Edgar Filing: PENNYMAC FINANCIAL SERVICES, INC.

pfsi_Current_Folio_10Q

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

Form 10-Q

(Mark One)

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

For the quarterly period ended June 30, 2018

☐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: 001-35916

PennyMac Financial Services, Inc.

(Exact name of registrant as specified in its charter)


Delaware		80-0882793
(State or other jurisdiction of		(IRS Employer
incorporation or organization)		Identification No.)


3043 Townsgate Road, Westlake Village, California		91361
(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 ☒ 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 ☒ No ☐

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


Large accelerated filer ☐		Accelerated filer ☒

Non-accelerated filer ☐ (Do not check if a smaller reporting company)		Smaller reporting company ☐
Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ◻

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

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 July 31, 2018
Class A Common Stock, $0.0001 par value		25,101,553
Class B Common Stock, $0.0001 par value		45

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PENNYMAC FINANCIAL SERVICES, INC.

FORM 10-Q

June 30, 2018

TABLE OF CONTENTS


		Page
	Special Note Regarding Forward-Looking Statements	3

PART I. FINANCIAL INFORMATION		5

Item 1.	Financial Statements (Unaudited):	5
	Consolidated Balance Sheets	5
	Consolidated Statements of Income	6
	Consolidated Statements of Changes in Stockholders’ Equity	7
	Consolidated Statements of Cash Flows	8
	Notes to Consolidated Financial Statements	9
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	67
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	83
Item 4.	Controls and Procedures	84

PART II. OTHER INFORMATION		85

Item 1.	Legal Proceedings	85
Item 1A.	Risk Factors	85
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	85
Item 3.	Defaults Upon Senior Securities	85
Item 4.	Mine Safety Disclosures	85
Item 5.	Other Information	86
Item 6.	Exhibits	86

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SPECIAL NOTE REGARDING FORWARD‑LOOKING STATEMENTS

This Quarterly Report on Form 10-Q (“Report”) contains certain forward‑looking statements that are subject to various risks and uncertainties. Forward‑looking statements are generally identifiable by use of forward‑looking terminology such as “may,” “will,” “should,” “potential,” “intend,” “expect,” “seek,” “anticipate,” “estimate,” “approximately,” “believe,” “could,” “project,” “predict,” “continue,” “plan” or other similar words or expressions.

Forward‑looking statements are based on certain assumptions, discuss future expectations, describe future plans and strategies, contain financial and operating projections or state other forward‑looking information. Examples of forward‑looking statements include the following:

projections of our revenues, income, earnings per share, capital structure or other financial items;

descriptions of our plans or objectives for future operations, products or services;

forecasts of our future economic performance, interest rates, profit margins and our share of future markets; and

descriptions of assumptions underlying or relating to any of the foregoing expectations regarding the timing of generating any revenues.

Our ability to predict results or the actual effect of future events, actions, plans or strategies is inherently uncertain. Although we believe that the expectations reflected in such forward‑looking statements are based on reasonable assumptions, our actual results and performance could differ materially from those set forth in the forward‑looking statements. There are a number of factors, many of which are beyond our control that could cause actual results to differ significantly from management’s expectations. Some of these factors are discussed below.

You should not place undue reliance on any forward‑looking statement and should consider the following uncertainties and risks, as well as the risks and uncertainties discussed elsewhere in this Report and the section entitled “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2017, filed with the Securities and Exchange Commission (“SEC”) on March 9, 2018.

Factors that could cause actual results to differ materially from historical results or those anticipated include, but are not limited to:

the continually changing federal, state and local laws and regulations applicable to the highly regulated industry in which we operate;

lawsuits or governmental actions if we do not comply with the laws and regulations applicable to our businesses;

the mortgage lending and servicing-related regulations promulgated by the Consumer Financial Protection Bureau (“CFPB”) and its enforcement of these regulations;

our dependence on U.S. government‑sponsored entities and changes in their current roles or their guarantees or guidelines;

changes to government mortgage modification programs;

certain banking regulations that may limit our business activities;

foreclosure delays and changes in foreclosure practices;

the licensing and operational requirements of states and other jurisdictions applicable to our businesses, to which our bank competitors are not subject;

changes in macroeconomic and U.S. real estate market conditions;

difficulties inherent in growing loan production volume;

difficulties inherent in adjusting the size of our operations to reflect changes in business levels;

