement of loans		6,626			3,253
Share-based compensation expense		1,814			1,452
Purchases of mortgage loans acquired for sale at fair value		(5,046,603	)		(8,849,152	)
Sales of mortgage loans acquired for sale at fair value to nonaffiliates		2,026,306			5,134,736
Sales of mortgage loans acquired for sale to PennyMac Financial Services, Inc.		3,130,531			3,548,397
Increase in servicing advances		(5,647	)		(5,504	)
Decrease (increase) in due from PennyMac Financial Services, Inc.		3,196			(1,161	)
Decrease (increase) in other assets		17,434			(2,210	)
Decrease in accounts payable and accrued liabilities		(1,124	)		(20,142	)
Increase in payable to PennyMac Financial Services, Inc.		2,212			2,532
(Decrease) increase in income taxes payable		(1,626	)		2,165

Net cash provided by (used in) operating activities		113,302			(225,145	)

Cash flows from investing activities
Net decrease (increase) in short-term investments		1,060			(6,007	)
Repayments of mortgage-backed securities at fair value		1,978			—
Purchases of mortgage loans at fair value		(256,280	)		(200,473	)
Repayments and sales of mortgage loans at fair value		246,839			61,421
Repayments of mortgage loans under forward purchase agreements at fair value		5,329			—
Repayments of mortgage loans at fair value held by variable interest entity		5,453			—
Purchase of excess servicing spread from PennyMac Financial Services, Inc.		(20,526	)		—
Repayment of excess spread investment		7,413			—
Purchases of derivative financial instruments		(259	)		—
Sales of real estate acquired in settlement of loans		31,772			32,024
Purchase of real estate acquired in settlement of loans		(3,049	)		—
Sales of real estate acquired in settlement of loans under forward purchase agreements		1,620			—
Increase in margin deposits and restricted cash		(21,857	)		(1,493	)

Net cash used in investing activities		(507	)		(114,528	)

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

PENNYMAC MORTGAGE INVESTMENT TRUST AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) (UNAUDITED)


	Quarter ended March 31,
	2014			2013
	(in thousands)
Cash flows from financing activities
Sale of assets under agreement to repurchase		6,814,735			8,510,958
Repurchases of assets sold under agreements to repurchase		(6,966,561	)		(8,152,010	)
Repayments of borrowings under forward purchase agreements		(13,124	)		—
Repayments of asset-backed secured financing of the variable interest entity at fair value		(1,805	)		—
Proceeds from issuance of common shares		81,017			—
Payment of common share underwriting and offering costs		(918	)		(78	)
Payment of contingent underwriting fees payable		(109	)		—
Payment of dividends		(41,570	)		(33,577	)

Net cash (used in) provided by financing activities		(128,335	)		325,293

Net decrease in cash		(15,540	)		(14,380	)
Cash at beginning of period		27,411			33,756

Cash at end of period	$	11,871		$	19,376

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 “Manager”) and PennyMac Loan Services, LLC (“PLS” or “Servicer”), both subsidiaries of PennyMac Financial Services, Inc. (“PFSI”).

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 mortgage-related assets, which include distressed mortgage loans, real estate acquired in settlement of loans (“REO”), MBS, mortgage servicing rights (“MSRs”) and excess servicing spread (“ESS”). 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.

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 has 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 wholly-owned 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”) as codified in the Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification 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, 2013 (the “Annual Report”). Intercompany accounts and transactions have been eliminated.

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.

Reclassification of previously presented balances

Certain prior period amounts have been reclassified to conform to the current presentation. Specifically:

•

Interest expense is included with Interest income under a new caption, Net interest income, to better reflect the Company’s results due to growth in its portfolio of interest-earning assets. This reclassification results in the presentation of Net interest income in Net investment income and a decrease in Expenses.

•

Loan servicing fees payable to PennyMac Financial Services, Inc. is presented without the inclusion of other servicing expenses payable to nonaffiliates. Previously, Loan servicing expense included amounts payable to PFSI and to nonaffiliates. Amounts payable to nonaffiliates have been reclassified to Other expenses.

•

Other minor amounts were reclassified to Other expenses, to conform to the current period presentation.

Following is a summary of the reclassifications:


	Quarter ended March 31, 2013
	As reported		As previously reported		Reclassification
	(in thousands)
Net interest income (new caption):
Interest income	$	16,875	$	16,875	$	—
Interest expense		11,236		—		11,236

		5,639		16,875		(11,236	)

Net investment income	$	107,816	$	119,052	$	(11,236	)
Expenses:
Interest expense	$	—	$	11,236	$	(11,236	)
Expenses payable to PennyMac Financial Services, Inc.:
Loan servicing fees		7,726		8,090		(364	)
Other		4,946		4,690		256
Total expenses	$	51,881	$	63,117	$	(11,236	)

These reclassifications did not change previously reported income before provision for income taxes, (benefit from) provision for income taxes, net income, reported consolidated balance sheet amounts, including shareholders’ equity, or consolidated cash flows.

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 mortgage-related assets, a substantial portion of which are distressed at acquisition. 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.

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.

A substantial portion of the distressed mortgage loans and REO purchased by the Company has been acquired from or through one or more subsidiaries of Citigroup Inc. The following tables present purchases for the Company’s investment portfolio of mortgage loans and REO (including purchases under forward purchase agreements), and the portion thereof representing assets purchased from or through one or more subsidiaries of Citigroup Inc.:


	Quarter ended March 31,
	2014		2013
	(in thousands)
Investment portfolio purchases:
Mortgage loans	$	257,200	$	200,473
REO		3,087		—

	$	260,287	$	200,473

Investment portfolio purchases above through one or more subsidiaries of Citigroup Inc.:
Mortgage loans	$	—	$	200,473
REO		38		—

	$	38	$	200,473

Following is a summary of the Company’s holdings of assets purchased through one or more subsidiaries of Citigroup Inc.:


	March 31, 2014		December 31, 2013
	(in thousands)
Mortgage loans	$	927,107	$	1,138,131
Mortgage loans - forward		202,661		218,128
REO		88,081		84,726
REO - forward		13,032		8,705

	$	1,230,881	$	1,449,690

During the year ended December 31, 2013, the Company entered into forward purchase agreements with Citigroup Global Markets Realty Corp. (“CGM”), a subsidiary of Citigroup Inc., to purchase certain nonperforming mortgage loans and REO (collectively, the “CGM Assets”). The CGM Assets were acquired by CGM from unaffiliated money center banks and are held in a trust subsidiary by CGM pending payment by the Company.

The Company recognized these assets and related obligations as of the dates of the agreements and recognizes all subsequent income and changes in value relating to such assets. As a result of recognizing these assets, the Company’s consolidated statements of income and cash flows include the following amounts related to the forward purchase agreements:


	Quarter ended March 31,
	2014			2013
	(in thousands)
Statements of income:
Interest income on mortgage loans	$	2,154		$	—
Interest expense	$	1,580		$	—
Net gain on investments	$	(940	)	$	—
Results of REO	$	(400	)	$	—

Loan servicing fees	$	316		$	—
Statements of cash flows:
Repayments of mortgage loans	$	5,329		$	—
Sales of REO	$	1,622		$	—
Repayments of borrowings under forward purchase agreements	$	(13,124	)	$	—

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.

Note 3—Transactions with Related Parties

Following is a summary of the base management and performance incentive fees payable to PFSI recorded by the Company:


	Quarter ended March 31,
	2014		2013
	(in thousands)
Management fee:
Base	$	5,521	$	4,364
Performance incentive		2,553		2,128

	$	8,074	$	6,492

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

Following is a summary of mortgage loan servicing fees payable to PFSI:


	Quarter ended March 31,
	2014		2013
	(in thousands)
Mortgage loan servicing fees payable to PFSI:
Mortgage loans acquired for sale at fair value:
Base	$	17	$	77
Activity-based		26		72

		43		149

Distressed mortgage loans:
Base		4,966		3,875
Activity-based		6,386		1,877

		11,352		5,752

MSRs:
Base		3,148		1,763
Activity-based		48		62

		3,196		1,825

	$	14,591	$	7,726

Following is a summary of correspondent lending activity between the Company and PFSI:


	Quarter ended March 31,
	2014		2013
	(in thousands)
Fulfillment fees expense payable to PFSI	$	8,902	$	28,244
Unpaid principal balance of loans fulfilled by PFSI	$	1,919,578	$	4,786,826

Sourcing fees received from PFSI	$	892	$	1,010
Fair value of loans sold to PFSI	$	3,130,530	$	3,548,397

At period end:
Mortgage loans included in mortgage loans acquired for sale pending sale to PFSI	$	48,909	$	542,490

Following is a summary of investment activity between the Company and PFSI:


	Quarter ended March 31,
	2014		2013
	(in thousands)
Purchases of excess servicing spread	$	20,526	$	—
Interest income from excess servicing spread	$	2,862	$	—
Excess servicing spread recapture recognized	$	1,890	$	—
MSR recapture recognized	$	8	$	133

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 PFSI pursuant to which the Company agreed to reimburse PFSI for the $2.9 million payment that it made to the IPO underwriters if the Company satisfied certain performance measures over a specified period (the “Conditional

Reimbursement”). Effective February 1, 2013, the Company amended the terms of the reimbursement agreement to provide for the reimbursement of PFSI of the Conditional Reimbursement if the Company is required to pay PFSI 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. During the quarter ended March 31, 2014, the Company paid $36,000 to PFSI.

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. As PFSI 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 PFSI. 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. During the quarter ended March 31, 2014, the Company paid $72,000 to the underwriters.

In the event the termination fee is payable to PFSI under the management agreement and PFSI 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 PFSI and its affiliates for other expenses, including common overhead expenses and other expenses incurred on its behalf by PFSI, in accordance with the terms of its management agreement as summarized below:


	Quarter ended March 31,
	2014		2013
	(in thousands)
Reimbursement of:
Common overhead incurred by PFSI	$	2,578	$	2,606
Expenses incurred on the Company’s behalf		445		1,358

	$	3,023	$	3,964

Payments and settlements during the period (1)	$	18,386	$	33,362

(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 PFSI.

Amounts due to PFSI are summarized below:


	March 31,		December 31,
	2014		2013
	(in thousands)
Contingent underwriting fees	$	1,752	$	1,788
Servicing fees		8,222		5,915
Management fees		8,074		8,924
Allocated expenses		2,764		2,009

	$	20,812	$	18,636

Amounts due from affiliates totaling $3.6 million and $6.0 million at March 31, 2014 and December 31, 2013, respectively. At March 31, 2014, the balance represent payments receivable relating to cash flows from the Company’s investment in ESS and amounts receivable relating to unsettled MSR and ESS recaptures. At March 31, 2013, amounts due from affiliates represent amounts receivable pursuant to loan sales to PFSI and reimbursable expenses paid on the affiliates’ behalf by the Company.

PFSI held 75,000 of the Company’s common shares of beneficial interest at both March 31, 2014 and December 31, 2013.

