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

Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

Form 10-Q

(Mark One)

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

For the quarterly period ended June 30, 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 August 7, 2014
Common Shares of Beneficial Interest, $0.01 par value		74,139,570

PENNYMAC MORTGAGE INVESTMENT TRUST

FORM 10-Q

June 30, 2014

TABLE OF CONTENTS


		Page
PART I. FINANCIAL INFORMATION			1
Item 1.	Financial Statements (Unaudited):		1
	Consolidated Balance Sheets		1
	Consolidated Statements of Income		3
	Consolidated Statements of Changes in Shareholders’ Equity		4
	Consolidated Statements of Cash Flows		5
	Notes to Consolidated Financial Statements		7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		58
	Observations on Current Market Opportunities		59
	Results of Operations		61
	Net Investment Income		62
	Expenses		84
	Balance Sheet Analysis		87
	Asset Acquisitions		88
	Investment Portfolio Composition		89
	Cash Flows		94
	Liquidity and Capital Resources		96
	Off-Balance Sheet Arrangements and Aggregate Contractual Obligations		99
	Quantitative and Qualitative Disclosures About Market Risk		105
	Factors That May Affect Our Future Results		107
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		110
Item 4.	Controls and Procedures		110
PART II. OTHER INFORMATION			110
Item 1.	Legal Proceedings		110
Item 1A.	Risk Factors		110
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		110
Item 3.	Defaults Upon Senior Securities		110
Item 4.	Mine Safety Disclosures		111
Item 5.	Other Information		111
Item 6.	Exhibits and Financial Statement Schedules		112

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

PENNYMAC MORTGAGE INVESTMENT TRUST AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (UNAUDITED)


	June 30,		December 31,
	2014		2013
	(in thousands, except share data)
ASSETS
Cash	$	37,902	$	27,411
Short-term investments		104,453		92,398
Mortgage-backed securities at fair value pledged to secure assets sold under agreements to repurchase		218,725		197,401
Mortgage loans acquired for sale at fair value (includes $905,044 and $454,210 pledged to secure assets sold under agreements to repurchase)		909,085		458,137
Mortgage loans at fair value (includes $2,407,512 and $1,963,266 pledged to secure assets sold under agreements to repurchase)		2,697,821		2,600,317
Mortgage loans under forward purchase agreements at fair value pledged to secure borrowings under forward purchase agreements		—		218,128
Excess servicing spread purchased from PennyMac Financial Services, Inc. at fair value		190,244		138,723
Derivative assets		14,594		7,976
Real estate acquired in settlement of loans (includes $107,684 and $89,404 pledged to secure assets sold under agreements to repurchase)		240,471		138,942
Real estate acquired in settlement of loans under forward purchase agreements pledged to secure forward purchase agreements		—		9,138
Mortgage servicing rights (includes $46,802 and $26,452 carried at fair value)		315,484		290,572
Servicing advances		63,993		59,573
Due from PennyMac Financial Services, Inc.		4,137		6,009
Other assets		72,836		66,192

Total assets	$	4,869,745	$	4,310,917

LIABILITIES
Assets sold under agreements to repurchase	$	2,701,755	$	2,039,605
Borrowings under forward purchase agreements		—		226,580
Asset-backed secured financing of the variable interest entity at fair value		170,201		165,415
Exchangeable senior notes		250,000		250,000
Derivative liabilities		6,347		1,961
Accounts payable and accrued liabilities		69,552		71,561
Due to PennyMac Financial Services, Inc.		19,636		18,636
Income taxes payable		63,218		59,935
Liability for losses under representations and warranties		11,876		10,110

Total liabilities		3,292,585		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, 74,139,070 and 70,458,082 common shares, respectively		741		705
Additional paid-in capital		1,468,791		1,384,468
Retained earnings		107,628		81,941

Total shareholders’ equity		1,577,160		1,467,114

Total liabilities and shareholders’ equity	$	4,869,745	$	4,310,917

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

PENNYMAC MORTGAGE INVESTMENT TRUST AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (UNAUDITED)

Assets and liabilities of consolidated variable interest entity (“VIE”) included in total assets and liabilities (the assets of the VIE can only be used to settle liabilities of the VIE):


	June 30,		December 31,
	2014		2013
	(in thousands)
ASSETS
Mortgage loans at fair value	$	541,320	$	523,652
Other assets - interest receivable		1,702		1,584

	$	543,022	$	525,236

LIABILITIES
Asset-backed secured financing at fair value	$	170,201	$	165,415
Accounts payable and accrued expenses - interest payable		492		497

	$	170,693	$	165,912

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 June 30,						Six months ended June 30,
	2014			2013			2014			2013
	(in thousands, except per share data)
Net investment income
Net gain on mortgage loans acquired for sale	$	10,222		$	44,438		$	20,193		$	73,717
Loan origination fees		4,485			4,752			6,841			10,225
Net interest income:
Interest income		48,518			26,797			87,864			43,672
Interest expense		21,865			14,144			41,640			25,380

		26,653			12,653			46,224			18,292

Net gain on investments		73,134			46,834			115,719			110,814
Net loan servicing fees		8,758			7,892			16,179			13,903
Results of real estate acquired in settlement of loans		(5,348	)		(1,929	)		(11,974	)		(5,182	)
Other		2,652			913			3,969			1,600

Net investment income		120,556			115,553			197,151			223,369

Expenses
Expenses payable to PennyMac Financial Services, Inc.:
Loan servicing fees		14,180			8,787			28,771			16,513
Loan fulfillment fees		12,433			22,054			21,335			50,298
Management fees		8,912			8,455			16,986			14,947
Professional services		2,690			1,339			4,421			3,723
Compensation		1,883			1,438			4,825			3,527
Other		7,154			5,571			11,221			10,517

Total expenses		47,252			47,644			87,559			99,525

Income before provision for income taxes		73,304			67,909			109,592			123,844
(Benefit from) provision for income taxes		(1,907	)		13,412			(3,492	)		16,051

Net income	$	75,211		$	54,497		$	113,084		$	107,793

Earnings per share
Basic	$	1.01		$	0.92		$	1.54		$	1.81
Diluted	$	0.93		$	0.86		$	1.44		$	1.75
Weighted-average shares outstanding
Basic		74,065			59,035			72,803			58,981
Diluted		82,750			65,104			81,535			62,217
Dividends declared per share	$	0.59		$	0.57		$	1.18		$	1.14

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 of shares		Par value		Additional paid-in capital			Retained earnings			Total
	(in thousands)
Balance at December 31, 2012		58,904	$	589	$	1,129,858		$	70,889		$	1,201,336
Net income		—		—		—			107,793			107,793
Share-based compensation		173		2		2,468			—			2,470
Dividends, $1.14 per share		—		—		—			(67,249	)		(67,249	)
Underwriting and offering costs		—		—		(169	)		—			(169	)