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any required additional capital and liquidity to support business growth that may not be available on acceptable terms, if at all;

changes in prevailing interest rates;

increases in loan delinquencies and defaults;

our dependence on the success of the multifamily market for future originations of commercial mortgage loans and other commercial real estate-related loans;

our reliance on PennyMac Mortgage Investment Trust (“PMT”) as a significant source of financing for, and revenue related to, our mortgage banking business;

our obligation to indemnify third‑party purchasers or repurchase loans if loans that we originate, acquire, service or assist in the fulfillment of, fail to meet certain criteria or characteristics or under other circumstances;

our ability to realize the anticipated benefit of potential future acquisitions of mortgage servicing rights (“MSRs”);

our obligation to indemnify PMT and the Investment Funds if our services fail to meet certain criteria or characteristics or under other circumstances;

decreases in the returns on the assets that we select and manage for our clients, and our resulting management and incentive fees;

the extensive amount of regulation applicable to our investment management segment;

conflicts of interest in allocating our services and investment opportunities among ourselves and our Advised Entities;

the effect of public opinion on our reputation;

our recent growth;

our ability to effectively identify, manage, monitor and mitigate financial risks;

our initiation of new business activities or expansion of existing business activities;

our ability to detect misconduct and fraud;

our ability to mitigate cybersecurity risks and cyber incidents;

our exposure to risks of loss resulting from adverse weather conditions and man-made or natural disasters; and

our organizational structure and certain requirements in our charter documents.

Other factors that could also cause results to differ from our expectations may not be described in this Report or any other document. Each of these factors could by itself, or together with one or more other factors, adversely affect our business, results of operations and/or financial condition.

Forward-looking statements speak only as of the date they are made, and we undertake no obligation to update any forward-looking statement to reflect the impact of circumstances or events that arise after the date the forward-looking statement was made.

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

PENNYMAC FINANCIAL SERVICES, INC.

CONSOLIDATED BALANCE SHEETS (UNAUDITED)


	June 30,		December 31,
	2018		2017
	(in thousands, except share amounts)
ASSETS
Cash (includes $152,382 and $20,765 pledged to creditors)	$	189,663	$	37,725
Short-term investments at fair value		98,571		170,080
Mortgage loans held for sale at fair value (includes $2,498,583 and $3,081,987 pledged to creditors)		2,527,231		3,099,103
Derivative assets		92,471		78,179
Servicing advances, net (includes valuation allowance of $61,825 and $59,958; $94,715 and $114,643 pledged to creditors)		258,900		318,066
Carried Interest due from Investment Funds pledged to creditors		370		8,552
Investment in PennyMac Mortgage Investment Trust at fair value		1,424		1,205
Mortgage servicing rights (includes $2,486,157 and $638,010 at fair value; $2,333,750 and $2,098,067 pledged to creditors)		2,486,157		2,119,588
Real estate acquired in settlement of loans		2,300		2,447
Furniture, fixtures, equipment and building improvements, net (includes $20,656 and $23,915 pledged to creditors)		29,607		29,453
Capitalized software, net (includes $1,347 and $1,568 pledged to creditors)		31,913		25,729
Assets purchased from PennyMac Mortgage Investment Trust under agreements to resell pledged to creditors		138,582		144,128
Receivable from PennyMac Mortgage Investment Trust		19,661		27,119
Receivable from Investment Funds		12		417
Mortgage loans eligible for repurchase		879,621		1,208,195
Other		85,223		98,107
Total assets	$	6,841,706	$	7,368,093
LIABILITIES
Assets sold under agreements to repurchase	$	1,825,813	$	2,381,538
Mortgage loan participation purchase and sale agreements		528,368		527,395
Notes payable		1,140,546		891,505
Obligations under capital lease		13,032		20,971
Excess servicing spread financing payable to PennyMac Mortgage Investment Trust at fair value		229,470		236,534
Derivative liabilities		4,094		5,796
Accounts payable and accrued expenses		114,005		106,716
Mortgage servicing liabilities at fair value		10,253		14,120
Payable to Investment Funds		404		2,427
Payable to PennyMac Mortgage Investment Trust		99,309		136,998
Payable to exchanged Private National Mortgage Acceptance Company, LLC unitholders under tax receivable agreement		46,903		44,011
Income taxes payable		67,357		52,160
Liability for mortgage loans eligible for repurchase		879,621		1,208,195
Liability for losses under representations and warranties		20,587		20,053
Total liabilities		4,979,762		5,648,419

