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 significant inputs used to determine fair value. These levels are:

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.

The Company identified its MSRs, its mortgage servicing liabilities (“MSLs”) and all of its non-cash financial assets 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.

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

As shown above, all or a portion of the Company’s loans held for sale, Interest Rate Lock Commitments (“IRLCs”), MSRs, ESS and MSLs are measured using Level 3 fair value inputs. Following are roll forwards of assets and liabilities measured at fair value using “Level 3” inputs at either the beginning or the end of the period presented:

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

	Quarter ended
Liabilities	September 30, 2022
	(in thousands)
Mortgage servicing liabilities:
Balance, June 30, 2022	$	2,337
Changes in fair value included in income		(123)
Balance, September 30, 2022	$	2,214
Changes in fair value recognized during the quarter relating to liabilities still outstanding at September 30, 2022	$	(123)


	Quarter ended September 30, 2021
			Net interest		Mortgage
	Loans held		rate lock		servicing
Assets	for sale		commitments (1)		rights			Total

	(in thousands)
Balance, June 30, 2021	$	3,818,261	$	343,610	$	3,412,648	$	7,574,519
Purchases and issuances, net		5,573,766		449,834		—		6,023,600
Capitalization of interest and advances		40,035		—		—		40,035
Sales and repayments		(4,286,574)		—		—		(4,286,574)
Mortgage servicing rights resulting from loan sales		—		—		432,429		432,429
Changes in fair value included in income arising from:
Changes in instrument-specific credit risk		38,698		—		—		38,698
Other factors		—		236,316		(233,957)		2,359
		38,698		236,316		(233,957)		41,057
Transfers from Level 3 to Level 2		(3,068,841)		—		—		(3,068,841)
Transfers to loans held for sale		—		(668,837)		—		(668,837)
Balance, September 30, 2021	$	2,115,345	$	360,923	$	3,611,120	$	6,087,388
Changes in fair value recognized during the quarter relating to assets still held at September 30, 2021	$	16,415	$	360,923	$	(233,957)	$	143,381

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



	Quarter ended
Liabilities	September 30, 2021
	(in thousands)
Mortgage servicing liabilities:
Balance, June 30, 2021	$	100,091
Mortgage servicing liabilities resulting from loan sales		33,764
Changes in fair value included in income		(86,288)
Balance, September 30, 2021	$	47,567
Changes in fair value recognized during the quarter relating to liabilities still outstanding at September 30, 2021	$	(86,288)


	Nine months ended September 30, 2022
			Net interest		Mortgage
	Loans held		rate lock		servicing
Assets	for sale		commitments (1)		rights		Total

	(in thousands)
Balance, December 31, 2021	$	1,128,876	$	322,193	$	3,878,078	$	5,329,147
Purchases and issuances, net		2,994,447		345,770		4,140		3,344,357
Capitalization of interest and advances		54,080		—		—		54,080
Sales and repayments		(1,335,966)		—		—		(1,335,966)
Mortgage servicing rights resulting from loan sales		—		—		1,359,632		1,359,632
Changes in fair value included in income arising from:
Changes in instrument-specific credit risk		(39,427)		—		—		(39,427)
Other factors		(26,119)		(694,318)		419,822		(300,615)
		(65,546)		(694,318)		419,822		(340,042)
Transfers from Level 3 to Level 2		(2,430,869)		—		—		(2,430,869)
Transfers to real estate acquired in settlement of loans		(386)		—		—		(386)
Transfers to loans held for sale		—		(29,848)		—		(29,848)
Balance, September 30, 2022	$	344,636	$	(56,203)	$	5,661,672	$	5,950,105
Changes in fair value recognized during the period relating to assets still held at September 30, 2022	$	(31,587)	$	(56,203)	$	419,822	$	332,032

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



	Nine months ended
Liabilities	September 30, 2022
	(in thousands)
Mortgage servicing liabilities:
Balance, December 31, 2021	$	2,816
Changes in fair value included in income		(602)
Balance, September 30, 2022	$	2,214
Changes in fair value recognized during the period relating to liabilities still outstanding at September 30, 2022	$	(602)


	Nine months ended September 30, 2021
			Net interest		Mortgage
	Loans held		rate lock		servicing
Assets	for sale		commitments (1)		rights		Total

	(in thousands)
Balance, December 31, 2020	$	4,675,169	$	677,026	$	2,581,174	$	7,933,369
Purchases and issuances, net		16,630,301		1,279,701		—		17,910,002
Capitalization of interest and advances		118,879		—		—		118,879
Sales and repayments		(9,081,815)		—		—		(9,081,815)
Mortgage servicing rights resulting from loan sales		—		—		1,386,324		1,386,324
Changes in fair value included in income arising from:
Changes in instrument-specific credit risk		266,644		—		—		266,644
Other factors		—		389,138		(356,378)		32,760
		266,644		389,138		(356,378)		299,404
Transfers from Level 3 to Level 2		(10,493,751)		—		—		(10,493,751)
Transfers to real estate acquired in settlement of loans		(82)		—		—		(82)
Transfers of interest rate lock commitments to loans held for sale		—		(1,984,942)		—		(1,984,942)
Balance, September 30, 2021	$	2,115,345	$	360,923	$	3,611,120	$	6,087,388
Changes in fair value recognized during the period relating to assets still held at September 30, 2021	$	79,529	$	360,923	$	(356,378)	$	84,074

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


	Nine months ended September 30, 2021
	Excess
	servicing		Mortgage
	spread		servicing
Liabilities	financing		liabilities		Total

	(in thousands)
Balance, December 31, 2020	$	131,750	$	45,324	$	177,074
Issuance of excess servicing spread financing pursuant to a recapture agreement with PennyMac Mortgage Investment Trust		557		—		557
Accrual of interest		1,280		—		1,280
Mortgage servicing liabilities resulting from loan sales		—		98,147		98,147
Changes in fair value included in income		1,037		(95,904)		(94,867)
Repayments		(134,624)		—		(134,624)
Balance, September 30, 2021	$	—	$	47,567	$	47,567
Changes in fair value recognized during the period relating to liabilities still outstanding at September 30, 2021	$	—	$	(95,904)	$	(95,904)

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

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,
	2022						2021
	Net gains on		Net				Net gains on		Net
	loans held		loan				loans held		loan
	for sale at		servicing				for sale at		servicing
	fair value		fees		Total		fair value		fees		Total

	(in thousands)
Assets:
Loans held for sale	$	(69,358)	$	—	$	(69,358)	$	645,536	$	—	$	645,536
Mortgage servicing rights		—		95,288		95,288		—		(233,957)		(233,957)
	$	(69,358)	$	95,288	$	25,930	$	645,536	$	(233,957)	$	411,579
Liabilities:
Mortgage servicing liabilities	$	—	$	123	$	123	$	—	$	86,288	$	86,288


	Nine months ended September 30,
	2022						2021
	Net gains on		Net				Net gains on		Net
	loans held		loan				loans held		loan
	for sale at		servicing				for sale at		servicing
	fair value		fees		Total		fair value		fees		Total

	(in thousands)
Assets:
Loans held for sale	$	(273,701)	$	—	$	(273,701)	$	2,057,496	$	—	$	2,057,496
Mortgage servicing rights		—		419,822		419,822		—		(356,378)		(356,378)
	$	(273,701)	$	419,822	$	146,121	$	2,057,496	$	(356,378)	$	1,701,118
Liabilities:
Excess servicing spread financing payable to PennyMac Mortgage Investment Trust	$	—	$	—	$	—	$	—	$	(1,037)	$	(1,037)
Mortgage servicing liabilities		—		602		602		—		95,904		95,904
	$	—	$	602	$	602	$	—	$	94,867	$	94,867

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


	September 30, 2022						December 31, 2021
			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	$	4,087,039	$	4,217,099	$	(130,060)	$	9,577,398	$	9,263,242	$	314,156
90 days or more delinquent:
Not in foreclosure		50,232		54,141		(3,909)		153,162		153,875		(713)
In foreclosure		12,455		16,345		(3,890)		11,923		13,649		(1,726)
	$	4,149,726	$	4,287,585	$	(137,859)	$	9,742,483	$	9,430,766	$	311,717

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, 2022	$	—	$	—	$	911	$	911
December 31, 2021	$	—	$	—	$	2,588	$	2,588

The following table summarizes the losses recognized on assets when they were remeasured at fair value on a nonrecurring basis:


	Quarter ended September 30,				Nine months ended September 30,
	2022		2021		2022		2021

	(in thousands)
Real estate acquired in settlement of loans	$	(131)	$	(284)	$	(838)	$	(912)

Fair Value of Financial Instruments Carried at Amortized Cost

The Company’s Assets sold under agreements to repurchase, Mortgage loan participation purchase and sale agreements, Notes payable secured by mortgage servicing assets, Unsecured senior notes and Obligations under capital lease are carried at amortized cost.

These 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 liabilities other than Notes payable secured by mortgage servicing assets and the Unsecured senior notes approximate their carrying values due to their short terms and/or variable interest rates.

The Company estimates the fair value of the Notes payable secured by mortgage servicing assets and the Unsecured senior notes using indications of fair value provided by non-affiliate brokers. The fair value and carrying value of these notes are summarized below:


	September 30, 2022				December 31, 2021
	Fair value		Carrying value		Fair value		Carrying value

	(in thousands)
Notes payable secured by mortgage servicing assets	$	1,717,125	$	1,793,972	$	1,302,640	$	1,297,622
Unsecured senior notes	$	1,371,500	$	1,778,988	$	1,790,375	$	1,776,219

Valuation Governance

Most of the Company’s financial assets, and all of its derivatives, MSRs, ESS, 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 derivatives 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 responsibility for estimating the fair value of these assets and liabilities 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 responsible for estimating the fair values of “Level 3” fair value assets and liabilities other than IRLCs and maintaining its valuation policies and procedures.

●

The Company’s Capital Markets Risk Management staff develops the fair value of the Company’s IRLCs which is reviewed by its Capital Markets Operations group.

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 as well as 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 the Company’s senior management valuation committee. 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’s senior management valuation committee includes the Company’s chief financial, investment and credit officers as well as other senior members of the Company’s finance, capital markets and risk management staffs.

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:

●

Government guaranteed or insured loans purchased by the Company from Ginnie Mae guaranteed securities in its loan servicing portfolio. The Company’s right to purchase a government guaranteed or insured loan arises as the result of the loan being at least three months delinquent on the date of purchase 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 loans may be resold to investors and thereafter may be repurchased to the extent they become eligible for resale into a new Ginnie Mae guaranteed security.

Loans become eligible for resale into a new Ginnie Mae security when the loans become current either through completion of a modification of the loan’s terms or after six months of timely payments following either the completion of certain types of payment deferral programs or borrower reperformance and when the issuance date of the new security is at least 210 days after the date the loan was last delinquent.

●

Loans 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 and total prepayment/resale 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, 2022		December 31, 2021
Fair value (in thousands)	$	344,636	$	1,128,876
Key inputs (1):
Discount rate:
Range		3.3% – 10.2%		2.2% – 9.2%
Weighted average		3.6%		2.3%
Twelve-month projected housing price index change:
Range		(0.1)% – 0.1%		6.1% – 6.5%
Weighted average		0.0%		6.2%
Voluntary prepayment/resale speed (2):
Range		4.7% – 27.6%		0.4% – 30.3%
Weighted average		24.4%		22.0%
Total prepayment/resale speed (3):
Range		4.8% – 37.4%		0.4% – 39.3%
Weighted average		31.9%		28.2%

(1)	Weighted average inputs are based on the fair value of the “Level 3” loans.

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

(3)	Total prepayment/resale speed is measured using Life Total CPR, which includes both voluntary and involuntary prepayment/resale speeds.

Changes in fair value of loans held for sale attributable to changes in the loan’s instrument-specific credit risk are measured with 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 estimated fair value of MSRs attributable to 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 held 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:



	September 30, 2022		December 31, 2021
Fair value (in thousands) (1)	$	(56,203)	$	322,193
Key inputs (2):
Pull-through rate:
Range		7.9% – 100%		8.0% – 100%
Weighted average		79.5%		78.4%
Mortgage servicing rights fair value expressed as:
Servicing fee multiple:
Range		(3.3) – 7.5		(8.5) – 6.7
Weighted average		4.4		3.8
Percentage of loan commitment amount
Range		(0.6)% – 3.8%		(1.6)% – 3.6%
Weighted average		2.0%		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 values of derivative financial instruments actively traded on exchanges are categorized by the Company as “Level 1” fair value assets and liabilities; fair values of derivative financial instruments based on observable interest rates, volatilities and prices in the MBS or other markets are categorized by the Company as “Level 2” fair value assets and liabilities.

Changes in the fair value of hedging derivatives are included in Net gains on loans held for sale at fair value, or Net loan servicing fees – Mortgage servicing rights hedging results, as applicable, in the consolidated statements of income.

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 prepayment rate (prepayment speed), pricing spread (discount rate), and annual per-loan cost to service the underlying 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 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,
	2022		2021		2022		2021

	(Amount recognized and unpaid principal balance of underlying loans in thousands)
MSR and pool characteristics:
Amount recognized	$	345,077	$	432,429	$	1,359,632	$	1,386,324
Unpaid principal balance of underlying loans	$	16,003,556	$	33,697,228	$	65,956,748	$	105,470,580
Weighted average servicing fee rate (in basis points)		49		34		44		33
Key inputs (1):
Annual total prepayment speed (2):
Range		6.8% – 19.1%		7.2% – 31.0%		5.7% – 23.4%		6.2% – 31.0%
Weighted average		11.1%		9.2%		9.0%		8.5%
Equivalent average life (in years):
Range		4.0 – 8.1		3.0 – 8.4		3.7 – 9.2		3.0 – 9.0
Weighted average		7.4		7.7		8.1		8.1
Pricing spread (3):
Range		5.5% – 11.4%		6.0% – 16.9%		5.5% – 16.1%		6.0% – 16.9%
Weighted average		8.1%		8.5%		7.8%		9.0%
Per-loan annual cost of servicing:
Range		$79 – $116		$80 – $117		$79 – $177		$80 – $117
Weighted average		$105		$102		$104		$104

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

(2)	Annual total prepayment speed is measured using Life Total CPR, which includes both voluntary and involuntary prepayments. Equivalent average life is provided as supplementary information.

