PennyMac Financial Services Inc

Previous wording

Due to ongoing inflationary pressures, over the last several quarters, the U.S. Federal Reserve has maintained the federal funds rate at its highest level since the great financial crisis of 2007 and has continued to reduce the federal government’s overall holdings of Treasury and mortgage-backed securities. Elevated interest rates are expected to constrain growth in the size of the mortgage origination market from $1.5 trillion in 2023 to an estimated $1.7 trillion in 2024 according to mortgage lending industry economists but this estimate may decline if interest rates remain elevated for longer than expected.

Current wording

The U.S. Federal Reserve has begun to reduce the federal funds rate from its highest level since 2007 as inflationary pressures have abated, and longer term interest rates have declined slightly from their most elevated levels in recent years. Elevated interest rates have constrained growth in the size of the mortgage origination market from $1.5 trillion in 2023 to an estimated $1.7 trillion in 2024, but declining interest rates and increased refinancing activity are projected to drive growth in the origination market to $2.3 trillion in 2025 according to mortgage origination economists.

Previous wording

The limited size of the mortgage origination market and interest rates at sustained higher levels continue to impact our mortgage production activities and gains from the redelivery of loans bought out from Ginnie Mae securities. Higher interest rates have also increased the costs of floating rate borrowings, increased interest income from placement fees we receive relating to custodial funds that we manage on deposits and loans held for sale as compared to the same period in the prior year, and have led to prepayment speeds below historical averages in our mortgage servicing portfolio. We continued our acquisition of conventional loans from PMT during the six months ended June 30, 2024 and expect to purchase conventional loans from PMT during the remainder of 2024 at a reduced rate.

Current wording

Declining interest rates and increasing opportunity for refinancing have driven increased mortgage production activity in the most recent quarter and also led to increasing prepayment speeds on our mortgage servicing portfolio from the historically slow prepayment speeds experienced earlier in the year. Higher interest rate levels have increased the costs of floating rate borrowings and interest income from placement fees we receive relating to custodial funds that we manage on deposits and loans held for sale as compared to the same period in the prior year, although we would expect these to begin declining as well as if the Federal Reserve continues to reduce the federal funds rate as expected. We continued our acquisition of conventional loans from PMT during the nine months ended September 30, 2024 and expect to purchase conventional loans from PMT during the remainder of 2024.

Previous wording

We define “Adjusted EBITDA” as net income plus provision for income taxes, depreciation and amortization, excluding decrease (increase) in fair value of mortgage servicing rights (“MSRs”) net of mortgage servicing liabilities (“MSLs”), due to changes in the valuation inputs we use in our valuation models, hedging losses (gains) associated with MSRs, stock-based compensation and interest expense on corporate debt or corporate revolving credit facilities and capital lease.

Current wording

We define “Adjusted EBITDA” as net income plus provision for income taxes, depreciation and amortization, excluding decrease (increase) in fair value of mortgage servicing rights (“MSRs”) net of mortgage servicing liabilities (“MSLs”), due to changes in the valuation inputs we use in our valuation models, hedging (gains) losses associated with MSRs, stock-based compensation and interest expense on corporate debt or corporate revolving credit facilities and capital lease.

Previous wording

For the quarter ended June 30, 2024, income before provision for income taxes increased $60.9 million compared to the same period in 2023. The increase was primarily due to a $36.7 million increase in loan production revenue due to higher volume across all production channels, a $21.5 million increase inNet loan servicing fees resulting from growth in servicing fees in excess of increases in net MSR valuation losses and a $12.6 million increase in other income resulting from a non-cash gain related to a non-recurring transaction in Townsgate Closing Services, LLC, a joint venture, partially offset by an $8.6 million increase in total expenses.

Current wording

For the quarter ended September 30, 2024, income before provision for income taxes decreased $32.9 million compared to the same period in 2023. The decrease was primarily due to a $109.5 million decrease inNet loan servicing fees resulting from increases in net MSR valuation losses in excess of growth in servicing fees and a $44.4 million increase in total expenses, partially offset by a $123.1 million increase in loan production revenue due to higher volume across all production channels.

