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 all of its MSRs, MSLs and all of its non-cash financial assets other than Assets purchased from PennyMac Mortgage Investment Trust under agreements to resell pledged to creditors, 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.

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, 2019
	Level 1		Level 2		Level 3		Total
	(in thousands)
Assets:
Short-term investments	$	74,611	$	—	$	—	$	74,611
Loans held for sale at fair value		—		4,529,075		383,878		4,912,953
Derivative assets:
Interest rate lock commitments		—		—		138,511		138,511
Repurchase agreement derivatives		—		—		8,187		8,187
Forward purchase contracts		—		12,364		—		12,364
Forward sales contracts		—		17,097		—		17,097
MBS put options		—		3,415		—		3,415
Swaptions		—		2,409				2,409
Put options on interest rate futures purchase contracts		3,945		—		—		3,945
Call options on interest rate futures purchase contracts		1,469		—		—		1,469
Total derivative assets before netting		5,414		35,285		146,698		187,397
Netting		—		—		—		(27,711)
Total derivative assets		5,414		35,285		146,698		159,686
Mortgage servicing rights at fair value		—		—		2,926,790		2,926,790
Investment in PennyMac Mortgage Investment Trust		1,672		—		—		1,672
	$	81,697	$	4,564,360	$	3,457,366	$	8,075,712
Liabilities:
Excess servicing spread financing payable to PennyMac Mortgage Investment Trust at fair value	$	—	$	—	$	178,586	$	178,586
Derivative liabilities:
Interest rate lock commitments		—		—		1,861		1,861
Forward purchase contracts		—		19,040		—		19,040
Forward sales contracts		—		18,045		—		18,045
Total derivative liabilities before netting		—		37,085		1,861		38,946
Netting		—		—		—		(16,616)
Total derivative liabilities		—		37,085		1,861		22,330
Mortgage servicing liabilities at fair value		—		—		29,140		29,140
	$	—	$	37,085	$	209,587	$	230,056


	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, certain of the Company’s loans held for sale, 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 three years ended December 31, 2019:


	Year ended December 31, 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		5,163,730		570,072		15,019		227,445		5,976,266
Capitalization of interest and advances		72,302		—		—		—		72,302
Sales and repayments		(3,456,856)		—		(31,993)		—		(3,488,849)
Mortgage servicing rights resulting from loan sales		—		—		—		884,876		884,876
Changes in fair value included in income arising from:
Changes in instrument-specific credit risk		(6,332)		—		—		—		(6,332)
Other factors		—		331,067		(1,609)		(1,006,143)		(676,685)
		(6,332)		331,067		(1,609)		(1,006,143)		(683,017)
Transfers from Level 3 to Level 2		(1,646,554)		—		—		—		(1,646,554)
Transfers to real estate acquired in settlement of loans		(2,420)		—		—		—		(2,420)
Transfers of interest rate lock commitments to loans held for sale		—		(813,827)		—		—		(813,827)
Balance, December 31, 2019	$	383,878	$	136,650	$	8,187	$	2,926,790	$	3,455,505
Changes in fair value recognized during the year relating to assets still held at December 31, 2019	$	(5,755)	$	136,650	$	165	$	(1,006,143)	$	(875,083)

(1)

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


	Year ended December 31, 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		1,757		—		1,757
Accrual of interest		10,291		—		10,291
Repayments		(40,316)		—		(40,316)
Mortgage servicing liabilities resulting from loan sales		—		37,988		37,988
Changes in fair value included in income		(9,256)		(17,529)		(26,785)
Balance, December 31, 2019	$	178,586	$	29,140	$	207,726
Changes in fair value recognized during the year relating to liabilities still outstanding at December 31, 2019	$	(9,256)	$	(17,529)	$	(26,785)


	Year ended December 31, 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		2,972,042		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 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 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
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		2,688		—		2,688
Accrual of interest		15,138		—		15,138
Repayments		(46,750)		—		(46,750)
Mortgage servicing liabilities resulting from 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
			Net interest		Repurchase		Mortgage
	Loans held		rate lock		agreement		servicing
Assets	for sale		commitments (1)		derivatives		rights			Total
	(in thousands)
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 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 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
Liabilities	financing		liabilities		Total
	(in thousands)
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 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)

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 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 the Company’s election of the fair value option by income statement line item are summarized below:


