Note 6—Fair Value

Most of the Company’s assets and certain of its liabilities are measured at or based on their fair values. The application of 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 Company has elected to carry the item at its fair value as discussed in the following paragraphs.

Fair Value Accounting Elections

The Company identified its MSLs and all of its non-cash financial assets other than Assets purchased from PennyMac Mortgage Investment Trust under agreements to resell, and, beginning January 1, 2018, all of it MSRs to be accounted for at fair value so changes in fair value will be reflected in income as they occur and more timely reflect the results of the Company’s performance. Management has also identified its ESS financing to be accounted for at fair value as a means of hedging the related MSRs’ fair value risk.

Before January 1, 2018, originated MSRs backed by mortgage loans with initial interest rates of less than or equal to 4.5% were accounted for using the amortization method. Effective January 1, 2018, the Company elected to change the accounting for the classes of 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 currently existing classes of MSRs is consistent with lender valuation under its financing arrangements and simplifies the Company’s hedging activities.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

Following is a summary of assets and liabilities that are measured at fair value on a recurring basis:


	December 31, 2018
	Level 1		Level 2		Level 3		Total
	(in thousands)
Assets:
Short-term investments	$	117,824	$	—	$	—	$	117,824
Mortgage loans held for sale at fair value		—		2,261,639		260,008		2,521,647
Derivative assets:
Interest rate lock commitments		—		—		50,507		50,507
Repurchase agreement derivatives		—		—		26,770		26,770
Forward purchase contracts		—		35,916		—		35,916
Forward sales contracts		—		437		—		437
MBS put options		—		720		—		720
MBS call options		—		2,135		—		2,135
Put options on interest rate futures purchase contracts		866		—		—		866
Call options on interest rate futures purchase contracts		5,965		—		—		5,965
Total derivative assets before netting		6,831		39,208		77,277		123,316
Netting		—		—		—		(26,969)
Total derivative assets		6,831		39,208		77,277		96,347
Investment in PennyMac Mortgage Investment Trust		1,397		—		—		1,397
Mortgage servicing rights at fair value		—		—		2,820,612		2,820,612
	$	126,052	$	2,300,847	$	3,157,897	$	5,557,827
Liabilities:
Excess servicing spread financing payable to PennyMac Mortgage Investment Trust at fair value	$	—	$	—	$	216,110	$	216,110
Derivative liabilities:
Interest rate lock commitments		—		—		1,169		1,169
Forward purchase contracts		—		215		—		215
Forward sales contracts		—		26,762		—		26,762
Total derivative liabilities before netting		—		26,977		1,169		28,146
Netting		—		—		—		(25,082)
Total derivative liabilities		—		26,977		1,169		3,064
Mortgage servicing liabilities at fair value		—		—		8,681		8,681
	$	—	$	26,977	$	225,960	$	227,855


	December 31, 2017
	Level 1		Level 2		Level 3		Total
	(in thousands)
Assets:
Short-term investments	$	170,080	$	—	$	—	$	170,080
Mortgage loans held for sale at fair value		—		2,316,892		782,211		3,099,103
Derivative assets:
Interest rate lock commitments		—		—		60,012		60,012
Repurchase agreement derivatives		—		—		10,656		10,656
Forward purchase contracts		—		4,288		—		4,288
Forward sales contracts		—		2,101		—		2,101
MBS put options		—		3,481		—		3,481
Put options on interest rate futures purchase contracts		3,570		—		—		3,570
Call options on interest rate futures purchase contracts		938		—		—		938
Total derivative assets before netting		4,508		9,870		70,668		85,046
Netting		—		—		—		(6,867)
Total derivative assets		4,508		9,870		70,668		78,179
Investment in PennyMac Mortgage Investment Trust		1,205		—		—		1,205
Mortgage servicing rights at fair value		—		—		638,010		638,010
	$	175,793	$	2,326,762	$	1,490,889	$	3,986,577
Liabilities:
Excess servicing spread financing payable to PennyMac Mortgage Investment Trust at fair value	$	—	$	—	$	236,534	$	236,534
Derivative liabilities:
Interest rate lock commitments		—		—		1,740		1,740
Forward purchase contracts		—		1,272		—		1,272
Forward sales contracts		—		7,031		—		7,031
Total derivative liabilities before netting		—		8,303		1,740		10,043
Netting		—		—		—		(4,247)
Total derivative liabilities		—		8,303		1,740		5,796
Mortgage servicing liabilities at fair value		—		—		14,120		14,120
	$	—	$	8,303	$	252,394	$	256,450

