PFSI - NYSE

Good afternoon, and welcome to PennyMac Financial Services, Inc.'s Third Quarter 2025 Earnings Call. Additional earnings materials, including presentation slides that will be referred to on this call, are available on PennyMac Financial's website at pfsi.pennymac.com. Before we begin, let me remind you that this call may contain forward-looking statements that are subject to certain risks identified on Slide 2 of the earnings presentation that could cause the company's actual results to differ materially, as well as non-GAAP measures that have been reconciled to their GAAP equivalent in the earnings materials. Now I'd like to introduce David Spector, PennyMac Financial's Chairman and Chief Executive Officer; and Dan Perotti, PennyMac Financial's Chief Financial Officer. You may go ahead.

Thank you, operator. Good afternoon, and thank you to everyone for participating in our third quarter earnings call. As shown on Slide 3, PFSI delivered outstanding financial and operational results in the third quarter, with an 18% return on equity on both a GAAP and operating basis. These results highlight the strategic advantage of our balanced business model, our ability to rapidly address refinance opportunities as they arise and the success of our dynamic hedging program, which offset MSR fair value declines, thereby demonstrating the financial stability that is central to our operating model. As you can see on Slide 5, our consistent performance demonstrates the strength of our organic and comprehensive mortgage banking platform. The chart on the left shows our annualized operating ROEs in recent quarters. The 20% operating return on equity we earned in the third quarter of 2024 was achieved when mortgage rates declined to approximately 6%. Similarly, this quarter, we achieved an 18% operating return on equity as mortgage rates move closer to that level. These 2 quarters illustrate the earnings power of our business. A key benefit of our balanced business model has been the consistent strength of our servicing business. As you can see from the chart on the right, servicing pretax net valuation-related changes has provided the majority of our mortgage banking operating pretax income over the last several quarters. While there can be some fluctuations in our results due to typical seasonality, if mortgage rates remain between 6% and 6.5%, while delinquency rates remain stable, we expect annualized operating returns on equity to average in the high-teens to low 20s through 2026, with potential for additional upside if origination market volumes grow further. I would like to bring your attention to the recently announced strategic transaction we completed this quarter that highlights our active capital management. As you can see on Slide 6, we successfully completed the sale of MSRs with an unpaid principal balance of $12 billion to Annaly Capital Management with subservicing retained, accelerating the growth of our capital-light subservicing business. This transaction allowed us to monetize a mature asset with a weighted average coupon of 3.1% and projected go-forward returns at the lower end of our target range, freeing up capital to deploy into new higher coupon MSRs with greater recapture and return potential. Importantly, we retained the core elements that drive the growth of our mortgage flywheel, the subservicing, recapture and marketing rights for closed-end seconds and other products, preserving our customers' ongoing relationship with PennyMac. This transaction is a testament to our ongoing drive to grow capital-light revenue streams that leverage our servicing expertise, operational scale and proprietary technology. It also reinforces our best-in-class servicing capabilities and signals our intent to be a dominant subservicer in the market. We view this transaction as a part of our disciplined effort to optimize our balance sheet and enhance long-term value for both our customers and stockholders, a win for all parties. Turning to production. Our results this quarter reflect the strength of our unique multichannel production platform. On Slide 7, we proudly showcased our position as the outright leader in correspondent lending. Over the last 12 months, we have generated more than $100 billion in UPB of correspondent production, achieving an estimated market share of approximately 20% in the first 9 months of 2025. This significant volume is a direct result of our operational excellence, technology innovation and deep partnerships with many of our nearly 800 active correspondent sellers across the country. A key aspect of our leadership in this channel is our exceptional operational leverage and scale, which underscores our fundamental strength as a highly efficient, low-cost provider with a significant competitive advantage. Similarly, you can see on Slide 8 that our broker direct business was a key contributor this quarter and represents a significant ongoing opportunity. From our entry into this business in 2018, our broker direct market share has expanded significantly, currently standing at just under 6%. We have clearly established ourselves as a trusted partner for brokers. And though we are already the third largest in the channel, we see tremendous momentum to continue our growth to more than 10% market share by the end of 2026. Our strength in this channel is driven by our tech-enabled platform with unmatched support throughout the origination process. This advanced infrastructure and dedicated assistance assures brokers that their customers will experience a seamless and efficient origination process, empowering brokers and reinforcing their trust in us as a reliable, long-term partner. On Slide 9, we highlight the significant opportunity for our consumer direct channel as mortgage rates decline. As a reminder, our operating ROE this quarter was 18% and a substantial portion of the increase versus the prior quarter can be directly attributed to the success of our recapture activities. Our performance this quarter is a powerful real-time indicator that our current investments and strategy are working, and it highlights the opportunity for us in future periods as market rates decline. As of September 30, $291 billion in UPB or 41% of the loans in our servicing portfolio have a note rate above 5%, and $201 billion in UPB or 28% of the loans in our portfolio have a note rate above 6%. This large and growing portfolio of borrowers who recently entered into mortgages at higher rates stands to significantly benefit by refinancing their loan when interest rates decline, as this refinancial potential positions are consumer direct lending divisions for stronger future growth. Our multiyear investments in technology and process innovation, including the introduction of our new loan origination system have already driven meaningful improvements in both our overall efficiency and recapture. We expect our recapture rates to continue improving, translating directly into higher earnings potential as refinance opportunities materialize. In conclusion, our strong quarterly results reflect our ability to rapidly address refinance demand when rates decline and the increase in sophistication introduced into the hedging of our MSRs, which demonstrated robust financial stability and risk management that underpins our system. I am extraordinarily proud of the work and effort provided by the management team in producing these strong quarterly results, defined by outstanding execution in both production and servicing and of course, an 18% gap in operating return on equity. Looking ahead, as we continue deploying AI throughout the organization, I am confident that our strategic positioning and our relentless focus on efficiency ensures we are well equipped to drive substantial growth, superior returns and a continued upward trajectory for PennyMac. I will now turn it over to Dan, who will review the drivers of PFSI's third quarter financial performance.