Note 4—Earnings Per Share

Basic earnings per share is determined using the two-class method. Under the two-class method, all earnings (distributed and undistributed) are allocated to common shares and participating securities, based on their respective rights to receive dividends. Basic earnings per share is determined using net income reduced by income attributable to the participating securities and divided by the weighted-average common shares outstanding during the period. 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 shares. Unvested share-based compensation awards containing non-forfeitable rights to receive dividends or dividend equivalents (collectively, “dividends”) are classified as “participating securities” and are included in the basic earnings per share calculation using the two-class method.

Diluted earnings per share is determined by dividing net income attributable to diluted shareholders, which adds back to net income the interest expense, net of applicable income taxes, on the Company’s exchangeable senior notes (the “Notes”), by the weighted-average shares outstanding, assuming all potentially dilutive securities were issued. In periods in which the Company records a loss, potentially dilutive securities are excluded from the diluted loss per share calculation, as their effect on loss per share is anti-dilutive.

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


	Quarter ended March 31,
	2014			2013
	(in thousands, except per share amounts)
Basic earnings per share:
Net income	$	37,873		$	53,296
Effect of participating securities—share-based compensation awards		(408	)		(518	)

Net income attributable to common shareholders	$	37,465		$	52,778

Weighted-average shares outstanding		71,527			58,927
Basic earnings per share	$	0.52		$	0.90
Diluted earnings per share:
Net income	$	37,873		$	53,296
Interest on exchangeable senior notes, net of income taxes		2,079			—

Net income attributable to diluted shareholders	$	39,952		$	53,296

Weighted-average shares outstanding		71,527			58,927
Potentially dilutive securities:
Shares issuable pursuant exchange of the Notes		8,379			—
Shares issuable under share-based compensation		383			392

Diluted weighted-average number of shares outstanding		80,289			59,319

Diluted earnings per share	$	0.50		$	0.90

Note 5—Loan Sales

The Company is a variable interest holder in various special purpose entities that relate to its loan transfer and financing activities. The Company has segregated its involvement with variable interest entities (“VIEs”) between those VIEs which the Company does not consolidate and those VIEs which the Company consolidates.

Unconsolidated VIEs with Continuing Involvement

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


	Quarter ended March 31,
	2014		2013
	(in thousands)
Cash flows:
Proceeds from sales	$	2,026,306	$	5,134,736
Servicing fees received (1)	$	16,838	$	9,136
Period end information:
Unpaid principal balance of mortgage loans outstanding	$	27,192,550	$	16,642,130
Unpaid principal balance of delinquent mortgage loans:
30-89 days delinquent	$	70,365	$	38,272
90 or more days delinquent
Not in foreclosure or bankruptcy	$	7,700	$	2,731
In foreclosure or bankruptcy	$	10,569	$	1,526

(1)	Net of guarantee fees

Consolidated VIE

On September 30, 2013, the Company completed a securitization transaction in which a wholly-owned VIE issued $537.0 million in offered certificates backed by fixed rate prime jumbo mortgage loans of PMT Loan Trust 2013-J1, at a 3.9% weighted yield. The Company retained $366.8 million of those certificates. Management concluded that the Company is the primary beneficiary of the VIE and, as a result, the Company consolidates the VIE. Consolidation of the VIE results in the securitized mortgage loans remaining on the consolidated balance sheets of the Company and the certificates issued by the VIE to nonaffiliates being accounted for as secured financing. The certificates are secured solely by the assets of the VIE and not by any other assets of the Company. The assets of the VIE are the only source of funds for repayment of the certificates.

The following table presents a summary of the assets and liabilities of the VIE. Intercompany balances have been eliminated for purposes of this presentation.

Assets and Liabilities of Consolidated VIE


	March 31, 2014		December 31, 2013
	(in thousands)
Assets
Mortgage loans at fair value held by VIE	$	529,680	$	523,652
Interest receivable, included in Other assets		1,718		1,584

Total	$	531,398	$	525,236

Liabilities
Asset-backed secured financing of the variable interest entity at fair value	$	166,514	$	165,415
Interest payable, included in Accounts payable and accrued liabilities		497		497

Total	$	167,011	$	165,912

Note 6—Netting of Financial Instruments

The Company uses derivative financial instruments to manage exposure to interest rate risk created by its interest rate lock commitments (“IRLC”), mortgage loans acquired for sale at fair value, MBS, ESS 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 legally enforceable master netting arrangement. The derivative financial instruments that are not subject to master netting arrangements are IRLCs.

Offsetting of Derivative Assets

Following is a summary of net derivative assets. As discussed above, all derivatives with the exception of IRLCs are subject to master netting arrangements.


	March 31, 2014								December 31, 2013
	Gross amounts of recognized assets		Gross amounts offset in the consolidated balance sheet			Net amounts of assets presented in the consolidated balance sheet			Gross amounts of recognized assets		Gross amounts offset in the consolidated balance sheet			Net amounts of assets presented in the consolidated balance sheet
	(in thousands)
Derivatives subject to master netting arrangements:
MBS put options	$	1,027	$	—		$	1,027		$	272	$	—		$	272
MBS call options		93		—			93
Forward purchase contracts		777		—			777			1,229		—			1,229
Forward sale contracts		5,434		—			5,434			16,385		—			16,385
Treasury futures		328		—			328			—		—			—
Put options on Eurodollar futures		432		—			432			566		—			566
Call options on Eurodollar futures		66		—			66			—		—			—
Netting		—		(3,738	)		(3,738	)		—		(12,986	)		(12,986	)

		8,157		(3,738	)		4,419			18,452		(12,986	)		5,466
Derivatives not subject to master netting arrangements:
Interest rate lock commitments		3,509		—			3,509			2,510		—			2,510

	$	11,666	$	(3,738	)	$	7,928		$	20,962	$	(12,986	)	$	7,976

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.


	March 31, 2014								December 31, 2013
			Gross amounts not offset in the consolidated balance sheet								Gross amounts not offset in the consolidated balance sheet
	Net amount of assets presented in the balance sheet		Financial instruments		Cash collateral received		Net amount		Net amount of assets presented in the balance sheet		Financial instruments		Cash collateral received		Net amount
	(in thousands)
Interest rate lock commitments	$	3,509	$	—	$	—	$	3,509	$	2,510	$	—	$	—	$	2,510
RBS Securities		892		—		—		892		—		—		—		—
RJ O’Brien		826		—		—		826		566		—		—		566
Citibank		725		—		—		725		—		—		—		—
Bank of America, N.A.		594		—		—		594		1,024		—		—		1,024
Wells Fargo		245						245		378						378
Credit Suisse First Boston Mortgage Capital LLC		234		—		—		234		—		—		—		—
Daiwa Capital Markets		141		—		—		141		608		—		—		608
Fannie Mae Capital Markets		—		—		—		—		432		—		—		432
Morgan Stanley Bank, N.A.		—		—		—		—		546		—		—		546
Cantor Fitzgerald LP		—		—		—		—		613		—		—		613
Other		762		—		—		762		1,299		—		—		1,299

Total	$	7,928	$	—	$	—	$	7,928	$	7,976	$	—	$	—	$	7,976

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 netting.


	March 31, 2014								December 31, 2013
	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 subject to master netting arrangements:
Forward purchase contracts	$	3,547	$	—		$	3,547		$	7,420	$	—		$	7,420
Forward contracts		1,219		—			1,219			1,295		—			1,295
MBS options		333		—			333			—		—			—
Netting		—		(4,376	)		(4,376	)		—		(8,015	)		(8,015	)

		5,099		(4,376	)		723			8,715		(8,015	)		700
Derivatives not subject to master netting arrangements:
Interest rate lock commitments		238		—			238			1,261		—			1,261

		5,337		(4,376	)		961			9,976		(8,015	)		1,961

Assets sold under agreements to repurchase		1,887,778		—			1,887,778			2,039,605		—			2,039,605

	$	1,893,115	$	(4,376	)	$	1,888,739		$	2,049,581	$	(8,015	)	$	2,041,566

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 do not meet the accounting guidance qualifying for offset. All assets sold under agreements to repurchase represent sufficient collateral or exceed the liability amount recorded on the consolidated balance sheet.


	March 31, 2014									December 31, 2013
			Gross amounts not offset in the consolidated balance sheet									Gross amounts not offset in the consolidated balance sheet
	Net amount of liabilities presented in the consolidated balance sheet		Financial instruments			Cash collateral pledged		Net amount		Net amount of liabilities presented in the consolidated balance sheet		Financial instruments			Cash collateral pledged		Net amount
	(in thousands)
Citibank	$	778,460	$	(778,460	)	$	—	$	—	$	945,015	$	(944,856	)	$	—	$	159
Credit Suisse First Boston Mortgage Capital LLC		443,362		(443,362	)		—		—		523,546		(523,546	)		—		—
Bank of America, N.A.		334,772		(334,772	)		—		—		408,452		(408,452	)		—		—
Deutsche Bank		—		—					—		110		—					110
Daiwa Capital Markets		130,825		(130,825	)		—		—		132,525		(132,525	)		—		—
Morgan Stanley Bank, N.A.		109,884		(109,707	)		—		177		30,226		(30,226	)		—		—
RBS Securities		90,652		(90,652	)		—		—		—		—			—		—
JP Morgan		—		—					—		228							228
Interest rate lock commitments		238		—			—		238		1,261		—			—		1,261
Other		546		—			—		546		203		—			—		203

Total	$	1,888,739	$	(1,887,778	)	$	—	$	961	$	2,041,566	$	(2,039,605	)	$	—	$	1,961

Note 7—Fair Value

The Company’s consolidated financial statements include assets and liabilities that are measured based on their estimated 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 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 and MSRs relating to loans with initial interest rates of more than 4.5% to be accounted for at estimated fair value. Management has elected to account for these financial statement items at fair value so such changes in fair value will be reflected in income as they occur and more timely reflect the results of the Company’s performance. Management has also identified its asset-backed secured financing of the variable interest entity to be accounted for at fair value to reflect the generally offsetting changes in fair value of these borrowings to changes in fair value of mortgage loans held by variable interest entity which are also carried at fair value.

For MSRs relating to mortgage loans with initial interest rates of less than or equal to 4.5%, management 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 quarters ended March 31, 2014 and 2013, derivatives were used to hedge the fair value changes of the MSRs.