Previous wording

For the six months ended June 30, 2024, income before provision for income taxes increased $66.7 million compared to the same period in 2023. The increase was primarily due to a $92.7 million increase inNet gains on loans held for sale at fair value due to higher volume across all production channels, an $8.1 million increase inLoan origination fees and a $14.3 million increase in other income primarily resulting from a non-cash gain related to a non-recurring transaction in Townsgate Closing Services, LLC, a joint venture, partially offset by a $26.4 million decrease inNet loan servicing fees resulting from increases in net MSR valuation losses in excess of growth in servicing fees, an $8.9 million decrease inFulfillment fees from PennyMac Mortgage Investment Trust, a $7.4 million increase inNet interest expense and a $5.7 million increase in total expenses.

Current wording

For the nine months ended September 30, 2024, income before provision for income taxes increased $33.8 million compared to the same period in 2023. The increase was primarily due to a $215.0 million increase in loan production revenues due to higher volume across all production channels, partially offset by a $135.9 million decrease inNet loan servicing fees resulting from increases in net MSR valuation losses in excess of growth in servicing fees and a $50.1 million increase in total expenses.

Previous wording

In our production segment, revenues reflect the effects of market adjustments to higher interest rates continuing during the quarter and six months ended June 30, 2024 compared to the same periods in 2023.

Current wording

In our production segment, revenues reflect the effects of a reduction in market interest rates and mortgage rates from elevated levels during the quarter and nine months ended September 30, 2024 compared to the same periods in 2023.

Previous wording

During the quarter ended June 30, 2024, we recognizedNet gains on loans held for sale at fair value totaling $176.1 million, an increase of $34.6 million compared to the same period in 2023. The increase was primarily due to higher margins in the direct lending channels and an increase in loan production volume across all production channels during the quarter ended June 30, 2024 compared to the same period in 2023.

Current wording

During the quarter ended September 30, 2024, we recognizedNet gains on loans held for sale at fair value totaling $256.8 million, an increase of $105.4 million compared to the same period in 2023. The increase was due to an increase in loan production volume across all production channels due to a reduction in interest rates during the quarter ended September 30, 2024 compared to the same period in 2023.

Previous wording

During the six months ended June 30, 2024, we recognized* Net gains on loans held for sale at fair value* totaling $338.5 million, an increase of $92.7 million compared to the same period in 2023. The increase was primarily due to higher margins and increases in loan production volumes across all production channels during the six months ended June 30, 2024 compared to the same period in 2023.

Current wording

During the nine months ended September 30, 2024, we recognized* Net gains on loans held for sale at fair value* totaling $595.3 million, an increase of $198.1 million compared to the same period in 2023. The increase was primarily due to higher margins and increases in loan production volumes across all production channels during the nine months ended September 30, 2024 compared to the same period in 2023.

Previous wording

We also receive non-cash proceeds on sale that include our estimate of the fair value of MSRs and we incur mortgage servicing liabilities (“MSLs”) (which represent the fair value of the costs we expect to incur in excess of the fees we receive for delinquent loans we have bought out of Ginnie Mae guaranteed securities we service and have resold to third party investors) and for the fair value of our estimate of the losses we expect to incur relating to the representations and warranties we provide in our loan sale transactions.

Current wording

We also receive non-cash proceeds on sale that include our estimate of the fair value of MSRs and we incur MSLs (which represent the fair value of the costs we expect to incur in excess of the fees we receive for delinquent loans we have bought out of Ginnie Mae guaranteed securities we service and have resold to third party investors) and for the fair value of our estimate of the losses we expect to incur relating to the representations and warranties we provide in our loan sale transactions.

Previous wording

The MSRs, MSLs, and liabilities for representations and warranties we recognize represent our estimate of the fair value of future benefits and costs we will realize for years in the future. These estimates represented approximately 307% and 282% of our gains on sales of loans held for sale at fair value for the quarter and six months ended June 30, 2024, respectively, as compared to 397% and 345% for the same periods in 2023. These estimates change as circumstances change and changes in these estimates are recognized in income in subsequent periods. Subsequent changes in the fair value of our MSRs may significantly affect our income.

Current wording

The MSRs, MSLs, and liabilities for representations and warranties we recognize represent our estimate of the fair value of future benefits and costs we will realize for years in the future. These estimates represented approximately 225% and 257% of our gains on sales of loans held for sale at fair value for the quarter and nine months ended September 30, 2024, respectively, as compared to 297% and 327% for the same periods in 2023. These estimates change as circumstances change and changes in these estimates are recognized in income in subsequent periods. Subsequent changes in the fair value of our MSRs may significantly affect our income.