Commitments and contingencies – Note 14

STOCKHOLDERS’ EQUITY
Class A common stock—authorized 200,000,000 shares of $0.0001 par value; issued and outstanding, 25,008,655 and 23,529,970 shares, respectively		3		2
Class B common stock—authorized 1,000 shares of $0.0001 par value; issued and outstanding, 45 and 46 shares, respectively		—		—
Additional paid-in capital		229,941		204,103
Retained earnings		299,951		265,306
Total stockholders' equity attributable to PennyMac Financial Services, Inc. common stockholders		529,895		469,411
Noncontrolling interest in Private National Mortgage Acceptance Company, LLC		1,332,049		1,250,263
Total stockholders' equity		1,861,944		1,719,674
Total liabilities and stockholders’ equity	$	6,841,706	$	7,368,093

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

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PENNYMAC FINANCIAL SERVICES, INC.

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)


	Quarter ended June 30,				Six months ended June 30,
	2018		2017		2018		2017
	(in thousands, except earnings per share)
Revenues
Net gains on mortgage loans held for sale at fair value:
From non-affiliates	$	46,019	$	99,597	$	105,047	$	188,248
From PennyMac Mortgage Investment Trust		14,927		(1,506)		27,313		(3,201)
		60,946		98,091		132,360		185,047
Mortgage loan origination fees:
From non-affiliates		22,886		28,303		46,241		52,498
From PennyMac Mortgage Investment Trust		1,542		1,890		2,750		3,269
		24,428		30,193		48,991		55,767
Fulfillment fees from PennyMac Mortgage Investment Trust		14,559		21,107		26,503		37,677
Net mortgage loan servicing fees:
Mortgage loan servicing fees:
From non-affiliates		138,871		112,348		274,354		218,815
From PennyMac Mortgage Investment Trust		9,431		10,099		20,450		20,585
From Investment Funds		3		543		3		1,039
Ancillary and other fees		13,637		11,202		27,808		23,068
		161,942		134,192		322,615		263,507
Amortization, impairment and change in fair value of mortgage servicing rights and mortgage servicing liabilities		(47,257)		(94,435)		(84,220)		(152,360)
Change in fair value of excess servicing spread payable to PennyMac Mortgage Investment Trust		(996)		7,156		(7,917)		9,929
		(48,253)		(87,279)		(92,137)		(142,431)
Net mortgage loan servicing fees		113,689		46,913		230,478		121,076
Management fees, net:
From PennyMac Mortgage Investment Trust		5,728		5,638		11,424		10,646
From Investment Funds		(64)		369		15		735
		5,664		6,007		11,439		11,381
Carried Interest from Investment Funds		(168)		241		(348)		113
Net interest income (expense):
Interest income:
From non-affiliates		53,206		32,948		93,845		55,002
From PennyMac Mortgage Investment Trust		1,898		2,025		3,874		3,830
		55,104		34,973		97,719		58,832
Interest expense:
To non-affiliates		28,706		32,511		61,517		57,338
To PennyMac Mortgage Investment Trust		3,910		4,366		7,844		9,013
		32,616		36,877		69,361		66,351
Net interest income (expense)		22,488		(1,904)		28,358		(7,519)
Change in fair value of investment in and dividends received from PennyMac Mortgage Investment Trust		108		76		290		215
Results of real estate acquired in settlement of loans		13		(119)		(15)		(144)
Other		2,571		1,116		4,443		2,581
Total net revenues		244,298		201,721		482,499		406,194
Expenses
Compensation		98,540		82,967		200,553		168,207
Servicing		28,490		24,702		54,789		51,545
Technology		15,154		11,581		29,774		22,937
Occupancy and equipment		6,507		5,965		12,884		11,007
Professional services		5,587		4,523		11,325		8,341
Loan origination		5,144		5,116		7,259		9,249
Marketing		2,218		2,483		4,379		4,219
Other		7,960		6,424		13,842		10,697
Total expenses		169,600		143,761		334,805		286,202
Income before provision for income taxes		74,698		57,960		147,694		119,992
Provision for income taxes		6,293		7,214		12,363		14,860
Net income		68,405		50,746		135,331		105,132
Less: Net income attributable to noncontrolling interest		50,568		40,267		100,875		83,774
Net income attributable to PennyMac Financial Services, Inc. common stockholders	$	17,837	$	10,479	$	34,456	$	21,358