For assets sold under agreements to repurchase, borrowings under forward purchase agreements and the Notes, 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:


	March 31, 2014
	Level 1		Level 2		Level 3		Total
	(in thousands)
Assets:
Short-term investments	$	91,338	$	—	$	—	$	91,338
Mortgage-backed securities at fair value		—		198,110		—		198,110
Mortgage loans acquired for sale at fair value		—		344,680		—		344,680
Mortgage loans at fair value		—		—		2,079,020		2,079,020
Mortgage loans under forward purchase agreements at fair value		—		—		202,661		202,661
Mortgage loans at fair value held by variable interest entity		—		529,680		—		529,680
Excess servicing spread purchased from PennyMac Financial Services, Inc.		—		—		151,019		151,019
Derivative assets:
Interest rate lock commitments		—		—		3,509		3,509
MBS put options		—		1,027		—		1,027
MBS call options		—		93		—		93
Forward purchase contracts		—		777		—		777
Forward sales contracts		—		5,434		—		5,434
Treasury futures		—		328		—		328
Put options on Eurodollar futures		—		432		—		432
Call options on Eurodollar futures		—		66		—		66

Total derivative assets before netting		—		8,157		3,509		11,666
Netting (1)		—		—		—		(3,738	)

Total derivative assets before netting		—		8,157		3,509		7,928

Mortgage servicing rights at fair value		—		—		36,181		36,181

	$	91,338	$	1,080,627	$	2,472,390	$	3,640,617

Liabilities:
Asset-backed secured financing of the variable interest entity at fair value	$	—	$	166,514	$	—	$	166,514
Derivative liabilities:
Interest rate lock commitments		—		—		238		238
MBS call options		—		333		—		333
Forward purchase contracts		—		3,547		—		3,547
Forward sales contracts		—		1,219		—		1,219

Total derivative liabilities before netting		—		5,099		238		5,337
Netting (1)		—		—		—		(4,376	)

Total derivative liabilities		—		5,099		238		961

Total liabilities	$	—	$	171,613	$	238	$	167,475

(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, 2013
	Level 1		Level 2		Level 3		Total
	(in thousands)
Assets:
Short-term investments	$	92,398	$	—	$	—	$	92,398
Mortgage-backed securities at fair value		—		197,401		—		197,401
Mortgage loans acquired for sale at fair value		—		458,137		—		458,137
Mortgage loans at fair value		—		—		2,076,665		2,076,665
Mortgage loans under forward purchase agreements at fair value		—		—		218,128		218,128
Mortgage loans at fair value held by variable interest entity		—		523,652		—		523,652
Excess servicing spread purchased from PennyMac Financial Services, Inc.		—		—		138,723		138,723
Derivative assets:
Interest rate lock commitments		—		—		2,510		2,510
MBS put options		—		272		—		272
Forward purchase contracts		—		1,229		—		1,229
Forward sales contracts		—		16,385		—		16,385
Options on Eurodollar futures		—		566		—		566

Total derivative assets before netting		—		18,452		2,510		20,962
Netting (1)		—		—		—		(12,986	)

Total derivative assets		—		18,452		2,510		7,976

Mortgage servicing rights at fair value		—		—		26,452		26,452

	$	92,398	$	1,197,642	$	2,462,478	$	3,739,532

Liabilities:
Asset-backed secured financing of the variable interest entity at fair value	$	—	$	165,415	$	—	$	165,415
Derivative liabilities:
Interest rate lock commitments		—		—		1,261		1,261
Forward purchase contracts		—		7,420		—		7,420
Forward sales contracts		—		1,295		—		1,295

Total derivative liabilities		—		8,715		1,261		9,976
Netting (1)		—		—		—		(8,015	)

Total derivative liabilities		—		8,715		1,261		1,961

Total liabilities	$	—	$	174,130	$	1,261	$	167,376

(1)

The following is a summary of changes in items measured using Level 3 inputs on a recurring basis:


	Mortgage loans at fair value			Mortgage loans under forward purchase agreements			Excess servicing spread			Interest rate lock commitments(1)			Mortgage servicing rights			Total
	(in thousands)
Assets:
Balance, December 31, 2013	$	2,076,665		$	218,128		$	138,723		$	1,249		$	26,452		$	2,461,217
Purchases		256,280			920			20,526			—			—			277,726
Repayments		(54,436	)		(5,329	)		(7,413	)		—			—			(67,178	)
Accrual of interest		—			—			2,862			—			—			2,862
ESS received pursuant to a recapture agreement with PFSI		—			—			1,113			—			—			1,113
Interest rate lock commitments issued, net		—			—			—			12,596			—			12,596
Capitalization of interest		11,726			744			—			—			—			12,470
Sales		(192,403	)		—			—			—			—			(192,403	)
Servicing received as proceeds from sales of mortgage loans		—			—			—			—			11,757			11,757
Changes in fair value included in income arising from:
Changes in instrument-specific credit risk		15,742			2,397												18,139
Other factors		25,116			(3,337	)		(4,792	)		2,430			(2,028	)		17,389

		40,858			(940	)		(4,792	)		2,430			(2,028	)		35,528

Transfers of mortgage loans under forward purchase agreements to mortgage loans		4,460			(4,460	)		—			—			—			—
Transfers of mortgage loans to REO		(64,130	)		—			—			—			—			(64,130	)
Transfers of mortgage loans under forward purchase agreements to REO under forward purchase agreements		—			(6,402	)		—			—			—			(6,402	)
Transfers of interest rate lock commitments to mortgage loans acquired for sale		—			—			—			(13,004	)		—			(13,004	)

Balance, March 31, 2014	$	2,079,020		$	202,661		$	151,019		$	3,271		$	36,181		$	2,472,152

Changes in fair value recognized during the period relating to assets still held at March 31, 2014	$	34,209		$	(1,623	)	$	(4,792	)	$	3,271		$	(2,028	)	$	29,037

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


	March 31, 2013
	Mortgage loans at fair value			Interest rate lock commitments(1)			Mortgage servicing rights			Total
	(in thousands)
Assets:
Balance, December 31, 2012	$	1,189,971		$	19,479		$	1,346		$	1,210,796
Purchases		200,473			—			—			200,473
Repayments		(61,421	)		—			—			(61,421	)
Interest rate lock commitments issued, net		—			35,414			—			35,414
Capitalization of interest		5,230			—			—			5,230
Servicing received as proceeds from sales of mortgage loans		—			—			26			26
Changes in fair value included in income arising from:
Changes in instrument-specific credit risk		8,445									8,445
Other factors		55,535			—			(67	)		55,468

		63,980			—			(67	)		63,913

Transfers of mortgage loans to REO		(31,311	)		—			—			(31,311	)
Transfers of interest rate lock commitments to mortgage loans acquired for sale		—			(43,841	)		—			(43,841	)

Balance, March 31, 2013	$	1,366,922		$	11,052		$	1,305		$	1,379,279

Changes in fair value recognized during the period relating to assets still held at March 31, 2013	$	50,608		$	11,052		$	(67	)	$	61,593

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

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, mortgage loans under forward purchase agreements at fair value and mortgage loans at fair value held by variable interest entity):


	March 31, 2014
	Fair value		Principal amount due upon maturity		Difference
	(in thousands)
Mortgage loans acquired for sale:
Current through 89 days delinquent	$	344,515	$	332,267	$	12,248
90 or more days delinquent (1)
Not in foreclosure		165		162		3
In foreclosure		—		—		—

		344,680		332,429		12,251

Mortgage loans and mortgage loans under forward purchase agreements at fair value:
Current through 89 days delinquent		541,634		859,763		(318,129	)
90 or more days delinquent (1)
Not in foreclosure		719,726		1,149,611		(429,885	)
In foreclosure		1,020,321		1,635,615		(615,294	)

		2,281,681		3,644,989		(1,363,308	)

Mortgage loans at fair value held by variable interest entity:
Current through 89 days delinquent		529,680		537,804		(8,124	)
90 or more days delinquent (1)
Not in foreclosure		—		—		—
In foreclosure		—		—		—

		529,680		537,804		(8,124	)

	$	3,156,041	$	4,515,222	$	(1,359,181	)

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


	December 31, 2013
	Fair value		Principal amount due upon maturity		Difference
	(in thousands)
Mortgage loans acquired for sale:
Current through 89 days delinquent	$	457,968	$	447,224	$	10,744
90 or more days delinquent (1)
Not in foreclosure		169		162		7
In foreclosure		—		—		—

		458,137		447,386		10,751

Mortgage loans and mortgage loans under forward purchase agreements at fair value:
Current through 89 days delinquent		647,266		962,919		(315,653	)
90 or more days delinquent (1)
Not in foreclosure		738,043		1,190,403		(452,360	)
In foreclosure		909,484		1,493,644		(584,160	)

		2,294,793		3,646,966		(1,352,173	)

Mortgage loans at fair value held by variable interest entity:
Current through 89 days delinquent		523,652		543,257		(19,605	)
90 or more days delinquent (1)
Not in foreclosure		—		—		—
In foreclosure		—		—		—

		523,652		543,257		(19,605	)

	$	3,276,582	$	4,637,609	$	(1,361,027	)

(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:


	Quarter ended March 31, 2014
	Net gain on mortgage loans acquired for sale		Net interest income			Net gain on investments			Net loan servicing fees			Total
	(in thousands)
Assets:
Short-term investments	$	—	$	—		$	—		$	—		$	—
Mortgage-backed securities at fair value		—		33			2,652			—			2,685
Mortgage loans acquired for sale at fair value		18,632		—			—			—			18,632
Mortgage loans at fair value		—		—			40,858			—			40,858
Mortgage loans under forward purchase agreements at fair value		—		—			(940	)		—			(940	)
Mortgage loans at fair value held by variable interest entity		—		330			11,307			—			11,637
Excess servicing spread at fair value		—		—			(2,901	)		—			(2,901	)
Mortgage servicing rights at fair value		—		—			—			(2,027	)		(2,027	)

	$	18,632	$	363		$	50,976		$	(2,027	)	$	67,944

Liabilities:
Asset-backed secured financing of the variable interest entity at fair value	$	—	$	(124	)	$	(2,780	)	$	—		$	(2,904	)

	$	—	$	(124	)	$	(2,780	)	$	—		$	(2,904	)


	Quarter ended March 31, 2013
	Net gain on mortgage loans acquired for sale		Net interest income			Net gain on investments			Net loan servicing fees			Total
	(in thousands)
Assets:
Short-term investments	$	—	$	—		$	—		$	—		$	—
Mortgage loans acquired for sale at fair value		24,757		—			—			—			24,757
Mortgage loans at fair value		—		—			63,980			—			63,980
Mortgage servicing rights at fair value		—		—			—			(67	)		(67	)

	$	24,757	$	—		$	63,980		$	(67	)	$	88,670

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:


	March 31, 2014
	Level 1		Level 2		Level 3		Total
	(in thousands)
Real estate asset acquired in settlement of loans	$	—	$	—	$	75,025	$	75,025
Real estate asset acquired in settlement of loans under forward purchase agreements		—		—		10,236		10,236
Mortgage servicing rights at lower of amortized cost or fair value		—		—		49,108		49,108

	$	—	$	—	$	134,369	$	134,369


	December 31, 2013
	Level 1		Level 2		Level 3		Total
	(in thousands)
Real estate asset acquired in settlement of loans	$	—	$	—	$	63,043	$	63,043
Real estate asset acquired in settlement of loans under forward purchase agreements		—		—		7,760		7,760
Mortgage servicing rights at lower of amortized cost or fair value		—		—		184,067		184,067

	$	—	$	—	$	254,870	$	254,870

The following table summarizes the net losses recognized during the period on assets measured at estimated fair values on a nonrecurring basis:


	Quarter ended March 31,
	2014			2013
	(in thousands)
Real estate asset acquired in settlement of loans	$	(7,314	)	$	(4,954	)
Real estate asset acquired in settlement of loans under forward purchase agreements		(528	)		—
Mortgage servicing rights at lower of amortized cost or fair value		(627	)		2,486

	$	(8,469	)	$	(2,468	)

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 measured by cost in the case of purchased REO or by the fair value of the property at the time of acquisition in the case of acquisition in settlement of a loan. REO may be subsequently revalued due to the Company receiving greater access to the property, the property being held for an extended period or 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 pools of mortgage loans with 50 basis point interest rate ranges for fixed-rate mortgage loans with interest rates between 3% and 4.5% and a single pool for mortgage loans with interest 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 interest rate pools is below the amortized cost 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 in value is recognized in current period income only to the extent of the valuation allowance for the respective impairment 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 recoverable value is charged to the valuation allowance.