	Year ended December 31,
	2019						2018						2017
	Net		Net gains on				Net		Net gains on				Net		Net gains on
	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:
Loans held for sale	$	—	$	811,895	$	811,895	$	—	$	188,611	$	188,611	$	—	$	426,092	$	426,092
Mortgage servicing rights		(1,006,143)		—		(1,006,143)		(129,384)		—		(129,384)		(86,236)		—		(86,236)
	$	(1,006,143)	$	811,895	$	(194,248)	$	(129,384)	$	188,611	$	59,227	$	(86,236)	$	426,092	$	339,856
Liabilities:
Excess servicing spread financing payable to PennyMac Mortgage Investment Trust	$	9,256	$	—	$	9,256	$	(8,500)	$	—	$	(8,500)	$	19,350	$	—	$	19,350
Mortgage servicing liabilities		17,529		—		17,529		13,040		—		13,040		18,301		—		18,301
	$	26,785	$	—	$	26,785	$	4,540	$	—	$	4,540	$	37,651	$	—	$	37,651

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


	December 31, 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	$	4,628,333	$	4,431,854	$	196,479	$	2,324,203	$	2,220,371	$	103,832
90 days or more delinquent:
Not in foreclosure		236,650		241,958		(5,308)		143,631		144,011		(380)
In foreclosure		47,970		50,194		(2,224)		53,813		56,254		(2,441)
	$	4,912,953	$	4,724,006	$	188,947	$	2,521,647	$	2,420,636	$	101,011

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:


Real estate acquired in settlement of loans	Level 1		Level 2		Level 3		Total
	(in thousands)
December 31, 2019	$	—	$	—	$	9,850	$	9,850
December 31, 2018	$	—	$	—	$	2,150	$	2,150

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


	Year ended December 31,
	2019		2018		2017
	(in thousands)
Real estate acquired in settlement of loans	$	(1,913)	$	(75)	$	(125)
Mortgage servicing rights at lower of amortized cost or fair value		—		—		(6,853)
	$	(1,913)	$	(75)	$	(6,978)

Fair Value of Financial Instruments Carried at Amortized Cost

The Company’s Assets purchased from PennyMac Mortgage Investment Trust under agreements to resell pledged to creditors, Assets sold under agreements to repurchase, Mortgage loan participation purchase and sale agreements, Notes payable secured by mortgage servicing assets 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 secured by mortgage servicing assets approximate their carrying values due to their short terms and/or variable interest rates.

The fair value of the Term Notes at December 31, 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	December 31, 2019		December 31, 2018
	(in thousands)
Fair value	$	1,303,047	$	1,285,894
Carrying value	$	1,294,070	$	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 require 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, 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. During the years presented, the Company’s senior management valuation committee included 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 quoted market or contracted selling price or market price equivalent.

Certain of the Company’s loans held for sale are not saleable into active markets with observable inputs that are significant to the estimation of fair value 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 loan being at least three months delinquent on the date of repurchase by the Company and provides an alternative to its 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 pool. Such eligibility for resale generally 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 PFSI’s loans held for sale that become non-saleable into active markets due to identification of a defect or to the repurchase of a loan with an identified defect by the Company.

Home equity lines of credit held for sale to PMT. At present, an active market with observable inputs that are significant to the estimation of fair value of home equity lines of credit does not exist.

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 at fair value:



	December 31, 2019		December 31, 2018
Fair value (in thousands)	$	383,878	$	260,008
Key inputs (1):
Discount rate:
Range		3.0% – 9.2%		2.8% – 9.2%
Weighted average		3.0%		2.9%
Twelve-month projected housing price index change:
Range		2.6% – 3.2%		2.2% – 5.0%
Weighted average		2.8%		3.5%
Voluntary prepayment/resale speed (2):
Range		0.4% – 21.4%		0.1% – 21.8%
Weighted average		18.2%		20.1%
Total prepayment speed (3):
Range		0.5% – 39.2%		0.1% – 40.5%
Weighted average		36.2%		37.7%

(1)

Weighted average inputs are based on 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.

All changes in fair value relating to loans held for sale are the result of changes in the loan’s instrument specific credit risk as indicated by successful modifications of the loan’s terms or changes in the respective 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 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

IRLCs are categorized 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 loans and the probability that the 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 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 loans acquired for sale at fair value in the consolidated statements of income.

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



	December 31, 2019		December 31, 2018
Fair value (in thousands) (1)	$	136,650	$	49,338
Key inputs (2):
Pull-through rate:
Range		12.2% – 100%		16.6% – 100%
Weighted average		86.5%		84.1%
Mortgage servicing rights value expressed as:
Servicing fee multiple:
Range		1.4 – 5.7		1.5 – 5.5
Weighted average		4.2		3.8
Percentage of unpaid principal balance:
Range		0.3% – 2.8%		0.4% – 3.2%
Weighted average		1.6%		1.5%

(1)

For purposes of this table, the IRLC assets and liability positions are shown net.

(2)

Weighted average inputs are based on the committed amounts.