Earnings per share
Basic	$	0.71	$	0.45	$	1.41	$	0.93
Diluted	$	0.70	$	0.44	$	1.38	$	0.91
Weighted average shares outstanding
Basic		24,959		23,388		24,399		23,006
Diluted		78,825		77,650		78,947		77,641

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

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PENNYMAC FINANCIAL SERVICES, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (UNAUDITED)


	Class A Common Stock							Noncontrolling
								interest in Private
				Additional				National Mortgage		Total
	Number of	Par		paid-in		Retained		Acceptance		stockholders'
	shares	value		capital		earnings		Company, LLC		equity
	(in thousands)

Balance at December 31, 2016	22,427	$	2	$	182,772	$	164,549	$	1,052,033	$	1,399,356
Net income	—		—		—		21,358		83,774		105,132
Stock and unit-based compensation	—		—		3,450		—		7,256		10,706
Issuance of Class A common stock in settlement of directors' fees	—		—		108		—		61		169
Exchange of Class A units of Private National Mortgage Acceptance Company, LLC to Class A common stock of PennyMac Financial Services, Inc.	1,046		—		16,927		—		(16,927)		—
Tax effect of exchange of Class A units of Private National Mortgage Acceptance Company, LLC to Class A common stock of PennyMac Financial Services, Inc.	—		—		(4,111)		—		—		(4,111)
Balance at June 30, 2017	23,473	$	2	$	199,146	$	185,907	$	1,126,197	$	1,511,252

Balance at December 31, 2017	23,530	$	2	$	204,103	$	265,306	$	1,250,263	$	1,719,674
Cumulative effect of change in accounting principle – accounting for all existing classes of mortgage servicing rights at fair value	—		—		—		189		587		776
Balance at January 1, 2018	23,530		2		204,103		265,495		1,250,850		1,720,450
Net income	—		—		—		34,456		100,875		135,331
Stock and unit-based compensation	230		—		7,728		—		8,340		16,068
Issuance of Class A common stock in settlement of directors' fees	—		—		51		—		109		160
Repurchase of Class A common stock	(236)		—		(4,826)		—		—		(4,826)
Exchange of Class A units of Private National Mortgage Acceptance Company, LLC to Class A common stock of PennyMac Financial Services, Inc. by noncontrolling interest unitholders and issued as equity compensation	1,485		1		28,124		—		(28,125)		—
Tax effect of exchange and repurchases of Class A units of Private National Mortgage Acceptance Company, LLC to Class A common stock of PennyMac Financial Services, Inc., net	—		—		(5,239)		—		—		(5,239)
Balance at June 30, 2018	25,009	$	3	$	229,941	$	299,951	$	1,332,049	$	1,861,944

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

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PENNYMAC FINANCIAL SERVICES, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)


