PennyMac Financial Services, Inc. (PFSI) FY 2021 MD&A

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Critical Accounting Policies

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Preparation of financial statements in compliance with accounting principles generally accepted in the United States (“GAAP”) requires us to make estimates that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, and revenues and expenses during the reporting period. Certain of these estimates significantly influence the portrayal of our financial condition and results, and they require us to make difficult, subjective or complex judgments. Our critical accounting policies primarily relate to our fair value estimates.

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Fair Value

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We group assets measured at or based on fair value in three levels based on the markets in which the assets are traded and the observability of the inputs used to determine fair value. These levels are:

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At December 31, 2021, $14.0 billion or 74% of our total assets were carried at fair value on a recurring basis and $7.5 million (real estate acquired in settlement of loans (“REO”)), were carried based on fair value on a non-recurring basis when fair value indicates evidence of impairment of individual properties.

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Changes in fair value of our holdings of assets carried at fair value have significant effects on our financial position and results of operations. As summarized above, changes in fair values of “Level 1” and “Level 2” fair value assets are determinable with reference to direct quotes in active markets on the measurement date in the case of “Level 1” assets, or reference to publicly available reference interest rates and credit spreads and prices of similar assets in the case of “Level 2” assets.

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$5.3 billion or 28% of our total assets are measured using “Level 3” fair value inputs – significant inputs where there is difficulty observing the inputs used by market participants to establish fair value. Different approaches to valuing those assets or changes in inputs to measurement of these assets can have a significant effect on the amounts reported for these items including their reported balances and their effects on our income.

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During the three years ended December 31, 2021, we recognized significant changes in the fair value of our holdings of “Level 3” fair value assets and liabilities as shown below:

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The changes above primarily reflect changes attributable to our observations of changes in the markets for those assets and liabilities as opposed to changes in accounting policies or approaches to the valuation of those instruments.

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As a result of the difficulty in observing certain significant valuation inputs affecting our “Level 3” fair value assets and liabilities, we are 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, subsequent transactions may be at values significantly different from those reported.

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Because the fair value of “Level 3” fair value assets and liabilities are difficult to estimate, our valuation process includes performance of these items’ fair value estimation by specialized staff with significant senior management oversight. We have assigned the responsibility for estimating the fair values of non-interest rate lock commitment “Level 3” fair value assets and liabilities to our Financial Analysis and Valuation group (the “FAV group”), which is responsible for valuing and monitoring these items and maintenance of our valuation policies and procedures for non-IRLC assets and liabilities. The FAV group submits the results of its valuations to our senior management valuation committee, which oversees the valuations. Our 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.

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The fair value of our interest rate lock commitments (“IRLCs”) is developed by our Capital Markets Risk Management staff and is reviewed by our Capital Markets Operations group.

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Following is a discussion of our approach to measuring the balance sheet items that are most affected by “Level 3” fair value estimates.

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Interest Rate Lock Commitments

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Our net gains on loans held for sale include our estimates of the gains or losses we expect to realize upon the sale of loans we have contractually committed to fund or purchase but have not yet funded, purchased or sold. We recognize a substantial portion of our net gains on loans held for sale at fair value before we fund or purchase the loans as the result of these commitments. We call these commitments interest rate lock commitments or IRLCs. We recognize the fair value of IRLCs at the time we make the commitment to the correspondent seller, broker or loan applicant and adjust the fair value of such IRLCs as the loan approaches the point of funding or purchase or the prospective transaction is canceled.

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We carry IRLCs as either Derivative assets or Derivative liabilities on our consolidated balance sheet. The fair value of an IRLC is transferred to Loans held for sale at fair value when the loan is funded or purchased.

An active, observable market for IRLCs does not exist. Therefore, we measure the fair value of IRLCs using methods we believe that market participants use in pricing IRLCs. We estimate the fair value of an IRLC based on observable Agency MBS prices, our estimates of the fair value of the MSRs we expect to receive in the sale of the loans and the probability that we will fund or purchase the loan (the “pull-through rate”).

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Pull-through rates and MSR fair values are based on our estimates as these inputs are difficult to observe in the marketplace. Our estimate of the probability that a loan will be funded and market interest rates are updated as the loans move through the funding or purchase process and as market interest rates change and may result in significant changes in our estimates of the fair value of the IRLCs. Such changes are reflected in the change in fair value of IRLCs which is a component of our Net gains on loans held for sale at fair value in the period of the change. The financial effects of changes in these inputs are generally inversely correlated. 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.

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A shift in our assessment of an input to the valuation of IRLCs can have a significant effect on the amount of Net gains on loans held for sale at fair value for the period. We believe that the most significant “Level 3” fair value input to the measurement of IRLCs is the pull-through rate. At December 31, 2021, we held $322.2 million of net IRLC assets at fair value. Following is a quantitative summary of the effect of changes in the pull-through rate input on the fair value of IRLCs at December 31, 2021:

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The preceding analysis holds constant all of the other inputs to show an estimate of the effect on fair value of a change in the pull-through rate. We expect that in a market shock event, multiple inputs would be affected and the effects of these changes may compound or counteract each other. Therefore the preceding analysis is not a projection of the effects of a shock event or a change in our estimate of an input and should not be relied upon as an earnings projection.

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Loans Held for Sale

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We carry loans at their fair values. We recognize changes in the fair value of loans in current period income as a component of Net gains on loans held for sale at fair value. How we estimate the fair value of loans is based on whether the loans are saleable into active markets with observable fair value inputs.

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We use a discounted cash flow model to estimate the fair value of “Level 3” fair value loans. The significant unobservable inputs used in the fair value measurement of our “Level 3” fair value loans held for sale are discount rates, home price projections and prepayment speeds. Significant changes in any of those inputs in isolation could result in a significant change to the loans’ fair value measurement.

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Mortgage Servicing Rights and Mortgage Servicing Liabilities

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MSRs and MSLs represent the fair value assigned to contracts that obligate us to service the mortgage loans on behalf of the owners of the mortgage loans in exchange for servicing fees and the right to collect certain ancillary income from the borrower. We recognize MSRs and MSLs at our estimate of the fair value of the contract to service the loans.

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We include changes in fair value of MSRs and MSLs in current period income as a component of Net loan servicing fees—Change in fair value of mortgage servicing rights and mortgage servicing liabilities. Both our estimate of the change in fair value attributable to realization of cash flows and of other changes in fair value are affected by changes in fair value inputs. During the year ended December 31, 2021, we recognized a $415.9 million net reduction in fair value of MSRs and MSLs: $347.6 million of the reduction was due to realization of cash flows underlying the fair value of MSRs and $68.3 million of the reduction was due to changes in fair value inputs.

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We estimate fair value of MSRs and MSLs using a discounted cash flow approach. We believe the most significant “Level 3” fair value inputs to the valuation of MSRs and MSLs are the pricing spread (used to develop periodic discount rates), prepayment speed and annual per-loan cost of servicing.

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A shift in the market for MSRs and MSLs or a change in our assessment of an input to the valuation of MSRs and MSLs can have a significant effect on their fair value and in our income for the period. The net fair value of MSRs and MSLs that we held at December 31, 2021 was $3.9 billion.

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Following is a summary of the effect on fair value of MSRs of various changes to these key inputs at December 31, 2021:

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The preceding analyses hold constant all of the inputs other than the input that is being changed to show an estimate of the effect on fair value of a change in a specific input. We expect that in a market shock event, multiple inputs would be affected and the effects of these changes may compound or counteract each other. Therefore the preceding analyses are not projections of the effects of a shock event or a change in our estimate of an input and should not be relied upon as earnings projections.

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Results of Operations

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Our results of operations are summarized below:

We define “Adjusted EBITDA” as net income plus provision for income taxes, depreciation and amortization, excluding decrease (increase) in fair value of MSRs net of MSLs, due to changes in the valuation inputs we use in

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our valuation models, increase (decrease) in fair value of excess servicing spread (“ESS”) payable to PMT, hedging losses (gains) associated with MSRs, stock-based compensation and interest expense on corporate debt or corporate revolving credit facilities and capital lease.

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We believe that the presentation of Adjusted EBITDA provides useful information to investors regarding our results of operations because each measure assists both investors and management in analyzing and benchmarking the performance and value of our business. However, other companies may define Adjusted EBITDA differently, and as a result, our measures of Adjusted EBITDA may not be directly comparable to those of other companies.

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Adjusted EBITDA measures have limitations as analytical tools, and should not be considered in isolation or as a substitute for analysis of our results as reported under GAAP. Some of these limitations are:

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Because of these limitations, Adjusted EBITDA measures are not intended as alternatives to net income as an indicator of our operating performance and should not be considered as measures of discretionary cash available to us to invest in the growth of our business or as measures of cash that will be available to us to meet our obligations.

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The following table presents a reconciliation of Adjusted EBITDA to our net income, the most directly comparable financial measure calculated and presented in accordance with GAAP, for each of the years indicated:

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Impact of COVID-19

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The United States continues to be impacted by the COVID-19 pandemic and the effects of market and government responses to the COVID-19 pandemic. These developments have resulted in continued economic uncertainty, financial hardships and unemployment for many existing borrowers.

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As part of its response to the COVID-19 pandemic, the federal government included requirements in the CARES Act that we provide borrowers with loans we service for the Agencies with substantial payment forbearance. As a result of the CARES Act and other regulatory requirements, our costs to service delinquent loans in our servicing portfolio have increased and may require us to finance advances of principal and interest payments to the investors holding these loans, as well as property taxes, insurance and other costs to protect investors’ interest in the properties collateralizing the loans. As of December 31, 2021, 1.3% of loans in our predominately government-insured or guaranteed MSR portfolio were in forbearance plans and delinquent.

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The COVID-19 Pandemic has had a mixed effect on the earnings of our servicing segment by reducing the amount of placement fees we earn on custodial deposits related to these loans and increasing our cost to service due to higher delinquency and default rates, offset by gains we recognize when we are able to modify and resell previously delinquent government loans. Over time, as borrowers exit forbearance and as delinquencies impacted by the COVID-19 pandemic are resolved, we expect these activities relating to delinquent government loans to trend towards more normalized levels. In order to mitigate the risks and costs of maintaining delinquent government loans in Ginnie Mae securities or in our loan inventory, we sell a portion of those loans to third-party investors. We increased the volume of our sales of these loans during the year ended December 31, 2021, and serviced $8.9 billion in UPB of these loans for third-party investors at the end of the year. As the impact of the COVID-19 pandemic lessens, we expect purchases of delinquent EBO loans to decrease and trend towards more normalized levels.

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In our production segment, gain on sale margins reflect both the strong but moderating demand for loans due to historically low interest rates as well as growth in loan production from our consumer direct and broker direct channels from 2020. The mortgage origination market for 2020 was $4.1 trillion and for 2021 was estimated at $4.8 trillion. The increase in demand for mortgage loans in 2020, combined with constraints on mortgage industry origination capacity that existed before the COVID-19 pandemic, allowed us to realize higher gain-on sale margins in our production segment in 2020. As increasing interest rates have affected demand for loans during 2021 and industry capacity has increased to meet the previous growth in demand, our gain on sale margins have moderated from 2020 levels, and in certain channels reflect the effects of significant competitive pressures.

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While the Federal Reserve increased the supply of money due to the ongoing COVID-19 pandemic by purchasing securities and MBS on the open market, future interest rates and the liquidity of the MBS market could be impacted as the Federal Reserve increases the federal funds rate and tapers future MBS purchases.

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The current environment caused by the COVID-19 pandemic in the United States is historically unprecedented and the source of much uncertainty surrounding future economic and market prospects and the ongoing effects on our future prospects are difficult to anticipate.

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Comparison of the years ended December 31, 2021, 2020 and 2019

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Income Before Provisions for Income Taxes

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For the year ended December 31, 2021, we recorded income before provision for income taxes of $1.4 billion, a decrease of $881.4 million or 39% from 2020. The decrease was primarily due to a $221.1 million decrease in production income (Net gains on loans held for sale at fair value, Loan origination fees and Fulfillment fees from PennyMac Mortgage Investment Trust) primarily due to lower gain on sale margins across all production channels and reduced fulfillment fee rates during the year ended December 31, 2021 compared to 2020, a $256.5 million decrease in Net loan servicing fees reflecting elevated prepayment speeds and a $343.2 million increase in total expenses. The increase in total expenses was mainly due to increases in compensation and origination expenses reflecting the growth of our direct lending production.

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For the year ended December 31, 2020, we recorded income before provision for income taxes of $2.2 billion, an increase of $1.7 billion or 323% from 2019. The increase was primarily due to an increase in production income which reflects higher production volume and improved margins, and an increase in Net loan servicing fees primarily due to growth in our loan servicing portfolio and an increase in income from the re-performance of loans bought out of Ginnie Mae securities for potential resecuritization, partially offset by an increase in total expenses. The increase in total expenses was mainly due to increases in compensation, servicing and loan origination expenses reflecting the continuing growth of our mortgage banking activities and the impact of the COVID-19 pandemic on our servicing portfolio and operations.

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Net gains on loans held for sale at fair value

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During the year ended December 31, 2021, we recognized Net gains on loans held for sale at fair value totaling $2.5 billion, compared to $2.7 billion and $725.5 million during the years ended December 31, 2020 and 2019, respectively.

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Our net gains on loans held for sale are summarized below:

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Non-cash elements of gain on sale of loans

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Our gains on loans held for sale include both cash and non-cash elements. We recognize a significant portion of our gains on loans held for sale when we make commitments to purchase or fund mortgage loans. We recognize this gain in the form of IRLCs. We adjust our initial gain amount as the loan purchase or origination process progresses until the loan is either funded or cancelled. We also receive non-cash proceeds on sale that include our estimate of the fair value of MSRs and we incur liabilities for MSLs (which represent the fair value of the costs we expect to incur in excess of the fees we receive to service the EBO loans we have resold to third party investors) and for the fair value of our estimate of the losses we expect to incur relating to the representations and warranties we provide in our loan sale transactions.

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The MSRs, MSLs, and liability for representations and warranties we recognize represent our estimate of the fair value of future benefits and costs we will realize for years in the future. These estimates represented approximately 71% of our gain on sale of loans at fair value for the year ended December 31, 2021, as compared to 40% and 117% for the years ended December 31, 2020 and 2019, respectively. These estimates change as circumstances change and changes in these estimates are recognized in income in subsequent periods.

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Interest Rate Lock Commitments, Mortgage Servicing Rights and Mortgage Servicing Liabilities

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The methods and key inputs we use to measure and update our measurements of IRLCs, MSRs and MSLs is detailed in Note 6 – Fair value – Valuation Techniques and Inputs to the consolidated financial statements included in this Annual Report.

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Representations and Warranties

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Our agreements with the purchasers and insurers include representations and warranties related to the loans we sell. The representations and warranties require adherence to purchaser and insurer origination and underwriting guidelines, including but not limited to the validity of the lien securing the loan, property eligibility, borrower credit, income and asset requirements, and compliance with applicable federal, state and local law.

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In the event of a breach of our representations and warranties, we may be required to either repurchase the loans with the identified defects or indemnify the purchaser or insurer. In such cases, we bear any subsequent credit loss on the loans. Our credit loss may be reduced by any recourse we have to correspondent originators that sold such loans to us and breached similar or other representations and warranties. In such event, we have the right to seek a recovery of related repurchase losses from that correspondent seller.

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Our representations and warranties are generally not subject to stated limits of exposure. However, we believe that the current UPB of loans sold by us and subject to representation and warranty liability to date represents the maximum exposure to repurchases related to representations and warranties.

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The level of the liability for losses under representations and warranties is difficult to estimate and requires considerable judgment. The level of loan repurchase losses is dependent on economic factors, purchaser or insurer loss mitigation strategies, and other external conditions that may change over the lives of the underlying loans. Our estimate of the liability for representations and warranties is developed by our credit administration staff and approved by our senior management credit committee which includes our senior executives and senior management in our loan production, loan servicing and credit risk management areas.

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The method used to estimate our losses on representations and warranties is a function of our estimate of future defaults, loan repurchase rates, the severity of loss in the event of default, if applicable, and the probability of reimbursement by the correspondent loan seller. We establish a liability at the time loans are sold and review our liability estimate on a periodic basis.

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During the years ended December 31, 2021, 2020, and 2019 we recorded provisions for losses under representations and warranties relating to current loan sales as a component of Net gains on loans held for sale at fair value totaling $31.6 million, $21.0 million, and $8.4 million, respectively. The increase in provision relating to current loan sales reflects both the increase in our loan production between the years ended December 31, 2021 and 2020 and a change in the mix of loan deliveries between the years. We also recorded reductions in the liability relating to previously sold loans of $16.0 million, $8.7 million, and $7.9 million, for the years ended December 31, 2021, 2020 and 2019, respectively. The reductions in the liability relating to previously sold loans resulted from those loans meeting performance criteria established by the Agencies which significantly limits the likelihood of certain repurchase or indemnification claims.

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Following is a summary of mortgage loan repurchase activity and the unpaid balance of mortgage loans subject to representations and warranties:

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During the year ended December 31, 2021, we repurchased loans with unpaid principal balances totaling $99.5 million and charged $4.7 million in net incurred losses relating to repurchases against our liability for representations and warranties. If the outstanding balance of loans we purchase and sell subject to representations and warranties increases, the loans sold continue to season, economic conditions change, correspondent lenders become unwilling or unable to repurchase defective loans, or investor and insurer loss mitigation strategies are adjusted, the level of repurchase and loss activity may increase. Such increases may require us to adjust our estimate of future losses relating to loans previously sold. Such an increase, if recognized, would be reflected in Net gains on loans held for sale at fair value in the period we recognize the change.

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Loan origination fees

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Following is a summary of our loan origination fees:

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Loan origination fees increased $98.6 million and $111.4 million during the year ended December 31, 2021 and 2020, compared to the years ended December 31, 2020, and 2019, respectively, and the increases were primarily due to increases in the volume of loans we produced.

Fulfillment fees from PennyMac Mortgage Investment Trust

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Following is a summary of our fulfillment fees:

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Fulfillment fees from PMT represent fees we collect for services we perform on behalf of PMT in connection with the acquisition, packaging and sale of loans. The fulfillment fees were calculated as a percentage of the UPB of the loans we fulfilled for PMT through June 30, 2020. Effective July 1, 2020, fulfillment fees are calculated based on the number of loans we lock and fulfill for PMT.

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Fulfillment fees decreased $43.3 million during the year ended December 31, 2021 compared to the year ended December 31, 2020. The decrease was primarily due to the fulfillment fee calculation changes, which generally reduced the fulfillment fees collected per loan fulfilled, and an increase in discretionary reductions in the fulfillment fee rate during the year ended December 31, 2021 compared to the year ended December 31, 2020. Fulfillment fees increased $61.6 million during the year ended December 31, 2020 compared to the year ended December 31, 2019. The increases were primarily due to increased volume of loans we fulfilled for PMT, partially offset by a decrease in the fulfillment fee collected per loan.

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Net loan servicing fees

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Our net loan servicing fee income has two primary components: fees earned for servicing the loans and the effects of MSR and MSL valuation changes, net of hedging results as summarized below:

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Loan Servicing Fees

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Following is a summary of our net loan servicing fees:

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Loan servicing fees from non-affiliates generally relate to our MSRs which are primarily related to servicing we provide for loans included in Agency securitizations. These fees are contractually established at an annualized percentage of the unpaid principal balance of the loan serviced and we collect these fees from borrower payments. Loan servicing fees from PMT are primarily related to PMT’s MSRs and are established at monthly per-loan amounts based on whether the loan is a fixed-rate or adjustable-rate loan and the loan’s delinquency or foreclosure status as detailed in Note 4 – Transactions with Affiliates to the consolidated financial statements included in this Annual Report. Other loan servicing fees are comprised primarily of borrower-contracted fees such as late charges and reconveyance fees.

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The increases in loan servicing fees from non-affiliates and from PMT for the year ended December 31, 2021, compared to the years ended December 31, 2020 and 2019, were primarily due to growth of our loan servicing portfolio. The increases in other loan servicing fees for the year ended December 31, 2021 compared to the years ended December 31, 2020 and 2019 were primarily due to increases in fees charged to correspondent lenders related to borrower early loan payoffs resulting from the low interest rate environment.

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Mortgage Servicing Rights and Mortgage Servicing Liabilities

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We have elected to carry our servicing assets and liabilities at fair value. Changes in fair value have two components: changes due to realization of the contractual servicing fees and changes due to changes in market inputs used to estimate the fair value of MSRs and MSLs. We endeavor to moderate the effects of changes in fair value by entering into derivatives transactions and – through March of 2021 – by financing certain of our purchases of MSRs with the sale of a portion of the MSR assets’ cash flows to PMT from an ESS financing.

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Change in fair value of MSR, MSL and ESS and the related hedging results are summarized below:

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Changes in realization of cash flows are influenced by changes in the level of servicing assets and liabilities and changes in estimates of the remaining cash flows to be realized. Realization of cash flows decreased during the year ended December 31, 2021, compared to the year ended December 31, 2020 primarily due to lower expected prepayments through 2021 compared to 2020. Realization of cash flows decreased during the year ended December 31, 2020, compared to the year ended December 31, 2019 primarily due to a lower average fair value of mortgage servicing rights in 2020 compared to 2019.

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Other changes in fair value of MSRs also reflect reduced prepayment expectations as well as reduced pricing spread at December 31, 2021 as compared to December 31, 2020. These factors combined to reduce fair value losses resulting from changes in market inputs.

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Hedging results reflect interest rate increases and elevated hedging costs during the year ended December 31, 2021 compared to the impact of interest rate declines in the years ended December 31, 2020 and 2019.

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Following is a summary of our loan servicing portfolio:

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Net Interest (Expense) Income

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Net interest expense increased $66.0 million during the year ended December 31, 2021 compared to the year ended December 31, 2020. The increase was primarily due to:

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Net interest income decreased $101.2 million during the year ended December 31, 2020 compared to the year ended December 31, 2019. The decrease was primarily due to:

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Management fees

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Management fees are summarized below:

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Management fees increased $3.3 million during the year ended December 31, 2021 compared to the year ended December 31, 2020. The increase is primarily due to $3.0 million of performance incentive fees earned as a result of PMT’s increased profitability during one of the twelve-month measurement periods used to measure PMT’s profitability during 2021 compared to 2020.

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Management fees decreased $2.0 million during the year ended December 31, 2020 compared to the year ended December 31, 2019. The decrease was due to a decrease of $7.2 million in incentive fees due to losses PMT incurred during the quarter ended March 31, 2020, partially offset by an increase of $5.2 million in base management fees reflecting the increase in PMT’s average shareholders’ equity upon which our base management fees are based, during the year ended December 31, 2020 compared to the year ended December 31, 2019.

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Change in Fair Value of Investment in and Dividends Received from PMT

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The results of our holdings of common shares of PMT, which is included in Changes in fair value of investment in, and dividends received from PMT are summarized below:

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Change in fair value of investment in and dividends received from PMT increased $789,000 during the year ended December 31, 2021, compared to the year ended December 31, 2020, and decreased $869,000 during the year ended December 31, 2020, compared to the year ended December 31, 2019, due to changes in the fair value of our investment in PMT. We held 75,000 common shares of PMT during each of the three years ended December 31, 2021.

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Expenses

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Compensation

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Our compensation expense is summarized below:

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Compensation expense increased $261.2 million and $235.1 million, during the years ended December 31, 2021 and December 31, 2020, respectively, compared to the years ended December 31, 2020 and 2019, respectively. The increases were primarily due to growth in head count made to accommodate the growth in our loan production and servicing activities as well as to increases in incentive compensation primarily due to higher production volume. The decrease in stock based compensation during the year ended December 31, 2021 compared to the year ended December 31, 2020 was primarily due to a stock option grant that vested on its grant date.

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Servicing

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Servicing expense decreased $147.1 million in the year ended December 31, 2021 compared to the year ended December 31, 2020 and increased $92.2 million in the year ended December 31, 2020 compared to the year ended December 31, 2019. The decrease in 2021 compared to 2020 was primarily due to reversal of the provision for estimated servicing advance losses recorded in prior periods during the year ended December 31, 2021. The reduction reflects the recent improvements in the performance of our servicing portfolio resulting from successful resolution of COVID-19 related forbearances. The increase in 2020 compared to 2019 was primarily the result of the increase in delinquencies we experienced due to the effects of the COVID-19 pandemic on borrower delinquencies.

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Technology

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Technology expense increased $28.9 million and $44.6 million in the years ended December 31, 2021 and 2020, respectively, compared to the years ended December 31, 2020 and 2019, respectively. The increases were primarily due to growth in our direct lending and loan servicing operations and continued investment in our loan production and servicing infrastructure. We recorded $728,000 and $13.1 million of impairment of capitalized software during the years ended December 31, 2021 and 2020, respectively.

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Marketing and advertising

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Marketing and advertising expenses increased $36.2 million and $3.5 million, during the years ended December 31, 2021 and 2020, compared to the years ended December 31, 2020 and 2019, respectively. The increases are primarily attributable to our investment in new brand marketing and increased marketing expenses for consumer direct lending.

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Occupancy and equipment

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Occupancy and equipment expenses increased $2.5 million and $4.4 million during the years ended December 31, 2021 and 2020, compared to the years ended December 31, 2020 and 2019, respectively. The increases are primarily attributable to expansion of our facilities to accommodate our growth.

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Provision for income taxes

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For the years ended December 31, 2021, 2020 and 2019, our effective tax rates were 26.2%, 26.5%, and 25.8%, respectively.

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Balance Sheet Analysis

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Following is a summary of key balance sheet items as of the dates presented:

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Total assets decreased $12.8 billion from $31.6 billion at December 31, 2020 to $18.8 billion at December 31, 2021. The decrease was primarily due to an $11.6 billion decrease in loans eligible for repurchase and $1.9 billion in loans held for sale at fair value, partially offset by an increase of $1.3 billion in MSRs. The decrease in loans eligible for repurchase was primarily due to increased early buyout activity resulting in a decrease in delinquent loans underlying Ginnie Mae securities in our servicing portfolio during the year ended December 31, 2021.

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Total liabilities decreased by $12.9 billion from $28.2 billion as of December 31, 2020 to $15.3 billion as of December 31, 2021. The decrease was primarily due to an $11.6 billion decrease in loans eligible for repurchase, and a $2.4 billion decrease in short-term debt, partially offset by a $1.0 billion increase in long-term debt.

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Cash Flows

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Our cash flows for the three years ended December 31, 2021 are summarized below:

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Operating activities

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Net cash provided by (used in) operating activities totaled $2.6 billion, $(6.2) billion, and $(2.2) billion during the years ended December 31, 2021, 2020, and 2019, respectively. Our cash flows from operating activities are primarily influenced by changes in the levels of our inventory of loans held for sale as shown below:

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Investing activities

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Net cash used in investing activities was $304.4 million during the year ended December 31, 2021, primarily comprised of $434.4 million in net settlement of derivative financial instruments used to hedge our investment in MSRs, partially offset by a $97.7 million decrease in margin deposits.

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Net cash provided by investing activities was $783.0 million during the year ended December 2020, primarily comprised of $913.1 million in net settlement of derivative financial instruments used to hedge our investment in MSRs, partially offset by $131.8 million increase in margin deposits.

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Net cash provided by investing activities was $148.8 million during the year ended December 2019, primarily comprised of $366.1 million in net settlement of derivative financial instruments used to hedge our investment in MSRs, partially offset by $227.4 million used in purchase of MSRs.

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Financing activities

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Net cash used in financing activities was $2.5 billion during the year ended December 31, 2021, primarily due to a $2.4 billion decrease in short-term borrowings, which reflects decreased borrowing requirements relating to our inventory of loans held for sale, and a $958.2 million repurchase of common stock, partially offset by a $1.2 billion issuance of unsecured senior notes.

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Net cash provided by financing activities totaled $5.8 billion during the year ended December 31, 2020, primarily due to an increase of $6.1 billion in borrowings to finance the growth in our inventory of loans held for sale, partially offset by a $337.5 million of repurchase of common stock and $30.9 million of dividends paid to our common stock holders.

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Net cash provided by financing activities totaled $2.1 billion during the year ended December 31, 2019 which was primarily to finance the growth in our inventory of loans held for sale and our investments in MSRs.

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Liquidity and Capital Resources

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Our liquidity reflects our ability to meet our current obligations (including our operating expenses and, when applicable, the retirement of, and margin calls relating to, our debt, and margin calls relating to hedges on our commitments to purchase or originate mortgage loans and on our MSR investments), fund new originations and purchases, and make investments as we identify them. We expect our primary sources of liquidity to be through cash flows from business activities, proceeds from bank borrowings, proceeds from and issuance of equity or debt offerings. We believe that our liquidity is sufficient to meet our current liquidity needs.

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Our current borrowing strategy is to finance our assets where we believe such borrowing is prudent, appropriate and available. Our borrowing activities are in the form of sales of assets under agreements to repurchase, sales of mortgage loan participation purchase and sale certificates, notes payable, a capital lease and unsecured senior notes. A significant amount of our borrowings have short-term maturities and provide for advances with terms ranging from 30 days to 364 days. Because a significant portion of our current debt facilities consist of short-term borrowings, we expect to renew these facilities in advance of maturity in order to ensure our ongoing liquidity and access to capital or otherwise allow ourselves sufficient time to replace any necessary financing.

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The effect of the COVID-19 pandemic on our operations, liquidity and capital resources remains uncertain and difficult to predict. For further discussion of the potential impacts of the COVID-19 pandemic please also see “Risk Factors” in Part I, Item 1A.

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The COVID-19 pandemic has significantly increased the number of loans that are delinquent in our Ginnie Mae MSR portfolio. The Ginnie Mae guidelines provide us with the option to purchase loans that are at least three months delinquent out of the underlying Ginnie Mae securities as an alternative to continuing to advance principal and interest payments to the holders of the Ginnie Mae securities. We refer to such loans as “early buyout” or EBO loans.

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During the year ended December 31, 2021, we repurchased $20.1 billion in UPB of EBO loans from our Ginnie Mae MSR portfolio. Our objective is to work with the borrowers to cure the loan delinquency through either borrower reperformance or modification of the loans’ terms. When curing the delinquency is not feasible, we work to settle the loan and collect our claims from the applicable insurer or guarantor. When we are able to cure the delinquency, we are able to re-deliver the cured loan into another Ginnie Mae guaranteed security. Depending on the method used to cure a borrower delinquency, the Ginnie Mae program may require at least a six month period of timely borrower payments before we are able to re-deliver the loan into another Ginnie Mae guaranteed security. Therefore, regardless of whether we cure or settle the repurchased loan, our investment in the EBO loans may require a substantial holding period.

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The CARES Act allows borrowers with federally-backed loans to request temporary payment forbearance in response to the increased borrower hardships resulting from the COVID-19 pandemic and may require us as the servicer to advance principal and interest, property taxes, insurance premiums and other expenses to the investors for up to four months on Fannie Mae and Freddie Mac loans and longer on Ginnie Mae and other government agency backed loans. In April 2020, the Company entered into a new Ginnie Mae servicing advance financing transaction allowing the Company to borrow $600 million against Ginnie Mae MSRs and servicing advances. The Ginnie Mae servicing advances eligible for financing include advances made to support regularly scheduled monthly principal and interest to mortgage-backed securities holders, taxes, homeowners insurance and escrowed items and other costs related to servicing delinquent loans. We are also in ongoing discussions with our lending partners to align our servicing advance assets and financing capacity, and to further diversify our financing alternatives.

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In connection with the GNMA MSR Facility, PLS pledges and/or sells to the PNMAC GMSR ISSUER TRUST (the “Issuer Trust”) participation certificates representing beneficial interests in MSRs and ESS pursuant to the terms of the master repurchase agreement by and among PLS, the Issuer Trust, and PNMAC, as guarantor (the “PC Repurchase Agreement”). In return, the Issuer Trust (a) has issued to PLS, pursuant to the terms of an indenture, the Series 2016-MSRVF1 Variable Funding Note, dated December 19, 2016, known as the “PNMAC GMSR ISSUER TRUST MSR Collateralized Notes, Series 2016-MSRVF1” (the “VFN”), and (b) has issued and may, from time to time pursuant to the terms of any supplemental indenture, issue to institutional investors additional term notes, in each case secured on a pari passu basis by the participation certificates relating to the MSRs and ESS. The maximum principal balance of the VFN is $1 billion.

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On July 30, 2021, the Company through two of its indirect, wholly owned subsidiaries, Issuer Trust and PLS, and its direct wholly owned subsidiary, PNMAC, entered into agreements to syndicate two existing variable funding note repurchase agreements, as part of the structured finance transaction that PLS uses to finance Ginnie Mae mortgage servicing rights and related excess servicing spread and servicing advance receivables. The Company entered into (i) an Amended and Restated Series 2016-MSRVF1 Master Repurchase Agreement by and among PLS, as seller, Credit Suisse First Boston Mortgage Capital LLC (“CSFB”), as administrative agent to the buyers, Credit Suisse AG, Cayman Islands Branch (“CSCIB”), as a buyer, Citibank, N.A., as a buyer, and PNMAC, as a guarantor (the “Syndicated GMSR Servicing Spread Agreement”), related to the servicing spread; and (ii) an Amended and Restated Series 2020-SPIADVF1 Master Repurchase Agreement by and among PLS, as seller, CSFB, as administrative agent to the buyers, CSCIB, as a buyer, Citibank, as a buyer, and PNMAC, as a guarantor (the “Syndicated GMSR SAR Agreement”), related to the servicing advance receivables.

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The Syndicated GMSR Servicing Spread Agreement added Citibank as a syndicate buyer, and increased the maximum purchase price from $400 to $500 million, all of which is committed on a 50-50 pro rata basis between CSCIB and Citibank. The Syndicated GMSR SAR Agreement added Citibank as a syndicate buyer, with the maximum purchase price of $600 million unchanged, all of which is committed on a 50-50 pro rata basis between CSCIB and Citibank.

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Our repurchase agreements represent the sales of assets together with agreements for us to buy back the assets at a later date. The table below presents the average outstanding, maximum and ending balances for each of the three years ended December 31, 2021, 2020 and 2019:

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The differences between the average and maximum daily balances on our repurchase agreements reflect the fluctuations throughout the month of our inventory as we fund and pool mortgage loans for sale in guaranteed mortgage securitizations and the fluctuation in our EBO inventory through the year.

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Our secured financing agreements at PLS require us to comply with various financial covenants. The most significant financial covenants currently include the following:

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With respect to servicing performed for PMT, PLS is also subject to certain covenants under PMT’s debt agreements. Covenants in PMT’s debt agreements are equally, or sometimes less, restrictive than the covenants described above.

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In addition to the covenants noted above, the indenture governing our unsecured senior notes contains covenants that limit our and our restricted subsidiaries’ ability to engage in specified types of transactions. These covenants limit our and our restricted subsidiaries’ ability to, among other things:

Although these financial covenants limit the amount of indebtedness that we may incur and affect our liquidity through minimum cash reserve requirements, we believe that these covenants currently provide us with sufficient flexibility to successfully operate our business and obtain the financing necessary to achieve that purpose.

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Our debt financing agreements also contain margin call provisions that, upon notice from the applicable lender at its option, require us to transfer cash or, in some instances, additional assets in an amount sufficient to eliminate any margin deficit. A margin deficit will generally result from any decline in the market value (as determined by the applicable lender) of the assets subject to the related financing agreement. Upon notice from the applicable lender, we will generally be required to satisfy the margin call on the day of such notice or within one business day thereafter, depending on the timing of the notice.

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We are also subject to liquidity and net worth requirements established by FHFA for Agency seller/servicers and Ginnie Mae for single-family issuers. FHFA and Ginnie Mae have established minimum liquidity requirements and revised their net worth requirements for their approved non-depository single-family sellers/servicers or issuers as summarized below:

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We believe that we are currently in compliance with the applicable Agency requirements.

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We have purchased portfolios of MSRs and have financed them in part through the sale to PMT of the right to receive ESS. The recorded amount of the ESS is its current fair value. During the quarter ended March 31, 2021, we repaid the outstanding ESS financing through the repurchase of the ESS from PMT.

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On August 4, 2021, our Board of Directors increased our common stock repurchase program from $1 billion to $2 billion. Share repurchases may be effected through open market purchases or privately negotiated transactions in accordance with applicable rules and regulations. The stock repurchase program does not have an expiration date and the authorization does not obligate us to acquire any particular amount of common stock. From inception through December 31, 2021, we have repurchased approximately $1.3 billion of common shares under our stock repurchase program.

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We continue to explore a variety of means of financing our continued growth, including debt financing through bank warehouse lines of credit, bank loans, repurchase agreements, securitization transactions and corporate debt. However, there can be no assurance as to how much additional financing capacity such efforts will produce, what form the financing will take or whether such efforts will be successful.

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Off-Balance Sheet Arrangements

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As of December 31, 2021, we have not entered into any off-balance sheet arrangements or guarantees.

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Debt Obligations

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As described further above in “Liquidity and Capital Resources,” we currently finance certain of our assets through short-term borrowings with major financial institutions in the form of sales of assets under agreements to repurchase and mortgage loan participation purchase and sale agreements. We access the capital market for long-term debt through the issuance of secured term notes and unsecured senior notes and we have an outstanding long term capital lease. The issuer under our secured term note facilities is PLS or a wholly-owned issuer trust guaranteed by PNMAC. In addition, We have issued unsecured senior notes guaranteed by certain of our restricted wholly-owned subsidiaries.

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Under the terms of these financing agreements, PLS is required to comply with certain financial covenants, as described further above in “Liquidity and Capital Resources,” and various non-financial covenants customary for transactions of this nature. As of December 31, 2021, we believe we were in compliance in all material respects with these covenants.

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Many of our debt financing agreements contain a condition precedent to obtaining additional funding that requires PLS to maintain positive net income for at least one of the previous two consecutive quarters, or other similar measures. PLS is compliant with all such conditions.

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The financing agreements also contain margin call provisions that, upon notice from the applicable lender, require us to transfer cash or, in some instances, additional assets in an amount sufficient to eliminate any margin deficit. Upon notice from the applicable lender, we will generally be required to satisfy the margin call on the day of such notice or within one business day thereafter, depending on the timing of the notice.

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In addition, the financing agreements contain events of default (subject to certain materiality thresholds and grace periods), including payment defaults, breaches of covenants and/or certain representations and warranties, cross-defaults, guarantor defaults, servicer termination events and defaults, material adverse changes, bankruptcy or insolvency proceedings and other events of default customary for these types of transactions. The remedies for such events of default are also customary for these types of transactions and include the acceleration of the principal amount outstanding under the agreements and the liquidation by our lenders of the mortgage loans or other collateral then subject to the agreements.

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The Company has issued unsecured senior notes (the “Unsecured Notes”) to qualified institutional buyers under Rule 144A of the Securities Act of 1933, as amended. The Unsecured Notes are fully and unconditionally guaranteed, jointly and severally, on a senior unsecured basis by the Company’s existing and future wholly-owned domestic subsidiaries (other than certain excluded subsidiaries defined in the indentures under which the Unsecured Notes were issued). The Company is required to maintain certain financial covenants under terms of the Unsecured Notes. We believe the Company was in compliance with all financial covenants in the Unsecured Notes as of December 31, 2021.

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The borrowings have maturities as follows:

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The amount at risk (the fair value of the assets pledged plus the related margin deposit, less the amount advanced by the counterparty and accrued interest) relating to our assets sold under agreements to repurchase is summarized by counterparty below as of December 31, 2021:

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All debt financing arrangements that matured between December 31, 2021 and the date of this Annual Report have been renewed or extended and are described in Note 12—Short-Term Borrowings to the accompanying consolidated financial statements.

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