Fair Value of Financial Instruments Carried at Amortized Cost

The Company’s cash balances as well as certain of its borrowings are carried at amortized cost. Management has concluded that the estimated fair values of Cash, Securities sold under agreements to repurchase, Mortgage loans acquired for sale at fair value sold under agreements to repurchase, Mortgage loans at fair value sold under agreements to repurchase, Mortgage loans at fair value held by variable interest entity 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.

Cash is measured using Level 1 inputs. The Company’s assets sold under agreements to repurchase and borrowings under forward purchase agreements are carried at amortized cost. The Company has classified these financial instruments as “Level 3” financial statement items as of March 31, 2014 due to the lack of current market activity and the Company’s reliance on unobservable inputs to estimate these instruments’ fair values.

Exchangeable Senior Notes are carried at amortized cost. The fair value of the Notes at March 31, 2014 was $242.0 million. The fair value of the Notes is estimated using a broker indication of value. The Company has classified the Notes as “Level 3” financial statement items as of March 31, 2014 due to the lack of current market activity and the reliance on the broker’s quote to estimate the instrument’s fair values.

Valuation Techniques and Assumptions

Most of the Company’s assets and a portion of its liabilities are carried at fair value with changes in fair value recognized in current period income. A substantial portion of those items are “Level 3” financial statement items which require the use of significant unobservable inputs in the estimation of the assets’ and liabilities’ fair 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.

PFSI 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 PFSI’s valuation committee, which oversees and approves the valuations. The valuation committee includes the chief executive, financial, operating, credit, and asset/liability management officers of PFSI. 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 PFSI’s valuation committee on a monthly basis on the changes in the valuation of the Level 3 assets and liabilities it values, 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 valuation 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-Backed Securities

The Company’s MBS securities are presently Agency MBS. Agency MBS are categorized as “Level 2” financial statement items. Fair value of Agency MBS is estimated based on quoted market prices for similar securities.

Mortgage Loans

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

•

Mortgage loans that are saleable into active markets, comprised of the Company’s mortgage loans acquired for sale at fair value and mortgage loans at fair value held by variable interest entity, are categorized as “Level 2” financial statement items. The fair values of mortgage loans acquired for sale at fair value are estimated using their quoted market or contracted price or market price equivalent. For mortgage loans at fair value held by variable interest entity, the fair values of all of the individual securities issued by the securitization trust are used to derive a price for the mortgage loans.

•

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, property type or contracted selling price, discount rates 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 PFSI’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 effect on fair value of 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 and mortgage loans under forward purchase agreements at fair value:


	Range
	(Weighted average)
Key inputs	March 31, 2014	December 31, 2013
Mortgage loans at fair value
Discount rate	8.5% – 16.9%	8.7% – 16.9%
	(12.4%)	(12.7%)
Twelve-month projected housing price index change	2.1% – 3.8%	2.5% – 4.3%
	(3.5%)	(3.7%)
Prepayment speed(1)	0.0% – 6.0%	0.0% – 3.9%
	(2.1%)	(2.0%)
Total prepayment speed (2)	0.6% – 32.9%	0.3% – 33.9%
	(23.6%)	(24.3%)

Mortgage loans under forward purchase agreements
Discount rate	8.5% – 15.2%	9.5% – 13.5%
	(12.5%)	(11.9%)
Twelve-month projected housing price index change	3.2% – 3.8%	3.3% – 4.2%
	(3.6%)	(3.8%)
Prepayment speed(1)	1.9% – 3.9%	1.1% – 2.9%
	(2.7%)	(2.2%)
Total prepayment speed (2)	11.3% – 26.6%	13.4% – 27.9%
	(21.6%)	(22.8%)

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

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

Excess Servicing Spread Purchased from PennyMac Financial Services, Inc.

The Company categorizes ESS as a “Level 3” financial statement item. The Company uses a discounted cash flow approach to estimate the fair value of ESS. The key inputs used in the estimation of the fair value of ESS include prepayment speed and discount rate. Significant changes to those inputs in isolation could result in a significant change in the ESS fair value measurement. Changes in these key inputs are not necessarily directly related.

ESS is generally subject to loss in value when interest rates decrease. Decreasing mortgage rates normally encourage increased mortgage refinancing activity. Increased refinancing activity reduces the life of the loans underlying the ESS, thereby reducing ESS value. Reductions in the value of ESS affect income primarily through change in fair value.

Interest income for ESS is accrued using the interest method, based upon the expected interest yield from the ESS through the expected life of the underlying mortgages. Changes to expected interest yield result in a change in interest income which is recorded in Interest income. Changes to expected cash flows result in a change to fair value that is recognized in Net gain (loss) on investments.

Following are the key inputs used in determining the fair value of ESS:


	Range
	(Weighted average)
Key inputs	March 31, 2014		December 31, 2013
Unpaid principal balance of underlying mortgage loans (in thousands)	$	22,246,336	$	20,512,659
Average servicing fee rate (in basis points)		32		32
Average ESS rate (in basis points)		16		16
Pricing spread (1)		1.7% – 14.4%		2.8% - 14.4%
		(4.8%)		(5.4%)
Life (in years)		0. 6 - 7.3		0.9 - 8.0
		(5.7)		(6.1)
Annual total prepayment speed (2)		7.7% – 63.8%		7.7% - 48.6%
		(10.4%)		(9.7%)

(1)

Pricing spread represents a margin that is applied to a reference interest rate’s forward rate curve to develop periodic discount rates. The Company applies a pricing spread to the United States Dollar London Interbank Offered Rate (“LIBOR”) curve for purposes of discounting cash flows relating to ESS.

(2)	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 be purchased as a percentage of the commitments it has made (the “pull-through rate”). The Company categorizes IRLCs as “Level 3” financial statement items.

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.

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


	Range (Weighted average)
Key inputs	March 31, 2014		December 31, 2013
Pull-through rate		64.0% - 98.0%		64.8% - 98.0%
		(83.5%)		(86.4%)
MSR value expressed as:
Servicing fee multiple		2.1 - 4.9		1.4 - 5.1
		(3.9)		(4.1)
Percentage of unpaid principal balance		0.5% - 1.2%		0.4% - 1.3%
		(1.0%)		(1.0%)

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.

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 estimated 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 difference between the values received. PCM’s staff appraisers will attempt to resolve the difference 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 determine the 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 inputs used in the Company’s discounted cash flow model are based on market factors which management believes are consistent with inputs and data used by market participants valuing similar MSRs. The key inputs used in the estimation of the fair value of MSRs include prepayment and default rates of the underlying loans, the applicable pricing spread or discount rate, and annual per-loan cost to service mortgage loans, all of which are unobservable. Significant changes to any of those inputs in isolation could result in a significant change in the MSR fair value measurement. Changes in these key inputs are not necessarily directly related. The results of the estimates of fair value of MSRs are reported to PFSI’s valuation committee as part of their review and approval of monthly valuation results.

MSRs are generally subject to loss in value when mortgage interest rates decrease. Decreasing mortgage interest 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 March 31,
	2014				2013
	Range (Weighted average)
Key inputs	Amortized cost		Fair value		Amortized cost		Fair value
	(MSR recognized and unpaid principal balance of underlying loan amounts in thousands)
MSR recognized	$	9,118	$	11,757	$	56,190	$	26
Unpaid principal balance of underlying mortgage loans	$	850,548	$	1,091,714	$	5,003,557	$	2,600
Weighted-average annual servicing fee rate (in basis points)		25		25		25		33
Pricing spread (1)		6.3% – 14.3%		8.5% – 12.3%		5.4% – 14.4%		7.5% - 14.4%
		(8.5%)		(8.9%)		(7.0%)		(8.5%)
Life (in years)		1.1 – 7.3		2.8 – 7.3		2.7 - 6.9		2.8 - 6.8
		(5.9)		(7.1)		(6.4)		(6.1)
Annual total prepayment speed (2)		7.6% – 56.4%		8.0% – 23.8%		8.5% – 22.7%		10.4% - 27.0%
		(10.3%)		(9.3%)		(9.1%)		(14.4%)
Annual per-loan cost of servicing		$68 – $68		$68 – $68		$68 – $140		$68 - $68
		($68)		($68)		($68)		($68)

(1)

Pricing spread represents a margin that is applied to a reference interest rate’s forward rate curve to develop periodic discount rates. The Company applies a pricing spread to the United States Dollar LIBOR curve for purposes of discounting cash flows relating to MSRs acquired as proceeds from the sale of mortgage loans.

