As discussed in Note 1— Organization above, PMT’s operations and investing activities are centered in residential mortgage-related assets, including CRT arrangements and distressed loans. These investments include assets that are more sensitive to borrower creditworthiness than other mortgage investments such as traditional loans and mortgage-backed securities.

As detailed in Note 6 – Loan Sales and Variable Interest Entities, the Company invests in CRT arrangements whereby it sells pools of recently-originated loans into Fannie Mae-guaranteed securitizations while either:

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through May 2018, entering into CRT Agreements, whereby it retains a portion of the credit risk underlying such loans as part of the retention of an interest-only (“IO”) ownership interest in such loans and an obligation to absorb credit losses arising from such loans (“Recourse Obligations”); or

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beginning in June 2018, entering into firm commitments to purchase CRT strips that absorb losses from defaults of such loans.

The Company’s retention of credit risk through its investment in CRT arrangements subjects it to risks associated with delinquency and foreclosure similar to the risks associated with owning the related loans, and exposes the Company to the risk of loss greater than the risks associated with selling such loans to Fannie Mae without the retention of such credit risk.

CRT Agreements are structured such that loans that reach a specific number of days delinquent will trigger losses chargeable to the CRT Agreements in proportion to the size of the loan and a contractual schedule of loss severity. Therefore, the risks associated with delinquency and foreclosure may in some instances be greater than the risks associated with owning the related loans because the structure of the CRT Agreements provides that the Company may be required to realize losses in the event of delinquency or foreclosure even when there is ultimately no loss realized with respect to such loans (e.g., as a result of a borrower’s re-performance).

Unlike the Company’s investment in CRT Agreements before June 2018, the structure of its investment in CRT strips requires the Company to absorb incurred losses when the reference loans realize actual losses. The Company makes a firm commitment to purchase the CRT securities at the beginning of the aggregation period and before the settlement of the CRT strips. The Company has elected to account for these commitments at fair value. Accordingly, the Company recognizes the fair value of such commitment as it sells loans subject to the firm commitment, and also recognizes changes in fair value of the firm commitment during the time it is outstanding.

The Company is exposed to market risk in addition to the risks specific to credit and, as a result of prevailing market conditions or the economy generally, may be required to recognize losses associated with adverse changes to the fair value of the CRT arrangements.