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

Balance at December 31, 2013		70,458	$	705	$	1,384,468		$	81,941		$	1,467,114
Net income		—		—		—			113,084			113,084
Share-based compensation		234		2		2,956			—			2,958
Dividends, $1.18 per share		—		—		—			(87,397	)		(87,397	)
Proceeds from offerings of common shares		3,447		34		82,419			—			82,453
Underwriting and offering costs		—		—		(1,052	)		—			(1,052	)

Balance at June 30, 2014		74,139	$	741	$	1,468,791		$	107,628		$	1,577,160

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

PENNYMAC MORTGAGE INVESTMENT TRUST AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)


	Six months ended June 30,
	2014			2013
	(in thousands)
Cash flows from operating activities
Net income	$	113,084		$	107,793
Adjustments to reconcile net income to net cash used by operating activities:
Net gain on mortgage loans acquired for sale at fair value		(20,193	)		(73,717	)
Accrual of unearned discounts and amortization of premiums on mortgage-backed securities, mortgage loans at fair value, and asset-backed secured financing		(537	)		—
Capitalization of interest on mortgage loans at fair value		(30,353	)		(11,814	)
Accrual of interest on excess servicing spread		(6,001	)		—
Amortization of credit facility commitment fees and debt issuance costs		4,879			4,036
(Reversal) accrual of costs related to forward purchase agreements		(168	)		251
Net gain on investments		(115,719	)		(110,814	)
Change in fair value, amortization and impairment of mortgage servicing rights		20,518			9,321
Results of real estate acquired in settlement of loans		11,974			5,182
Share-based compensation expense		2,958			2,471
Purchases of mortgage loans acquired for sale at fair value		(12,347,365	)		(17,759,140	)
Sales of mortgage loans acquired for sale at fair value to nonaffiliates		4,789,444			9,044,480
Sales of mortgage loans acquired for sale to PennyMac Financial Services, Inc.		7,085,859			8,282,163
(Increase) decrease in servicing advances		(15,218	)		7,481
Decrease in due from PennyMac Financial Services, Inc.		2,812			1,766
(Increase) decrease in other assets		(25,427	)		41,379
Decrease in accounts payable and accrued liabilities		(45,366	)		(11,016	)
Increase in payable to PennyMac Financial Services, Inc.		1,036			4,509
Increase in income taxes payable		3,283			15,088

Net cash used by operating activities		(570,500	)		(440,581	)

Cash flows from investing activities
Net increase in short-term investments		(12,055	)		(34,219	)
Purchases of mortgage-backed securities at fair value		(19,638	)		—
Repayments of mortgage-backed securities at fair value		5,419			—
Purchases of mortgage loans at fair value		(283,017	)		(200,486	)
Repayments and sales of mortgage loans at fair value		397,643			135,242
Repayments of mortgage loans under forward purchase agreements at fair value		6,413			—
Purchase of excess servicing spread from PennyMac Financial Services, Inc.		(73,393	)		—
Repayment of excess spread investment		16,494			—
Settlements of derivative financial instruments used for hedging		(9,785	)		—
Purchase of real estate acquired in settlement of loans		(3,049	)		—
Sales of real estate acquired in settlement of loans		76,903			63,017
Sales of real estate acquired in settlement of loans under forward purchase agreements		5,365			—
Purchase of mortgage servicing rights		—			(185	)
Decrease (increase) in margin deposits and restricted cash		5,454			(13,426	)

Net cash provided (used) by investing activities		112,754			(50,057	)

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

PENNYMAC MORTGAGE INVESTMENT TRUST AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)


	Six months ended June 30,
	2014			2013
	(in thousands)
Cash flows from financing activities
Sales of assets under agreement to repurchase		15,938,914			16,841,470
Repurchases of assets sold under agreements to repurchase		(15,276,762	)		(16,516,020	)
Repurchases of real estate acquired in settlement of loans financed under agreement to repurchase		—			(15,656	)
Repayments of borrowings under forward purchase agreements		(227,866	)		—
Repayments of asset-backed secured financing at fair value		(3,372	)		—
Issuance of exchangeable senior notes		—			250,000
Payment of exchangeable senior notes issuance costs		—			(7,425	)
Proceeds from issuance of common shares		82,453			—
Payment of common share underwriting and offering costs		(1,052	)		(169	)
Payment of contingent underwriting fees payable		(424	)		(427	)
Payment of dividends		(43,654	)		(67,249	)

Net cash provided by financing activities		468,237			484,524

Net increase (decrease) in cash		10,491			(6,114	)
Cash at beginning of period		27,411			33,756

Cash at end of period	$	37,902		$	27,642

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 (“common 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 production and investment activities:

•

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

Most of the loans the Company has acquired in its correspondent production activities have been eligible for sale to government-sponsored entities such as 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, the Company pays PCM 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 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.

Following is a summary of the reclassifications:


	As reported				As previously reported				Reclassification
	Quarter ended June 30, 2013		Six months ended June 30, 2013		Quarter ended June 30, 2013		Six months ended June 30, 2013		Quarter ended June 30, 2013			Six months ended June 30, 2013
	(in thousands)
Net interest income (new caption):
Interest income	$	26,797	$	43,672	$	26,797	$	43,672	$	—		$	—
Interest expense		14,144		25,380		—		—		14,144			25,380

		12,653		18,292		26,797		43,672		(14,144	)		(25,380	)

Net investment income	$	115,553	$	223,369	$	129,697	$	248,749	$	(14,144	)	$	(25,380	)
Expenses:
Interest expense	$	—	$	—	$	14,144	$	25,380	$	(14,144	)	$	(25,380	)
Total expenses	$	47,644	$	99,525	$	61,788	$	124,905	$	(14,144	)	$	(25,380	)

These reclassifications did not change previously reported income before provision for (benefit from) income taxes, provision for (benefit from) 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 Servicer’s 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 June 30,				Six months ended June 30,
	2014		2013		2014		2013
	(in thousands)
Investment portfolio purchases:
Mortgage loans	$	27,203	$	243,109	$	284,403	$	443,582
REO		30		89		3,117		89

	$	27,233	$	243,198	$	287,520	$	443,671

Investment portfolio purchases above through one or more subsidiaries of Citigroup Inc.:
Mortgage loans	$	26,737	$	242,886	$	26,737	$	443,183
REO		30		89		68		89

	$	26,767	$	242,975	$	26,805	$	443,272

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


	June 30,		December 31,
	2014		2013
	(in thousands)
Mortgage loans at fair value	$	1,067,099	$	1,138,131
Mortgage loans under forward purchase agreements at fair value		—		218,128
REO		111,946		84,726
REO under forward purchase agreements		—		8,705

	$	1,179,045	$	1,449,690

Total mortgage loans and REO held at period end	$	2,938,292	$	2,966,525

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 were held in a trust subsidiary by CGM pending settlement by the Company. The commitment under the forward purchase agreement was settled in full during the quarter ended June 30, 2014.