As shown above, certain of the Company’s mortgage loans held for sale, IRLCs, repurchase agreement derivatives, MSRs at fair value, ESS and MSLs are measured using Level 3 fair value inputs. Following are roll forwards of these items for each of the three years ended December 31, 2018 where significant Level 3 fair value inputs were used:


	Year ended December 31, 2018
	Mortgage		Net interest		Repurchase		Mortgage
	loans held		rate lock		agreement		servicing
	for sale		commitments (1)		derivatives		rights			Total
	(in thousands)
Assets:
Balance, December 31, 2017	$	782,211	$	58,272	$	10,656	$	638,010	$	1,489,149
Reclassification of mortgage servicing rights previously accounted for under the amortization method pursuant to adoption of the fair value method of accounting		—		—		—		1,482,426		1,482,426
Balance, January 1, 2018		782,211		58,272		10,656		2,120,436		2,971,575
Purchases and issuances, net		2,972,042		195,974		49,725		237,803		3,455,544
Sales and repayments		(1,360,667)		—		(31,907)		—		(1,392,574)
Mortgage servicing rights resulting from mortgage loan sales		—		—		—		591,757		591,757
Changes in fair value included in income arising from:
Changes in instrument-specific credit risk		158		—		—		—		158
Other factors		—		1,285		(1,704)		(129,384)		(129,803)
		158		1,285		(1,704)		(129,384)		(129,645)
Transfers from Level 3 to Level 2		(2,128,551)		—		—		—		(2,128,551)
Transfers to real estate acquired in settlement of loans		(5,185)		—		—		—		(5,185)
Transfers of interest rate lock commitments to mortgage loans held for sale		—		(206,193)		—		—		(206,193)
Balance, December 31, 2018	$	260,008	$	49,338	$	26,770	$	2,820,612	$	3,156,728
Changes in fair value recognized during the year relating to assets still held at December 31, 2018	$	(263)	$	49,338	$	—	$	(129,384)	$	(80,309)

(1)

For the purpose of this table, the IRLC asset and liability positions are shown net.


	Year ended December 31, 2018
	Excess
	servicing		Mortgage
	spread		servicing
	financing		liabilities		Total
	(in thousands)
Liabilities:
Balance, December 31, 2017	$	236,534	$	14,120	$	250,654
Issuance of excess servicing spread financing pursuant to a recapture agreement with PennyMac Mortgage Investment Trust		2,688		—		2,688
Accrual of interest		15,138		—		15,138
Repayments		(46,750)		—		(46,750)
Mortgage servicing liabilities resulting from mortgage loan sales		—		7,601		7,601
Changes in fair value included in income		8,500		(13,040)		(4,540)
Balance, December 31, 2018	$	216,110	$	8,681	$	224,791
Changes in fair value recognized during the year relating to liabilities still outstanding at December 31, 2018	$	8,500	$	(13,040)	$	(4,540)


	Year ended December 31, 2017
	Mortgage		Net interest		Repurchase		Mortgage
	loans held		rate lock		agreement		servicing
	for sale		commitments (1)		derivatives		rights			Total
	(in thousands)
Assets:
Balance, December 31, 2016	$	47,271	$	59,391	$	—	$	515,925	$	622,587
Purchases and issuances, net		2,928,249		302,389		10,986		183,850		3,425,474
Sales and repayments		(1,339,580)		—		—		—		(1,339,580)
Mortgage servicing rights resulting from mortgage loan sales		—		—		—		24,471		24,471
Changes in fair value included in income arising from:
Changes in instrument-specific credit risk		(1,794)		—		—		—		(1,794)
Other factors		—		115,434		(330)		(86,236)		28,868
		(1,794)		115,434		(330)		(86,236)		27,074
Transfers from Level 3 to Level 2		(851,935)		—		—		—		(851,935)
Transfers of interest rate lock commitments to mortgage loans held for sale		—		(418,942)		—		—		(418,942)
Balance, December 31, 2017	$	782,211	$	58,272	$	10,656	$	638,010	$	1,489,149
Changes in fair value recognized during the year relating to assets still held at December 31, 2017	$	(556)	$	58,272	$	(330)	$	(86,236)	$	(28,850)