Thank you, David. PFSI reported net income of $182 million in the third quarter or $3.37 in earnings per share for an annualized ROE of 18%. These results included $4 million of fair value declines on MSRs, net of hedges and costs. The contribution from these items to diluted earnings per share was negative $0.06. PFSI's Board of Directors declared a third quarter common share dividend of $0.30 per share. On Slides 12 and 13, beginning with our production segment. Pretax income was $123 million, more than twice the $58 million reported in the prior quarter. Total acquisition and origination volumes were $36 billion in unpaid principal balance, down 4% from the prior quarter. Of this, $33 billion was for PFSI's own account and $3 billion was fee-based fulfillment activity for PMT. Total lock volumes were $43 billion in UPB, essentially unchanged from the prior quarter, but with a greater mix of volume coming from our direct lending channels. PennyMac maintained its dominant position in correspondent lending in the third quarter with total acquisitions of $28 billion, down 7% from the prior quarter. Correspondent channel margins in the third quarter were 30 basis points, up from 25 basis points in the second quarter, with the revenue contribution unchanged from the prior quarter and displaying our margin discipline, driving slightly higher revenue on reduced volume. PMT retains the right to purchase up to 100% of nongovernment correspondent loan production from PFSI's correspondent production volumes. PMT purchased 17% of PFSI's total conventional conforming correspondent production, essentially unchanged from the percentage PMT retained in the prior quarter. In the fourth quarter, we expect PMT to purchase approximately 15% to 25% of PFSI's total conventional conforming correspondent production, consistent with levels in recent quarters. In broker direct, we continue to see strong trends and growth in market share as we position PennyMac as a strong alternative to channel leaders. Originations in the channel were up 6% and locks were up 11% from the prior quarter, driven by a growing number of approved brokers who are increasingly recognizing and leveraging our distinct value proposition. The number of brokers approved to do business with us at quarter end was nearly 5,200, up 17% from the same time last year. In broker direct, we saw a revenue contribution $10 million higher than the prior quarter, driven by increased volumes and margins. As David mentioned, consumer direct saw positive trends with origination volumes up 12% and lock volumes up 57% from the prior quarter as rates declined late in the third quarter. Revenue contribution from the channel increased by $29 million from the prior quarter, primarily driven by increased refinance volume. Margins were down, driven by a higher proportion of higher balance first lien refinance loans versus smaller balance second lien loans, although the refinances have lower margins on a basis point basis, revenue per loan is typically greater. PFSI account revenues benefited from a positive contribution from post lock items such as non-agency and specified pool of spreads -- spread improvement, which contributed $30 million in the third quarter compared to a loss of $10 million in the prior quarter. Activity across our channels in October has been strong, with increased activity across all 3 channels compared to what we reported for the third quarter with the most substantial increase in the consumer direct channel. Production expenses net of loan origination expense increased 11% from the prior quarter. The increase from the prior quarter was due to both higher volumes and additional capacity in our direct lending channels, which is expected to drive our ability to rapidly address opportunities presented by lower mortgage rates. Turning to servicing on Slides 