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 June 30,						Six months ended June 30,
	2014			2013			2014			2013
	(in thousands)
Statements of income:
Interest income	$	1,430		$	260		$	3,584		$	260
Interest expense	$	783		$	251		$	2,364		$	251
Net gain on investments	$	1,743		$	(690	)	$	803		$	(690	)
Net loan servicing fees	$	201		$	—		$	517		$	—
Results of REO	$	(72	)	$	—		$	(473	)	$	—
Statements of cash flows:
Repayments of mortgage loans	$	1,084		$	—		$	3,463		$	—
Sales of REO	$	3,743		$	—		$	5,365		$	—
Repayments of borrowings under forward purchase agreements	$	(214,742	)	$	—		$	(227,866	)	$	—

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 June 30,				Six months ended June 30,
	2014		2013		2014		2013
	(in thousands)
Management fee:
Base	$	5,838	$	4,575	$	11,359	$	8,940
Performance incentive		3,074		3,880		5,627		6,007

	$	8,912	$	8,455	$	16,986	$	14,947

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

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


	Quarter ended June 30,				Six months ended June 30,
	2014		2013		2014		2013
	(in thousands)
Mortgage loans acquired for sale at fair value:
Base	$	29	$	90	$	46	$	169
Activity-based		51		111		77		183

		80		201		123		352

Distressed mortgage loans:
Base		4,975		3,699		9,941		7,572
Activity-based		5,746		2,447		12,132		4,324

		10,721		6,146		22,073		11,896

MSRs:
Base		3,323		2,363		6,471		4,126
Activity-based		56		77		104		139

		3,379		2,440		6,575		4,265

	$	14,180	$	8,787	$	28,771	$	16,513

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


	Quarter ended June 30,				Six months ended June 30,
	2014		2013		2014		2013
	(in thousands)
Fulfillment fee expense payable to PFSI	$	12,433	$	22,054	$	21,335	$	50,298
Unpaid principal balance of loans fulfilled by PFSI	$	2,991,764	$	4,323,885	$	4,911,342	$	9,110,711

Sourcing fees received from PFSI	$	1,125	$	1,349	$	2,017	$	2,359
Fair value of loans sold to PFSI	$	3,955,329	$	4,733,767	$	7,085,859	$	8,282,163

At period end:
Mortgage loans included in mortgage loans acquired for sale pending sale to PFSI	$	304,707	$	290,567

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


	Quarter ended June 30,				Six months ended June 30,
	2014		2013		2014		2013
	(in thousands)
Purchases of excess servicing spread	$	52,867	$	—	$	73,393	$	—
Interest income from excess servicing spread	$	3,138	$	—	$	6,001	$	—
Excess servicing spread recapture recognized	$	2,525	$	—	$	4,415	$	—
MSR recapture recognized	$	1	$	367	$	9	$	499

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 six months ended June 30, 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 and six months ended June 30, 2014, the Company paid $315,000 and $387,000 to the underwriters, respectively.

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 June 30,				Six months ended June 30,
	2014		2013		2014		2013
	(in thousands)
Reimbursement of:
Common overhead incurred by PFSI	$	2,691	$	3,201	$	5,269	$	5,807
Expenses incurred on the Company’s behalf		104		585		549		1,834

	$	2,795	$	3,786	$	5,818	$	7,641

Payments and settlements during the period (1)	$	14,894	$	32,616	$	33,280	$	65,290

(1)	Payments and settlements include payments for management fees and correspondent production 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:


	June 30,		December 31,
	2014		2013
	(in thousands)
Servicing fees	$	5,208	$	5,915
Management fees		8,912		8,924
Allocated expenses		3,764		2,009
Contingent underwriting fees		1,752		1,788

	$	19,636	$	18,636

Amounts due from affiliates totaled $4.1 million and $6.0 million at June 30, 2014 and December 31, 2013, respectively. At June 30, 2014, the balance represents payments receivable relating to cash flows from the Company’s investment in ESS and amounts receivable relating to unsettled MSR and ESS recaptures. At June 30, 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 at both June 30, 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 common shares. Unvested share-based compensation awards containing non-forfeitable rights to receive dividends or dividend equivalents (collectively, “dividends”) are classified as “participating securities” and are included in the basic earnings per share calculation using the two-class method.

Under the two-class method, all earnings (distributed and undistributed) are allocated to common shares and participating securities, based on their respective rights to receive dividends. Basic earnings per share is determined using net income reduced by income attributable to the participating securities and divided by the weighted-average common shares outstanding during the period.

Diluted earnings per share is determined by dividing net income attributable to diluted shareholders, which adds back to net income the interest expense, net of applicable income taxes, on the Company’s exchangeable senior notes (the “Notes”), by the weighted-average common 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 June 30,						Six months ended June 30,
	2014			2013			2014			2013
	(in thousands except per share amounts)
Basic earnings per share:
Net income	$	75,211		$	54,497		$	113,084		$	107,793
Effect of participating securities—share-based compensation awards		(433	)		(444	)		(841	)		(961	)

Net income attributable to common shareholders	$	74,778		$	54,053		$	112,243		$	106,832

Weighted-average shares outstanding		74,065			59,035			72,803			58,981
Basic earnings per share	$	1.01		$	0.92		$	1.54		$	1.81

Diluted earnings per share:
Net income	$	75,211		$	54,497		$	113,084		$	107,793
Interest on exchangeable senior notes, net of income taxes		2,079			1,382			4,156			1,382

Net income attributable to diluted shareholders	$	77,290		$	55,879		$	117,240		$	109,175

Weighted-average shares outstanding		74,065			59,035			72,803			58,981

Potentially dilutive securities:
Shares issuable pursuant exchange of the Notes		8,393			5,709			8,393			2,870
Shares issuable under share-based compensation plan		292			360			338			366

Diluted weighted-average number of shares outstanding		82,750			65,104			81,534			62,217

Diluted earnings per share	$	0.93		$	0.86		$	1.44		$	1.75

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 June 30,				Six months ended June 30,
	2014		2013		2014		2013
	(in thousands)
Cash flows:
Proceeds from sales	$	2,763,138	$	3,909,744	$	4,789,444		9,044,480
Servicing fees received (1)	$	19,019	$	11,772	$	34,907	$	20,908
Period end information:
Unpaid principal balance of mortgage loans outstanding	$	29,268,039	$	19,850,609
Unpaid principal balance of delinquent mortgage loans:
30-89 days delinquent	$	90,091	$	44,436
90 or more days delinquent
Not in foreclosure		13,325		2,485
In foreclosure or bankruptcy		11,306		3,163

		24,631		5,648

	$	114,722	$	50,084

(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 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 repayment of the certificates.