(1)

For the purpose of this table, the IRLC asset and liability positions are shown net.


	Year ended December 31, 2017
	Excess
	servicing		Mortgage
	spread		servicing
	financing		liabilities		Total
	(in thousands)
Liabilities:
Balance, December 31, 2016	$	288,669	$	15,192	$	303,861
Issuance of excess servicing spread financing pursuant to a recapture agreement with PennyMac Mortgage Investment Trust		5,244		—		5,244
Accrual of interest		16,951		—		16,951
Repayments		(54,980)		—		(54,980)
Mortgage servicing liabilities resulting from mortgage loan sales		—		17,229		17,229
Changes in fair value included in income		(19,350)		(18,301)		(37,651)
Balance, December 31, 2017	$	236,534	$	14,120	$	250,654
Changes in fair value recognized during the year relating to liabilities still outstanding at December 31, 2017	$	(19,350)	$	(18,301)	$	(37,651)


	Year ended December 31, 2016
	Mortgage		Net interest		Mortgage
	loans held		rate lock		servicing
	for sale		commitments (1)		rights		Total
	(in thousands)
Assets:
Balance December 31, 2015	$	48,531	$	43,773	$	660,247	$	752,551
Purchases		1,608,627		—		146		1,608,773
Sales and repayments		(1,202,621)		—		—		(1,202,621)
Interest rate lock commitments issued, net		—		429,598		—		429,598
Mortgage servicing rights resulting from mortgage loan sales		—		—		17,319		17,319
Changes in fair value included in income arising from:
Changes in instrument-specific credit risk		3,469		—		—		3,469
Other factors		—		143,867		(161,787)		(17,920)
		3,469		143,867		(161,787)		(14,451)
Transfers from Level 3 to Level 2		(410,735)		—		—		(410,735)
Transfers of interest rate lock commitments to mortgage loans held for sale		—		(557,847)		—		(557,847)
Balance, December 31, 2016	$	47,271	$	59,391	$	515,925	$	622,587
Changes in fair value recognized during the year relating to assets still held at December 31, 2016	$	936	$	59,391	$	(161,787)	$	(101,460)

(1)

For the purpose of this table, the IRLC asset and liability positions are shown net.


	Year ended December 31, 2016
	Excess
	servicing		Mortgage
	spread		servicing
	financing		liabilities		Total
	(in thousands)
Liabilities:
Balance December 31, 2015	$	412,425	$	1,399	$	413,824
Issuance of excess servicing spread financing pursuant to a recapture agreement with PennyMac Mortgage Investment Trust		6,603		—		6,603
Accrual of interest		22,601		—		22,601
Repayments		(69,992)		—		(69,992)
Settlement		(59,045)		—		(59,045)
Mortgage servicing liabilities resulting from mortgage loan sales		—		14,991		14,991
Mortgage servicing liabilities assumed		—		10,139		10,139
Changes in fair value included in income		(23,923)		(11,337)		(35,260)
Balance, December 31, 2016	$	288,669	$	15,192	$	303,861
Changes in fair value recognized during the year relating to liabilities still outstanding at December 31, 2016	$	(16,713)	$	(11,337)	$	(28,050)

The information used in the preceding roll forwards represents activity for any assets and liabilities 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 years 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 or funding of the respective mortgage loans and from the return to salability in the active secondary market of certain mortgage loans held for sale.