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

Following is a quantitative summary of key inputs used in the valuation of MSRs as of the dates presented, and the effect on the estimated fair value from adverse changes in those assumptions (weighted averages are based upon unpaid principal balance or fair value where applicable):


	March 31, 2014						December 31, 2013
	Range (Weighted average)
	Amortized cost			Fair value			Amortized cost			Fair value
	(Carrying value, unpaid principal balance and effect on value amounts in thousands)
Carrying value	$	265,246		$	36,181		$	264,120		$	26,452

Key inputs:
Unpaid principal balance of underlying mortgage loans	$	23,897,201		$	3,426,693		$	23,399,612		$	2,393,321
Weighted-average annual servicing fee rate (in basis points)		26			26			26			26
Weighted-average note interest rate		3.70%			4.79%			3.68%			4.78%
Pricing spread (1)		6.3% – 17.5%			7.3% – 15.3%			6.3% – 17.5%			7.3% – 15.3%
		(6.9%)			(8.8%)			(6.7%)			(8.6%)
Effect on fair value of a:
5% adverse change	$	(5,406	)	$	(656	)	$	(5,490	)	$	(488	)
10% adverse change	$	(10,628	)	$	(1,290	)	$	(10,791	)	$	(959	)
20% adverse change	$	(20,557	)	$	(2,495	)	$	(20,861	)	$	(1,855	)
Weighted average life (in years)		1.1 - 7.3			2.6 - 7.3			1.3 - 7.3			2.8 - 7.3
		(6.5)			(7.1)			(6.7)			(7.2)
Prepayment speed (2)		7.7% – 56.4%			8.0% – 23.9%			7.7% - 51.9%			8.0% - 20.0%
		(8.3%)			(9.4%)			(8.2%)			(8.9%)
Effect on fair value of a:
5% adverse change	$	(5,443	)	$	(824	)	$	(5,467	)	$	(568	)
10% adverse change	$	(10,719	)	$	(1,619	)	$	(10,765	)	$	(1,117	)
20% adverse change	$	(20,800	)	$	(3,128	)	$	(20,886	)	$	(2,160	)
Annual per-loan cost of servicing		$68 – $140			$68 – $140			$68 – $140			$68 – $140
		($68)			($68)			($68)			($68)
Effect on fair value of a:
5% adverse change	$	(1,735	)	$	(220	)	$	(1,695	)	$	(158	)
10% adverse change	$	(3,471	)	$	(439	)	$	(3,390	)	$	(316	)
20% adverse change	$	(6,941	)	$	(878	)	$	(6,780	)	$	(633	)

(1)

Pricing spread represents a margin that is applied to a reference interest rate’s forward rate curve to develop periodic discount rates. The Company applies a pricing spread to the United States Dollar LIBOR curve for purposes of discounting cash flows relating to MSRs acquired as proceeds from the sale of mortgage loans and purchased MSRs not backed by pools of distressed mortgage loans.

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

The preceding sensitivity analyses are limited in that they were performed at a particular point in time; only contemplate the movements in the indicated inputs; do not incorporate changes in the inputs in relation to other inputs; are subject to the accuracy of various models and assumptions used; and do not incorporate other factors that would affect the Company’s overall financial performance in such scenarios, including operational adjustments made by management to account for changing circumstances. For these reasons, the preceding estimates should not be viewed as earnings forecasts.

Note 8—Mortgage Loans Acquired for Sale at Fair Value

Mortgage loans acquired for sale at fair value is comprised of recently originated mortgage loans purchased by the Company for resale. Following is a summary of the distribution of the Company’s mortgage loans acquired for sale at fair value:


	March 31, 2014				December 31, 2013
	Fair value		Unpaid principal balance		Fair value		Unpaid principal balance
Loan type	(in thousands)
Conventional:
Agency-eligible	$	282,250	$	272,765	$	311,162	$	304,749
Jumbo		13,521		13,092		34,615		35,050
Government-insured or guaranteed		48,909		46,572		112,360		107,587

	$	344,680	$	332,429	$	458,137	$	447,386

Loans pledged to secure assets sold under agreements to repurchase	$	339,153			$	454,210

The Company is not approved by Ginnie Mae as an issuer of Ginnie Mae-guaranteed securities which are backed by government-insured or guaranteed mortgage loans. The Company transfers government-insured or guaranteed mortgage loans that it purchases from correspondent lenders to PLS, which is a Ginnie Mae-approved issuer, and earns a sourcing fee of three basis points on the unpaid principal balance plus interest earned during the period it holds each such loan.

Note 9—Derivative Financial Instruments

The Company is exposed to price risk relative to its mortgage loans acquired for sale as well as to the IRLCs it issues to correspondent lenders. The Company bears price risk from the time an IRLC is issued to a correspondent lender to the time the purchased mortgage loan is sold. During this period, the Company is exposed to losses if mortgage interest rates increase because the value of the purchase commitment or mortgage loan acquired for sale decreases.

The Company engages in interest rate risk management activities in an effort to reduce the variability of earnings caused by changes in interest rates. To manage the price risk resulting from interest rate risk, the Company uses derivative financial instruments acquired with the intention of moderating the risk that changes in market interest rates will result in unfavorable changes in the fair value of the Company’s IRLCs and inventory of mortgage loans acquired for sale.

The Company is also exposed to risk relative to the fair value of its MSRs. The Company is exposed to loss in value of its MSRs when interest rates decrease. The Company periodically includes MSRs in its hedging activities.

Beginning in the third quarter of 2013, the Company entered into Eurodollar futures, which settle daily, to economically hedge net fair value changes of a portion of fixed-rate mortgage loans at fair value held by variable interest entity and MBS securities at fair value and the related variable rate repurchase agreement liabilities indexed to LIBOR. The Company uses the Eurodollar futures with the intention of moderating the risk of rising market interest rates that will result in unfavorable changes in the value of the Company’s fixed-rate assets and economic performance of its LIBOR-indexed variable interest rate repurchase agreement liabilities.

The Company does not use derivative financial instruments for purposes other than in support of its risk management activities other than IRLCs, which are generated in the normal course of business when the Company commits to purchase mortgage loans acquired for sale. The Company records all derivative financial instruments at fair value and records changes in fair value in current period income.

The Company had the following derivative assets and liabilities and related margin deposits recorded within Derivative assets and Derivative liabilities on the consolidated balance sheets:


	March 31, 2014								December 31, 2013
			Fair value								Fair value
	Notional		Derivative			Derivative			Notional		Derivative			Derivative
Instrument	amount		assets			liabilities			amount		assets			liabilities
	(in thousands)
Derivatives not designated as hedging instruments:
Free-standing derivatives:
Interest rate lock commitments		704,824	$	3,509		$	238			557,343	$	2,510		$	1,261
Forward sales contracts		2,497,960		5,434			1,219			3,588,027		16,385			1,295
Forward purchase contracts		1,777,353		777			3,547			2,781,066		1,229			7,420
MBS put options		260,000		1,027			—			55,000		272			—
MBS call options		35,000		93			333			110,000		—			—
Eurodollar futures		6,084,000		—			—			8,779,000		—			—
Treasury futures		75,000		328			—			105,000		—			—
Call options on Eurodollar futures		380,000		66			—			—		—			—
Put options on Eurodollar futures		90,000		432			—			52,500		566			—

Total derivative instruments before netting				11,666			5,337					20,962			9,976
Netting				(3,738	)		(4,376	)				(12,986	)		(8,015	)

			$	7,928		$	961				$	7,976		$	1,961

Margin deposits with (collateral received from) derivatives counterparties			$	638							$	(4,971	)

The following table summarizes the notional amount activity for derivative contracts used to hedge the Company’s IRLCs, inventory of mortgage loans acquired for sale and MSR:


	Balance,							Balance,
	beginning				Dispositions/			end
Period/Instrument	of period		Additions		expirations			of period
	(in thousands)
Quarter ended March 31, 2014
Forward purchase contracts		2,781,066		6,397,817		(7,401,530	)		1,777,353
Forward sales contracts		3,588,027		8,668,939		(9,759,006	)		2,497,960
MBS put option sales contracts		15,000		—		(15,000	)		—
MBS put option purchase contracts		55,000		405,000		(225,000	)		235,000
MBS call option purchase contracts		110,000		60,000		(135,000	)		35,000
Treasury Future sale contracts		—		28,800		(28,800	)		—
Treasury Future purchase contracts		—		21,600		(21,600	)		—
Put option on Eurodollar futures		—		325,000		—			325,000
Call option on Eurodollar futures		—		150,000		(60,000	)		90,000

The Company recorded net gains on derivative financial instruments used to hedge the Company’s IRLCs and inventory of mortgage loans totaling $10.7 million and $12.9 million for the quarters ended March 31, 2014 and 2013, respectively. Derivative gains and losses are included in Net gains on mortgage loans acquired for sale in the Company’s consolidated statements of income.

The Company recorded net losses on derivative financial instruments used as economic hedges of MSRs totaling $99,000 and $2.0 million for the quarters ended March 31, 2014 and 2013, respectively. The derivative losses are included in Net loan servicing fees in the Company’s consolidated statements of income.

The following table summarizes the notional amount activity for derivative contracts used to hedge the Company’s net fair value changes of a portion of fixed-rate Mortgage loans at fair value held by variable interest entity and MBS securities at fair value and the related variable LIBOR rate repurchase agreement liabilities:


Period/Instrument	Balance, beginning of period		Additions		Dispositions/ expirations			Balance, end of period
	(in thousands)
Quarter ended March 31, 2014
Eurodollar Future sale contracts		8,779,000		126,000		(2,821,000	)		6,084,000
Eurodollar Future purchase contracts		—		2,597,000		(2,597,000	)		—
Treasury Future sale contracts		105,000		75,000		(105,000	)		75,000
Treasury Future purchase contracts		—		75,000		(75,000	)		—
Put options on Eurodollar futures		52,500		112,000		(109,500	)		55,000
MBS put option purchase contracts		15,000		25,000		(15,000	)		25,000

The Company recorded net losses on derivative financial instruments used to hedge the net change in fair value of fixed-rate assets and its variable LIBOR rate repurchase agreement liabilities of $5.6 million for the quarter ended March 31, 2014. The derivative losses are included in Net gain on investments in the Company’s consolidated statements of income. The Company had no similar economic hedges in place for the quarter ended March 31, 2013.

Note 10—Mortgage Loans at Fair Value

Mortgage loans at fair value are comprised of mortgage loans that are not acquired for sale and may be sold at a later date pursuant to a management determination that such a sale represents the most advantageous liquidation strategy for the identified loan.