Note 6—Netting of Financial Instruments

The Company uses derivative financial instruments to manage exposure to interest rate risk created by its MBS, interest rate lock commitments (“IRLC”), mortgage loans acquired for sale at fair value, mortgage loans at fair value, 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.


	June 30, 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	$	471	$	—		$	471		$	272	$	—		$	272
MBS call options		519		—			519			—		—			—
Forward purchase contracts		14,723		—			14,723			1,229		—			1,229
Forward sale contracts		314		—			314			16,385		—			16,385
Treasury futures		545		—			545			—		—			—
Put options on Eurodollar futures		181		—			181			566		—			566
Call options on Eurodollar futures		214		—			214			—		—			—
Netting		—		(13,855	)		(13,855	)		—		(12,986	)		(12,986	)

		16,967		(13,855	)		3,112			18,452		(12,986	)		5,466
Derivatives not subject to master netting arrangements:
Interest rate lock commitments		11,482		—			11,482			2,510		—			2,510

	$	28,449	$	(13,855	)	$	14,594		$	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.


	June 30, 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 consolidated balance sheet		Financial instruments		Cash collateral received		Net amount		Net amount of assets presented in the consolidated balance sheet		Financial instruments		Cash collateral received		Net amount
	(in thousands)
Interest rate lock commitments	$	11,482	$	—	$	—	$	11,482	$	2,510	$	—	$	—	$	2,510
RBS Securities		433		—		—		433		133		—		—		133
RJ O’Brien		940		—		—		940		566		—		—		566
Nomura		284		—		—		284		273						273
JP Morgan		252		—		—		252		—						—
Cantor Fitzgerald LP		210		—		—		210		613		—		—		613
Credit Suisse First Boston Mortgage Capital LLC		138		—		—		138		196		—		—		196
Bank of America, N.A.		—		—		—		—		1,024		—		—		1,024
Other		855		—		—		855		2,661		—		—		2,661

Total	$	14,594	$	—	$	—	$	14,594	$	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.


	June 30, 2014								December 31, 2013
	Gross amounts of recognized liabilities		Gross amounts offset in the consolidated balance sheet			Net amounts of liabilities presented in the consolidated balance sheet			Gross amounts of recognized liabilities		Gross amounts offset in the consolidated balance sheet			Net amounts of liabilities presented in the consolidated balance sheet
	(in thousands)
Derivatives subject to master netting arrangements:
Forward purchase contracts	$	266	$	—		$	266		$	7,420	$	—		$	7,420
Forward sales contracts		23,236		—			23,236			1,295		—			1,295
Netting		—		(17,550	)		(17,550	)		—		(8,015	)		(8,015	)

		23,502		(17,550	)		5,952			8,715		(8,015	)		700
Derivatives not subject to master netting arrangements:
Interest rate lock commitments		395		—			395			1,261		—			1,261

		23,897		(17,550	)		6,347			9,976		(8,015	)		1,961

Assets sold under agreements to repurchase		2,701,755		—			2,701,755			2,039,605		—			2,039,605

	$	2,725,652	$	(17,550	)	$	2,708,102		$	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.


	June 30, 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)
Interest rate lock commitments	$	395	$	—		$	—	$	395	$	1,261	$	—		$	—	$	1,261
Citibank		843,000		(842,377	)		—		623		945,015		(944,856	)		—		159
Credit Suisse First Boston Mortgage Capital LLC		734,416		(734,416	)		—		—		523,546		(523,546	)		—		—
Bank of America, N.A.		610,966		(610,218	)		—		748		408,452		(408,452	)		—		—
RBS Securities		229,153		(229,153	)		—		—		—		—			—		—
Morgan Stanley Bank, N.A.		155,189		(154,457	)		—		732		30,226		(30,226	)		—		—
Daiwa Capital Markets		131,334		(131,134	)		—		200		132,525		(132,525	)		—		—
Fannie Mae Capital Markets		1,021		—			—		1,021		—		—			—		—
Other		2,628		—			—		2,628		541		—			—		541

Total	$	2,708,102	$	(2,701,755	)	$	—	$	6,347	$	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 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 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 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 VIE to be accounted for at fair value to reflect the generally offsetting changes in fair value of these borrowings to changes in fair value of the mortgage loans at fair value collateralizing this financing.

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’ fair values. Management has identified these assets to be accounted for using the amortization method.

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’ fair values.

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 fair value on a recurring basis:


	June 30, 2014
	Level 1		Level 2			Level 3		Total
	(in thousands)
Assets:
Short-term investments	$	104,453	$	—		$	—	$	104,453
Mortgage-backed securities at fair value		—		218,725			—		218,725
Mortgage loans acquired for sale at fair value		—		909,085			—		909,085
Mortgage loans at fair value		—		541,320			2,156,501		2,697,821
Excess servicing spread purchased from PFSI		—		—			190,244		190,244
Derivative assets:
Interest rate lock commitments		—		—			11,482		11,482
MBS put options		—		471			—		471
MBS call options		—		519			—		519
Forward purchase contracts		—		14,723			—		14,723
Forward sales contracts		—		314			—		314
Treasury futures		—		545			—		545
Put options on Eurodollar futures		—		181			—		181
Call options on Eurodollar futures		—		214			—		214

Total derivative assets before netting		—		16,967			11,482		28,449
Netting (1)		—		(13,855	)		—		(13,855	)

Total derivative assets after netting		—		3,112			11,482		14,594

Mortgage servicing rights at fair value		—		—			46,802		46,802

	$	104,453	$	1,645,242		$	2,405,029	$	4,154,724

Liabilities:
Asset-backed secured financing of the variable interest entity at fair value	$	—	$	170,201		$	—	$	170,201
Derivative liabilities:
Interest rate lock commitments		—		—			395		395
Forward purchase contracts		—		266			—		266
Forward sales contracts		—		23,236			—		23,236

Total derivative liabilities before netting		—		23,502			395		23,897
Netting (1)		—		(17,550	)		—		(17,550	)

Total derivative liabilities after netting		—		5,952			395		6,347

Total liabilities	$	—	$	176,153		$	395	$	176,548

(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		—		523,652			2,076,665		2,600,317
Mortgage loans under forward purchase agreements at fair value		—		—			218,128		218,128
Excess servicing spread purchased from PFSI		—		—			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		—		18,452			2,510		20,962
Netting (1)		—		(12,986	)		—		(12,986	)

Total derivative assets after netting		—		5,466			2,510		7,976

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

	$	92,398	$	1,184,656		$	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	)		—		(8,015	)

Total derivative liabilities		—		700			1,261		1,961

Total liabilities	$	—	$	166,115		$	1,261	$	167,376

(1)