Assets and Liabilities Measured at Fair Value under the Fair Value Option

Net changes in fair values included in income for assets and liabilities carried at fair value as a result of management’s election of the fair value option by income statement line item are summarized below:


	Year ended December 31,
	2018						2017						2016
	Net		Net gains on				Net		Net gains on				Net		Net gains on
	mortgage		mortgage				mortgage		mortgage				mortgage		mortgage
	loan		loans held				loan		loans held				loan		loans held
	servicing		for sale at				servicing		for sale at				servicing		for sale at
	fees		fair value		Total		fees		fair value		Total		fees		fair value		Total
	(in thousands)
Assets:
Mortgage loans held for sale	$	—	$	188,611	$	188,611	$	—	$	426,092	$	426,092	$	—	$	513,331	$	513,331
Mortgage servicing rights		(129,384)		—		(129,384)		(86,236)		—		(86,236)		(161,787)		—		(161,787)
	$	(129,384)	$	188,611	$	59,227	$	(86,236)	$	426,092	$	339,856	$	(161,787)	$	513,331	$	351,544
Liabilities:
Excess servicing spread financing at fair value payable to PennyMac Mortgage Investment Trust	$	(8,500)	$	—	$	(8,500)	$	19,350	$	—	$	19,350	$	23,923	$	—	$	23,923
Mortgage servicing liabilities		13,040		—		13,040		18,301		—		18,301		11,337		—		11,337
	$	4,540	$	—	$	4,540	$	37,651	$	—	$	37,651	$	35,260	$	—	$	35,260

Following are the fair value and related principal amounts due upon maturity of assets accounted for under the fair value option:


	December 31, 2018						December 31, 2017
			Principal						Principal
			amount						amount
	Fair		due upon				Fair		due upon
	value		maturity		Difference		value		maturity		Difference
	(in thousands)
Mortgage loans held for sale:
Current through 89 days delinquent	$	2,324,203	$	2,220,371	$	103,832	$	2,430,517	$	2,326,772	$	103,745
90 days or more delinquent:
Not in foreclosure		143,631		144,011		(380)		614,329		614,357		(28)
In foreclosure		53,813		56,254		(2,441)		54,257		57,248		(2,991)
	$	2,521,647	$	2,420,636	$	101,011	$	3,099,103	$	2,998,377	$	100,726

Assets Measured at Fair Value on a Nonrecurring Basis

Following is a summary of assets that are measured at fair value on a nonrecurring basis:


	December 31, 2018
	Level 1		Level 2		Level 3		Total
	(in thousands)
Real estate acquired in settlement of loans	$	—	$	—	$	2,150	$	2,150


	December 31, 2017
	Level 1		Level 2		Level 3		Total
	(in thousands)
Mortgage servicing rights at lower of amortized cost or fair value	$	—	$	—	$	1,463,552	$	1,463,552
Real estate acquired in settlement of loans		—		—		2,355		2,355
	$	—	$	—	$	1,465,907	$	1,465,907

The following table summarizes the total net losses on assets measured at fair values on a nonrecurring basis:


	Year ended December 31,
	2018		2017		2016
	(in thousands)
Mortgage servicing rights at lower of amortized cost or fair value	$	—	$	(6,853)	$	(60,487)
Real estate acquired in settlement of loans		(75)		(125)		(86)
	$	(75)	$	(6,978)	$	(60,487)

Fair Value of Financial Instruments Carried at Amortized Cost

The Company’s Assets purchased from PennyMac Mortgage Investment Trust under agreements to resell, Assets sold under agreements to repurchase, Mortgage loan participation purchase and sale agreements, Notes payable and Obligations under capital lease are carried at amortized cost.

These assets and liabilities are classified as “Level 3” fair value items due to the Company’s reliance on unobservable inputs to estimate these instruments’ fair values. The Company has concluded that these assets and liabilities’ fair values approximate the carrying value other than the term notes due to their short terms and/or variable interest rates. The fair value of the term notes at December 31, 2018 and 2017, was $1.3 billion and $903.9 million, respectively. The fair value of term notes is estimated using a discounted cash flow approach using indications of market pricing spreads provided by non-affiliated brokers to develop an appropriate discount rate.

Valuation Governance

Most of the Company’s financial assets, and all of its MSRs, ESS, derivative liabilities and MSLs, are carried at fair value with changes in fair value recognized in current period income. Certain of the Company’s financial assets and all of its MSRs, ESS and MSLs are “Level 3” fair value assets and liabilities which require the use of unobservable inputs that are significant to the estimation of the items’ fair values. Unobservable inputs reflect the Company’s own judgments about the factors that market participants use in pricing an asset or liability, and are based on the best information available under the circumstances.

Due to the difficulty in estimating the fair values of “Level 3” fair value assets and liabilities, management has assigned the responsibility for estimating the fair value of these items to specialized staff and subjects the valuation process to significant senior management oversight. The Company’s Financial Analysis and Valuation group (the “FAV group”) is the Company’s specialized staff responsible for estimating the fair values of “Level 3” fair value assets and liabilities other than IRLCs.

With respect to the non-IRLC “Level 3” valuations, the FAV group reports to the Company’s senior management valuation committee, which oversees the valuations. The FAV group monitors the models used for valuation of the Company’s “Level 3” fair value assets and liabilities, including the models’ performance versus actual results, and reports those results to the Company’s senior management valuation committee. The Company’s senior management valuation committee includes the Company’s executive chairman, chief executive, chief financial, chief risk and deputy chief financial officers.

The FAV group is responsible for reporting to the Company’s senior management valuation committee on the changes in the valuation of the non-IRLC “Level 3” fair value 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 Company has assigned responsibility for developing IRLCs fair values to its Capital Markets Risk Management staff. The fair values developed by the Capital Markets Risk Management staff are reviewed by the Company’s Capital Markets Operations group.

Valuation Techniques and Inputs

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 Loans Held for Sale

Most of the Company’s mortgage loans held for sale at fair value are saleable into active markets and are therefore categorized as “Level 2” fair value assets. The fair values of “Level 2” fair value mortgage loans are determined using their quoted market or contracted selling price or market price equivalent.

Certain of the Company’s mortgage loans held for sale are not saleable into active markets and are therefore categorized as “Level 3” fair value assets. Mortgage loans held for sale categorized as “Level 3” fair value assets include:

Certain delinquent government guaranteed or insured mortgage loans purchased by the Company from Ginnie Mae guaranteed pools in its mortgage loan servicing portfolio. The Company’s right to purchase delinquent government guaranteed or insured mortgage loans arises as the result of the borrower’s failure to make payments for at least three consecutive months preceding the month of repurchase by the Company and provides an alternative to the Company’s obligation to continue advancing principal and interest at the coupon rate of the related Ginnie Mae security. Such repurchased mortgage loans may be resold to investors and thereafter may be repurchased to the extent eligible for resale into a new Ginnie Mae guaranteed pool. Such eligibility for resale generally occurs when the repurchased mortgage loans become current either through the borrower’s reperformance or through completion of a modification of the mortgage loan’s terms.

Certain of the Company’s mortgage loans held for sale that become non-saleable into active markets due to identification of a defect by the Company or to the repurchase by the Company of a mortgage loan with an identified defect.

The Company uses a discounted cash flow model to estimate the fair value of its “Level 3” fair value mortgage loans held for sale. The significant unobservable inputs used in the fair value measurement of the Company’s “Level 3” fair value mortgage loans held for sale are discount rates, home price projections, voluntary prepayment/resale speeds and total prepayment 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.

Following is a quantitative summary of key “Level 3” fair value inputs used in the valuation of mortgage loans held for sale at fair value:



Key inputs (1)	December 31, 2018	December 31, 2017
Discount rate:
Range	2.8% – 9.2%	2.9% – 10.0%
Weighted average	2.9%	2.9%
Twelve-month projected housing price index change:
Range	2.2% – 5.0%	3.1% – 5.6%
Weighted average	3.5%	3.6%
Voluntary prepayment / resale speed (2):
Range	0.1% – 21.8%	0.2% – 72.2%
Weighted average	20.1%	44.6%
Total prepayment speed (3):
Range	0.1% – 40.5%	0.2% – 75.2%
Weighted average	37.7%	55.8%

(1)

Weighted average inputs are based on fair value of mortgage loans.