	Six months ended June 30,
	2018		2017
	(in thousands)
Cash flow from operating activities
Net income	$	135,331	$	105,132
Adjustments to reconcile net income to net cash used in operating activities:
Net gains on mortgage loans held for sale at fair value		(132,360)		(185,047)
Accrual of servicing rebate payable to Investment Funds		—		100
Amortization, impairment and change in fair value of mortgage servicing rights, mortgage servicing liabilities and excess servicing spread		92,137		142,431
Carried Interest from Investment Funds		348		(113)
Capitalization of interest on mortgage loans held for sale at fair value		(39,390)		(21,615)
Accrual of interest on excess servicing spread financing		7,844		9,013
Amortization of premiums and debt issuance costs		(13,385)		7,122
Change in fair value of investment in common shares of PennyMac Mortgage Investment Trust		(219)		(144)
Results of real estate acquired in settlement in loans		15		144
Stock-based compensation expense		12,235		10,390
Provision for servicing advance losses		12,097		18,030
Loss from disposition of fixed assets and impairment of capitalized software		—		377
Depreciation and amortization		5,647		4,117
Purchase of mortgage loans held for sale from PennyMac Mortgage Investment Trust		(19,267,316)		(21,244,194)
Originations of mortgage loans held for sale		(2,518,992)		(2,353,899)
Purchase of mortgage loans from Ginnie Mae securities and early buyout investors for modification and subsequent sale		(2,002,582)		(1,814,080)
Sale and principal payments of mortgage loans held for sale to non-affiliates		22,832,809		24,497,179
Sale of mortgage loans held for sale to PennyMac Mortgage Investment Trust		1,427,637		40,222
Repurchase of mortgage loans subject to representations and warranties		(12,974)		(11,520)
Settlement of repurchase agreeement derivatives		7,478		—
Decrease in servicing advances		47,980		38,821
Collection of Carried Interest		7,834		—
Sale of real estate acquired in settlement of loans		2,130		—
Decrease (increase) in receivable from PennyMac Mortgage Investment Trust		5,873		(1,092)
Decrease (increase) in receivable from Investment Funds		405		(211)
Decrease (increase) in other assets		7,792		(29,492)
Increase (decrease) in accounts payable and accrued expenses		5,349		(30,395)
Decrease in payable to Investment Funds		(2,023)		(5,157)
Decrease in payable to PennyMac Mortgage Investment Trust		(38,580)		(37,650)
Payments to exchanged Private National Mortgage Acceptance Company, LLC unitholders under tax receivable agreement		—		(6,221)
Increase in income taxes payable		12,778		14,824
Net cash provided by (used in) operating activities		595,898		(852,928)
Cash flow from investing activities
Decrease (increase) in short-term investments		71,509		(59,476)
Net settlement of derivative financial instruments used for hedging		(126,918)		(30,949)
Purchase of mortgage servicing rights		(30,129)		(159,465)
Purchase of furniture, fixtures, equipment and leasehold improvements		(4,321)		(4,668)
Acquisition of capitalized software		(7,664)		(7,719)
Net change in assets purchased from PMT under agreement to resell		5,546		—
Increase in margin deposits		(3,774)		(12,071)
Net cash used in investing activities		(95,751)		(274,348)
Cash flow from financing activities
Sale of assets under agreements to repurchase		20,763,584		13,332,610
Repurchase of assets sold under agreements to repurchase		(21,319,387)		(12,046,244)
Issuance of mortgage loan participation certificates		12,486,542		10,491,796
Repayment of mortgage loan participation certificates		(12,485,880)		(10,919,650)
Advances on notes payable		650,000		435,000
Repayment of notes payable		(400,000)		(153,073)
Advances of obligations under capital lease		—		10,298
Repayment of obligations under capital lease		(7,939)		(7,081)
Repayment of excess servicing spread financing		(24,309)		(28,910)
Payment of debt issuance costs		(9,788)		(11,059)
Issuance of common stock pursuant to exercise of stock options		3,833		316
Repurchase of common stock		(4,826)		—
Net cash (used in) provided by financing activities		(348,170)		1,104,003
Net increase (decrease) in cash and restricted cash		151,977		(23,273)
Cash and restricted cash at beginning of period		38,173		99,642
Cash and restricted cash at end of period	$	190,150	$	76,369
Cash and restricted cash at end of period are comprised of the following:
Cash	$	189,663	$	75,978
Restricted cash included in Other assets		487		391
	$	190,150	$	76,369

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

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PENNYMAC FINANCIAL SERVICES, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Note 1—Organization

PennyMac Financial Services, Inc. (“PFSI” or the “Company”) was formed as a Delaware corporation on December 31, 2012. Pursuant to a reorganization, the Company became a holding corporation and its primary asset is an equity interest in Private National Mortgage Acceptance Company, LLC (“PennyMac”). The Company is the managing member of PennyMac and operates and controls all of the businesses and affairs of PennyMac subject to the consent rights of other members under certain circumstances, and consolidates the financial results of PennyMac and its subsidiaries.

