PennyMac Financial Services, Inc. (PFSI) FY 2022 MD&A

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

The following discussion and analysis of our financial condition and results of operations should be read together with our consolidated financial statements and related notes appearing elsewhere in this Report. The following discussion and analysis contains forward-looking statements that involve risks and uncertainties. When reviewing the discussion below, you should keep in mind the substantial risks and uncertainties that could impact our business. In particular, we encourage you to review the risks and uncertainties described in the section titled “Risk Factors” included elsewhere in this Report. These risks and uncertainties could cause actual results to differ materially from those projected in forward-looking statements contained in this report or implied by past results and trends.

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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, 2022, $9.6 billion or 57% of our total assets were carried at fair value on a recurring basis and $11.5 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” fair value assets, or reference to publicly available pricing inputs (such as reference interest rates and credit spreads and prices of similar assets) in the case of “Level 2” fair value assets.

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$6.3 billion or 38% 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, 2022, 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-interest rate lock commitment (“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, risk, credit and deputy chief investment officers as well as other senior members of the Company’s finance, capital markets and risk management staff.

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The fair value of our IRLC 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 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.

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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 IRLCs 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 loans (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, 2022, we held $25.8 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, 2022:

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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. In the year ended December 31, 2022, we recognized a $354.2 million net increase in fair value of MSRs and MSLs: $877.7 million of the increase due to changes in fair value inputs, partially offset by $523.5 million of reduction due to realization of cash flows underlying the fair value of MSRs.

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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, 2022 was $6.0 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, 2022:

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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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Business Trends

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Due to significant inflationary pressures, the U.S. Federal Reserve raised the federal funds rates throughout the year in 2022, as well as reduced its overall holdings of Treasury and mortgage-backed securities. Higher interest rates are expected to contribute to reducing the size of the mortgage origination market from an estimated $2.2 trillion in 2022 to a projected range from $1.6 trillion to $1.9 trillion for 2023 according to leading economists.

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Lower projected mortgage transaction volumes and increasing interest rates caused a decrease in all mortgage production activities, reduced gains from the redelivery of EBO loans bought from Ginnie Mae securities and increased competition in the mortgage production business, while also leading to a reduction in prepayment speeds in our mortgage servicing portfolio from the elevated levels experienced in 2021. Rising interest rates increased the costs of certain floating rate borrowings, as well as driving higher earnings rates from our placement fees on deposits and loans held for sale. We expect some of these business trends to continue in 2023. Due to the significant contraction in the mortgage market, we reduced business expenses to align with the lower mortgage production activities during the year ended December 31, 2022 and expected mortgage production activity levels in 2023.

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Our results of operations are summarized below:

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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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Comparison of the years ended December 31, 2022, 2021 and 2020

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Income Before Provisions for Income Taxes

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In the year ended December 31, 2022, we recorded income before provision for income taxes of $665.2 million, a decrease of $693.9 million or 51% from 2021. The decrease was primarily due to a $2.0 billion 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 production volume and gain on sale margins across all channels, partially offset by a $768.4 million increase in Net loan servicing fees reflecting improved valuation results in our MSRs, net of hedging results, and a $487.7 million decrease in total expenses, primarily due to reductions in compensation, loan origination and servicing expenses.

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In 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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Net gains on loans held for sale at fair value

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In our production segment, revenues reflect the effects of increasing interest rates on both demand for mortgage loans and gain on sale margins during the year ended December 31, 2022, compared to the strong demand due to the historically low interest rate environment that prevailed during 2021 and 2020.

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In the year ended December 31, 2022, we recognized Net gains on loans held for sale at fair value totaling $791.6 million, as compared to $2.5 billion and $2.7 billion in 2021 and 2020, respectively. The decrease was primarily due to lower gains from production due to decreased production volumes and gain on sale margins and lower EBO loan redelivery gains due to reduced reperformance and modifications and diminished redelivery margins in the year ended December 31, 2022 compared to 2021 and 2020.

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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 estimate 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) 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 217% of our gain on sale of loans at fair value for the year ended December 31, 2022, as compared to 71% and 40% in 2021 and 2020, 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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In the years ended December 31, 2022, 2021, and 2020 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 $9.6 million, $31.6 million, and $21.0 million, respectively. The decrease in provision relating to current loan sales reflects the decrease in our loan production in the year ended December 31, 2022 compared to 2021, and the increase in 2021 compared to 2020 was due to a change in the mix of loan deliveries between the years. We also recorded reductions in the liability relating to previously sold loans of $8.5 million, $16.0 million, and $8.7 million, for the years ended December 31, 2022, 2021 and 2020, 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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In the year ended December 31, 2022, we repurchased loans with unpaid principal balances totaling $93.0 million and charged $12.3 million in net incurred losses relating to repurchases against our liability for representations and warranties. Our losses arising from representations and warranties have historically been reduced by our ability to either recover most of the losses from our correspondent sellers or from our ability to profitably refinance and resell repurchased loans.