14 and 15. As David mentioned, our servicing portfolio continues to grow, ending the quarter at $717 billion in unpaid principal balance. The servicing segment recorded pretax income of $158 million, nearly 3x that of the prior quarter. Excluding valuation-related changes, pretax income was $162 million or 9.1 basis points of average servicing portfolio UPB, up from $144 million or 8.3 basis points in the prior quarter. Loan servicing fees were up from the prior quarter, primarily due to growth in PFSI's MSR portfolio. Custodial funds managed for PFSI's own portfolio averaged $8.5 billion in the third quarter, up from $7.5 billion in the second quarter due to seasonal impacts and higher prepayments. As a result, earnings on custodial balances and deposits and other income increased. Realization of MSR cash flows increased from the prior quarter due to continued growth of the MSR asset and higher realized and projected prepayment activity due to lower mortgage rates. Operating expenses were $85 million for the quarter or 4.8 basis points of average servicing portfolio UPB, up slightly from the prior quarter. As David mentioned, we saw the operating ROE and GAAP ROE converged this quarter with strong hedge results that offset the vast majority of MSR fair value declines. These results were a direct result of adjustments made to our hedging practices at the beginning of the quarter, more directly incorporating recapture expectations into our hedge management and thereby reducing our reliance on more expensive option positions. This, in turn, allows us to be more measured in our approach to rebalancing our hedge positions. In addition, the environment for hedging has also improved with volatility declining, improving option pricing and short-term interest rates expected to decline in comparison to longer-term interest rates, improving the carry of our hedge positions. As a result of our hedging practice adjustments and these improving market factors, going forward, we expect hedge costs to remain contained, and we expect to realize results closer to our targeted hedge ratio, which is currently around 85% to 90%. During the third quarter, the fair value of PFSI's MSR decreased by $102 million, $94 million was due to changes in market interest rates and $9 million was due to other assumption and performance-related impacts. Excluding costs, hedge fair value gains were $102 million. Hedge costs were $4 million, down significantly from $54 million in the second quarter. Corporate and other items contributed a pretax loss of $44 million, up from $35 million in the prior quarter, primarily driven by expenses related to technology initiatives and increased performance-based incentive compensation. PFSI recorded a tax expense of $55 million, resulting in an effective tax rate of 23.2%. We were also active in the management of our financing in the third quarter. In August, we successfully issued $650 million of unsecured senior notes due in 2034, furthering our objective of increasing the proportion of long-term unsecured financing in our non-funding debt. Additionally, we issued $300 million of Ginnie Mae MSR term notes due in August 2030 and paid off $200 million of the $680 million notes due in February 2028, meaningfully improving our financing cost on the secured debt. Total debt to equity at the end of the quarter was 3.3x and non-funding debt to equity at the end of the quarter was 1.5x, both down slightly from the end of last quarter as we consistently manage to our target leverage levels. We ended the quarter with nearly $5 billion of total liquidity, which includes cash and amounts available to draw on facilities where we have collateral pledged, giving us significant liquidity resources to be able to deploy opportunistically or in adverse market circumstances. We'll now open it up for questions. Operator?