PennyMac is a Delaware limited liability company which, through its subsidiaries, engages in mortgage banking and investment management activities. PennyMac’s mortgage banking activities consist of residential mortgage loan production and mortgage loan servicing. PennyMac’s investment management activities and a portion of its mortgage loan servicing activities are conducted on behalf of investment vehicles that invest in residential mortgage loans and related assets. PennyMac’s primary wholly owned subsidiaries are:

PNMAC Capital Management, LLC (“PCM”)—a Delaware limited liability company registered with the Securities and Exchange Commission (“SEC”) as an investment adviser under the Investment Advisers Act of 1940, as amended. PCM enters into investment management agreements with entities that invest in residential mortgage loans and related assets.

Presently, PCM has a management agreement with PennyMac Mortgage Investment Trust (“PMT”), a publicly held real estate investment trust (“REIT”). Previously, PCM had management agreements with PNMAC Mortgage Opportunity Fund, LLC (the “Registered Fund”) and PNMAC Mortgage Opportunity Fund, L.P. (the “Master Fund”), both formerly registered under the Investment Company Act of 1940, as amended, an affiliate of these registered funds, and PNMAC Mortgage Opportunity Fund Investors, LLC (the Private Fund”) (collectively, the “Investment Funds”). Together, the Investment Funds and PMT are referred to as the “Advised Entities.” In 2017 and through the six months ended June 30, 2018, the Investment Funds sold or liquidated all of their remaining investments. The Registered Fund and the Master Fund obtained orders of de-registration on July 25, 2018, and the management agreements with the Registered Fund, the Master Fund and the Private Fund expired or were otherwise terminated on or before August 2, 2018. PCM expects to complete liquidation of the Investment Funds during 2018.

PennyMac Loan Services, LLC (“PLS”) — a Delaware limited liability company that services portfolios of residential mortgage loans on behalf of non-affiliates and PMT, purchases, originates and sells new prime credit quality residential mortgage loans and engages in other mortgage banking activities for its own account and the account of PMT.

PLS is approved as a seller/servicer of mortgage loans by the Federal National Mortgage Association (“Fannie Mae”) and the Federal Home Loan Mortgage Corporation (“Freddie Mac”) and as an issuer of securities guaranteed by the Government National Mortgage Association (“Ginnie Mae”). PLS is a licensed Federal Housing Administration Nonsupervised Title II Lender with the U.S. Department of Housing and Urban Development (“HUD”) and a lender/servicer with the Veterans Administration (“VA”) and U.S. Department of Agriculture (“USDA”) (each an “Agency” and collectively the “Agencies”).

PNMAC Opportunity Fund Associates, LLC (“PMOFA”)—a Delaware limited liability company and the general partner of the Master Fund. PMOFA is entitled to incentive fees representing allocations of profits (“Carried Interest”) from the Master Fund.

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Note 2—Basis of Presentation and Accounting Changes

Basis of Presentation

The accompanying consolidated financial statements have been prepared in compliance with accounting principles generally accepted in the United States (“GAAP”) as codified in the Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification (“ASC”) for interim financial information and with the SEC’s instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, these financial statements and notes do not include all of the information required by GAAP for complete financial statements. This interim consolidated information should be read together with the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

The accompanying unaudited consolidated financial statements reflect all normal recurring adjustments necessary to present fairly the financial position, income, and cash flows for the interim periods, but are not necessarily indicative of income to be anticipated for the full year ending December 31, 2018. Intercompany accounts and transactions have been eliminated.

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

Accounting Changes

During the six months ended June 30, 2018, the Company adopted changes to the accounting principles used in the preparation of its financial statements summarized below.