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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. Furthermore, as expected economic conditions, such as interest rates, home values and borrower default rates change, our realized loss rates may increase. Such increases may require us to adjust our estimate of future losses relating to loans previously sold. Such increased loss estimates, 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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The recent increases in market interest rates may affect certain of our correspondent sellers’ ability to honor their obligations to repurchase defective loans. Furthermore, these market factors and the expected economic slowdown may increase the level of borrower defaults, increasing the level of repurchases we are required to make, and may make it more difficult to minimize losses on repurchased loans due to reduced opportunities to refinance loans and decreasing market values for resales of loans. We expect these developments will increase the losses we incur in relation to our representations and warranties compared to our historical experience. However, we believe our recorded liability is presently adequate to absorb such losses.

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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 decreased $214.3 million in the year ended December 31, 2022 compared to 2021, primarily due to a decrease in loan production volumes. Loan origination fees increased $98.6 million in the year ended December 31, 2021 compared to 2020, primarily due to an increase in loan production volumes.

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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. We charged fulfillment fees as a percentage of the UPB of the loans we fulfilled for PMT through June 30, 2020. Effective July 1, 2020, we charge fulfillment fees based on the number of loans we lock and fulfill for PMT.

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Fulfillment fees decreased $110.9 million in the year ended December 31, 2022 compared to 2021, primarily due to a decrease in loan production volume. Fulfillment fees decreased $43.3 million in the year ended December 31, 2021 compared to 2020. The decrease was primarily due to fulfillment fee structure changes, which generally reduced the fulfillment fees per loan fulfilled, and an increase in discretionary reductions in the fulfillment fee rate in the year ended December 31, 2021 compared to 2020.

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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 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 fees charged to correspondent lenders relating to loans that are repaid shortly after we purchase them and 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, 2022, compared to 2021 and 2020, were primarily due to growth of our loan servicing portfolio. The decrease in other loan servicing fees for the year ended December 31, 2022 compared to 2021 was primarily due to a decrease in fees charged to correspondent lenders related to borrower early loan payoffs and decreased recording and release fees charged to borrowers due to lower prepayment activity we experienced in the current rising interest rate environment compared to 2021. The increases in other loan servicing fees for the year ended December 31, 2021 compared to 2020 was primarily due to an increase 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, until 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 in the form of ESS certificates.

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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 increased in the year ended December 31, 2022 compared to 2021 primarily due to the growth in our investment in MSRs. Realization of cash flows decreased in the year ended December 31, 2021, compared to 2020, primarily due to lower prepayment expectations through 2021 which slows the rate at which cash flows are expected to be realized.

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Other changes in fair value of MSRs increased in the year ended December 31, 2022 compared to 2021 and 2020 primarily due to significant increases in interest rates and resulting decreases in expected future prepayment speeds in 2022.

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Hedging results reflect valuation losses attributable to the effects of interest rate increases on the fair value of the hedging instruments in the year ended December 31, 2022 compared to lesser or opposite circumstances and effects in 2021 and 2020.

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Following is a summary of our loan servicing portfolio:

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Following is a summary of characteristics of our MSR and MSL servicing portfolio as of December 31, 2022:

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Net Interest Expense

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Net interest expense is summarized below:

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Net interest expense decreased $49.2 million in the year ended December 31, 2022 compared to 2021. The decrease was primarily due to:

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Net interest expense increased $66.0 million in the year ended December 31, 2021 compared to 2020. The increase 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 decreased $6.7 million in the year ended December 31, 2022 compared to 2021, reflecting the decrease in PMT’s average shareholders’ equity upon which its base management fees are based and a decrease in performance incentive fees.

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Management fees increased $3.3 million in the year ended December 31, 2021 compared to 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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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 decreased $571,000 in the year ended December 31, 2022 compared to 2021 and increased $789,000 in the year ended December 31, 2021 compared to 2020, primarily 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, 2022.

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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 decreased $264.6 million in the year ended December 31, 2022 compared to 2021 primarily due to work force reductions necessitated by reductions in loan production in 2022 and decreased incentive compensation accruals due to reduced staffing levels and lower achievement of profitability targets. Compensation expense increased $261.2 million in the year ended December 31, 2021 compared to 2020. The increase was primarily due to growth in staffing levels 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 in the year ended December 31, 2021 compared to 2020 was primarily due to a 2020 stock option grant that vested on its grant date.

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Loan origination

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Loan origination expense decreased $157.2 million in the year ended December 31, 2022 compared to 2021 due to decreased lending activities. Loan origination expense increased $111.0 million in the year ended December 31, 2021 compared to 2020 due to increased lending activities.

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Servicing

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Servicing expense decreased $50.2 million in the year ended December 31, 2022 compared to 2021 and $147.1 million in the year ended December 31, 2021 compared to 2020. These decreases were primarily due to a larger reversal of the provision for estimated servicing advance losses recorded in prior years and decreased purchases of EBO loans from Ginnie Mae guaranteed pools. The reduction reflects the improvements in the performance of our servicing portfolio due to the resolution of delinquent loans relating to the COVID-19 pandemic.

