PennyMac Financial Services, Inc. Q2 FY2025 earnings call

• Business Model Resilience: The balanced business model demonstrated resilience during volatility, with an annualized return on equity of 14%, and expects operating returns on equity to range in the mid- to high teens if interest rates stay in 6.5% to 7.5% range.
• Comprehensive Mortgage Banking Platform: Has a scale advantage in loan production and servicing, with a loan servicing portfolio of $700 billion UPB representing 2.7 million households, driving growth in consumer direct business.
• Correspondent Lending: Leader in correspondent lending, generated ~$100 billion in UPB of correspondent production over 12 months, with 20% market share in H1 2025, and ability to increase production 50% without fixed expense increase.
• Broker Direct Channel: Broker direct market share expanded to ~5%, aims for >10% market share by end of 2026, driven by tech-forward platform and support throughout origination process.
• Consumer Direct Business: Large network of over 5 million homeowners, refinance recapture rates twice industry average, leveraging AI and strategic partnerships.
• Artificial Intelligence Focus: Over 35 AI tools/applications launched, projected $25 million annual economic benefit, with vision for fully automated loan process including self-service origination and servicing.

Production Segment

• Pretax income was $58 million, down from $62 million in the prior quarter. Total acquisition and origination volumes were $38 billion in unpaid principal balance, up 31% from the prior quarter. Correspondent lending had total acquisitions of $30 billion, up 30% from the prior quarter. Broker Direct originations were up almost 60% and locks were up more than 30% from the prior quarter, but margins were down slightly. Consumer Direct had origination volumes up 6% and locked volumes down 2% from the prior quarter, with margins up due to a larger mix of higher-margin closed-end second liens.

Servicing Segment

• Servicing portfolio ended the quarter at $700 billion in unpaid principal balance. The Servicing segment recorded pretax income of $54 million. Excluding valuation-related changes, pretax income was $144 million or 8.3 basis points of average servicing portfolio of UPB. Loan servicing fees were up primarily due to growth in PFSI's MSR portfolio. Custodial funds managed for PFSI's owned portfolio averaged $7.5 billion in the second quarter, up from $6.2 billion in the first quarter.

• Expect operating ROE to improve from Q2 levels as margins improve in production and servicing segments.
• Anticipate lower hedge costs and greater consistency in hedge performance in future periods as hedging strategy is adjusted.
• Servicing portfolio is expected to continue growing, creating future opportunities in consumer direct channel.

• Interest rate volatility could impact the fair value of the MSR asset.
• Spread volatility may affect cross-channel margins.
• Delinquency trends and related impacts on servicing profitability pose risks.
• Execution risks associated with the hedging strategy adjustments.

Q: Just on the operating ROEs. They were 13% in the quarter, some of the lowest levels for several quarters. So curious if you can first discuss some of the puts and takes in the quarter, including margin trends and then your confidence of getting back to that mid- to high teens level in the back half of the year as stated in your guidance?

A: Sure, Crispin. This is Dan. With respect to the operating ROE dipping a bit to 13% really, I would say, driven by two factors in the quarter. One was related to on the production side, related to the margins in the channel. So those came down a bit quarter-over-quarter. Some of that was driven, if you look versus the prior quarters by a negative impact in some of the cross-channel activities which was down about $10 million this quarter, a negative contribution of about $10 million this quarter versus $17 million in the prior quarter, and this is on Page 18 of the deck. We typically -- we see that those cross channel impacts fluctuate. We had bit of a negative impact due to some of the interest rate and spread volatility in the second quarter. We did see some of that reverse itself as we go into the third quarter and overall margins toward the end of the second quarter and beginning of the third quarter have been trending higher, especially in the correspondent channel. And so as we look out with respect to production, moving forward for the next few quarters, we expect improvement from the -- on a margin basis and in terms of the overall income from that channel. Looking at the servicing -- on the servicing side, did see a reduction in the pretax income, excluding valuation-related changes for the quarter. That was primarily driven by an increase in the realization of MSR cash flows quarter-over-quarter, which was driven by an uptick in overall prepayment speeds as well as an increase in the overall size of the MSR asset as well as a bit of an uptick in some of the nonoperating expense items. So payoff related expenses and interest expense. Some of those, especially related to some of the prepayment activity. We don't necessarily expect to see at the same level that we saw this quarter. Additionally, interest expense includes certain onetime items related to the retirement of some of our debt. And so we expect that to maintain on a bit more of a level basis as we continue to increase our servicing portfolio. So all of that being said is that our expectation as we're moving into the next couple of quarters in terms of our operating ROE is that we expect it to improve from the levels that we saw here in Q2.

Q: Just wanted to follow up on the profitability question. Just in terms of the servicing portfolio, what's a good run rate for the profitability there, just -- looking at it just in basis points. I mean it makes sense, the amortization increased with a bigger MSR, but conceptually, you might have thought that would be offset by a higher servicing fees. So yes, just kind of a good way to think about what that number should be.

A: Yes, if you look back over the past few quarters, this was a bit in terms of the pretax income, excluding market -- excluding valuation changes, was a bit of a dip from what we've seen historically. As I said, there were some onetime items or items that were specific to this quarter that impacted that. Generally, at these -- at the rate levels that we're at currently, which are a bit higher and assuming not great -- very significant levels of rate volatility, we'd expect the basis points on the servicing portfolio to move toward what we've seen over the past few quarters in the 9 to 10 basis point range. In any given quarter, there can be certain items that impacts the overall result, but that would be our expectation generally going forward at these rate levels.