Previous wording

We recorded provisions for losses under representations and warranties relating to current loan sales as a component ofNet gains on loans held for sale at fair value totaling $4.1 million and $8.1 million for the quarter and six months ended June 30, 2024, respectively, compared to $3.1 million and $4.9 million for the same periods in 2023. The increases in the provision relating to current loan sales were primarily attributable to an increase in production volume for the quarter and six months ended June 30, 2024 compared to the same periods in 2023.

Current wording

We recorded provisions for losses under representations and warranties relating to current loan sales as a component ofNet gains on loans held for sale at fair value totaling $4.1 million and $12.2 million for the quarter and nine months ended September 30, 2024, respectively, compared to $4.0 million and $8.9 million for the same periods in 2023. The increases in the provision relating to current loan sales were primarily attributable to an increase in production volume for the quarter and nine months ended September 30, 2024 compared to the same periods in 2023.

Previous wording

We also recorded reductions in the liability of $4.1 million and $7.4 million for the quarter and six months ended June 30, 2024, respectively, compared to $2.0 million and $3.5 million for the same periods in 2023. The reductions in the liability resulted from previously sold loans meeting performance criteria established by the Agencies which significantly limit the likelihood of certain repurchase or indemnification claims.

Current wording

We also recorded reductions in the liability of $3.5 million and $10.9 million for the quarter and nine months ended September 30, 2024, respectively, compared to $2.6 million and $6.0 million for the same periods in 2023. The reductions in the liability resulted from previously sold loans meeting performance criteria established by the Agencies which significantly limit the likelihood of certain repurchase or indemnification claims.

Previous wording

During the quarter and six months ended June 30, 2024, we repurchased loans totaling $23.5 million and $44.9 million, respectively. We charged losses of $1.3 million and $2.8 million to the liability during the quarter and six months ended June 30, 2024, respectively. Our losses arising from representations and warranties have historically been minimized by our ability to either recover most of the losses from our correspondent sellers or from our ability to profitably refinance and resell repurchased loans.

Current wording

During the quarter and nine months ended September 30, 2024, we repurchased loans totaling $25.8 million and $70.0 million, respectively. We charged losses of $1.0 million and $3.8 million to the liability during the quarter and nine months ended September 30, 2024, respectively. Our losses arising from representations and warranties have historically been minimized by our ability to either recover most of the losses from our correspondent sellers or from our ability to profitably refinance and resell repurchased loans.

Previous wording

Loan origination fees increased $3.1 million and $8.1 million during the quarter and six months ended June 30, 2024, respectively, compared to the same periods in 2023 primarily due to an increase in production volume.

Current wording

Loan origination fees increased $11.7 million and $19.8 million during the quarter and nine months ended September 30, 2024, respectively, compared to the same periods in 2023 primarily due to an increase in production volume.

Previous wording

Fulfillment fees decreased $1.0 million and $8.9 million during the quarter and six months ended June 30, 2024, respectively, compared to the same periods in 2023. The decrease was primarily due to PMT’s sale of a greater proportion of conventional correspondent loans to PFSI during the quarter and six months ended June 30, 2024 compared to the same periods in 2023.

Current wording

Fulfillment fees increased $6.0 million during the quarter ended September 30, 2024, compared to the same period in 2023; the increase was primarily due to an increase in the number of loans we fulfilled for PMT during the quarter ended September 30, 2024 compared to the same period in 2023. Fulfillment fees decreased $3.0 million during the nine months ended September 30, 2024, compared to the same period in 2023; the decrease was primarily due to PMT’s sale of a greater proportion of conventional correspondent loans to us during the nine months ended September 30, 2024 compared to the same period in 2023.

Previous wording

Loan servicing fees from non-affiliates and other fees increased during the quarter and six months ended June 30, 2024 compared to the same periods in 2023. The increase was primarily due to growth of our loan servicing portfolio. Other servicing fees increased due to growth in our MSR portfolio combined with increased incentives received for loss mitigation activities and recovery of servicing premiums from correspondent sellers for loans that paid off within a short period after origination.