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Technology

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Technology expense decreased $1.5 million in the year ended December 31, 2022 compared to 2021 and increased $28.9 million in the year ended December 31, 2021 compared to 2020. The increase between 2020 and 2021 was 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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Provision for income taxes

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For the years ended December 31, 2022, 2021 and 2020, our effective tax rates were 28.5%, 26.2%, and 26.5%, respectively. The higher effective tax rate for 2022 is primarily due to the effect of the repricing of the net deferred tax liability resulting from the higher booking tax rate partially offset by the effect of the reduction in the future tax rate for some states. The higher effective tax rate additionally reflects the effect of an increase in non-deductible compensation.

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The Inflation Reduction Act was signed into law on August 16, 2022 ("Act"), effective for tax years beginning after December 31, 2022. The Inflation Reduction Act imposes a 15% Alternative Minimum Tax ("AMT") on the adjusted financial statement income ("AFSI") of applicable corporations. Applicable corporations generally include any corporation whose 3-year average AFSI exceeds $1 billion. Based on the current legislation and the definition of AFSI, we do not expect the Company will be subject to this corporate minimum tax.

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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 $2.0 billion from $18.8 billion at December 31, 2021 to $16.8 billion at December 31, 2022. The decrease was primarily due to a $6.2 billion decrease in loans held for sale at fair value, partially offset by a $2.1 billion increase in MSRs and a $1.7 billion increase in loans eligible for repurchase. The decrease in loans held for sale at fair value was primarily due to lower loan production volume in 2022.

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Total liabilities decreased by $2.0 billion from $15.4 billion as of December 31, 2021 to $13.4 billion at December 31, 2022. The decrease was primarily due to a $3.8 billion decrease in borrowings, partially offset by a $1.7 billion increase in liability for loans eligible for repurchase.

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Cash Flows

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Our cash flows for the three years ended December 31, 2022 are summarized below:

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Operating activities

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Net cash provided by (used in) operating activities totaled $6.0 billion, $2.6 billion, and $(6.2) billion in the years ended December 31, 2022, 2021, and 2020, 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 $721.6 million in the year ended December 31, 2022, primarily comprised of $871.9 million in net settlement of derivative financial instruments used to hedge our investment in MSRs and $71.9 million used in acquisition of capitalized software, partially offset by a $238.7 million decrease in margin deposits.

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Net cash used in investing activities was $304.4 million in 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 in 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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Financing activities

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Net cash used in financing activities was $4.3 billion in the year ended December 31, 2022, primarily due to a $4.5 billion decrease in short-term borrowings, which reflects decreased borrowing requirements relating to our reduced inventory of loans held for sale, and $406.1 million in repurchases of common stock, partially offset by issuance of a $650 million note payable secured by mortgage servicing rights.

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Net cash used in financing activities was $2.5 billion in 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 issuance of $1.2 billion of unsecured senior notes.

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Net cash provided by financing activities totaled $5.8 billion in 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 $337.5 million of repurchases of common stock and $30.9 million of dividends paid to our common stock holders.

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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. In addition, we utilized existing borrowing facilities to increase our cash balances to $1.3 billion at December 31, 2022. 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 270 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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On June 8, 2022, the Company, through its indirect subsidiary, PNMAC GMSR ISSUER TRUST (“Issuer Trust”), issued an aggregate principal amount of $500 million in secured term notes (the “2022-GT1 Notes”) to qualified institutional buyers under Rule 144A of the Securities Act of 1933, as amended (the “Securities Act”). The 2022-GT1 Notes bear interest at a rate equal to United States 30 Day Average Secured Overnight Financing Rate or SOFR plus 4.25% per annum, payable each month beginning in June 2022, on the 25th day of such month or, if such 25th day is not a business day, the next business day and mature on May 25, 2027 unless extended to either May 25, 2028 or May 25, 2029.

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In December 16, 2022, the Company issued a note payable that is secured by Freddie Mac MSRs. Interest is charged at a rate based on SOFR plus a spread as defined in the agreement. The facility expires on November 13, 2024. The maximum amount that the Company may borrow under the note payable is $400 million, $350 million of which is committed and which may be reduced by other debt outstanding with the counter party.

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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:

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

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Our debt repurchase 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

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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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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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Our unsecured senior notes contain covenants that limit our and our restricted subsidiaries’ ability to engage in specified types of transactions, including, but not limited to, the following:

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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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. In August 2022, the Agencies issued revised capital and liquidity requirements. The requirements will be effective at various dates beginning September 30, 2023, for issuers of securities guaranteed by Ginnie Mae and seller/servicers of mortgage loans to Fannie Mae and Freddie Mac. We believe that we are also in compliance with Agencies’ revised requirements as currently interpreted as of December 31, 2022.

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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, 2022, we have repurchased approximately $1.7 billion of common shares under our stock repurchase program.

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We continue to explore a variety of means of financing our business, 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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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, 2022, 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, as described above in Liquidity and Capital Resources. We believe the Company was in compliance with all financial covenants in the Unsecured Notes as of December 31, 2022.

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Our 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, 2022:

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All debt financing arrangements that matured between December 31, 2022 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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