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 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 an asset or liability and are developed based on market data obtained from sources independent of the Company.

Level 3— Prices determined using significant unobservable inputs. In situations where 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, 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 and liabilities, the Company 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 and liabilities and their fair values. Such differences may result in significantly different fair value measurements. Likewise, due to the general illiquidity of some of these assets and liabilities, subsequent transactions may be at values significantly different from those reported.

Fair Value Accounting Elections

The Company identified all of its MSRs, its mortgage servicing liabilities (“MSLs”) and all of its non-cash financial assets other than Assets purchased from PennyMac Mortgage Investment Trust under agreements to resell, 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. The Company has also identified its ESS financing to be accounted for at fair value as a means of hedging the related MSRs’ fair value risk.

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:


	September 30, 2019
	Level 1		Level 2		Level 3		Total
	(in thousands)
Assets:
Short-term investments	$	90,663	$	—	$	—	$	90,663
Loans held for sale at fair value		—		4,437,954		85,017		4,522,971
Derivative assets:
Interest rate lock commitments		—		—		147,400		147,400
Repurchase agreement derivatives		—		—		8,187		8,187
Forward purchase contracts		—		17,943		—		17,943
Forward sales contracts		—		6,141		—		6,141
MBS put options		—		10,040		—		10,040
Put options on interest rate futures purchase contracts		6,266		—		—		6,266
Call options on interest rate futures purchase contracts		2,414		—		—		2,414
Total derivative assets before netting		8,680		34,124		155,587		198,391
Netting		—		—		—		34,557
Total derivative assets		8,680		34,124		155,587		232,948
Mortgage servicing rights at fair value		—		—		2,556,253		2,556,253
Investment in PennyMac Mortgage Investment Trust		1,667		—		—		1,667
	$	101,010	$	4,472,078	$	2,796,857	$	7,404,502
Liabilities:
Excess servicing spread financing payable to PennyMac Mortgage Investment Trust at fair value	$	—	$	—	$	183,141	$	183,141
Derivative liabilities:
Interest rate lock commitments		—		—		2,276		2,276
Forward purchase contracts		—		51,585		—		51,585
Forward sales contracts		—		34,498		—		34,498
Total derivative liabilities before netting		—		86,083		2,276		88,359
Netting		—		—		—		(74,324)
Total derivative liabilities		—		86,083		2,276		14,035
Mortgage servicing liabilities at fair value		—		—		34,294		34,294
	$	—	$	86,083	$	219,711	$	231,470


	December 31, 2018
	Level 1		Level 2		Level 3		Total
	(in thousands)
Assets:
Short-term investments	$	117,824	$	—	$	—	$	117,824
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
Mortgage servicing rights at fair value		—		—		2,820,612		2,820,612
Investment in PennyMac Mortgage Investment Trust		1,397		—		—		1,397
	$	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

As shown above, all or a portion of the Company’s loans held for sale, Interest Rate Lock Commitments (“IRLCs”), repurchase agreement derivatives, MSRs, ESS and MSLs are measured using Level 3 fair value inputs. Following are roll forwards of these items for each of the quarter and nine month periods ended September 30, 2019 and 2018:


	Quarter ended September 30, 2019
			Net interest		Repurchase		Mortgage
	Loans held		rate lock		agreement		servicing
Assets	for sale		commitments (1)		derivatives		rights		Total
	(in thousands)
Balance, June 30, 2019	$	217,998	$	111,776	$	16,015	$	2,720,335	$	3,066,124
Purchases and issuances, net		1,861,769		199,274		1,502		46		2,062,591
Sales and repayments		(1,582,564)		—		(9,422)		—		(1,591,986)
Mortgage servicing rights resulting from loan sales		—		—		—		246,757		246,757
Changes in fair value included in income arising from:
Changes in instrument-specific credit risk		4,252		—		—		—		4,252
Other factors		—		92,138		92		(410,885)		(318,655)
		4,252		92,138		92		(410,885)		(314,403)
Transfers from Level 3 to Level 2		(416,062)		—		—		—		(416,062)
Transfers to real estate acquired in settlement of loans		(376)		—		—		—		(376)
Transfers of interest rate lock commitments to loans held for sale		—		(258,064)		—		—		(258,064)
Balance, September 30, 2019	$	85,017	$	145,124	$	8,187	$	2,556,253	$	2,794,581
Changes in fair value recognized during the quarter relating to assets still held at September 30, 2019	$	(2,328)	$	145,124	$	41	$	(410,885)	$	(268,048)