Following is a summary of the distribution of the Company’s mortgage loans at fair value:


	March 31, 2014				December 31, 2013
Loan type	Fair value		Unpaid principal balance		Fair value		Unpaid principal balance
	(in thousands)
Nonperforming loans	$	1,584,703	$	2,549,293	$	1,469,686	$	2,415,446
Performing loans:
Fixed interest rate		277,352		440,005		310,607		475,568
Adjustable-rate mortgage (“ARM”)/hybrid		95,550		134,357		165,327		207,553
Interest rate step-up		121,274		211,866		130,906		215,702
Balloon		141		212		139		213

		494,317		786,440		606,979		899,036

	$	2,079,020	$	3,335,733	$	2,076,665	$	3,314,482

Mortgage loans at fair value pledged to secure borrowings at period end:
Assets sold under agreements to repurchase	$	1,913,828			$	1,963,266

Mortgage loans held in a consolidated subsidiary whose stock is pledged to secure financings of such loans	$	679			$	989

Following is a summary of certain concentrations of credit risk in the portfolio of mortgage loans at fair value:


Concentration	March 31, 2014			December 31, 2013
Portion of mortgage loans originated between 2005 and 2007		72	%		72	%
Percentage of fair value of mortgage loans with unpaid-principal-balance-to-current-property-value in excess of 100%		62	%		61	%
Percentage of mortgage loans secured by California real estate		21	%		24	%
Additional states contributing 5% or more of mortgage loans		New York Florida New Jersey Maryland			New York Florida New Jersey

Note 11—Mortgage Loans at Fair Value Held by Variable Interest Entity

Following is a summary of the distribution of the Company’s mortgage loans at fair value held by variable interest entity:

March 31, 2014

December 31, 2013

Unpaid

Fair

principal

Fair

principal

Loan type

value

balance

value

balance

(in thousands)

Jumbo fixed interest rate

529,680

537,804

523,652

543,257

Following is a summary of certain concentrations of credit risk in the portfolio of mortgage loans at fair value held by variable interest entity:


States comprising more than 5.00% of unpaid principal balance	March 31, 2014			December 31, 2013
California		57	%		57	%
Washington		8	%		8	%
Texas		6	%		6	%
Virginia		6	%		6	%
Other		23	%		23	%

Note 12—Mortgage Loans Under Forward Purchase Agreements at Fair Value

Mortgage loans under forward purchase agreements at fair value are comprised of mortgage loans not acquired for resale. Such loans may be sold at a later date pursuant to a management determination that such a sale represents the most advantageous liquidation strategy for the identified loan. Following is a summary of the distribution of the Company’s mortgage loans under forward purchase agreements at fair value:


	March 31, 2014				December 31, 2013
			Unpaid				Unpaid
	Fair		principal		Fair		principal
Loan type	value		balance		value		balance
	(in thousands)
Nonperforming loans	$	155,344	$	235,932	$	177,841	$	268,600
Performing loans:
Fixed		21,860		32,728		19,292		29,496
ARM/hybrid		21,094		33,016		19,510		31,933
Interest rate step-up		4,363		7,580		1,485		2,455

		47,317		73,324		40,287		63,884

	$	202,661	$	309,256	$	218,128	$	332,484

Following is a summary of certain concentrations of credit risk in the portfolio of mortgage loans under forward purchase agreements at fair value:


	March 31,			December 31,
	2014			2013
Portion of mortgage loans originated between 2005 and 2007		73	%		72	%
Percentage of mortgage loans secured by California real estate		25	%		25	%
Additional states contributing 5% or more of mortgage loans		New Jersey			New Jersey
		New York			Washington
		Washington			New York
		Maryland			Maryland
		Florida

At March 31, 2014, the entire balance of mortgage loans under forward purchase agreements was held in a VIE by the seller of the loans to secure borrowings under forward purchase agreements.

Note 13—Real Estate Acquired in Settlement of Loans

Following is a summary of financial information relating to REO:


	Quarter ended March 31,
	2014			2013
	(in thousands)
Balance at beginning of period	$	138,942		$	88,078
Purchases		3,049			—
Transfers from mortgage loans at fair value and advances		68,902			31,685
Transfers from REO under forward purchase agreements		92			—
Results of REO:
Valuation adjustments, net		(8,408	)		(6,089	)
Gain on sale, net		2,182			2,836

		(6,226	)		(3,253	)
Proceeds from sales		(31,772	)		(32,024	)

Balance at end of period	$	172,987		$	84,486

At period end:
REO pledged to secure assets sold under agreements to repurchase	$	29,966		$	8,233

REO held in a consolidated subsidiary whose stock is pledged to secure financings of such properties	$	51,649		$	7,122

Note 14—Real Estate Acquired in Settlement of Loans Under Forward Purchase Agreements

Following is a summary of the activity in REO under forward purchase agreements:


	Quarter ended March 31,
	2014			2013
	(in thousands)
Balance at beginning of period	$	9,138		$	—
Purchases		38			—
Purchases financed through forward purchase agreements		—			—
Transfers from mortgage loans under forward purchase agreements at fair value and advances		6,828			—
Transfers to REO		(92	)		—
Results of REO under forward purchase agreements:
Valuation adjustments, net		(484	)		—
Gain on sale, net		84			—

		(400	)		—
Proceeds from sales		(1,622	)		—

Balance at end of period	$	13,890		$	—

At March 31, 2014, the entire balance of REO under forward purchase agreements was subject to borrowings under forward purchase agreements.

Note 15—Mortgage Servicing Rights

Carried at Fair Value:

Following is a summary of MSRs carried at fair value:


	Quarter ended March 31,
	2014			2013
	(in thousands)
Balance at beginning of period	$	26,452		$	1,346
Additions:
Purchases		—			—
MSRs resulting from loan sales		11,757			26

Total additions		11,757			26

Change in fair value:
Due to changes in valuation inputs or assumptions used in valuation model(1)		(1,232	)		(9	)
Other changes in fair value(2)		(796	)		(58	)

		(2,028	)		(67	)

Sales		—			—

Balance at end of period	$	36,181		$	1,305

(1)	Principally reflects changes in pricing spread (discount rate) and prepayment speed inputs, primarily due to changes in interest rates.

(2)	Represents changes due to realization of expected cash flows.

Carried at Lower of Amortized Cost or Fair Value:

Following is a summary of MSRs carried at lower of amortized cost or fair value:


	Quarter ended March 31,
	2014			2013
	(in thousands)
Amortized Cost:
Balance at beginning of period	$	266,697		$	132,977
MSRs resulting from loan sales		9,118			56,190
Purchases		—			—

		9,118			56,190

Sales		—			—
Amortization		(7,365	)		(4,970	)
Application of valuation allowance to write down MSRs with other-than temporary impairment		—			—

Balance at end of period		268,450			184,197

Valuation Allowance:
Balance at beginning of period		(2,577	)		(7,547	)
(Additions) reversals		(627	)		2,486
Application of valuation allowance to write down MSRs with other-than temporary impairment		—			—

Balance at end of period		(3,204	)		(5,061	)

MSRs, net	$	265,246		$	179,136

Estimated fair value at end of period	$	289,934		$	186,209

The following table summarizes the Company’s estimate of amortization of its existing MSRs carried at amortized cost. This projection was developed using the assumptions made by management in its March 31, 2014 valuation of MSRs. The assumptions underlying the following estimate will change as market conditions and portfolio composition and behavior change, causing both actual and projected amortization levels to change over time. Therefore, the following estimates will change in a manner and amount not presently determinable by management.


	Estimated MSR
Year ended March 31,	amortization
	(in thousands)
2015	$	26,661
2016		26,082
2017		24,924
2018		23,513
2019		21,697
Thereafter		145,573

Total	$	268,450

Servicing fees relating to MSRs are recorded in Net loan servicing fees on the consolidated statements of income and are summarized below:


	Quarter ended March 31,
	2014		2013
	(in thousands)
Contractual servicing fees	$	16,816	$	8,937

Note 16— Assets Sold Under Agreements to Repurchase at Fair Value

Following is a summary of financial information relating to assets sold under agreements to repurchase at fair value:


	Quarter ended March 31,
	2014			2013
	(dollars in thousands)
During the period:
Weighted-average interest rate (1)		2.21	%		2.77	%
Average balance	$	1,795,702		$	1,221,766
Total interest expense	$	12,539		$	10,712
Maximum daily amount outstanding	$	2,079,090		$	1,619,022
Period end:
Balance	$	1,887,778		$	1,615,050
Weighted-average interest rate		2.31	%		3.51	%
Available borrowing capacity:
Committed	$	1,195,414		$	884,950
Uncommitted	$	865,223		$	50,000

	$	2,060,637		$	934,950

Margin deposits placed with counterparties	$	3,780		$	2,973
Fair value of assets securing agreements to repurchase:
Mortgage-backed securities	$	198,110		$	—
Mortgage loans acquired for sale at fair value	$	339,153		$	1,122,940
Mortgage loans at fair value	$	1,914,507		$	1,203,788
Mortgage loans at fair value held by variable interest entity	$	356,170		$	—
Real estate acquired in settlement of loans	$	81,615		$	15,355

	$	2,889,555		$	2,342,083

(1)	Excludes the amortization of commitment fees and issuance costs of $2.5 million and $2.3 million for the quarters ended March 31, 2014 and 2013, respectively.

Following is a summary of maturities of outstanding assets sold under agreements to repurchase by maturity date:


Remaining Maturity at March 31, 2014	Balance
	(in thousands)
Within 30 days	$	372,590
Over 30 to 90 days		130,825
Over 90 days to 180 days		704,238
Over 180 days to 1 year		680,125

	$	1,887,778

Weighted average maturity (in months)		4.5

The Company is subject to margin calls during the period the agreements are outstanding and therefore may be required to repay a portion of the borrowings before the respective agreements mature if the value (as determined by the applicable lender) of the assets securing those agreements decreases. Margin deposits are included in Other assets in the consolidated balance sheets.

The amount at risk (the fair value of the assets pledged plus the related margin deposit, less the amount advanced by the counterparty and interest payable) and maturity information relating to the Company’s assets sold under agreements to repurchase is summarized by counterparty below as of March 31, 2014:

Mortgage loans acquired for sale, mortgage loans and REO sold under agreements to repurchase

Counterparty

Amount at risk

Mortgage loans
acquired for sale
weighted-average
repurchase agreement
maturity

Facility maturity

(in thousands)

Credit Suisse First Boston Mortgage Capital LLC

339,267

June 22, 2014

October 31, 2014

Bank of America, N.A.

32,059

June 12, 2014

January 30, 2015

Morgan Stanley

6,317

May 20, 2014

December 18, 2014

The Royal Bank of Scotland Group

57,295

February 17, 2015

Citibank, N.A.

559,042

March 31, 2014

July 24, 2014

Securities sold under agreements to repurchase


Counterparty	Amount at risk		Maturity
	(in thousands)
Daiwa Capital Markets America, Inc	$	6,217		May 3, 2014
Credit Suisse First Boston Mortgage Capital LLC	$	2,374		April 15, 2014
Bank of America, N.A.	$	612		April 15, 2014

The Company’s debt financing agreements require PMT and certain of its subsidiaries to comply with financial covenants that include a minimum tangible net worth for the Company of $860 million; a minimum tangible net worth for certain of the Company’s subsidiaries, including the Operating Partnership of $700 million (net worth was $1.6 billion, which includes PennyMac Holdings, LLC “PMH” and PennyMac Corp. (“PMC”)), PMH of $250 million (net worth was $694.5 million), and PMC of $150 million (net worth was $342.3 million). These tangible net worth requirements limit the subsidiaries’ abilities to transfer funds to the Company.

Note 17—Asset-backed secured financing of the variable interest entity at fair value

Following is a summary of financial information relating to the asset-backed secured financing of the variable interest entity:


	Quarter ended March 31,
	2014			2013
	(dollars in thousands)
Period end:
Balance	$	166,514		$	—
Weighted-average interest rate		3.58	%		—
During the period:
Weighted-average balance	$	166,894			0.00	%
Interest expense	$	1,617		$	—

The Asset-backed secured financing of the variable interest entity is a non-recourse liability and secured solely by the assets of the VIE and not by any other assets of the Company. The assets of the VIE are the only source of funds for repayment of the certificates.

Note 18—Exchangeable Senior Notes

PMC issued in a private offering $250 million aggregate principal amount of Notes due May 1, 2020. The Notes bear interest at a rate of 5.375% per year, payable semiannually. The Notes are exchangeable into common shares of beneficial interest of the Company at a rate of 33.5149 common shares per $1,000 principal amount of the Notes.