[Operator Instructions] Your first question comes from the line of Crispin Love with Piper Sandler.

First, on operating ROEs, definitely saw a nice bounce back in the quarter to 18%. I appreciate your high-teens to low-20s ROE guide through 2026. But just given the mortgage rate rally late in the quarter is in the September time frame and the lag in correspondent, would you expect the fourth quarter ROEs to be more towards that low-20s range, just given where rates stand today?

Overall -- so there's a couple of factors in the fourth quarter specifically. So we do -- we have had a rally recently. We've obviously seen an uptick in volumes. If we stay here, that could well drive up our volumes and our ROEs to the higher end of -- operating ROEs to the higher end of that range. Offsetting that typically in the fourth quarter with seasonality with respect to purchase, et cetera, you can see a bit of a lag there as well as with custodial balances on our servicing portfolio. So with the fourth quarter, those tend to be a little bit lower from a seasonal perspective. So overall, if we stay at these rate levels, that probably pushes our operating ROE higher -- to the higher teens to, as you said, low 20s, but we do expect some of those typical effects as we're here in the fourth quarter.

Absolutely. No, that makes sense. And then just with the government shutdown, can you discuss the implications and expected impact of PFSI to the FHA business as well as other areas, just what that has meant for you in October and then what you could expect in the fourth quarter if the shutdown continues?

Yes. So we are always prepared for a range of outcomes in the company, and we've been through this drill a few times. We are -- it starts with how we think about having enough commitment authority with Ginnie Mae to be able to continue to issue Ginnie Mae securities. And we always look out to make sure we have at least 9 months of commitment authority. On the delinquency side, where you could see this start to show up, we have a couple of thousand borrowers in forbearance as a result of the government shutdown. We've received 2 to 2.5x that number of calls coming from the government shutdown. But I'm not expecting anything substantive. And I think it's suffice it to say that our technology and what we've built allows us to be able to adapt to something to whether it's a government shutdown or a natural disaster, which there hasn't been really any this year to something even as extreme of COVID. And so the team is always ready to be able to adapt to whatever comes its way.

Your next question comes from the line of Bose George with KBW.

Actually, the first question, can you talk about the trend in rate locks in the fourth quarter? I know it's only been a couple of weeks, but how does that compare to the third quarter?

Sure. So, so far in the fourth quarter, we've seen an uptick in volumes really across all of our channels, in particular, our direct lending and consumer direct lending, given the lower rates, we've seen a significant amount of refinance volume coming in. And so overall, as you mentioned, it's only a couple of weeks in, and things can change, but the trajectory is very positive thus far.

And Bose to the earlier point, as you see some of the August and September locks in the industry fund out, you should see an increase in bulk production and correspondent. And so I think to the point Dan raised, we're seeing a nice little uptick in consumer direct, and it's just really a function of rates, which have come down even over the last week.

Okay. Great. That makes sense. And then just in terms of the margins, can you just talk about the margins, just the different channels, the consumer direct was down, but was that really kind of a mix issue? Or yes, just color on that. And then it was up in the other channels, so just some color on trends as well.

Exactly. So as you mentioned, as I talked about a bit in my remarks, the consumer direct, it's really the mix of products. So on a basis point basis, the second lien loans tend to be higher and refinances tend to be lower. But first lien refinances are higher loan sizes generally. And so on a revenue per loan basis, we actually see higher revenues per loan despite lower basis points per UPB for those loans. And so we've seen those fluctuations in the past, but really as rates declined, it's an indicative of greater refinances, which generally is more profitable activity in the consumer direct channel on a per loan basis. As you mentioned, in both correspondent and broker saw margins go up. With respect to correspondent really around margin discipline, you can see that our margins increased and volumes declined a bit, but we made slightly -- or had slightly greater revenues in the correspondent channel than in the prior quarter. And so that's really indicative of our margin discipline in that channel. And with broker continues to be a positive environment, we continue to gain share and gain momentum in that channel.

Your next question comes from the line of Douglas Harter with UBS.

You guys repurchased some shares in the quarter. Can you just talk about your appetite to continue to do that and how the MSR sale to Annaly might factor into that?