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


	Quarter ended June 30, 2014
	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, March 31, 2014	$	2,079,020		$	202,661		$	151,019		$	3,271		$	36,181		$	2,472,152
Purchases		26,737			466			52,867			—			—			80,070
Repayments and sale		(140,807	)		(1,084	)		(9,080	)		—			—			(150,971	)
Accrual of interest		—			—			3,138			—			—			3,138
ESS received pursuant to a recapture agreement with PFSI		—			—			2,362			—			—			2,362
Interest rate lock commitments issued, net		—			—			—			19,158			—			19,158
Capitalization of interest		17,042			1,057			—			—			—			18,099
Servicing received as proceeds from sales of mortgage loans		—			—			—			—			15,385			15,385
Changes in fair value included in income arising from:
Changes in instrument-specific credit risk		19,326			1,236												20,562
Other factors		52,525			507			(10,062	)		9,563			(4,764	)		47,769

		71,851			1,743			(10,062	)		9,563			(4,764	)		68,331

Transfers of mortgage loans under forward purchase agreements to mortgage loans		201,443			(201,443	)		—			—			—			—
Transfers of mortgage loans to REO		(98,785	)		—			—			—			—			(98,785	)
Transfers of mortgage loans under forward purchase agreements to REO under forward purchase agreements		—			(3,400	)		—			—			—			(3,400	)
Transfers of interest rate lock commitments to mortgage loans acquired for sale at fair value		—			—			—			(20,905	)		—			(20,905	)

Balance, June 30, 2014	$	2,156,501		$	—		$	190,244		$	11,087		$	46,802		$	2,404,634

Changes in fair value recognized during the period relating to assets still held at June 30, 2014	$	50,613		$	—		$	(10,062	)	$	11,088		$	(4,764	)	$	46,875

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


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

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

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

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

Changes in fair value recognized during the period relating to assets still held at June 30, 2013	$	33,292		$	(689	)	$	(16,967	)	$	260	$	15,896

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


	Six months ended June 30, 2014
	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		283,017			1,386			73,393			—			—			357,796
Repayments and sale		(387,430	)		(6,413	)		(16,494	)		—			—			(410,337	)
Accrual of interest		—			—			6,001			—			—			6,001
ESS received pursuant to a recapture agreement with PFSI		—			—			3,475			—			—			3,475
Interest rate lock commitments issued, net		—			—			—			31,754			—			31,754
Capitalization of interest		28,553			1,801			—			—			—			30,354
Servicing received as proceeds from sales of mortgage loans		—			—			—			—			27,142			27,142
Changes in fair value included in income arising from:
Changes in instrument-specific credit risk		42,629			2,269			—			—						44,898
Other factors		70,080			(1,466	)		(14,854	)		11,993			(6,792	)		58,961

		112,709			803			(14,854	)		11,993			(6,792	)		103,859

Transfers of mortgage loans under forward purchase agreements to mortgage loans		205,902			(205,902	)		—			—			—			—
Transfers of mortgage loans to REO		(162,915	)		—			—			—			—			(162,915	)
Transfers of mortgage loans under forward purchase agreements to REO under forward purchase agreements		—			(9,803	)		—			—			—			(9,803	)
Transfers of interest rate lock commitments to mortgage loans acquired for sale		—			—			—			(33,909	)		—			(33,909	)

Balance, June 30, 2014	$	2,156,501		$	—		$	190,244		$	11,087		$	46,802		$	2,404,634

Changes in fair value recognized during the period relating to assets still held at June 30, 2014	$	73,951		$	—		$	(14,854	)	$	11,087		$	(6,792	)	$	63,392

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


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

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

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

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

Changes in fair value recognized during the period relating to assets still held at June 30, 2013	$	77,771		$	(689	)	$	(16,967	)	$	192	$	60,307

(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 VIE):


	June 30, 2014
	Fair value		Principal amount due upon maturity		Difference
	(in thousands)
Mortgage loans acquired for sale:
Current through 89 days delinquent	$	909,085	$	866,821	$	42,264
90 or more days delinquent (1)
Not in foreclosure		—		—		—
In foreclosure		—		—		—

		—		—		—

		909,085		866,821		42,264

Mortgage loans and mortgage loans under forward purchase agreements at fair value:
Current through 89 days delinquent		1,151,747		1,442,755		(291,008	)
90 or more days delinquent (1)
Not in foreclosure		629,021		1,002,407		(373,386	)
In foreclosure		917,053		1,437,698		(520,645	)

		1,546,074		2,440,105		(894,031	)

		2,697,821		3,882,860		(1,185,039	)

	$	3,606,906	$	4,749,681	$	(1,142,775	)

(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		—		—		—

		169		162		7

		458,137		447,386		10,751

Mortgage loans and mortgage loans under forward purchase agreements at fair value:
Current through 89 days delinquent		1,170,918		1,495,961		(325,043	)
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	)

		1,647,527		2,684,047		(1,036,520	)

		2,818,445		4,180,008		(1,361,563	)

	$	3,276,582	$	4,627,394	$	(1,350,812	)

(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 June 30, 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		—			155			4,081			—			4,236
Mortgage loans acquired for sale at fair value		31,202						—			—			31,202
Mortgage loans at fair value		—			223			88,029			—			88,252
Mortgage loans under forward purchase agreements at fair value		—			—			1,743			—			1,743
Excess servicing spread at fair value		—			—			(7,537	)		—			(7,537	)
Mortgage servicing rights at fair value		—			—			—			(4,764	)		(4,764	)

	$	31,202		$	378		$	86,316		$	(4,764	)	$	113,132

Liabilities:
Asset-backed secured financing at fair value	$	(5,175	)	$	(80	)	$	—		$	—		$	(5,255	)

	$	(5,175	)	$	(80	)	$	—		$	—		$	(5,255	)


	Quarter ended June 30, 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		(56,951	)		—			—			—			(56,951	)
Mortgage loans at fair value		—			—			47,523			—			47,523
Mortgage loans under forward purchase agreements at fair value		—			—			(689	)		—			(689	)
Mortgage servicing rights at fair value		—			—			—			260			260

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


	Six months ended June 30, 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		—			188			6,734			—			6,922
Mortgage loans acquired for sale at fair value		49,834			—			—			—			49,834
Mortgage loans at fair value		—			553			140,194			—			140,747
Mortgage loans under forward purchase agreements at fair value		—			—			803			—			803
Excess servicing spread at fair value		—			—			(10,438	)		—			(10,438	)
Mortgage servicing rights at fair value		—			—			—			(6,792	)		(6,792	)

	$	49,834		$	741		$	137,293		$	(6,792	)	$	181,076

Liabilities:
Asset-backed secured financing at fair value	$	(7,954	)	$	(204	)	$	—		$	—		$	(8,158	)

	$	(7,954	)	$	(204	)	$	—		$	—		$	(8,158	)


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

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

Financial Statement Items Measured at Fair Value on a Nonrecurring Basis

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


	June 30, 2014
	Level 1		Level 2		Level 3		Total
	(in thousands)
Real estate asset acquired in settlement of loans	$	—	$	—	$	102,660	$	102,660
Mortgage servicing rights at lower of amortized cost or fair value		—		—		56,171		56,171

	$	—	$	—	$	158,831	$	158,831


	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 June 30,						Six months ended June 30,
	2014			2013			2014			2013
	(in thousands)
Real estate asset acquired in settlement of loans	$	(7,942	)	$	(4,095	)	$	(12,525	)	$	(6,594	)
Mortgage servicing rights at lower of amortized cost or fair value		(2,224	)		1,222			(2,851	)		3,708

	$	(10,166	)	$	(2,873	)	$	(15,376	)	$	(2,886	)

Real Estate Acquired in Settlement of Loans

The Company measures its investment in REO at the respective properties’ 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 mortgage loan immediately before 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 amount 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 reduced by the existing valuation allowance for that pool, those MSRs are impaired.