Mortgage Servicing Rights

Effective January 1, 2018, the Company has elected to change the accounting for the classes of mortgage servicing rights (“MSRs”) it had accounted for using the amortization method through December 31, 2017, to the fair value method as allowed in the Transfers and Servicing topic of the FASB’s ASC. The Company determined that a single accounting treatment across all MSRs is consistent with lender valuation under its financing arrangements and simplifies the Company’s hedging activities. As the result of this change, the Company recorded an adjustment to increase its investment in MSRs by $848,000, an increase in its liability for income taxes payable of $72,000 and in increase in stockholders’ equity of $776,000.

Revenue Recognition

In May 2014, the FASB issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Subtopic 606) (“ASU 2014-09”), which supersedes the guidance in the Revenue Recognition topic of the ASC. Effective January 1, 2018, the Company adopted ASU 2014-09 as amended using the modified retrospective method. The adoption of ASU 2014-09 did not require the Company to record a cumulative effect adjustment to its beginning retained earnings.

The Company’s revenues from contracts with customers that are subject to ASU 2014-09 include fulfillment fees, management fees, Carried Interest and certain reimbursed overhead costs. Other revenue and income streams are not subject to ASU 2014-09 as they are financial instruments or other contractual rights and obligations accounted for under the Receivables, Investments and Debt and Equity Securities, Transfers and Servicing, Financial Instruments and Derivatives and Hedging topics of the ASC.

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Fulfillment Fees

Fulfillment fees represent fees the Company collects for services it performs on behalf of PMT in connection with the acquisition, packaging and sale of mortgage loans. Fulfillment fee amounts are based upon a negotiated fee schedule and the unpaid principal balance of the mortgage loans purchased by PMT. The Company’s obligation under the agreement is fulfilled when PMT completes the sale or securitization of a mortgage loan it purchases. Fulfillment fees are generally collected within 30 days of purchase by PMT, although a portion of the fulfillment fees may not be collected until 30 days following sale or securitization to the extent such sale or securitization does not occur in the month of purchase. Fulfillment fee revenue is recognized in the month the fee is earned. Fulfillment fees receivable contract assets are disclosed in Note 4—Transactions with Affiliates.

Management fees

Management fees represent compensation to the Company for its management services provided to the Advised Entities. Management fees are earned based on the Investment Funds’ net assets and PMT’s shareholders’ equity amounts and profitability in excess of specified thresholds, and are recognized as services are provided and are paid to the Company on a quarterly basis within 30 days of the end of the quarter. Management fees receivable contract assets are disclosed in Note 4—Transactions with Affiliates.

Carried Interest

The Company’s Carried Interest arrangements with the Investment Funds represent capital allocations to the Company. As a result, the Company has concluded as part of its assessment of the effect of the adoption of ASU 2014-09 that its Carried Interest represents an equity method investment subject to the Investments – Equity Method and Joint Ventures topic of the ASC. Therefore, effective January 1, 2018, the Company recharacterized its Carried Interest as financial instruments under the equity method of accounting. Carried Interest balances are disclosed in Note 9—Carried Interest Due from Investment Funds.

Expense reimbursements

Under the Company’s management agreement with PMT, PMT is required to pay its pro rata portion of rent, telephone, utilities, office furniture, equipment, machinery and other office, internal and overhead expenses of the Company and its affiliates required for PMT’s and its subsidiaries’ operations. These expenses are allocated based on the ratio of PMT’s proportion of gross assets compared to all remaining gross assets managed by the Company as calculated at each fiscal quarter end. Before the adoption of ASU 2014-09, the Company accounted for such reimbursements as reductions to expenses. With the adoption of ASU 2014-09, the Company is required to include such expense reimbursements in its net revenues. As a result of the adoption of ASU 2014-09, certain overhead reimbursement amounts were reclassified from the following expense line items to Other revenue as summarized below:


	Quarter ended		Six months ended
Income statement line	June 30, 2018		June 30, 2018
	(in thousands)
Occupancy and equipment	$	647	$	1,236
Technology		302		522
Compensation		120		240
Other		227		419
Total expense reimbursements included in Other revenue	$	1,296	$	2,417