Sure. So with respect to all of our capital deployment, and I think both of those items are indicative of our more active stance towards allocation of capital in PFSI. With respect to the share repurchases, we really look at that as the opportunity for doing that versus what we see as other opportunities for deployment of capital, as shares got down -- in terms of the pricing of our shares got down to a level where we saw that return as being attractive to our other -- as compared to our other opportunities, we did enter into the market. Obviously, the prices have changed somewhat since then. And we do believe that as we have in the past, we have very attractive opportunities in terms of deploying capital into higher-rate MSRs with really excellent recapture potential, which is evidencing itself as we're going in lower in rates currently. But when we see that opportunity, we've shown our willingness and ability in the past to be in the market repurchasing shares, and that will continue to be on our menu of capital allocation items to the extent that we see those opportunities. With respect to the Annaly transaction, really there looking more toward allocating the capital that we raise from that more toward, again, those opportunities to bring on additional high note rate servicing with opportunities for recapture and believe that the returns from -- the go-forward returns from that Annaly transaction we're at the lower end of our targeted range, being able to deploy into higher note rate servicing with much greater recapture potential and reallocate that capital is a positive benefit for PFSI.

Yes, Doug, the 2 other things I'd add to that is that as we see the growth in broker, the capital needs to support that growth are going to grow, and we can be put on higher rate MSRs to continue to support that initiative. While at the same time, we saw a slight tick down in our non-funding debt to equity was down slightly from 1.6x to 1.5x. And keeping it at that 1.5x is important to us and especially as we're talking to key constituents like the rating agencies, I think that's something that we're keeping in mind as well. So all in all, a great quarter in terms of recycling out of lower returning investments to set ourselves up to redeploy in higher returning investments.

And Dan, you mentioned the tax rate, it was down a couple of hundred basis points this quarter. Anything to call out there? And how sustainable is that this quarter's level?

This quarter is a little bit lower than what we would expect on a go-forward basis. Some of that was driven by option executions during the quarter, which has the effect of creating a permanent tax difference which reduces the tax rate in the quarter. So our overall tax rate, we expect to be -- over time, we expect to be, as you mentioned, slightly higher -- a couple of hundred basis points higher, but it was a benefit that we did see in the quarter.

Your next question comes from the line of Trevor Cranston with Citizens JMP.

Okay. So I was curious about what you guys are seeing within the servicing portfolio as we get rate rallies, I was curious if you guys are seeing any difference in the responsiveness of borrowers sort of jumping on refi opportunities today versus kind of what your experience has been like in the past or what your models have projected? And the second part of that, I was curious, I don't think I saw a recapture rate specifically for the third quarter. So I was wondering if you could also just comment specifically on the third quarter recapture performance?

Yes. Look, I'll let Dan go over the recapture rates in a minutes. I will tell you that my observation is, one, they were up for the quarter, and that is a byproduct of the work and efforts done by Doug and Abbie and Scott and the team and really honing in on perfecting recapture. And that's a byproduct of technology. We're already seeing really good results from the deployment of our new loan origination system upwards of a 50% reduction in time to complete a lock application, and that's allowing us to meet the demands driven into the call center by our marketing initiatives. And those marketing initiatives are really key to driving in leads to the call center. And so it's really in and of itself its own set of initiatives, but I'm really happy with where the recapture rates came in.

Yes. With respect to the responsiveness, I think, generally, we've seen some folks come to the table a little bit quicker than we have historically, just folks that had purchased homes at higher rates are excited to get into slightly lower rates. And so that's probably -- the responsiveness has been slightly higher than what we have seen historically. With respect to the recapture rate, they continue to improve in the third quarter, as David mentioned. I think that as we get into the fourth quarter, that's where you're going to -- and some of the loans that we locked in the third quarter and they'll come to sort of fruition with payoffs in the fourth quarter is where you really see the benefits of the improved focus on recapture.

Your next question comes from the line of Eric Hagen with BTIG.

Hopefully, I'm coming in. Lots of renewed attention here on community banks and speculation on whether some of the credit risk that we're talking about is systemic or if it's more contained. I mean, how do you think just generally that changes their appetite for originating mortgages and their relationship back to you? And when there's consolidation in the banking space, I mean, how do you think that generally impacts just the flow of credit and the opportunity that you guys have to encroach on market share?