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

Management periodically reviews the various impairment strata to determine whether the fair value of the impaired MSRs in a given stratum is likely to recover. When 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 fair values of Cash, Assets sold 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 June 30, 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 June 30, 2014 and December 31, 2013 was $247.1 million and $238.4 million, respectively. 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 June 30, 2014 due to the lack of current market activity and the use of broker’s indication of value to estimate the instrument’s fair values.

Valuation Techniques and Inputs

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 PFSI’s 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 the portion of mortgage loans at fair value held in a VIE, 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 the mortgage loans at fair value held in a VIE, 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 held outside the VIE 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	June 30, 2014	December 31, 2013
Mortgage loans at fair value
Discount rate	7.1% – 16.9%	8.7% –16.9%
	(11.8%)	(12.7%)
Twelve-month projected housing price index change	3.5% – 9.1%	2.5% – 4.3%
	(4.7%)	(3.7%)
Prepayment speed (1)	0.0% – 6.6%	0.0% – 3.9%
	(2.5%)	(2.0%)
Total prepayment speed (2)	0.8% – 27.4%	0.3% – 33.9%
	(21.8%)	(24.3%)

Mortgage loans under forward purchase agreements
Discount rate	—	9.5% – 13.5%
	—	(11.9%)
Twelve-month projected housing price index change	—	3.3% – 4.2%
	—	(3.8%)
Prepayment speed (1)	—	1.1% – 2.9%
	—	(2.2%)
Total prepayment speed (2)	—	13.4% – 27.9%
	—	(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 fair 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 fair value. Reductions in the fair 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	June 30, 2014		December 31, 2013
Unpaid principal balance of underlying mortgage loans (in thousands)	$	27,445,826	$	20,512,659
Average servicing fee rate (in basis points)		31		32
Average ESS rate (in basis points)		16		16
Pricing spread (1)		1.7% – 14.6%		2.8% - 14.4%
		(5.1%)		(5.4%)
Life (in years)		0.5 - 7.3		0.9 - 8.0
		(5.9)		(6.1)
Annual total prepayment speed (2)		7.6% – 67.0%		7.7% - 48.6%
		(10.3%)		(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 fair 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	June 30, 2014		December 31, 2013
Pull-through rate		49.0% - 98.0%		64.8% - 98.0%
		(81.6%)		(86.4%)
MSR value expressed as:
Servicing fee multiple		1.7 - 5.0		1.4 - 5.1
		(3.9)		(4.1)
Percentage of unpaid principal balance		0.4% - 1.3%		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 fair 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 fair value. Reductions in the value of MSRs affect income primarily through change in fair value and impairment charges. For MSRs backed by mortgage loans with historically low interest rates, factors other than interest rates (such as housing price changes) take on increasing influence on prepayment behavior of the underlying mortgage loans.

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


	Quarter ended June 30,
	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	$	13,356	$	15,385	$	50,978	$	77
Unpaid principal balance of underlying mortgage loans	$	1,244,538	$	1,458,400	$	3,840,110	$	27,346
Weighted-average annual servicing fee rate (in basis points)		25		25		28		27
Pricing spread (1)		6.3% – 14.3%		8.5% – 10.3%		5.4% – 13.5%		6.6% – 11.9%
		(8.7%)		(9.1%)		(6.5%)		(7.5%)
Life (in years)		1.3 – 7.3		3.2 – 7.3		2.6 – 6.9		6.3 – 6.9
		(6.1)		(7.1)		(6.4)		(6.8)
Annual total prepayment speed (2)		7.6% – 50.9%		8.1% – 25.4%		8.5% –23.6%		8.8% – 13.6%
		(10.4%)		(9.6%)		(9.1%)		(9.3%)
Annual per-loan cost of servicing		$68 – $100		$68 – $68		$68 – $140		$68 – $68
		($68)		($68)		($68)		($68)


	Six months ended June 30,
	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	$	22,474	$	27,142	$	107,167	$	104
Unpaid principal balance of underlying mortgage loans	$	2,095,087	$	2,550,114	$	8,843,667	$	29,946
Weighted-average annual servicing fee rate (in basis points)		25		25		26		27
Pricing spread (1)		6.3% – 14.3%		8.5% – 12.3%		5.4% – 14.4%		6.6% – 14.4%
		(8.6%)		(9.0%)		(6.8%)		(7.6%)
Life (in years)		1.1 – 7.3		2.8 –7.3		2.6 – 6.9		2.8 – 6.9
		(6.0)		(7.1)		(6.4)		(6.7)
Annual total prepayment speed (2)		7.6% – 56.4%		8.0% – 25.4%		8.5% – 23.6%		8.8% – 27.0%
		(10.4%)		(9.5%)		(9.1%)		(9.7%)
Annual per-loan cost of servicing		$68 – $100		$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 fair value from adverse changes in those assumptions (weighted averages are based upon unpaid principal balance or fair value where applicable):


	June 30, 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	$	268,682		$	46,802		$	264,120		$	26,452

Key inputs:
Unpaid principal balance of underlying mortgage loans	$	24,639,750		$	4,758,331		$	23,399,612		$	2,393,321
Weighted-average annual servicing fee rate (in basis points)		26			25			26			26
Weighted-average note interest rate		3.72%			4.79%			3.68%			4.78%
Pricing spread (1) (2)		6.3% –17.5%			7.6% –15.3%			6.3% –17.5%			7.3% –15.3%
		(7.4%)			(9.2%)			(6.7%)			(8.6%)
Effect on fair value of a:
5% adverse change	$	(5,302	)	$	(827	)	$	(5,490	)	$	(488	)
10% adverse change	$	(10,427	)	$	(1,627	)	$	(10,791	)	$	(959	)
20% adverse change	$	(20,177	)	$	(3,149	)	$	(20,861	)	$	(1,855	)
Weighted average life (in years)		1.1 – 7.2			2.4 – 7.2			1.3 – 7.3			2.8 – 7.3
		(6.4)			(7.0)			(6.7)			(7.2)
Prepayment speed (1) (3)		7.7% – 58.9%			8.0% – 30.6%			7.7% – 51.9%			8.0% – 20.0%
		(8.6%)			(10.2%)			(8.2%)			(8.9%)
Effect on fair value of a:
5% adverse change	$	(5,495	)	$	(1,160	)	$	(5,467	)	$	(568	)
10% adverse change	$	(10,821	)	$	(2,277	)	$	(10,765	)	$	(1,117	)
20% adverse change	$	(20,993	)	$	(4,390	)	$	(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	$	(1,761	)	$	(290	)	$	(1,695	)	$	(158	)
10% adverse change	$	(3,522	)	$	(580	)	$	(3,390	)	$	(316	)
20% adverse change	$	(7,043	)	$	(1,159	)	$	(6,780	)	$	(633	)