(2)

Voluntary prepayment/resale speed is measured using Life Voluntary Conditional Prepayment Rate (“CPR”).

(3)

Total prepayment speed is measured using Life Total CPR.

Changes in fair value attributable to changes in instrument specific credit risk are measured by reference to the change in the respective mortgage loan’s delinquency status and performance history at year end from the later of the beginning of the year or acquisition date. Changes in fair value of mortgage loans held for sale are included in Net gains on mortgage loans held for sale at fair value in the Company’s consolidated statements of income.

Derivative Financial Instruments

Interest Rate Lock Commitments

The Company categorizes IRLCs as a “Level 3” fair value asset or liability. The Company estimates the fair value of an IRLC 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 loans and the probability that the mortgage loan will fund or be purchased (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, could result in significant changes in the IRLCs’ fair value measurement. 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 fair value, but increase the pull-through rate for the mortgage loan principal and interest payment cash flow component, which has decreased in fair value.

Changes in fair value of IRLCs are included in Net gains on mortgage loans acquired for sale at fair value and may be allocated to Net mortgage loan servicing fees – Amortization, impairment and change in fair value of mortgage servicing rights and mortgage servicing liabilities as an economic hedge of the fair value of MSRs in the consolidated statements of income when IRLCs are included as a component of the Company’s MSR hedging strategy.

Following is a quantitative summary of key unobservable inputs used in the valuation of IRLCs:



Key inputs (1)	December 31, 2018	December 31, 2017
Pull-through rate:
Range	16.6% – 100%	25.0% – 100%
Weighted average	84.1%	85.6%
Mortgage servicing rights value expressed as:
Servicing fee multiple:
Range	1.5 – 5.5	1.4 – 5.8
Weighted average	3.8	4.0
Percentage of unpaid principal balance:
Range	0.4% – 3.2%	0.3% – 3.0%
Weighted average	1.5%	1.4%

(1)

Weighted average inputs are based on the committed amounts.

Hedging Derivatives

Fair value of exchange-traded hedging derivative financial instruments are categorized by the Company as “Level 1” fair value assets and liabilities. Fair value of hedging derivative financial instruments based on observable MBS prices or interest rate volatilities in the MBS market are categorized as “Level 2” fair value assets and liabilities.

Changes in the fair value of hedging derivatives are included in Net gains on mortgage loans acquired for sale at fair value, or Net mortgage loan servicing fees – Amortization, impairment and change in fair value of mortgage servicing rights and mortgage servicing liabilities, as applicable, in the consolidated statements of income.

Repurchase Agreement Derivatives

The Company has a master repurchase agreement that includes incentives for financing mortgage loans approved for satisfying certain consumer relief characteristics. These incentives are classified for financial reporting purposes as embedded derivatives and are accounted for separate from the master repurchase agreement. The Company classifies these derivatives as “Level 3” fair value assets. The significant unobservable inputs into the valuation of these derivative assets are the discount rate and the Company’s expected approval rate of the mortgage loans financed under the master repurchase agreement. The resulting ratio included in the Company’s fair value estimate was 97% at December 31, 2018.

Mortgage Servicing Rights

MSRs are categorized as “Level 3” fair value assets. 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 prepayment and default rates of the underlying mortgage loans, the applicable pricing spread (discount rate) and annual per-loan cost to service mortgage loans, all of which are unobservable. Significant changes to any of those inputs in isolation could result in a significant change in the MSR fair value measurement. Changes in these key inputs are not necessarily directly related. Recognized changes in the fair value of MSRs are included in Net mortgage loan servicing fees—Amortization, impairment and change in fair value of mortgage servicing rights and mortgage servicing liabilities in the consolidated statements of income.