Following is financial information relating to the Notes:


	Quarter ended March 31,
	2014			2013
	(dollars in thousands)
Period end:
Balance	$	250,000		$	—
Unamortized issuance costs (1)	$	6,616		$	—
Weighted-average interest rate		5.38	%		—
During the period:
Weighted-average balance	$	250,000		$	—
Interest expense (2)	$	3,584		$	—

(1)	Unamortized issuance costs are included in Other assets in the consolidated balance sheets.

(2)	Total interest expense includes amortization of debt issuance costs of $225,000 during the quarter ended March 31, 2014.

Note 19—Borrowings under Forward Purchase Agreements

Following is a summary of financial information relating to borrowings under forward purchase agreements:


	Quarter ended March 31,
	2014			2013
	(dollars in thousands)
Period end:
Balance	$	216,614		$	—
Interest rate		3.01	%		0.00	%
Fair value of underlying loans and REO	$	215,693		$	—
During the period:
Weighted-average interest rate		2.85	%		0.00	%
Weighted-average balance	$	221,769		$	—
Interest expense	$	1,580		$	—
Maximum daily amount outstanding	$	226,848		$	—

Note 20—Liability for Losses Under Representations and Warranties

Following is a summary of the Company’s liability for losses under representations and warranties:


	Quarter ended March 31,
	2014		2013
	(in thousands)
Balance, beginning of period	$	10,110	$	4,441
Provision for losses		744		1,790
Incurred losses		—		—

Balance, end of period	$	10,854	$	6,231

Following is a summary of the Company’s repurchase activity:


	Quarter ended March 31,
	2014		2013
	(in thousands)
During the period:
Unpaid principal balance of mortgage loans repurchased	$	4,939	$	648
Unpaid principal balance of repurchased mortgage loans repurchased by correspondent lenders	$	1,333	$	710
At end of period:
Unpaid principal balance of mortgage loans subject to pending claims for repurchase	$	12,097	$	—
Unpaid principal balance of mortgage loans subject to representations and warranties	$	27,188,848	$	16,639,996

Note 21—Commitments and Contingencies

Litigation

From time to time, the Company may be involved in various proceedings, claims and legal actions arising in the ordinary course of business. As of March 31, 2014, the Company was not involved in any such proceedings, claims or legal actions that in management’s view would reasonably be likely to have a material adverse effect on the Company.

Mortgage Loan Commitments

The following table summarizes the Company’s outstanding contractual loan commitments:


	March 31, 2014
	(in thousands)
Commitments to purchase mortgage loans:
Correspondent lending	$	704,824
Other mortgage loans	$	—

Note 22—Shareholders’ Equity

At March 31, 2014, the Company had approximately $117.6 million of common shares available for issuance under its ATM Equity Offering Sales Agreement^SM. During the three months ended March 31, 2014, the Company sold a total of 3,387,022 of its common shares at a weighted average price of $23.92 per share, providing net proceeds to the Company of approximately $80.1 million, net of sales commissions of $874,000.

Note 23—Net Gain on Mortgage Loans Acquired for Sale

Net gain on mortgage loans acquired for sale is summarized below:


	Quarter ended March 31,
	2014			2013
	(in thousands)
Cash gain (loss):
Sales proceeds, net	$	(2,894	)	$	(27,247	)
Hedging activities		(3,547	)		13,614

		(6,441	)		(13,633	)
Non cash gain:
Receipt of MSRs in loan sale transactions		20,875			56,216
Provision for losses relating to representations and warranties provided in loan sales		(744	)		(1,790	)
Change in fair value relating to IRLCs, mortgage loans, and hedging derivatives held at period end:
IRLCs		2,022			(8,426	)
Mortgage loans		1,411			(2,422	)
Hedging derivatives		(7,152	)		(666	)

		(3,719	)		(11,514	)

	$	9,971		$	29,279

Note 24—Net Interest Income

Net interest income is summarized below:


	Quarter ended March 31,
	2014		2013
	(in thousands)
Interest income:
Short-term investments	$	152	$	31
Mortgage-backed securities		1,761		—
Mortgage loans acquired for sale at fair value		3,625		6,323
Mortgage loans at fair value		23,286		10,497
Mortgage loans under forward purchase agreements at fair value		2,154		—
Mortgage loans at fair value held by variable interest entity		5,495		—
Excess servicing spread purchased from PFSI, at fair value		2,862		—
Other		11		24

		39,346		16,875

Interest expense:
Assets sold under agreements to repurchase		12,539		10,712
Borrowings under forward purchase agreements		1,580		—
Asset-backed secured financing and the variable interest entity		1,617		—
Exchangeable senior notes		3,584		—
Other		455		524

		19,775		11,236

Net interest income	$	19,571	$	5,639

Note 25—Net Gain on Investments

Net gain on investments is summarized below:


	Quarter ended March 31,
	2014			2013
	(in thousands)
Net gain (loss) on investments:
Mortgage-backed securities	$	709		$	—
Mortgage loans		39,918			63,980
Mortgage loans held by VIE and related secured financing:
Mortgage loans held by variable interest entity		7,639			—
Asset-backed secured financing and the variable interest entity		(2,780	)		—

		4,859			—
Excess servicing spread purchased from PFSI, at fair value		(2,901	)		—

	$	42,585		$	63,980

Note 26—Net Loan Servicing Fees

Net loan servicing fees are summarized below:


	Quarter ended March 31,
	2014			2013
	(in thousands)
Servicing fees (1)	$	17,532		$	10,417
MSR recapture fee receivable from PFSI		8			133
Effect of MSRs:
Carried at lower of amortized cost or fair value
Amortization		(7,365	)		(4,970	)
(Provision for) reversal of impairment		(627	)		2,486
Carried at fair value - change in fair value		(2,028	)		(67	)
Losses on hedging derivatives		(99	)		(1,988	)

		(10,119	)		(4,539	)

Net loan servicing fees	$	7,421		$	6,011

(1)	Includes contractually specified servicing and ancillary fees.

Note 27—Share-Based Compensation Plans

On March 31, 2014 and 2013, the Company had one share-based compensation plan. Compensation expense relating to grants under the plan of $2.6 million and $1.8 million, which includes dividend equivalents paid to unvested restricted share unit holders, was recognized for the three months ended March 31, 2014 and 2013, respectively. The Company issued no new grants and had vestings of 84,437 and 85,769 units during the three months ended March 31, 2014 and 2013, respectively.

Note 28—Income Taxes

The Company had a tax benefit of $1.6 million for the three months ended March 31, 2014 and a tax expense of $2.6 million for the three months ended March 31, 2013. The Company’s effective tax rate was (4.4)% for the three months ended March 31, 2014 compared to 4.7% for the same period in 2013. The decrease in the Company’s effective tax rate for the three months ended March 31, 2014 compared to the prior period in 2013 is due primarily to a loss in the Company’s taxable REIT subsidiary for the first quarter of 2014 compared to income in that entity for the same period in 2013. The primary difference between the Company’s effective tax rate and the statutory tax rate is non-taxable REIT income resulting from the deduction for dividends paid.

In general, cash dividends declared by the Company will be considered ordinary income to shareholders for income tax purposes. Some portion of the dividends may be characterized as capital gain distributions or a return of capital.

Note 29—Segments and Related Information

The Company has two segments: correspondent lending and investment activities.

•

Most of the loans the Company has acquired in its correspondent lending activities have been eligible for sale to government-sponsored entities such as Fannie Mae and Freddie Mac or through government agencies such as Ginnie Mae.

•

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

Financial highlights by operating segment are summarized below:


Quarter ended March 31, 2014	Correspondent lending			Investment activities			Intersegment elimination & other			Total
	(in thousands)
Net investment income:
Net gain on mortgage loans acquired for sale	$	9,971		$	—		$	—		$	9,971
Net gain on investments		—			42,585			—			42,585
Interest income		3,635			36,598			(887	)		39,346
Interest expense		(3,655	)		(17,007	)		887			(19,775	)

		(20	)		19,591			—			19,571
Net loan servicing fees		—			7,421						7,421
Other investment income (loss)		2,356			(5,309	)		—			(2,953	)

		12,307			64,288			—			76,595

Expenses:
Loan fulfillment, Servicing and Management fees payable to PennyMac Financial Services, Inc.		9,071			22,496			—			31,567
Other		88			8,651			—			8,739

		9,159			31,147			—			40,306

Income before provision for income taxes	$	3,148		$	33,141		$	—		$	36,289

Total assets at period end	$	359,348		$	3,868,189		$	—		$	4,227,537


Quarter ended March 31, 2013	Correspondent lending			Investment activities			Intersegment elimination & other			Total
	(in thousands)
Net investment income:
Net gain on mortgage loans acquired for sale	$	29,279		$	—		$	—		$	29,279
Net gain on investments		—			63,980			—			63,980
Interest income		6,324			10,592			(41	)		16,875
Interest expense		(5,688	)		(5,589	)		41			(11,236	)

		636			5,003			—			5,639
Net loan servicing fees		—			6,011			—			6,011
Other investment income (loss)		5,473			(2,566	)		—			2,907

		35,388			72,428			—			107,816

Expenses:
Loan fulfillment, Servicing and Management fees payable to PennyMac Financial Services, Inc.		25,454			13,724			3,284	(1)		42,462
Other		1,054			8,365			—			9,419

		26,508			22,089			3,284			51,881

Income before provision for income taxes	$	8,880		$	50,339		$	(3,284	)	$	55,935

Total assets at period end	$	1,142,774		$	1,829,246		$	(44,860	)	$	2,927,160

(1)	Corporate absorption of fulfillment fees for transition adjustment related to the amended and restated management agreement effective February 1, 2013.

Note 30—Supplemental Cash Flow Information


	Quarter ended March 31,
	2014		2013
	(in thousands)
Cash paid for interest	$	25,490	$	11,192
Income tax payment	$	42	$	473
Non-cash investing activities:
Transfer of mortgage loans and advances to real estate acquired in settlement of loans	$	68,902	$	31,510
Purchase of mortgage loans financed through forward purchase agreements	$	920	$	—
Transfer of mortgage loans under forward purchase agreements to mortgage loans at fair value	$	4,460	$	—
Transfer of mortgage loans under forward purchase agreements and advances to REO under forward purchase agreements	$	6,828	$	—
Receipt of MSRs as proceeds from sales of loans	$	20,875	$	56,216
Purchase of REO financed through forward purchase agreements	$	38	$	—
Receipt of ESS pursuant to recapture agreement with PFSI	$	1,113	$	—
Transfer of REO under forward purchase agreements to REO	$	92	$	—
Non-cash financing activities:
Purchase of mortgage loans financed through forward purchase agreements	$	920	$	—
Purchase of REO financed through forward purchase agreements	$	38	$	—
Transfer of mortgage loans at fair value financed through agreements to repurchase to REO financed under agreements to repurchase	$	2,046	$	—
Dividends payable	$	43,618	$	—

Note 31—Regulatory Net Worth

PMC is a seller-servicer for Fannie Mae and Freddie Mac. To retain its status as an approved seller-servicer, PMC is required to meet Fannie Mae’s and Freddie Mac’s capital standards, which require PMC to maintain a minimum net worth of $53.0 million and $20.6 million, respectively. Management believes that PMC complies with Fannie Mae’s and Freddie Mac’s net worth requirement as of March 31, 2014.