(1)	The effect on value of an adverse change in one of the above-mentioned key inputs may result in recognition of MSR impairment. The extent of impairment recognized will depend on the relationship of fair value to the carrying value of MSRs.

(2)

Pricing spread represents a margin that is added 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.

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

The preceding sensitivity analyses are limited in that they were performed at a particular point in time; only 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:


	June 30, 2014				December 31, 2013
	Fair value		Unpaid principal balance		Fair value		Unpaid principal balance
Loan type	(in thousands)
Conventional:
Agency-eligible	$	507,887	$	485,096	$	311,162	$	304,749
Jumbo		96,491		93,110		34,615		35,050
Government-insured or guaranteed		304,707		288,616		112,360		107,587

	$	909,085	$	866,822	$	458,137	$	447,386

Loans pledged to secure assets sold under agreements to repurchase	$	905,044			$	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 MBS, 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 in a VIE 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:


	June 30, 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		1,291,181	$	11,482		$	395			557,343	$	2,510		$	1,261
Forward sales contracts		4,185,633		314			23,236			3,588,027		16,385			1,295
Forward purchase contracts		3,058,604		14,723			266			2,781,066		1,229			7,420
MBS put options		392,500		471			—			55,000		272			—
MBS call options		95,000		519			—			110,000		—			—
Eurodollar futures		5,562,000		—			—			8,779,000		—			—
Treasury futures		85,000		545			—			105,000		—			—
Call options on Eurodollar futures		230,000		214						—		—			—
Put options on Eurodollar futures		125,000		181			—			52,500		566			—

Total derivative instruments before netting				28,449			23,897					20,962			9,976
Netting				(13,855	)		(17,550	)				(12,986	)		(8,015	)

			$	14,594		$	6,347				$	7,976		$	1,961

Margin deposits with (collateral received from) derivatives counterparties			$	3,695							$	(4,971	)

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


	Quarter ended June 30, 2014
Period/Instrument	Balance, beginning of period		Additions		Dispositions/ expirations			Balance, end of period
	(in thousands)
Forward purchase contracts		1,777,353		11,967,081		(10,685,830	)		3,058,604
Forward sales contracts		2,497,960		15,282,582		(13,594,909	)		4,185,633
MBS put option		235,000		290,000		(255,000	)		270,000
MBS call option		—		25,000		—			25,000


	Quarter ended June 30, 2013
Period/Instrument	Balance, beginning of period		Additions		Dispositions/ expirations			Balance, end of period
	(in thousands)
Forward purchase contracts		1,890,960		15,323,298		(11,802,474	)		5,411,784
Forward sales contracts		3,224,190		20,418,956		(15,915,080	)		7,728,066
MBS put options		225,000		1,545,000		(1,310,000	)		460,000
MBS call options		350,000		1,000,000		(625,000	)		725,000


	Six months ended June 30, 2014
Period/Instrument	Balance, beginning of period		Additions		Dispositions/ expirations			Balance, end of period
	(in thousands)
Forward purchase contracts		2,781,066		18,364,898		(18,087,360	)		3,058,604
Forward sales contracts		3,463,027		24,051,521		(23,328,915	)		4,185,633
MBS put option		55,000		695,000		(480,000	)		270,000
MBS call option		110,000		25,000		(110,000	)		25,000


	Six months ended June 30, 2013
Period/Instrument	Balance, beginning of period		Additions		Dispositions/ expirations			Balance, end of period
	(in thousands)
Forward purchase contracts		2,206,539		27,765,642		(24,560,397	)		5,411,784
Forward sales contracts		4,266,983		38,269,229		(34,808,146	)		7,728,066
MBS put options		495,000		3,025,000		(3,060,000	)		460,000
MBS call options		—		1,900,000		(1,175,000	)		725,000

The Company recorded net (losses) gains on derivative financial instruments used to hedge the Company’s IRLCs and inventory of mortgage loans totaling $(28.8) million and $129.1 million for the quarters ended June 30, 2014 and 2013, respectively, and $(39.5) million and $140.1 million for the six months ended June 30, 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 following table summarizes the notional amount activity for derivative contracts used to hedge the Company’s MSRs:


	Quarter ended June 30, 2014
Period/Instrument	Balance, beginning of period		Additions		Dispositions/ expirations			Balance, end of period
	(in thousands)
Quarter ended June 30, 2014
Forward purchase contracts		—		70,000		(70,000	)		—
Forward sales contracts		—		35,000		(35,000	)		—
MBS put option		—		25,000		—			25,000
MBS call option		35,000		70,000		(35,000	)		70,000
Treasury Future sale contracts		—		4,000		(4,000	)		—
Treasury Future purchase contracts		—		4,000		(4,000	)		—
Put option on Eurodollar futures		325,000		40,000		(325,000	)		40,000
Call option on Eurodollar futures		90,000		130,000		(90,000	)		130,000


	Six months ended June 30, 2014
Period/Instrument	Balance, beginning of period		Additions		Dispositions/ expirations			Balance, end of period
	(in thousands)
Six months ended June 30, 2014
Forward purchase contracts		—		70,000		(70,000	)		—
Forward sales contracts		—		60,000		(60,000	)		—
MBS put option		—		25,000		—			25,000
MBS call option		—		130,000		(60,000	)		70,000
Treasury Future sale contracts		—		32,800		(32,800	)		—
Treasury Future purchase contracts		—		25,600		(25,600	)		—
Put option on Eurodollar futures		—		365,000		(325,000	)		40,000
Call option on Eurodollar futures		—		280,000		(150,000	)		130,000

The Company recorded net gains (losses) on derivative financial instruments used as economic hedges of MSRs totaling $4.3 million and none for the quarters ended June 30, 2014 and 2013, respectively, and $4.2 million and $(2.0) million for the six months ended June 30, 2014 and 2013, respectively. The derivative net gains (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 in a VIE and MBS securities at fair value and the related variable LIBOR rate repurchase agreement liabilities:


	Quarter ended June 30, 2014
Period/Instrument	Balance, beginning of period		Additions		Dispositions/ expirations			Balance, end of period
	(in thousands)
Quarter ended June 30, 2014
Eurodollar Future sale contracts		6,084,000		336,000		(858,000	)		5,562,000
Eurodollar Future purchase contracts		—		400,000		(400,000	)		—
Treasury Future sale contracts		75,000		113,000		(103,000	)		85,000
Treasury Future purchase contracts		—		93,000		(93,000	)		—
Put options on Eurodollar futures		55,000		85,000		(55,000	)		85,000
Call option on Eurodollar futures		—		100,000		—			100,000
MBS put option purchase contracts		25,000		97,500		(25,000	)		97,500


	Six months ended June 30, 2014
Period/Instrument	Balance, beginning of period		Additions		Dispositions/ expirations			Balance, end of period
	(in thousands)
Six months ended June 30, 2014
Eurodollar Future sale contracts		8,779,000		462,000		(3,679,000	)		5,562,000
Eurodollar Future purchase contracts		—		2,997,000		(2,997,000	)		—
Treasury Future sale contracts		105,000		188,000		(208,000	)		85,000
Treasury Future purchase contracts		—		168,000		(168,000	)		—
Put options on Eurodollar futures		52,500		197,000		(164,500	)		85,000
Call option on Eurodollar futures		—		100,000		—			100,000
MBS put option purchase contracts		15,000		122,500		(40,000	)		97,500

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 $8.2 million for the quarter ended June 30, 2014 and $13.8 million for the six months ended June 30, 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 and six months ended June 30, 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, to the extent they are not held in a VIE securing an asset-backed financing, may be sold at a later date pursuant to a management determination that such a sale represents the most advantageous liquidation strategy for the identified loan.

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


	June 30, 2014				December 31, 2013
Loan type	Fair value		Unpaid principal balance		Fair value		Unpaid principal balance
	(in thousands)
Distressed lending
Nonperforming loans	$	1,546,074	$	2,440,105	$	1,469,686	$	2,415,446
Performing loans:
Fixed interest rate		320,212		475,586		310,607		475,568
Adjustable-rate mortgage (“ARM”)/hybrid		113,271		152,158		165,327		207,553
Interest rate step-up		176,794		281,758		130,906		215,702
Balloon		150		210		139		213

		610,427		909,712		606,979		899,036

Mortgage loans held in a VIE securing asset-backed financing
Fixed interest rate jumbo		541,320		533,043		523,652		543,257

	$	2,697,821	$	3,882,860	$	2,600,317	$	3,857,739

Mortgage loans at fair value pledged to secure borrowings at period end:
Assets sold under agreements to repurchase	$	2,407,512			$	1,963,266

Mortgage loans held in a consolidated subsidiary whose stock is pledged to secure financings of such loans	$	309			$	989

Mortgage loans held in a VIE securing an asset-backed financing	$	541,320			$	523,652

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


Concentration	June 30, 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%		59	%		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			New York Florida New Jersey

Note 11—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:


	June 30, 2014				December 31, 2013
			Unpaid				Unpaid
	Fair		principal		Fair		principal
Loan type	value		balance		value		balance
	(in thousands)
Nonperforming loans	$	—	$	—	$	177,841	$	268,600
Performing loans:
Fixed		—		—		19,292		29,496
ARM/hybrid		—		—		19,510		31,933
Interest rate step-up		—		—		1,485		2,455

		—		—		40,287		63,884

	$	—	$	—	$	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:


	June 30,		December 31,
	2014		2013
Portion of mortgage loans originated between 2005 and 2007		—		72	%
Percentage of mortgage loans secured by California real estate		—		25	%
Additional states contributing 5% or more of mortgage loans				New Jersey
				Washington
				New York
				Maryland

Note 12—Real Estate Acquired in Settlement of Loans

Following is a summary of financial information relating to REO:


	Quarter ended June 30,						Six months ended June 30,
	2014			2013			2014			2013
	(in thousands)
Balance at beginning of period	$	172,987		$	84,487		$	138,942		$	88,078
Purchases		—			—			3,049			—
Transfers from mortgage loans at fair value and advances		105,245			37,117			174,147			68,803
Transfers from REO under forward purchase agreements		12,645			—			12,737			—
Results of REO:
Valuation adjustments, net		(8,865	)		(4,978	)		(17,273	)		(11,067	)
Gain on sale, net		3,590			3,049			5,772			5,885

		(5,275	)		(1,929	)		(11,501	)		(5,182	)
Proceeds from sales		(45,131	)		(30,993	)		(76,903	)		(63,017	)

Balance at end of period	$	240,471		$	88,682		$	240,471		$	88,682

At period end:
REO pledged to secure assets sold under agreements to repurchase	$	76,258		$	9,253

REO held in a consolidated subsidiary whose stock is pledged to secure financings of such properties	$	31,426		$	43,131

Note 13—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 June 30,					Six months ended June 30,
	2014			2013		2014			2013
	(in thousands)
Balance at beginning of period	$	13,890		$	—	$	9,138		$	—
Purchases		29			—		68			—
Transfers from mortgage loans under forward purchase agreements at fair value and advances		2,542			89		9,369			89
Transfers to REO		(12,646	)		—		(12,737	)		—
Results of REO under forward purchase agreements:
Valuation adjustments, net		(294	)		—		(779	)		—
Gain on sale, net		222			—		306			—

		(72	)		—		(473	)		—
Proceeds from sales		(3,743	)		—		(5,365	)		—

Balance at end of period	$	—		$	89	$	—		$	89

At June 30, 2014, the entire balance of REO under forward purchase agreements was subject to borrowings under forward purchase agreements.

Note 14—Mortgage Servicing Rights

Carried at Fair Value:

Following is a summary of MSRs carried at fair value:


	Quarter ended June 30,						Six months ended June 30,
	2014			2013			2014			2013
	(in thousands)
Balance at beginning of period	$	36,181		$	1,305		$	26,452		$	1,346
Additions:
Purchases		—			186			—			186
MSRs resulting from loan sales		15,385			77			27,142			104

Total additions		15,385			263			27,142			290

Change in fair value:
Due to changes in valuation inputs or assumptions used in valuation model(1)		(3,636	)		312			(4,868	)		302
Other changes in fair value(2)		(1,128	)		(52	)		(1,924	)		(110	)

		(4,764	)		260			(6,792	)		192

Sales		—			—			—			—

Balance at end of period	$	46,802		$	1,828		$	46,802		$	1,828

(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 June 30,				Six months ended June 30,
	2014		2013		2014		2013
	(in thousands)
Amortized Cost:
Balance at beginning of period	$	268,450	$	184,197	$	266,697	$	132,977
Additions:
MSRs resulting from loan sales		13,356		50,978		22,474		107,167
Purchases		—		—		—		—