Hedging Derivatives

Fair value of hedging derivative financial instruments that are actively traded on exchanges 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 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

Through August 21, 2019, the Company had a master repurchase agreement that included incentives for financing 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 loans financed under the master repurchase agreement. The resulting ratios included in the Company’s fair value estimate were 99.0% and 97.0% at December 31, 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 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 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,
	2019	2018	2017
	Fair	Fair	Fair	Amortized
	value	value	value	cost
	(Amount recognized and unpaid principal balance of underlying mortgage loans amounts in thousands)
MSR and pool characteristics:
Amount recognized	$884,876	$591,757	$24,471	$556,630
Unpaid principal balance of underlying mortgage loans	$56,038,354	$42,008,585	$2,316,539	$44,664,551
Weighted average servicing fee rate (in basis points)	41	36	31	31
Key inputs (1):
Pricing spread (2):
Range	5.5% – 16.2%	5.8% – 16.4%	7.6% – 11.2%	7.6% – 15.2%
Weighted average	8.5%	9.9%	10.5%	10.7%
Prepayment speed (3):
Range	7.7% – 32.8%	3.9% – 61.8%	3.9% – 71.8%	3.4% – 47.6%
Weighted average	13.5%	10.8%	12.6%	9.1%
Average life (in years):
Range	2.6 – 8.2	0.5 – 11.6	0.8 – 11.7	1.5 – 12.2
Weighted average	6.2	7.3	6.6	8.1
Annual per-loan cost of servicing:
Range	$78 – $100	$78 – $99	$78 – $101	$79 – $101
Weighted average	$97	$91	$89	$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”)/swap curve for purposes of discounting cash flows relating to MSRs.

(3)

Prepayment speed is measured using Life Total CPR. Equivalent average life is included for informational purposes.

Following is a quantitative summary of key inputs used in the valuation of the Company’s MSRs and the effect on the fair value from adverse changes in those inputs:


	December 31, 2019	December 31, 2018
	(Fair value, unpaid principal balance of underlying
	loans and effect on fair value amounts in thousands)
Fair value	$ 2,926,790	$ 2,820,612
Pool characteristics:
Unpaid principal balance of underlying loans	$ 225,787,103	$ 201,054,144
Weighted average note interest rate	3.9%	4.0%
Weighted average servicing fee rate (in basis points)	35	33
Key inputs (1):
Pricing spread (2):
Range	6.8% – 15.8%	5.8% – 16.1%
Weighted average	8.5%	8.7%
Effect on fair value of:
5% adverse change	($44,561)	($45,268)
10% adverse change	($87,734)	($89,073)
20% adverse change	($170,155)	($172,556)
Prepayment speed (3):
Range	9.3% – 40.9%	8.4% – 32.6%
Weighted average	12.7%	9.9%
Average life (in years):
Range	1.4 – 7.4	1.5 – 7.9
Weighted average	6.1	7.2
Effect on fair value of:
5% adverse change	($63,569)	($47,687)
10% adverse change	($124,411)	($93,626)
20% adverse change	($238,549)	($180,623)
Annual per-loan cost of servicing:
Range	$77 – $100	$78 – $99
Weighted average	$97	$93
Effect on fair value of:
5% adverse change	($24,516)	($22,944)
10% adverse change	($49,032)	($45,888)
20% adverse change	($98,065)	($91,775)

(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/swap curve for purposes of discounting cash flows relating to MSRs.

(3)

Prepayment speed is measured using Life Total CPR. Equivalent average life is included for informational purposes.

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 analysis should not be viewed as earnings forecasts.

Excess Servicing Spread Financing at Fair Value

ESS are categorized 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 MSRs 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 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,
	2019	2018
Fair value (in thousands)	$ 178,586	$ 216,110
Pool characteristics:
Unpaid principal balance of underlying loans (in thousands)	$ 19,904,571	$ 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	3.1%	3.1%
Annualized prepayment speed (3):
Range	8.7% – 16.2%	8.2% – 29.5%
Weighted average	11.0%	9.7%
Average life (in years):
Range	2.7 – 7.2	1.6 – 7.6
Weighted average	6.1	6.8

(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/swap curve for purposes of discounting cash flows relating to ESS.

(3)

Prepayment speed is measured using Life Total CPR. Equivalent average life is included for informational purposes.

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 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,
		2019		2018
Fair value (in thousands)	$	29,140	$	8,681
Pool characteristics:
Unpaid principal balance of underlying loans (in thousands)	$	2,758,454	$	1,160,938
Servicing fee rate (in basis points)		25		25
Key inputs:
Pricing spread (1)		8.2%		7.3%
Prepayment speed (2)		29.2%		32.2%
Average life (in years)		3.9		3.8
Annual per-loan cost of servicing	$	300	$	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. Equivalent average life is included for informational purposes.