(1)

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


	Quarter ended September 30, 2019
	Excess
	servicing		Mortgage
	spread		servicing
Liabilities	financing		liabilities		Total
	(in thousands)
Balance, June 30, 2019	$	194,156	$	12,948	$	207,104
Issuance of excess servicing spread financing pursuant to a recapture agreement with PennyMac Mortgage Investment Trust		377		—		377
Accrual of interest		2,291		—		2,291
Repayments		(9,819)		—		(9,819)
Mortgage servicing liabilities resulting from loan sales		—		19,501		19,501
Changes in fair value included in income		(3,864)		1,845		(2,019)
Balance, September 30, 2019	$	183,141	$	34,294	$	217,435
Changes in fair value recognized during the quarter relating to liabilities still outstanding at September 30, 2019	$	(3,864)	$	1,845	$	(2,019)


	Quarter ended September 30, 2018
			Net interest		Repurchase		Mortgage
	Loans held		rate lock		agreement		servicing
Assets	for sale		commitments (1)		derivatives		rights			Total
	(in thousands)
Balance, June 30, 2018	$	334,166	$	55,689	$	25,781	$	2,486,157	$	2,901,793
Purchases and issuances, net		1,008,662		41,721		12,903		163,511		1,226,797
Sales and repayments		(231,921)		—		(11,982)		—		(243,903)
Mortgage servicing rights resulting from loan sales		—		—		—		149,000		149,000
Changes in fair value included in income arising from:
Changes in instrument-specific credit risk		84		—		—		—		84
Other factors		—		10,696		(227)		(12,704)		(2,235)
		84		10,696		(227)		(12,704)		(2,151)
Transfers from Level 3 to Level 2		(744,324)		—		—		—		(744,324)
Transfers to real estate acquired in settlement of loans		(1,364)		—		—		—		(1,364)
Transfers of interest rate lock commitments to loans held for sale		—		(70,943)		—		—		(70,943)
Balance, September 30, 2018	$	365,303	$	37,163	$	26,475	$	2,785,964	$	3,214,905
Changes in fair value recognized during the quarter relating to assets still held at September 30, 2018	$	(4,811)	$	37,163	$	—	$	(12,704)	$	19,648

(1)

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


	Quarter ended September 30, 2018
	Excess
	servicing		Mortgage
	spread		servicing
Liabilities	financing		liabilities		Total
	(in thousands)
Balance, June 30, 2018	$	229,470	$	10,253	$	239,723
Issuance of excess servicing spread financing pursuant to a recapture agreement with PennyMac Mortgage Investment Trust		499		—		499
Accrual of interest		3,740		—		3,740
Repayments		(11,543)		—		(11,543)
Mortgage servicing liabilities resulting from loan sales		—		1,741		1,741
Changes in fair value included in income		1,109		(2,225)		(1,116)
Balance, September 30, 2018	$	223,275	$	9,769	$	233,044
Changes in fair value recognized during the quarter relating to liabilities still outstanding at September 30, 2018	$	1,109	$	(2,225)	$	(1,116)