Look, I think that it's a little early. I'll tell you that there's been consolidation going on for quite some time now in the industry. Our job is to continue to do the work that we do to make sure that our correspondent counterparts or counterparties have the right risks under control. The capital is reviewed on a regular basis. We have a robust underwriting and review process to really understand the manufacturing that goes into the loans that we buy. And so I think that, that's something that gives us comfort. We just have to stay diligent and our risk management practices are well honed. And I believe that you'll see consolidation, that consolidation will benefit us in the long run. And this is why it's really important that we're in all 3 channels because whether it benefits us in correspondent or broker or our call center, we will be able to participate.

That's good color. I appreciate that. Are there any opportunities you guys feel like to reduce servicing expenses from this point forward or reduce them kind of meaningfully over the near term? I mean, is there a target rate that you have in mind for servicing expenses and does the ROE guidance that you've given include any reductions in servicing costs?

So yes, we do expect servicing costs or unit servicing costs to continue to decline, both through the use of our technology, implementation of some of our artificial intelligence initiatives. We think that there are places in parts of the operations where we can gain significant additional operational leverage and reduce costs to a greater degree. As we're moving into 2026 and the guidance that was reflected, the guidance that was put out did reflect additional cost savings in terms of servicing on a unit basis. And as the portfolio grows, to the extent that we can move as quickly as we want to with our technology initiatives, there could be potential additional upside there. But we do think that there is continued opportunity to be able to reduce costs in a meaningful way in the servicing segment.

We had a little slight uptick in our corporate expenses because of the investments in technology to enhance our servicing system. A lot of these initiatives are AI related to help speed up the decline in expenses as well as look at other ways that we can use our technology in the marketplace.

[Operator Instructions] Your next question comes from the line of Ryan Shelley with Bank of America.

I just wanted to zone in a bit on the broker direct channel, especially after recent consolidation in this space. Have you guys seen any changes to competitive behavior, whether by the player involved in that consolidation or players not in the top 2 and not you guys? Any changes to call out there?

Look, I think our rapid ascent in broker direct is, to me, the results of the hard work and effort that the team has gone through in building technology to meet the demands and needs of the broker as well as to be able to provide a clear alternative to the top 2 brokers. And I think that's resonating with our broker partners. I think that we are -- I know we're the only mortgage bank out there that's not distracted. And it's those distractions that's allowing -- that the other participants are having that's allowing us to focus on meeting the needs of our broker partners as well as to grow share. And that's why I'm very confident that we're going to get to the 10% market share number by the end of 2026. And I think that you're going to continue to see growth. The nice part about the growth this quarter is you had growth in share and growth in margin. And I think that, that's really important to keep in mind. It's something that we're seeing the broker market, really having a nice increase in that margin, and it's something that is starting to have good meaningful impact on the results of the company. And as I said earlier, being able to participate in all 3 parts of the production ecosystem allows us to not focus on just one part of the origination lead system, for example, whether it's correspondent, we're just focusing on bulk or consumer direct, just focusing on recapture of our own portfolio. By being in broker as well, we continue to have a presence with the purchase market as well as the refinance market. So it's something that I'm really bullish about and really happy to see.

Got it. Yes, definitely. And then one more quick one. So I think there's this narrative out there that you'll see further consolidation in this industry? I guess do you guys buy into that narrative? And how do you think you would fit into that?

Yes. Look, I think that there are some parts of the market where perhaps you'll see more consolidation than the other -- than others. We've been -- we're -- at the end of this year, we'll finish our 18th year. Most of -- just about everything we've done has been done organically. We're an organic management team. We've built our 3 production divisions organically. We built our servicing platform organically. And I don't foresee anything that would change that. And so it's something that we are going to continue to operate. We're going to continue to grow. And while others may be focused on consolidation or other corporate activities, that allows us to continue to grow faster and it allows us to do it profitably. And that's something that's really one of the great highlights of this quarter, for me is just the focus on capital allocation and focusing on really deploying capital and the higher returning assets and finding assets that perhaps aren't meeting our return targets and being able to find alternatives, and that's what this management team is great at, and that's something that I want to continue to focus on.

We have no further questions at this time. I'll now turn it back to David Spector for closing remarks.

Thank you, operator, and thank you all for joining us this afternoon. We really appreciate the time and the opportunity to present the quarter and answer any questions. I encourage all of you if you have any additional questions to contact our Investor Relations team by e-mail or phone. I'm going to look forward to speaking to all of you in the future. Thanks again.