Current wording

Loan servicing fees from non-affiliates and other fees increased during the quarter and nine months ended September 30, 2024 compared to the same periods in 2023. The increase was primarily due to growth of our loan servicing portfolio. Other servicing fees increased due to growth in our MSR portfolio combined with increased incentives received for loss mitigation activities and recovery of servicing premiums from correspondent sellers for loans that paid off within a short period after origination.

Previous wording

Changes in fair value of MSRs attributable to changes in fair value inputs decreased during the quarter ended June 30, 2024 and increased during the six months ended June 30, 2024, compared to the same periods in 2023, respectively. The decrease was due to a less significant increase in interest rates during the quarter ended June 30, 2024 compared to the same period in 2023. Increasing interest rates reduce the rate of prepayments of the underlying loans, which increases the cash flows expected from the servicing rights, while decreasing interest rates have the opposite effect.

Current wording

Changes in fair value of MSRs attributable to changes in fair value inputs decreased during the quarter and nine months ended September 30, 2024 compared to the same periods in 2023. The decreases were due to decreases in interest rates during the quarter and nine months ended September 30, 2024 compared to increasing interest rates during the same periods in 2023. Increasing interest rates reduce the rate of prepayments of the underlying loans, which increases the cash flows expected from the servicing rights, while decreasing interest rates have the opposite effect.

Previous wording

Hedging results reflect valuation losses attributable to the effects of interest rate increases on the fair value of the hedging instruments as well as increased net exposure to interest rate volatility to limit elevated hedge costs during the quarter and six months ended June 30, 2024 and in the same periods in 2023.

Current wording

Hedging results reflect valuation losses attributable to the effects of interest rate decreases on the fair value of the hedging instruments as well as increased net exposure to interest rate volatility to limit elevated hedge costs during the quarter and nine months ended September 30, 2024 and in the same periods in 2023.

Previous wording

Changes in realization of cash flows are influenced by changes in the level of servicing assets and liabilities and changes in estimates of the remaining cash flows to be realized. During the quarter and six months ended June 30, 2024, realization of cash flows increased compared to the same periods in 2023, primarily due to the growth in our investment in MSRs.

Current wording

Changes in fair value attributable to realization of cash flows are influenced by changes in the level of servicing assets and liabilities and changes in estimates of the remaining cash flows to be realized. During the quarter and nine months ended September 30, 2024, realization of cash flows increased compared to the same periods in 2023, primarily due to the growth in our investment in MSRs.

Previous wording

Following is a summary of net interest expense:

Current wording

Following is a summary of net interest income (expense):

Previous wording

Net interest expenses increased $1.4 million and $7.4 million during the quarter and six months ended June 30, 2024 compared to the same periods in 2023. The increases were primarily due to increase in interest expense on borrowings due to the higher interest rate environment and to growth in our balance sheet, partially offset by an increase in placement fees we receive relating to custodial funds that we manage due to increased earning rates.

Current wording

Net interest income decreased $1.8 million and $9.2 million during the quarter and nine months ended September 30, 2024, respectively, compared to the same periods in 2023. The decreases were primarily due to an increase in interest expense on borrowings due to the higher interest rate environment and to growth in our balance sheet, partially offset by an increase in placement fees we receive relating to custodial funds that we manage primarily due to increased average custodial deposit balances.

Previous wording

Management fees increased $55,000 during the quarter ended June 30, 2024 compared to the same period in 2023 due to an increase in average PMT’s shareholders’ equity which is the basis for the base management fees. Management fees decreased $14,000 during the six months ended June 30, 2024, compared to the same period in 2023 due to a decrease in average PMT’s shareholders’ equity.

Current wording

Management fees decreased $22,000 and $36,000 during the quarter and nine months ended September 30, 2024, respectively, compared to the same periods in 2023, due to decreases in average PMT’s shareholders’ equity which is the basis for the base management fees.

Previous wording

Loan origination expenses increased $8.6 million and $12.1 million for the quarter and six months ended June 30, 2024, respectively, compared to the same periods in 2023. The increases were primarily due to higher origination volumes.

Current wording

Loan origination expenses increased $16.3 million and $28.4 million for the quarter and nine months ended September 30, 2024, respectively, compared to the same periods in 2023. The increases were primarily due to higher origination volumes.