Note 32—Subsequent Events

Management has evaluated all events and transactions through the date the Company issued these consolidated financial statements. During this period:

•

On May 8, 2014, the Company purchased a pool of nonperforming mortgage loans with an aggregate unpaid principal balance of $37.9 million.

•

On April 29, 2014, PFSI entered into a letter of intent with a third party to purchase a $3.5 billion unpaid principal balance portfolio of Ginnie Mae MSRs. The Company intends to purchase from PFSI approximately $26 million of ESS from this MSR portfolio. The MSR acquisition by PFSI and the Company’s purchase of ESS are subject to the negotiation and execution of definitive documentation, continuing due diligence and customary closing conditions and approvals. There can be no assurance that the committed amounts will ultimately be acquired or that the transactions will be completed at all.

•

All agreements to repurchase assets that matured between March 31, 2014 and the date of this Report were extended or renewed.

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

We are a specialty finance company that invests primarily in residential mortgage loans and mortgage-related assets. Our objective is to provide attractive risk-adjusted returns to our investors over the long-term, principally through dividends and secondarily through capital appreciation. We intend to achieve this objective largely by investing in distressed mortgage assets and acquiring, pooling and selling newly originated prime credit quality residential mortgage loans (“correspondent lending”).

We are externally managed by PCM, an investment adviser that specializes in and focuses on, residential mortgage loans. Most of our mortgage loan portfolio is serviced by PLS, an affiliate of PCM.

We invest in distressed mortgage loans through direct acquisitions of mortgage loan portfolios from institutions such as banks and mortgage companies. A substantial portion of the nonperforming loans we have purchased has been acquired from or through one or more subsidiaries of Citigroup Inc.

We seek to maximize the value of the distressed mortgage loans that we acquire using means that are appropriate for the particular loan, including both proprietary and nonproprietary loan modification programs, special servicing and other initiatives focused on avoiding foreclosure, when possible. When we are unable to effect a cure for a mortgage delinquency, our objective is to effect timely acquisition and/or liquidation of the property securing the loan through the use, in part, of short sales and deed-in-lieu of foreclosure programs. During the quarter ended March 31, 2014, we acquired distressed mortgage loans with fair values totaling $257.2 million, and we received proceeds from sales, liquidation, and payoffs from our portfolio of distressed mortgage loans and REO totaling $285.6 million.

Changes in the mortgage market have significantly reduced the outlets for sales of newly originated mortgage loans by mortgage lenders who have traditionally sold their loans to larger mortgage companies and banks who, in turn, sold those loans to Agencies and other investors or into securitizations. We believe that these changes are due in part to banks’ responses to changes in regulatory requirements and to loan and securitization-related capital requirements, along with a change in focus toward retail lending; and that the changes provide us with the opportunity to act as a link between loan originators and the Agency and securitization markets.

During the quarter ended March 31, 2014, we purchased loans with fair values totaling $5.0 billion, in furtherance of our correspondent lending business. To the extent that we purchase loans that are insured by the U.S. Department of Housing and Urban Development (“HUD”), through the Federal Housing Administration (“FHA”) or insured or guaranteed by the Veterans Administration (“VA”), we and PLS have agreed that PLS will fulfill and purchase such loans, as PLS is a Ginnie Mae-approved issuer and servicer and we are not. This arrangement has enabled us to compete with other correspondent lenders that purchase both government and conventional loans. We receive a sourcing fee from PLS of three basis points on the unpaid principal balance of each loan that we sell to PLS under such arrangement, and earn interest income on the loan for the time period we hold the loan prior to the sale to PLS. We received sourcing fees totaling $892,000, recorded in Net gain on mortgage loans acquired for sale, relating to $3.1 billion of loans at fair value we sold to PLS for the quarter ended March 31, 2014, compared to $1.0 million relating to $3.5 billion of loans at fair value that we sold to PLS for the quarter ended March 31, 2013.

We supplement these activities through participation in other mortgage-related activities, including:

•

Acquisition of MSRs or ESS from MSRs. We believe that MSR and ESS investments may allow us to earn attractive current returns and to leverage the loan servicing and origination capabilities of PLS to improve the assets’ value. During the quarter ended March 31, 2014, we purchased ESS with a fair value totaling $20.5 million. We also intend to continue to retain the MSRs that we receive as a portion of the proceeds from our sale or securitization of mortgage loans through our correspondent lending operation. During the quarter ended March 31, 2014, we retained MSRs with a fair value at initial recognition totaling $20.9 million, compared to $56.2 million during the quarter ended March 31, 2013.

•

To the extent that we transfer correspondent lending loans into private label securitizations, retention of a portion of the securities created in the securitization transaction.

•

Acquisition of REIT-eligible mortgage-backed or mortgage-related securities.

•

Providing inventory financing of mortgage loans for mortgage lenders. We believe this activity may result in attractive investment assets and will supplement and make our correspondent lending business more attractive to lenders from which we acquire newly originated loans.

We conduct substantially all of our operations, and make substantially all of our investments, through our Operating Partnership and its subsidiaries. We are the sole limited partner and one of our subsidiaries is the sole general partner of our Operating Partnership.

We believe that we qualify to be taxed as a REIT. We believe that we will not be subject to federal income tax on that portion of our income that is distributed to shareholders as long as we meet certain 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 we lose our REIT qualification. A portion of our activities, including our correspondent lending business, is conducted in a taxable REIT subsidiary (“our TRS”), which is subject to corporate federal and state income taxes. Accordingly, we have made 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.

Observations on Current Market Opportunities

Our business is affected by macroeconomic conditions in the United States, including economic growth, unemployment rates, the residential housing market and interest rate levels and expectations. During the first quarter of 2014, real U.S. gross domestic product expanded at an annual rate of 0.1% compared to revised 1.1% and 2.6% annual rates for the first and fourth quarters of 2013. The national unemployment rate was 6.7% at March 31, 2014 and compares to a revised seasonally adjusted rate of 7.5% at March 31, 2013 and 6.7% at December 31, 2013. While delinquency rates on residential real estate loans continue to decrease, they remain elevated compared to historical rates. As reported by the Federal Reserve Bank, during the fourth quarter of 2013, the delinquency rate on residential real estate loans held by commercial banks was 8.2%, a reduction from 10.0% during the fourth quarter of 2012.

Residential real estate activity was impacted by severe winter weather in many parts of the country during the first quarter of 2014. The seasonally adjusted annual rate of existing home sales for March 2014 was 7.5% lower than for March 2013 and the national median existing home price for all housing types was $198,500, a 7.9% increase from March 2013. On a national level, foreclosure filings during the first quarter of 2014 decreased by 23% as compared to the first quarter of 2013. Foreclosure activity across the country decreased throughout 2013; however, it is expected to remain above historical average levels through 2014 and beyond.

Thirty-year fixed mortgage interest rates ranged from a low of 4.30% to a high of 4.43% during the first quarter of 2014 while during the first quarter of 2013, thirty-year fixed mortgage interest rates ranged from a low of 3.41% to a high of 3.57% (Source: the Federal Home Loan Mortgage Corporation’s Weekly Primary Mortgage Market Survey).

Changes in fixed rate residential mortgage loan interest rates generally follow changes in long term U.S. Treasury yields. Toward the end of the second quarter of 2013, an increase in these Treasury yields led to an increase in mortgage loan interest rates. As a result of this increase in mortgage loan interest rates, market volumes for mortgage originations have decreased led by a reduction in refinance activity.

Mortgage lenders originated an estimated $235 billion of home loans during the quarter ended March 31, 2014, down 58.0% percent from the quarter ended March 31, 2013. Mortgage originations are forecast to continue to decline, with current industry estimates for 2014 totaling $1.2 trillion compared to $1.9 trillion for 2013 (Source: Average of Fannie Mae, Freddie Mac and Mortgage Bankers Association forecasts).

In the first quarter of 2014, prime jumbo MBS issuances surpassed the first quarter of 2013, with securitizations totaling $1.3 billion in unpaid principal balance. We believe there is significant long-term market opportunity in non-Agency jumbo mortgage loans. However, current investor demand for non-agency MBS is limited as evidenced by weaker pricing for securitizations issued in the second half of 2013. We believe that the Federal Housing Finance Agency (“FHFA”) will begin to reduce Agency conforming limits to pre-crisis levels beginning sometime in 2014. This would open a significant portion of the jumbo market to non-Agency securitization and move the market one step closer to normalization. During the quarter ended March 31, 2014, we produced approximately $12.5 million in unpaid principal balance (“UPB”) of jumbo loans, compared to $8.1 million in UPB of jumbo loans produced during the quarter ended March 31, 2013.

Our Manager continues to see substantial volumes of distressed residential mortgage loan sales (sales of loan pools that consist of either nonperforming loans, troubled but performing loans or a combination thereof) offered for sale by a limited number of sellers. During the first quarter of 2014, our Manager reviewed 37 mortgage loan pools with UPB totaling approximately $9.2 billion. This compares to our Manager’s review of 27 mortgage loan pools with UPB totaling approximately $5.7 billion during the first quarter of 2013. We acquired distressed loans with fair value totaling $256.3 million and $200.5 million during the quarters ended March 31, 2014 and 2013, respectively. While we expect to see a continued supply of distressed whole loans, we believe the pricing for recent transactions has been less attractive. We remain patient and selective in making new investments in distressed whole loans and we continue to monitor the market to assess best execution opportunities for our existing distressed portfolio investments.

In recent periods, we have seen increased competition from new and existing market participants in our correspondent lending business, as well as reductions in the overall level of refinancing activity. We believe that this change in supply and demand within the marketplace has been driving lower production margins in recent periods, which is reflected in our results of operations in our gains on mortgage loans acquired for sale. During the first several months of 2013, gains on mortgage loans acquired for sale benefited from wider secondary spreads (the difference between interest rates charged to borrowers and yields on mortgage-backed securities in the secondary market); however, secondary spreads narrowed in subsequent months and we expect them to continue to normalize toward their long-term averages in 2014.

Results of Operations

The following is a summary of our key performance measures:


	Quarter ended March 31,
	2014		2013
	(in thousands except share amounts)
Net investment income	$	76,595	$	107,816

Income before provision for income taxes by segment:
Correspondent lending	$	3,148	$	8,880
Investment activities		33,141		50,339
Other (1)		—		(3,284	)

	$	36,289	$	55,935

Net income	$	37,873	$	53,296
Earnings per share: