| Fair Value | 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 the Manager has elected to carry the item at its fair value as discussed in the following paragraphs. The Company groups its assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the observability of the inputs used to determine fair value. These levels are:
•
Level 1—Quoted prices in active markets for identical assets or liabilities.
•
Level 2—Prices determined or determinable using other significant observable inputs. Observable inputs are inputs that other market participants would use in pricing the asset or liability and are developed based on market data obtained from sources independent of the Company. These may include quoted prices for similar assets or liabilities, interest rates, prepayment speeds, credit risk and other inputs.
•
Level 3—Prices determined using significant unobservable inputs. In situations where significant observable inputs are unavailable unobservable inputs may be used. Unobservable inputs reflect the Company’s own judgments about the factors that market participants use in pricing an asset or liability financial statement item, and are based on the best information available in the circumstances. As a result of the difficulty in observing certain significant valuation inputs affecting “Level 3” fair value assets or liabilities, the Manager is required to make judgments regarding these items’ fair values. Different persons in possession of the same facts may reasonably arrive at different conclusions as to the inputs to be applied in valuing these assets or liabilities and to their fair values. Likewise, due to the general illiquidity of some of these assets or liabilities, subsequent transactions may be at values significantly different from those reported. Fair Value Accounting Elections The Manager identified all of the Company’s non-cash financial assets and MSRs relating to non-commercial real estate secured mortgage loans with initial interest rates of more than 4.5%, to be accounted for at fair value. The Manager has elected to account for these assets 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. The Manager has also identified the Company’s CRT financing and asset-backed financing of a 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 mortgage loans at fair value collateralizing these financings. For other borrowings, the Manager 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 availability 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:
September 30, 2016
Level 1
Level 2
Level 3
Total
(in thousands)
Assets:
Short-term investments
$
33,353
$
—
$
—
$
33,353
Mortgage-backed securities at fair value
—
708,862
—
708,862
Mortgage loans acquired for sale at fair value
—
2,043,453
—
2,043,453
Mortgage loans at fair value
—
397,740
1,559,377
1,957,117
Excess servicing spread purchased from PFSI
—
—
280,367
280,367
Derivative assets:
Interest rate lock commitments
—
—
15,535
15,535
CRT Agreements
—
—
16,662
16,662
MBS call options
—
3,441
—
3,441
Forward sales contracts
—
1,308
—
1,308
Forward purchase contracts
—
21,031
—
21,031
Call options on interest rate futures
1,965
—
—
1,965
Put options on interest rate futures
2,480
—
—
2,480
Total derivative assets before netting
4,445
25,780
32,197
62,422
Netting
—
—
—
(17,648
)
Total derivative assets after netting
4,445
25,780
32,197
44,774
Mortgage servicing rights at fair value
—
—
55,843
55,843
$
37,798
$
3,175,835
$
1,927,784
$
5,123,769
Liabilities:
Asset-backed financing of a VIE at fair value
$
—
$
384,407
$
—
$
384,407
Interest-only security payable at fair value
—
—
1,699
1,699
Derivative liabilities:
Interest rate lock commitments
—
—
207
207
Forward purchase contracts
—
808
—
808
Forward sales contracts
—
20,234
—
20,234
Put options on interest rate futures
188
—
—
188
Total derivative liabilities before netting
188
21,042
207
21,437
Netting
—
—
—
(19,817
)
Total derivative liabilities after netting
188
21,042
207
1,620
$
188
$
405,449
$
1,906
$
387,726
December 31, 2015
Level 1
Level 2
Level 3
Total
(in thousands)
Assets:
Short-term investments
$
41,865
$
—
$
—
$
41,865
Mortgage-backed securities at fair value
—
322,473
—
322,473
Mortgage loans acquired for sale at fair value
—
1,283,795
—
1,283,795
Mortgage loans at fair value
—
455,394
2,100,394
2,555,788
Excess servicing spread purchased from PFSI
—
—
412,425
412,425
Derivative assets:
Interest rate lock commitments
—
—
4,983
4,983
CRT Agreements
—
—
593
593
MBS put options
—
93
—
93
Forward purchase contracts
—
2,444
—
2,444
Forward sales contracts
—
2,604
—
2,604
Put options on interest rate futures
1,512
—
—
1,512
Call options on interest rate futures
1,156
—
—
1,156
Total derivative assets
2,668
5,141
5,576
13,385
Netting
—
—
—
(3,300
)
Total derivative assets after netting
2,668
5,141
5,576
10,085
Mortgage servicing rights at fair value
—
—
66,584
66,584
$
44,533
$
2,066,803
$
2,584,979
$
4,693,015
Liabilities:
Asset-backed financing of the VIE at fair value
$
—
$
247,690
$
—
$
247,690
Derivative liabilities:
Interest rate lock commitments
—
—
337
337
Put options on interest rate futures
39
—
—
39
Call options on interest rate futures
305
—
—
305
Forward purchase contracts
—
3,774
—
3,774
Forward sales contracts
—
2,680
—
2,680
Total derivative liabilities
344
6,454
337
7,135
Netting
—
—
—
(3,978
)
Total derivative liabilities after netting
344
6,454
337
3,157
$
344
$
254,144
$
337
$
250,847
The following is a summary of changes in items measured using Level 3 inputs on a recurring basis:
Quarter ended September 30, 2016
Mortgage
Excess
Interest
Mortgage
Interest-only
loans
servicing
rate lock
CRT
servicing
security
at fair value
spread
commitments (1)
Agreements (1)
rights
payable
Total
(in thousands)
Balance, June 30, 2016
$
1,608,906
$
294,551
$
16,757
$
(199
)
$
57,977
$
(1,663
)
$
1,976,329
Purchases and issuances
—
—
30,429
—
—
—
30,429
Repayments and sales
(29,921
)
(16,342
)
—
—
—
—
(46,263
)
Capitalization of interest
23,068
4,827
—
—
—
—
27,895
ESS received pursuant to a recapture agreement with PFSI
—
1,438
—
—
—
—
1,438
Servicing received as proceeds from sales of mortgage loans
—
—
—
—
1,068
—
1,068
Proceeds from CRT Agreements
—
—
—
(6,206
)
—
—
(6,206
)
Changes in fair value included in income arising from:
Changes in instrument- specific credit risk
9,699
—
—
—
—
—
9,699
Other factors
(13,099
)
(4,107
)
23,390
23,067
(3,202
)
(36
)
26,013
(3,400
)
(4,107
)
23,390
23,067
(3,202
)
(36
)
35,712
Transfers of mortgage loans to REO and real estate held for investment
(39,276
)
—
—
—
—
—
(39,276
)
Transfers of interest rate lock commitments to mortgage loans acquired for sale
—
—
(55,248
)
—
—
—
(55,248
)
Balance, September 30, 2016
$
1,559,377
$
280,367
$
15,328
$
16,662
$
55,843
$
(1,699
)
$
1,925,878
Changes in fair value recognized during the period relating to assets still held at September 30, 2016
$
(820
)
$
(4,107
)
$
15,328
$
16,662
$
(3,202
)
(36
)
$
23,825
(1)
For the purpose of this table, the IRLC and CRT Agreement “Level 3” asset and liability positions are shown net.
Quarter ended September 30, 2015
Mortgage
Excess
Interest
Mortgage
loans
servicing
rate lock
CRT
servicing
at fair value
spread
commitments (1)
Agreements (1)
rights
Total
(in thousands)
Balance, June 30, 2015
$
2,246,944
$
359,102
$
(267
)
$
—
$
57,343
$
2,663,122
Purchases and issuances
—
84,165
11,834
—
—
95,999
Repayments and sales
(57,022
)
(24,717
)
—
—
—
(81,739
)
Capitalization of interest
14,849
8,026
—
—
—
22,875
ESS received pursuant to a recapture agreement with PFSI
—
2,268
—
—
—
2,268
Servicing received as proceeds from sales of mortgage loans
—
—
—
—
5,674
5,674
Changes in fair value included in income arising from:
Changes in instrument- specific credit risk
9,255
—
—
—
—
9,255
Other factors
22,638
(10,272
)
16,458
626
(5,266
)
24,184
31,893
(10,272
)
16,458
626
(5,266
)
33,439
Transfers of mortgage loans to REO
(76,205
)
—
—
—
—
(76,205
)
Transfers of interest rate lock commitments to mortgage loans acquired for sale
—
—
(19,218
)
—
—
(19,218
)
Balance, September 31, 2015
$
2,160,459
$
418,572
$
8,807
$
626
$
57,751
$
2,646,215
Changes in fair value recognized during the period relating to assets still held at September 30, 2015
$
32,971
$
(10,272
)
$
8,807
$
626
$
(5,266
)
$
26,866
(1) For the purpose of this table, the IRLC and CRT Agreement “Level 3” asset and liability positions are shown net.
Nine months ended September 30, 2016
Mortgage
Excess
Interest
Mortgage
Interest-only
loans
servicing
rate lock
CRT
servicing
security
at fair value
spread
commitments (1)
Agreements (1)
rights
payable
Total
(in thousands)
Balance, December 31, 2015
$
2,100,394
$
412,425
$
4,646
$
593
$
66,584
$
—
$
2,584,642
Purchases and issuances
—
—
58,475
—
2,602
(2,136
)
58,941
Repayments and sales
(449,647
)
(113,668
)
—
—
—
—
(563,315
)
Capitalization of interest
62,783
17,555
—
—
—
—
80,338
ESS received pursuant to a recapture agreement with PFSI
—
5,039
—
—
—
—
5,039
Servicing received as proceeds from sales of mortgage loans
—
—
—
—
6,215
—
6,215
Proceeds from CRT Agreements
—
—
—
(12,601
)
—
—
(12,601
)
Changes in fair value included in income arising from:
Changes in instrument- specific credit risk
29,480
—
—
—
—
—
29,480
Other factors
(31,948
)
(40,984
)
71,286
28,670
(19,558
)
437
7,903
(2,468
)
(40,984
)
71,286
28,670
(19,558
)
437
37,383
Transfers of mortgage loans to REO and real estate held for investment
(151,685
)
—
—
—
—
—
(151,685
)
Transfers of interest rate lock commitments to mortgage loans acquired for sale
—
—
(119,079
)
—
—
—
(119,079
)
Balance, September 30, 2016
$
1,559,377
$
280,367
$
15,328
$
16,662
$
55,843
$
(1,699
)
$
1,925,878
Changes in fair value recognized during the period relating to assets still held at September 30, 2016
$
(2,399
)
$
(33,774
)
$
15,328
$
16,662
$
(19,558
)
$
437
$
(23,304
)
(1)
For the purpose of this table, the IRLC and CRT Agreement “Level 3” asset and liability positions are shown net.
Nine months ended September 30, 2015
Mortgage
Excess
Interest
Mortgage
loans
servicing
rate lock
CRT
servicing
at fair value
spread
commitments (1)
Agreements (1)
rights
Total
(in thousands)
Balance, December 31, 2014
$
2,199,583
$
191,166
$
5,661
$
—
$
57,358
$
2,453,768
Purchases and issuances
241,981
271,452
42,917
—
—
556,350
Repayments and sales
(171,093
)
(55,800
)
—
—
—
(226,893
)
Capitalization of interest
34,979
17,596
—
—
—
52,575
ESS received pursuant to a recapture agreement with PFSI
—
4,833
—
—
—
4,833
Servicing received as proceeds from sales of mortgage loans
—
—
—
—
9,169
9,169
Changes in fair value included in income arising from:
Changes in instrument- specific credit risk
29,563
—
—
—
—
29,563
Other factors
49,584
(10,675
)
(6,941
)
626
(8,776
)
23,818
79,147
(10,675
)
(6,941
)
626
(8,776
)
53,381
Transfers of mortgage loans to REO
(224,138
)
—
—
—
—
(224,138
)
Transfers of interest rate lock commitments to mortgage loans acquired for sale
—
—
(32,830
)
—
—
(32,830
)
Balance, September 30, 2015
$
2,160,459
$
418,572
$
8,807
$
626
$
57,751
$
2,646,215
Changes in fair value recognized during the period relating to assets still held at September 30, 2015
$
80,885
$
(10,675
)
$
8,807
$
626
$
(8,776
)
$
70,867
(1) For the purpose of this table, the IRLC and CRT Agreement “Level The information used in the preceding roll forwards represents activity for financial statement items measured at fair value on a recurring basis and identified as using “Level 3” significant fair value inputs at either the beginning or the end of the periods presented. The Company had transfers among the fair value levels arising from transfers of IRLCs to mortgage loans held for sale at fair value upon purchase of the respective mortgage loans. 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 held in a consolidated VIE, and other mortgage loans at fair value):
September 30, 2016
December 31, 2015
Fair value
Principal amount due upon maturity
Difference
Fair value
Principal amount due upon maturity
Difference
(in thousands)
Mortgage loans acquired for sale at fair value:
Current through 89 days delinquent
$
2,042,569
$
1,950,907
$
91,662
$
1,283,275
$
1,235,433
$
47,842
90 or more days delinquent
Not in foreclosure
631
665
(34
)
304
333
(29
)
In foreclosure
253
307
(54
)
216
253
(37
)
884
972
(88
)
520
586
(66
)
$
2,043,453
$
1,951,879
$
91,574
$
1,283,795
$
1,236,019
$
47,776
Mortgage loans at fair value:
Mortgage loans held in a consolidated VIE:
Current through 89 days delinquent
$
397,740
$
388,543
$
9,197
$
455,394
$
454,935
$
459
90 or more days delinquent
Not in foreclosure
—
—
—
—
—
—
In foreclosure
—
—
—
—
—
—
—
—
—
—
—
—
397,740
388,543
9,197
455,394
454,935
459
Other mortgage loans at fair value:
Current through 89 days delinquent
705,618
939,853
(234,235
)
877,438
1,134,560
(257,122
)
90 or more days delinquent
Not in foreclosure
334,850
463,405
(128,555
)
459,060
640,343
(181,283
)
In foreclosure
518,909
699,091
(180,182
)
763,896
1,062,205
(298,309
)
853,759
1,162,496
(308,737
)
1,222,956
1,702,548
(479,592
)
1,559,377
2,102,349
(542,972
)
2,100,394
2,837,108
(736,714
)
$
1,957,117
$
2,490,892
$
(533,775
)
$
2,555,788
$
3,292,043
$
(736,255
) 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 September 30, 2016
Net gain on
Net
mortgage
mortgage
loans
Net
Net gain
loan
acquired
interest
on
servicing
for sale
income
investments
fees
Total
(in thousands)
Assets:
Short-term investments
$
—
$
—
$
—
$
—
$
—
Mortgage-backed securities at fair value
—
(1,193
)
517
—
(676
)
Mortgage loans acquired for sale at fair value
58,128
—
—
—
58,128
Mortgage loans at fair value
—
193
(3,936
)
—
(3,743
)
ESS at fair value
—
—
(4,107
)
—
(4,107
)
MSRs at fair value
—
—
—
(3,202
)
(3,202
)
$
58,128
$
(1,000
)
$
(7,526
)
$
(3,202
)
$
46,400
Liabilities:
Asset-backed financing of a VIE at fair value
$
—
$
(2,520
)
$
2,990
$
—
$
470
$
—
$
(2,520
)
$
2,990
$
—
$
470
Quarter ended September 30, 2015
Net gain on
Net
mortgage
mortgage
loans
Net
Net gain
loan
acquired
interest
on
servicing
for sale
income
investments
fees
Total
(in thousands)
Assets:
Short-term investments
$
—
$
—
$
—
$
—
$
—
Mortgage-backed securities at fair value
—
91
3,564
—
3,655
Mortgage loans acquired for sale at fair value
39,504
—
—
—
39,504
Mortgage loans at fair value
—
1,024
39,273
—
40,297
ESS at fair value
—
—
(7,844
)
—
(7,844
)
MSRs at fair value
—
—
—
(5,266
)
(5,266
)
$
39,504
$
1,115
$
34,993
$
(5,266
)
$
70,346
Liabilities:
Asset-backed financing of a VIE at fair value
$
—
$
(351
)
$
(3,941
)
$
—
$
(4,292
)
$
—
$
(351
)
$
(3,941
)
$
—
$
(4,292
)
Nine months ended September 30, 2016
Net gain on
Net
mortgage
mortgage
loans
Net
Net gain
loan
acquired
interest
on
servicing
for sale
income
investments
fees
Total
(in thousands)
Assets:
Short-term investments
$
—
$
—
$
—
$
—
$
—
Mortgage-backed securities at fair value
—
(1,930
)
9,948
—
8,018
Mortgage loans acquired for sale at fair value
147,135
—
—
—
147,135
Mortgage loans at fair value
—
2,287
5,342
—
7,629
ESS at fair value
—
—
(40,984
)
—
(40,984
)
MSRs at fair value
—
—
—
(19,558
)
(19,558
)
$
147,135
$
357
$
(25,694
)
$
(19,558
)
$
102,240
Liabilities:
Asset-backed financing of a VIE at fair value
$
—
$
(1,985
)
$
(5,974
)
$
—
$
(7,959
)
$
—
$
(1,985
)
$
(5,974
)
$
—
$
(7,959
)
Nine months ended September 30, 2015
Net gain on
Net
mortgage
mortgage
loans
Net
Net gain
loan
acquired
interest
on
servicing
for sale
income
investments
fees
Total
(in thousands)
Assets:
Short-term investments
$
—
$
—
$
—
$
—
$
—
Mortgage-backed securities at fair value
—
155
(1,622
)
—
(1,467
)
Mortgage loans acquired for sale at fair value
57,568
—
—
—
57,568
Mortgage loans at fair value
—
1,203
76,249
—
77,452
ESS at fair value
—
—
(5,502
)
—
(5,502
)
MSRs at fair value
—
—
—
(8,776
)
(8,776
)
$
57,568
$
1,358
$
69,125
$
(8,776
)
$
119,275
Liabilities:
Asset-backed financing of a VIE at fair value
$
—
$
(474
)
$
(719
)
$
—
$
(1,193
)
$
—
$
(474
)
$
(719
)
$
—
$
(1,193
) Financial Statement Items Measured at Fair Value on a Nonrecurring Basis Following is a summary of financial statement items that were re-measured at fair value on a nonrecurring basis during the periods presented:
September 30, 2016
Level 1
Level 2
Level 3
Total
(in thousands)
Real estate acquired in settlement of loans
$
—
$
—
$
145,237
$
145,237
MSRs at lower of amortized cost or fair value
—
—
370,987
370,987
$
—
$
—
$
516,224
$
516,224
December 31, 2015
Level 1
Level 2
Level 3
Total
(in thousands)
Real estate acquired in settlement of loans
$
—
$
—
$
173,662
$
173,662
MSRs at lower of amortized cost or fair value
—
—
145,187
145,187
$
—
$
—
$
318,849
$
318,849
The following table summarizes the fair value changes recognized during the period on assets held at period end that were measured at fair value on a nonrecurring basis:
Quarter ended September 30,
Nine months ended September 30,
2016
2015
2016
2015
(in thousands)
Real estate asset acquired in settlement of loans
$
(6,940
)
$
(8,182
)
$
(14,552
)
$
(18,308
)
MSRs at lower of amortized cost or fair value
(3,460
)
(7,845
)
(44,336
)
(7,142
)
$
(10,400
)
$
(16,027
)
$
(58,888
)
$
(25,450
) Real Estate Acquired in Settlement of Loans The Company evaluates its REO for impairment with reference to the respective properties’ fair values less cost to sell on a nonrecurring basis. The initial carrying value of the REO is measured at cost as indicated by the purchase price in the case of purchased REO or as measured by the fair value of the mortgage loan immediately before REO 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 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 property’s cost is recognized in Results of real estate acquired in settlement of loans 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 asset’s 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 with 50 basis point interest rate ranges for fixed-rate mortgage loans with interest rates between 3.0% and 4.5% and a single pool for mortgage loans with interest rates below 3.0%. 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, those MSRs are impaired. When MSRs are impaired, the impairment is recognized in current-period results of operations 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. The Manager 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 the Manager deems recovery of fair 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 Assets sold under agreements to repurchase Mortgage loan participation and sale agreements Federal Home Loan Bank advances Notes payable Exchangeable senior notes The Manager has concluded that the fair values of Cash Assets sold under agreements to repurchase Mortgage loan participation and sale agreements Federal Home Loan Bank advances Notes payable Cash Exchangeable senior notes Exchangeable senior notes Valuation Techniques and Inputs Most of the Company’s assets, its Derivative liabilities Asset-backed financing of a VIE Interest-only security payable Due to the difficulty in estimating the fair values of “Level 3” fair value financial statement items, the Manager has assigned responsibility for estimating fair value of these items to specialized staff and subjects the valuation process to significant executive management oversight. The Manager’s Financial Analysis and Valuation group (the “FAV group”) is responsible for estimating the fair values of “Level 3” fair value financial statement items other than IRLCs and maintaining its valuation policies and procedures. With respect to the Company’s non-IRLC “Level 3” fair value financial statement items, the FAV group reports to PCM’s valuation committee, which oversees and approves the valuations. The FAV group monitors the models used for valuation of the Company’s non-IRLC “Level 3” fair value financial statement items, including the models’ performance versus actual results, and reports those results to PCM’s valuation committee. PCM’s valuation committee includes PFSI’s chief executive, financial, operating, risk, business development and asset/liability management officers. The FAV group is responsible for reporting to PCM’s valuation committee on a monthly basis on the changes in the valuation of the non-IRLC “Level 3” assets and liabilities, including major factors affecting the valuation and any changes in model methods and inputs. To assess the reasonableness of its valuations, the FAV group presents an analysis of the effect on the valuation of changes to the significant inputs to the models. The fair value of the Company’s IRLCs is developed by the Manager’s Capital Markets Risk Management staff and is reviewed by the Manager’s Capital Markets Operations group. The following is a description of the techniques and inputs used in estimating the fair values of “Level 2” and “Level 3” fair value assets and liabilities: Mortgage-Backed Securities The Company categorizes its current holdings of MBS as “Level 2” fair value financial statement items. Fair value of these MBS is established based on quoted market prices for the Company’s MBS or similar securities. Changes in the fair value of MBS are included in Net gain (loss) on investments Mortgage Loans Fair value of mortgage loans is estimated based on whether the mortgage loans are saleable into active markets:
•
Mortgage loans that are saleable into active markets, comprised of the Company’s mortgage loans acquired for sale at fair value and mortgage loans at fair value held in a VIE, are categorized as “Level 2” fair value financial statement items. The fair values of mortgage loans acquired for sale at fair value are established 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 fair value for the mortgage loans. The Company obtains indications of fair value from nonaffiliated brokers based on comparable securities and validates the brokers’ indications of fair value using pricing models and inputs the Manager believes are similar to the models and inputs used by other market participants.
•
Mortgage loans that are not saleable into active markets, comprised of mortgage loans at fair value held outside the VIE are categorized as “Level 3” fair value 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, discount rates and forecasts of future interest rates, home prices, prepayment speeds, default speeds, loss severities and contracted selling price where applicable. The valuation process includes the computation by stratum of the mortgage loans’ fair values 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 inputs such as interest rates, home prices, and delinquency status to assess the reasonableness of changes in the mortgage loan valuation. 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 mortgage loan’s delinquency status and performance history 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 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 mortgage loans’ fair value measurement. Increases in home price projections are generally accompanied by an increase in voluntary prepayment speeds. Changes in the fair value of mortgage loans at fair value are included in Net gain (loss) on investments Following is a quantitative summary of key inputs used in the valuation of mortgage loans at fair value:
Key inputs
September 30, 2016
December 31, 2015
Discount rate
Range
2.5% – 15.0%
2.5% – 15.0%
Weighted average
6.8%
7.1%
Twelve-month projected housing price index change
Range
3.2% – 5.8%
1.5% – 5.1%
Weighted average
4.5%
3.6%
Prepayment speed (1)
Range
0.1% – 14.7%
0.1% – 9.6%
Weighted average
4.0%
3.7%
Total prepayment speed (2)
Range
3.2% – 25.2%
0.5% – 27.2%
Weighted average
18.3%
19.6%
(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 PFSI The Company categorizes ESS as a “Level 3” fair value 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 may 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 mortgage loans underlying the ESS, thereby reducing the cash flows expected to accrue to ESS. Reductions in the fair value of ESS affect income primarily through change in fair value. Changes in the fair value of ESS are included in Net gain (loss) on investments Following are the key inputs used in determining the fair value of ESS:
Key inputs
September 30, 2016
December 31, 2015
UPB of underlying mortgage loans (in thousands)
$
34,189,425
$51,966,405
Average servicing fee rate (in basis points)
34
32
Average ESS rate (in basis points)
19
17
Pricing spread (1)
Range
4.7% - 6.0%
4.8% - 6.5%
Weighted average
5.5%
5.7%
Life (in years)
Range
2.2 - 8.9
1.4 - 9.0
Weighted average
6.2
6.9
Annual total prepayment speed (2)
Range
6.7% - 23.3%
5.2% - 52.4%
Weighted average
12.2%
9.6%
(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 Interest Rate Lock Commitments The Company categorizes IRLCs as a “Level 3” fair value financial statement item. 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 mortgage loan and the probability that the mortgage loans will be purchased under the commitment (the “pull-through rate”). 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 or the MSR component of the IRLCs, in isolation, may result in a significant change in fair value. The financial effects of changes in these inputs 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 mortgage loan principal and interest payment cash flows that have decreased in fair value. Changes in fair value of IRLCs are included in Net gain on mortgage loans acquired for sale Following is a quantitative summary of key unobservable inputs used in the valuation of IRLCs:
Key inputs
September 30, 2016
December 31, 2015
Pull-through rate
Range
57.2% - 100.0%
60.2% - 100.0%
Weighted average
87.6%
92.4%
MSR value expressed as:
Servicing fee multiple
Range
2.1 - 5.8
2.1 - 6.2
Weighted average
4.7
4.9
Percentage of UPB
Range
0.6% - 1.5%
0.5% - 3.8%
Weighted average
1.2%
1.2%
Hedging Derivatives The Company estimates the fair value of commitments to sell mortgage loans based on quoted MBS prices. These derivative financial instruments are categorized by the Company as “Level 1” fair value financial statement items for those based on exchange traded market prices or as “Level 2” fair value financial statement items for those based on observable interest rate volatilities in the MBS market. Changes in the fair value of hedging derivatives are included in Net gain on mortgage loans acquired for sale Net gain (loss) on investments Net mortgage loan servicing fees 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” fair value financial statement item. Fair value of REO is established by using a current estimate of fair value from a broker’s price opinion or a full appraisal, or the price given in a current contract of sale. REO fair values are reviewed by the Manager’s staff appraisers when the Company obtains multiple indications of fair value and there is a significant difference between the fair values received. PCM’s staff appraisers will attempt to resolve the difference between the indications of fair value. In circumstances where the appraisers are not able to generate adequate data to support a fair value conclusion, the staff appraisers will order an additional appraisal to determine fair value. Changes in the fair value of REO are included in Results of real estate acquired in settlement of loans Mortgage Servicing Rights MSRs are categorized as “Level 3” fair value financial statement items. The Company uses a discounted cash flow approach to estimate the fair value of MSRs. The key inputs used in the estimation of the fair value of MSRs include the applicable pricing spread, prepayment and default rates of the underlying mortgage loans, 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. Changes in the fair value of MSRs are included |