Previous wording

Servicing expenses increased $8.3 million and $11.7 million during the quarter and six months ended June 30, 2024, respectively, compared to the same periods in 2023. The increases were primarily due to an increase in provision for losses on servicing advances resulting from higher outstanding servicing advance balances during the quarter and six months ended June 30, 2024 compared to the same periods in 2023.

Current wording

Servicing expenses increased $15.6 million and $27.3 million during the quarter and nine months ended September 30, 2024, respectively, compared to the same periods in 2023. The increases were primarily due to an increase in provision for losses on servicing advances resulting from higher delinquent loan balances during the quarter and nine months ended September 30, 2024 compared to the same periods in 2023.

Previous wording

Professional expenses decreased $8.5 million and $20.2 million during the quarter and six months ended June 30, 2024, respectively, compared to the same periods in 2023. The decrease was primarily due to decreased legal expenses related to the Black Knight litigation discussed in Note 18 –Commitments and Contingencies to the consolidated financial statements included in this Quarterly Report.

Current wording

Professional expenses decreased $2.6 million and $22.8 million during the quarter and nine months ended September 30, 2024, respectively, compared to the same periods in 2023. The decrease was primarily due to decreased legal expenses related to the Black Knight litigation discussed in Note 18 –Commitments and Contingencies to the consolidated financial statements included in this Quarterly Report.

Previous wording

Total assets increased $2.7 billion from $18.8 billion at December 31, 2023 to $21.6 billion at June 30, 2024. The increase was primarily due to an increase of $1.8 billion in loans held for sale at fair value, an increase of $914.2 million in principal-only stripped MBS at fair value and an increase of $823.7 million in MSRs, partially offset by a decrease in cash and short-term investments of $164.5 million, a decrease in servicing advances of $279.8 million, and a decrease in loans eligible for repurchase of $329.9 million.

Current wording

Total assets increased $4.0 billion from $18.8 billion at December 31, 2023 to $22.9 billion at September 30, 2024. The increase was primarily due to an increase of $2.1 billion in loans held for sale at fair value, an increase of $960.3 million in principal-only stripped mortgage-backed securities at fair value, an increase of $652.9 million in MSRs, and an increase of $622.4 million of loans eligible for repurchase, partially offset by a decrease in cash and short-term investments of $134.9 million and a decrease in servicing advances of $293.3 million.

Previous wording

Total liabilities increased $2.6 billion from $15.3 billion at December 31, 2023 to $17.9 billion at June 30, 2024. The increase was primarily due to an increase of $3.2 billion in borrowings to fund our inventory of loans held for sale, MBS and MSRs, partially offset by a decrease of $329.9 million in liability for loans eligible for repurchase and $155.1 million in accounts payable and accrued expenses. As a result of our increased inventory financing requirements, our leverage ratios increased during the quarter ended June 30, 2024 from December 31, 2023.

Current wording

Total liabilities increased $3.8 billion from $15.3 billion at December 31, 2023 to $19.1 billion at September 30, 2024. The increase was primarily due to an increase of $3.4 billion in borrowings to fund our inventory of loans held for sale, MBS and MSRs and an increase of $622.4 million in liability for loans eligible for repurchase, partially offset by a decrease of $127.2 million in payable to PMT and a decrease of $118.4 million in accounts payable and accrued expenses. As a result of our increased inventory financing requirements, our leverage ratios increased during the quarter ended September 30, 2024 from December 31, 2023.

Previous wording

The net decrease in cash of $343.0 million during the six months ended June 30, 2024 is discussed below.

Current wording

The net decrease in cash of $792.6 million during the nine months ended September 30, 2024 is discussed below.

Previous wording

Net cash used in operating activities totaled $2.0 billion during the six months ended June 30, 2024 compared with net cash used in operating activities of $1.0 billion during the same period in 2023. Our cash flows from operating activities are primarily influenced by changes in the levels of our inventory of mortgage loans held for sale as shown below:

Current wording

Net cash used in operating activities totaled $2.4 billion during the nine months ended September 30, 2024 compared with net cash used in operating activities of $2.0 billion during the same period in 2023. Our cash flows from operating activities are primarily influenced by changes in the levels of our inventory of mortgage loans held for sale as shown below:

Previous wording

Net cash used in investing activities during the six months ended June 30, 2024 totaled $1.5 billion, primarily due to $935.4 million in purchase of principal-only stripped MBS, $391.5 million in net settlement of derivative financial instruments used to hedge our investment in MSRs and a $178.5 million increase in short-term investment. Net cash used in investing activities during the six months ended June 30, 2023 totaled $186.5 million, primarily due to a $150.7 million increase in margin deposits, $20.2 million in net settlement of derivative financial instruments used to hedge our investment in MSRs, and $19.2 million used in acquisition of capitalized software.