	Nine months ended September 30, 2019
			Net interest		Repurchase		Mortgage
	Loans held		rate lock		agreement		servicing
Assets	for sale		commitments (1)		derivatives		rights		Total
	(in thousands)
Balance, December 31, 2018	$	260,008	$	49,338	$	26,770	$	2,820,612	$	3,156,728
Purchases and issuances, net		3,537,177		376,137		15,019		227,445		4,155,778
Sales and repayments		(2,414,899)		—		(31,994)		—		(2,446,893)
Mortgage servicing rights resulting from loan sales		—		—		—		545,839		545,839
Changes in fair value included in income arising from:
Changes in instrument-specific credit risk		(2,025)		—		—		—		(2,025)
Other factors		—		248,889		(1,608)		(1,037,643)		(790,362)
		(2,025)		248,889		(1,608)		(1,037,643)		(792,387)
Transfers from Level 3 to Level 2		(1,292,824)		—		—		—		(1,292,824)
Transfers to real estate acquired in settlement of loans		(2,420)		—		—		—		(2,420)
Transfers of interest rate lock commitments to loans held for sale		—		(529,240)		—		—		(529,240)
Balance, September 30, 2019	$	85,017	$	145,124	$	8,187	$	2,556,253	$	2,794,581
Changes in fair value recognized during the period relating to assets still held at September 30, 2019	$	(2,478)	$	145,124	$	165	$	(1,037,643)	$	(894,832)

(1)

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


	Nine months ended September 30, 2019
	Excess
	servicing		Mortgage
	spread		servicing
Liabilities	financing		liabilities		Total
	(in thousands)
Balance, December 31, 2018	$	216,110	$	8,681	$	224,791
Issuance of excess servicing spread financing pursuant to a recapture agreement with PennyMac Mortgage Investment Trust		1,327		—		1,327
Accrual of interest		8,124		—		8,124
Repayments		(30,901)		—		(30,901)
Mortgage servicing liabilities resulting from loan sales		—		27,133		27,133
Changes in fair value included in income		(11,519)		(1,520)		(13,039)
Balance, September 30, 2019	$	183,141	$	34,294	$	217,435
Changes in fair value recognized during the period relating to liabilities still outstanding at September 30, 2019	$	(11,519)	$	(1,520)	$	(13,039)


	Nine months ended September 30, 2018
			Net interest		Repurchase		Mortgage
	Loans held		rate lock		agreement		servicing
Assets	for sale		commitments (1)		derivatives		rights		Total
	(in thousands)
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		2,480,523		157,649		36,624		193,640		2,868,436
Sales and repayments		(1,122,448)		—		(19,460)		—		(1,141,908)
Mortgage servicing rights resulting from loan sales		—		—		—		448,604		448,604
Changes in fair value included in income arising from:
Changes in instrument-specific credit risk		(4,944)		—		—		—		(4,944)
Other factors		—		(28,627)		(1,345)		23,284		(6,688)
		(4,944)		(28,627)		(1,345)		23,284		(11,632)
Transfers from Level 3 to Level 2		(1,765,854)		—		—		—		(1,765,854)
Transfers to real estate acquired in settlement of loans		(4,185)		—		—		—		(4,185)
Transfers of interest rate lock commitments to loans held for sale		—		(150,131)		—		—		(150,131)
Balance, September 30, 2018	$	365,303	$	37,163	$	26,475	$	2,785,964	$	3,214,905
Changes in fair value recognized during the period relating to assets still held at September 30, 2018	$	(4,912)	$	37,163	$	—	$	23,284	$	55,535

(1)

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


	Nine months ended September 30, 2018
	Excess
	servicing		Mortgage
	spread		servicing
Liabilities	financing		liabilities		Total
	(in thousands)
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		1,983		—		1,983
Accrual of interest		11,584		—		11,584
Repayments		(35,852)		—		(35,852)
Mortgage servicing liabilities resulting from loan sales		—		5,548		5,548
Changes in fair value included in income		9,026		(9,899)		(873)
Balance, September 30, 2018	$	223,275	$	9,769	$	233,044
Changes in fair value recognized during the period relating to liabilities still outstanding at September 30, 2018	$	9,026	$	(9,899)	$	(873)

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 periods presented. The Company had transfers among the fair value levels arising from transfers of IRLCs to loans held for sale at fair value upon purchase or funding of the respective loans and from the return to salability in the active secondary market of certain 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:


	Quarter ended September 30,
	2019						2018
	Net		Net gains on				Net		Net gains on
	loan		loans held				loan		loans held
	servicing		for sale at				servicing		for sale at
	fees		fair value		Total		fees		fair value		Total
	(in thousands)
Assets:
Loans held for sale	$	—	$	263,339	$	263,339	$	—	$	67,709	$	67,709
Mortgage servicing rights		(410,885)		—		(410,885)		(12,704)		—		(12,704)
	$	(410,885)	$	263,339	$	(147,546)	$	(12,704)	$	67,709	$	55,005
Liabilities:
Excess servicing spread financing payable to PennyMac Mortgage Investment Trust	$	3,864	$	—	$	3,864	$	(1,109)	$	—	$	(1,109)
Mortgage servicing liabilities		(1,845)		—		(1,845)		2,225		—		2,225
	$	2,019	$	—	$	2,019	$	1,116	$	—	$	1,116


	Nine months ended September 30,
	2019						2018
	Net		Net gains on				Net		Net gains on
	loan		loans held				loan		loans held
	servicing		for sale at				servicing		for sale at
	fees		fair value		Total		fees		fair value		Total
	(in thousands)
Assets:
Loans held for sale	$	—	$	538,086	$	538,086	$	—	$	118,452	$	118,452
Mortgage servicing rights		(1,037,643)		—		(1,037,643)		23,284		—		23,284
	$	(1,037,643)	$	538,086	$	(499,557)	$	23,284	$	118,452	$	141,736
Liabilities:
Excess servicing spread financing payable to PennyMac Mortgage Investment Trust	$	11,519	$	—	$	11,519	$	(9,026)	$	—	$	(9,026)
Mortgage servicing liabilities		1,520		—		1,520		9,899		—		9,899
	$	13,039	$	—	$	13,039	$	873	$	—	$	873

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


	September 30, 2019						December 31, 2018
			Principal						Principal
			amount						amount
	Fair		due upon				Fair		due upon
Loans held for sale	value		maturity		Difference		value		maturity		Difference
	(in thousands)
Current through 89 days delinquent	$	4,478,965	$	4,275,981	$	202,984	$	2,324,203	$	2,220,371	$	103,832
90 days or more delinquent:
Not in foreclosure		20,972		22,145		(1,173)		143,631		144,011		(380)
In foreclosure		23,034		25,126		(2,092)		53,813		56,254		(2,441)
	$	4,522,971	$	4,323,252	$	199,719	$	2,521,647	$	2,420,636	$	101,011

Assets Measured at Fair Value on a Nonrecurring Basis

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


Real estate acquired in settlement of loans	Level 1		Level 2		Level 3		Total
	(in thousands)
September 30, 2019	$	—	$	—	$	8,575	$	8,575
December 31, 2018	$	—	$	—	$	2,150	$	2,150

The following table summarizes the total gains (losses) on assets measured at fair value on a nonrecurring basis:


	Quarter ended September 30,				Nine months ended September 30,
	2019		2018		2019		2018
	(in thousands)
Real estate acquired in settlement of loans	$	139	$	(41)	$	162	$	(72)

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 their fair values. The Company has concluded that the fair values of these assets and liabilities other than the Term Notes included in Notes payable approximate their carrying values due to their short terms and/or variable interest rates.

The fair value of the Term Notes at September 30, 2019 was based on non-affiliate broker indications of fair value. The fair value of Term Notes at December 31, 2018 was estimated using a discounted cash flow approach using indications of market pricing spreads provided by non-affiliate brokers to develop an appropriate discount rate. The fair value and carrying value of the Term Notes are summarized below:


Term Notes	September 30, 2019		December 31, 2018
	(in thousands)
Fair value	$	1,306,828	$	1,285,894
Carrying value	$	1,293,625	$	1,292,291

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 are measured using 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, the Company 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 the fair values of IRLCs 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:

Loans Held for Sale

Most of the Company’s 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 loans are determined using their contracted selling price or quoted market price or market price equivalent.