(3)

Pricing spread represents a margin that is applied to a reference interest rate’s forward rate curve to develop periodic discount rates. Effective January 1, 2022, the Company applies a pricing spread to the United State Treasury Securities (the “Treasury”) yield curve for purposes of discounting cash flows relating to MSRs. Through December 31, 2021, the Company applied its pricing spread to the United States Dollar London Interbank Offered Rate (“LIBOR”)/swap curve. The change in reference interest rate from the LIBOR/swap curve to the Treasury yield curve did not have a significant effect on the Company’s fair value measurement of MSRs.

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:


	September 30, 2022	December 31, 2021

	(Fair value, unpaid principal balance of underlying
	loans and effect on fair value amounts in thousands)
Fair value	$ 5,661,672	$ 3,878,078
Pool characteristics:
Unpaid principal balance of underlying loans	$ 303,800,226	$ 278,324,780
Weighted average note interest rate	3.3%	3.2%
Weighted average servicing fee rate (in basis points)	36	34
Key inputs (1):
Annual total prepayment speed (2):
Range	5.1% – 17.1%	7.9% – 26.7%
Weighted average	7.6%	10.7%
Equivalent average life (in years):
Range	3.8 – 9.3	3.1 – 7.7
Weighted average	8.3	6.8
Effect on fair value of (3):
5% adverse change	($75,034)	($80,109)
10% adverse change	($147,692)	($157,252)
20% adverse change	($286,318)	($303,259)
Pricing spread (4):
Range	4.9% – 14.8%	5.3% – 15.5%
Weighted average	6.9%	7.7%
Effect on fair value of (3):
5% adverse change	($80,798)	($59,577)
10% adverse change	($159,312)	($117,352)
20% adverse change	($309,839)	($227,791)
Per-loan annual cost of servicing:
Range	$80 – $149	$79 – $197
Weighted average	$106	$108
Effect on fair value of (3):
5% adverse change	($38,133)	($32,979)
10% adverse change	($76,265)	($65,958)
20% adverse change	($152,531)	($131,916)

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

(2)	Annual total prepayment speed is measured using Life Total CPR, which includes both voluntary and involuntary prepayments. Equivalent average life is provided as supplementary information.

(3)

These 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 to account for changing circumstances. For these reasons, the estimates should not be viewed as earnings forecasts.

(4)

Effective January 1, 2022, the Company applies a pricing spread to the Treasury yield curve for purposes of discounting cash flows relating to MSRs. Through December 31, 2021, the Company applied its pricing spread to the United States Dollar LIBOR/swap curve. The change in reference interest rate from the LIBOR/swap curve to the Treasury yield curve did not have a significant effect on the Company’s fair value measurement of MSRs.

Excess Servicing Spread Financing at Fair Value

ESS is categorized as a “Level 3” fair value liability. Because 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 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 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 the fair value of this financing. Changes in the fair value of ESS are included in Net loan servicing fees—Change in fair value of excess servicing spread financing payable to PennyMac Mortgage Investment Trust.

During the nine months ended September 30, 2021, the Company repaid its outstanding ESS financing payable to PMT.

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. The key inputs used in the estimation of the fair value of MSLs include the applicable pricing spread, annual total prepayment speed, and the per-loan annual cost of servicing the underlying 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,
		2022		2021
Fair value (in thousands)	$	2,214	$	2,816
Pool characteristics:
Unpaid principal balance of underlying loans (in thousands)	$	35,143	$	60,593
Servicing fee rate (in basis points)		25		25
Key inputs (1):
Annual total prepayment speed (2)		17.5%		19.8%
Equivalent average life (in years)		4.8		4.1
Pricing spread (3)		7.7%		6.9%
Per-loan annual cost of servicing	$	1,208	$	1,406

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

(2)	Annual total prepayment speed is measured using Life Total CPR, which includes both voluntary and involuntary prepayments. Equivalent average life is provided as supplementary information.

(3)

Effective January 1, 2022, the Company applies a pricing spread to the Treasury yield curve for purposes of discounting cash flows relating to MSLs. Through December 31, 2021, the Company applied its pricing spread to the United States Dollar London LIBOR/swap curve. The change in reference interest rate from the LIBOR/swap curve to the Treasury yield curve did not have a significant effect on the Company’s fair value measurement of MSLs.