Current wording

Net cash used in investing activities during the nine months ended September 30, 2024 totaled $1.8 billion, primarily due to $935.4 million in purchases of principal-only stripped mortgage-backed securities, a $657.7 million increase in short-term investment and $210.2 million in net settlement of derivative financial instruments used to hedge our investment in MSRs. Net cash used in investing activities during the nine months ended September 30, 2023 totaled $378.0 million, primarily due to $450.2 million in net settlement of derivative financial instruments used to hedge our investment in MSRs and $27.7 million used in acquisition of capitalized software, partially offset by $98.1 million received from the sale of interest-only stripped securities.

Previous wording

Net cash provided by financing activities totaled $3.2 billion during the six months ended June 30, 2024, primarily due to an increase of $3.2 billion in borrowings. The increase in borrowings primarily reflects the increase in inventory of loans held for sale and our investment in MSRs. Net cash provided by financing activities totaled $1.4 billion during the six months ended June 30, 2023, primarily due to an increase of $1.5 billion in borrowings. The increase in borrowings primarily reflects the increase in inventory of loans held for sale and our investment in MSRs.

Current wording

Net cash provided by financing activities totaled $3.4 billion during the nine months ended September 30, 2024, primarily due to an increase of $3.4 billion in borrowings. The increase in borrowings primarily reflects the increase in inventory of loans held for sale, principal-only stripped mortgage-backed securities and our investment in MSRs. Net cash provided by financing activities totaled $2.2 billion during the nine months ended September 30, 2023, primarily due to an increase of $2.4 billion in borrowings. The increase in borrowings primarily reflects the increase in inventory of loans held for sale and our investment in MSRs.

Previous wording

Secured debt facilities for MSRs and servicing advances take various forms. Fannie Mae MSRs, Ginnie Mae MSRs and servicing advances are pledged to special purpose entities, each of which issues variable funding notes (“VFNs”) and may issue term notes and term loans that are secured by such Ginnie Mae or Fannie Mae assets. Term notes are issued to qualified institutional buyers under Rule 144A of Securities Act and term loans are syndicated to banking entities, while the VFNs are sold to bank partners under agreements to repurchase. Freddie Mac MSR’s are pledged to a single lender under a bi-lateral loan and security agreement.

Current wording

Secured debt facilities for MSRs and servicing advances take various forms. Fannie Mae MSRs, Ginnie Mae MSRs and servicing advances are pledged to special purpose entities, each of which may issue variable funding notes (“VFNs”) and term notes and term loans that are secured by such Ginnie Mae or Fannie Mae assets. Term notes are issued to qualified institutional buyers under Rule 144A of Securities Act and term loans are syndicated to banking entities, while the VFNs are sold to bank partners under agreements to repurchase. Freddie Mac MSR’s are pledged to a single lender under a bi-lateral loan and security agreement.

Previous wording

The differences between the average and maximum daily balances on our repurchase agreements reflect both the effect of increasing loan inventory levels during the quarter and six months ended June 30, 2024 and the fluctuations throughout the periods of our inventory as we fund and pool mortgage loans for sale in guaranteed mortgage securitizations.

Current wording

The differences between the average and maximum daily balances on our repurchase agreements reflect both the effect of increasing loan inventory levels during the quarter and nine months ended September 30, 2024 and the

Previous wording

We are also subject to liquidity and net worth requirements established by the Federal Housing Finance Agency (“FHFA”) for Agency seller/servicers and Ginnie Mae for single-family issuers. FHFA and Ginnie Mae have established minimum liquidity and net worth requirements for their approved non-depository single-family sellers/servicers in the case of Fannie Mae, Freddie Mac, and Ginnie Mae for its approved single-family issuers.

Current wording

We are also subject to liquidity and net worth requirements established by the Federal Housing Finance Agency (“FHFA”) for Agency seller/servicers and Ginnie Mae for single-family issuers. FHFA and Ginnie Mae have established