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

Certain delinquent government guaranteed or insured loans purchased by the Company from Ginnie Mae guaranteed pools in its loan servicing portfolio. The Company’s right to purchase delinquent government guaranteed or insured 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 loans may be resold to investors and thereafter may be repurchased to the extent eligible for resale into a new Ginnie Mae guaranteed security. Such eligibility occurs when the repurchased loans become current either through the borrower’s reperformance or through completion of a modification of the loan’s terms.

Certain of the Company’s loans held for sale that are not saleable into active markets due to identification of a defect by the Company or to the repurchase by the Company of a loan with an identified defect.

The Company uses a discounted cash flow model to estimate the fair value of its “Level 3” fair value loans held for sale. The significant unobservable inputs used in the fair value measurement of the Company’s “Level 3” fair value 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 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 loans held for sale:



	September 30, 2019		December 31, 2018
Carrying value (in thousands)	$	85,017	$	260,008
Key inputs (1):
Discount rate:
Range		3.2% – 9.2%		2.8% – 9.2%
Weighted average		3.4%		2.9%
Twelve-month projected housing price index change:
Range		2.6% – 3.2%		2.2% – 5.0%
Weighted average		2.9%		3.5%
Voluntary prepayment/resale speed (2):
Range		0.3% – 19.2%		0.1% – 21.8%
Weighted average		15.8%		20.1%
Total prepayment speed (3):
Range		0.6% – 34.8%		0.1% – 40.5%
Weighted average		29.6%		37.7%

(1)

Weighted average inputs are based on the fair value of 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 loan’s delinquency status and performance history at period end from the later of the beginning of the period or acquisition date. Changes in fair value of loans held for sale are included in Net gains on 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 “Level 3” fair value assets or liabilities. 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 loans and the probability that the loan will be funded or 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 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 loan principal and interest payment cash flow component, which decreases in fair value.

Changes in fair value of IRLCs are included in Net gains on loans held for sale at fair value and may be allocated to Net loan servicing fees – 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:



	September 30, 2019		December 31, 2018
Carrying value (in thousands) (1)	$	145,124	$	49,338
Key inputs (2):
Pull-through rate:
Range		12.2% – 100%		16.6% – 100%
Weighted average		85.6%		84.1%
Mortgage servicing rights value expressed as:
Servicing fee multiple:
Range		1.4 – 5.7		1.5 – 5.5
Weighted average		4.0		3.8
Percentage of unpaid principal balance:
Range		0.3% – 2.9%		0.4% – 3.2%
Weighted average		1.6%		1.5%

(1)

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

(2)

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 loans acquired for sale at fair value, or Net mortgage loan servicing fees – Change in fair value of mortgage servicing rights and mortgage servicing liabilities, as applicable, in the consolidated statements of income.

Repurchase Agreement Derivatives

Through August 21, 2019, the Company had a master repurchase agreement that included 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 separated for reporting purposes from the master repurchase agreement. The Company classifies repurchase agreement derivatives as “Level 3” fair value assets. The significant unobservable inputs into the valuation of repurchase agreement 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 were 99.0% and 97.0% at September 30, 2019 and December 31, 2018, respectively.

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 the applicable pricing spread (discount rate), prepayment rates of the underlying loans, and annual per-loan cost to service the 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 in Net loan servicing fees—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 MSRs received by the Company when it retains the obligation to service the mortgage loans it sells:


	Quarter ended September 30,				Nine months ended September 30,
	2019		2018		2019		2018
	(Amount recognized and unpaid principal balance of underlying loans in thousands)
MSR and pool characteristics:
Amount recognized	$	246,757	$	149,000	$	545,839	$	448,604
Unpaid principal balance of underlying loans	$	15,709,249	$	10,790,398	$	35,532,425	$	32,095,458
Weighted average servicing fee rate (in basis points)		43		37		42		36
Key inputs (1):
Pricing spread (2)
Range		5.5% – 16.2%		7.3% – 13.6%		5.5% – 16.2%		7.3% – 14.1%
Weighted average		8.3%		10.1%		8.6%		10.2%
Annual total prepayment speed (3)
Range		8.8% – 32.1%		4.4% – 55.7%		7.7% – 32.8%		3.9% – 61.8%
Weighted average		15.7%		11.8%		15.0%		10.6%
Life (in years)
Range		2.7 – 7.5		0.5 – 11.3		2.6 – 7.8		0.5 – 11.6
Weighted average		5.5		6.9		5.8		7.5
Per-loan annual cost of servicing
Range		$78 – $100		$78 – $98		$78 – $100		$78 – $98
Weighted average		$97		$92		$97		$90

(1)

Weighted average inputs are based on the UPB of the underlying 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”)/swap 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 used in the valuation and assessment for the Company’s MSRs and the effect on the fair value from adverse changes in those inputs:


	September 30, 2019	December 31, 2018
	(Carrying value, unpaid principal balance of underlying
	loans and effect on fair value amounts in thousands)
MSR and pool characteristics:
Carrying value	$ 2,556,253	$ 2,820,612
Unpaid principal balance of underlying loans	$ 221,215,993	$ 201,054,144
Weighted average note interest rate	4.0%	4.0%
Weighted average servicing fee rate (in basis points)	34	33
Key inputs (1):
Pricing spread (2):
Range	5.9% – 15.8%	5.8% – 16.1%
Weighted average	8.5%	8.7%
Effect on fair value of:
5% adverse change	($35,830)	($45,268)
10% adverse change	($70,578)	($89,073)
20% adverse change	($137,016)	($172,556)
Prepayment speed (3):
Range	9.8% – 33.0%	8.4% – 32.6%
Weighted average	15.6%	9.9%
Average life (in years):
Range	1.4 – 7.2	1.5 – 7.9
Weighted average	5.2	7.2
Effect on fair value of:
5% adverse change	($64,047)	($47,687)
10% adverse change	($124,892)	($93,626)
20% adverse change	($237,822)	($180,623)
Annual per-loan cost of servicing:
Range	$77 – $100	$78 – $99
Weighted average	$96	$93
Effect on fair value of:
5% adverse change	($21,731)	($22,944)
10% adverse change	($43,462)	($45,888)
20% adverse change	($86,925)	($91,775)

(1)

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

(2)

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

(3)

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 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 loans underlying the ESS, thereby increasing its fair value. Changes in the fair value of ESS are included in Net loan servicing fees—Change in fair value of excess servicing spread payable to PennyMac Mortgage Investment Trust in the consolidated statements of income.

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


	September 30,	December 31,
	2019	2018
Carrying value (in thousands)	$ 183,141	$ 216,110
ESS and pool characteristics:
Unpaid principal balance of underlying loans (in thousands)	$ 20,794,571	$ 23,196,033
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	3.0% – 3.3%	2.8% – 3.2%
Weighted average	3.2%	3.1%
Annualized prepayment speed (3):
Range	8.9% – 15.0%	8.2% – 29.5%
Weighted average	11.7%	9.7%
Average life (in years):
Range	2.8 – 7.1	1.6 – 7.6
Weighted average	5.9	6.8

(1)

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

(2)

The Company applies a pricing spread to the United States Dollar LIBOR/swap 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 the Company 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 loans, and the per-loan annual cost to service the respective loans. Changes in the fair value of MSLs are included in Net servicing fees—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:


		September 30,		December 31,
		2019		2018
MSL and pool characteristics:
Carrying value (in thousands)	$	34,294	$	8,681
Unpaid principal balance of underlying loans (in thousands)	$	2,327,687	$	1,160,938
Servicing fee rate (in basis points)		25		25
Key inputs:
Pricing spread (1)		8.0%		7.3%
Prepayment speed (2)		31.6%		32.2%
Average life (in years)		3.3		3.8
Annual per-loan cost of servicing	$	338	$	373

(1)

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

(2)

Prepayment speed is measured using Life Total CPR.