Following are the key inputs, separated by the Company’s basis of accounting for the respective asset, used in determining the fair value of MSRs at the time of initial recognition, excluding MSR purchases:


	Year ended December 31,
	2018	2017		2016
	Fair	Fair	Amortized	Fair	Amortized
	value	value	cost	value	cost
	(Amount recognized and unpaid principal balance of underlying mortgage loans amounts in thousands)
MSR and pool characteristics:
Amount recognized	$591,757	$24,471	$556,630	$17,319	$560,212
Unpaid principal balance of underlying mortgage loans	$42,008,585	$2,316,539	$44,664,551	$1,452,779	$44,827,516
Weighted average servicing fee rate (in basis points)	36	31	31	33	30
Key inputs (1):
Pricing spread (2):
Range	5.8% – 16.4%	7.6% – 11.2%	7.6% – 15.2%	7.2% – 10.5%	7.2% – 14.4%
Weighted average	9.9%	10.5%	10.7%	9.2%	9.5%
Annual total prepayment speed (3):
Range	3.9% – 61.8%	3.9% – 71.8%	3.4% – 47.6%	3.3% – 53.8%	2.8% – 50.9%
Weighted average	10.8%	12.6%	9.1%	11.8%	9.0%
Life (in years):
Range	0.5 – 11.6	0.8 – 11.7	1.5 – 12.2	0.5 – 11.9	1.3 – 12.9
Weighted average	7.3	6.6	8.1	6.8	8.1
Per-loan annual cost of servicing:
Range	$78 – $99	$78 – $101	$79 – $101	$68 – $105	$68 – $106
Weighted average	$91	$89	$89	$88	$89

(1)

Weighted average inputs are based on UPB of the underlying mortgage loans.

(2)

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 MSRs.

(3)

Prepayment speed is measured using Life Total CPR.

Following is a quantitative summary of key inputs, separated by the Company’s basis of accounting for the respective asset, used in the valuation and assessment for impairment of the Company’s MSRs at year end and the effect on the fair value from adverse changes in those inputs:


	December 31, 2018	December 31, 2017
	Fair	Fair	Amortized
	value	value	cost
	(Carrying value, unpaid principal balance of underlying
	mortgage loans and effect on fair value amounts in thousands)
MSR and pool characteristics:
Carrying value	$2,820,612	$638,010	$1,481,578
Unpaid principal balance of underlying mortgage loans	$201,054,144	$51,883,539	$114,365,698
Weighted average note interest rate	4.0%	4.0%	3.8%
Weighted average servicing fee rate (in basis points)	33	32	31
Key inputs (1):
Pricing spread (2):
Range	5.8% – 16.1%	7.6% – 14.1%	7.6% – 14.1%
Weighted average	8.7%	9.8%	10.3%
Effect on fair value of (3):
5% adverse change	($45,268)	($10,760)	($27,700)
10% adverse change	($89,073)	($21,155)	($54,376)
20% adverse change	($172,556)	($40,916)	($104,869)
Prepayment speed (4):
Range	8.4% – 32.6%	7.9% – 46.2%	7.4% – 44.1%
Weighted average	9.9%	10.5%	9.7%
Average life (in years):
Range	1.5 – 7.9	1.2 – 7.8	2.0 – 8.3
Weighted average	7.2	6.6	7.5
Effect on fair value of (3):
5% adverse change	($47,687)	($10,809)	($23,544)
10% adverse change	($93,626)	($21,239)	($46,284)
20% adverse change	($180,623)	($41,038)	($89,514)
Annual per-loan cost of servicing:
Range	$78 – $99	$78 – $97	$79 – $97
Weighted average	$93	$89	$89
Effect on fair value of (3):
5% adverse change	($22,944)	($6,247)	($11,216)
10% adverse change	($45,888)	($12,494)	($22,431)
20% adverse change	($91,775)	($24,987)	($44,863)

(1)

Weighted average inputs are based on UPB of the underlying mortgage loans.

(2)

The Company applies a pricing spread to the United States Dollar LIBOR curve for purposes of discounting cash flows relating to MSRs.

(3)

For MSRs carried at fair value, an adverse change in one of the above-mentioned key inputs is expected to result in a reduction in fair value which would be recognized in income. For MSRs carried at lower of amortized cost or fair value, an adverse change in one of the above-mentioned key inputs may have resulted in recognition of MSR impairment. The extent of the recognized MSR impairment depended on the relationship of fair value to the carrying value of such MSRs immediately before the adverse change event.

(4)

Prepayment speed is measured using Life Total CPR.

The preceding sensitivity analyses are limited in that they were performed as of a particular date; only contemplate the movements in the indicated inputs; do not incorporate changes to other inputs; are subject to the accuracy of the models and inputs used; and do not incorporate other factors that would affect the Company’s overall financial performance in such events, including operational adjustments made by management to account for changing circumstances. For these reasons, the preceding estimates should not be viewed as earnings forecasts.

Excess Servicing Spread Financing at Fair Value

The Company categorizes ESS as a “Level 3” fair value liability. Because the ESS is a claim to a portion of the cash flows from MSRs, the fair value measurement of the ESS is similar to that of MSRs. The Company uses the same discounted cash flow approach to measuring the ESS as it uses to measure MSRs except that certain inputs relating to the cost to service the mortgage loans underlying the MSR and certain ancillary income are not included as these cash flows do not accrue to the holder of the ESS. The key inputs used in the estimation of ESS fair value include pricing spread (discount rate) and prepayment speed. Significant changes to either of those inputs in isolation could result in a significant change in the fair value of ESS. Changes in these key inputs are not necessarily directly related.

ESS is generally subject to fair value increases when mortgage interest rates increase. Increasing mortgage interest rates normally discourage mortgage refinancing activity. Decreased refinancing activity increases the life of the mortgage loans underlying the ESS, thereby increasing its fair value. Changes in the fair value of ESS are included in Net mortgage loan servicing fees—Change in fair value of excess servicing spread payable to PennyMac Mortgage Investment Trust.

Following are the key inputs used in determining the fair value of ESS financing:


	December 31,	December 31,
	2018	2017
Carrying value (in thousands)	$216,110	$236,534
ESS and pool characteristics:
Unpaid principal balance of underlying mortgage loans (in thousands)	$23,196,033	$27,217,199
Average servicing fee rate (in basis points)	34	34
Average excess servicing spread (in basis points)	19	19
Key inputs (1):
Pricing spread (2):
Range	2.8% – 3.2%	3.8% – 4.3%
Weighted average	3.1%	4.1%
Annualized prepayment speed (3):
Range	8.2% – 29.5%	8.4% – 41.4%
Weighted average	9.7%	10.8%
Average life (in years):
Range	1.6 – 7.6	1.4 – 7.7
Weighted average	6.8	6.5

(1)

Weighted average inputs are based on UPB of the underlying mortgage loans.

(2)

The Company applies a pricing spread to the United States Dollar LIBOR curve for purposes of discounting cash flows relating to ESS.

(3)

Prepayment speed is measured using Life Total CPR.

Mortgage Servicing Liabilities

MSLs are categorized as “Level 3” fair value liabilities. The Company uses a discounted cash flow approach to estimate the fair value of MSLs. This approach consists of projecting net servicing cash flows discounted at a rate that management believes market participants would use in their determinations of fair value. The key inputs used in the estimation of the fair value of MSLs include the applicable pricing spread (discount rate), the prepayment rates of the underlying mortgage loans, and the per-loan annual cost to service the respective mortgage loans. Changes in the fair value of MSLs are included in Net servicing fees—Amortization, impairment and change in fair value of mortgage servicing rights and mortgage servicing liabilities in the consolidated statements of income.

Following are the key inputs used in determining the fair value of MSLs:


		December 31,
		2018		2017
MSL and pool characteristics:
Carrying value (in thousands)	$	8,681	$	14,120
Unpaid principal balance of underlying mortgage loans (in thousands)	$	1,160,938	$	1,620,609
Servicing fee rate (in basis points)		25		25
Key inputs:
Pricing spread (1)		7.3%		7.7%
Prepayment speed (2)		32.2%		32.9%
Average life (in years)		3.8		3.5
Annual per-loan cost of servicing	$	373	$	404

(1)

The Company applies a pricing spread to the United States Dollar LIBOR curve for purposes of discounting cash flows relating to MSLs.

(2)

Prepayment speed is measured using Life Total CPR.