Earnings Call Transcript - PFSI Q3 2025

Operator, Operator

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.

David Spector, CEO

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 two 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 nine 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 refinancing potential positions our 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.

Daniel Perotti, CFO

Thank you, David. PFSI reported a net income of $182 million for the third quarter, translating to earnings per share of $3.37 and an annualized return on equity of 18%. These figures include a $4 million decline in the fair value of mortgage servicing rights, net of hedges and costs, which negatively impacted diluted earnings per share by $0.06. PFSI's Board of Directors declared a common share dividend of $0.30 per share for the third quarter. In our production segment, pretax income reached $123 million, more than double the $58 million from the previous quarter. Total acquisition and origination volumes stood at $36 billion in unpaid principal balance, down 4% from the last quarter. Of this total, $33 billion was for PFSI's own account, while $3 billion was generated through fee-based fulfillment activity for PMT. Total lock volumes were approximately $43 billion in unpaid principal balance, remaining consistent with the prior quarter, but reflected a higher percentage of volume from our direct lending channels. PennyMac preserved its leading position in correspondent lending with total acquisitions of $28 billion, a decrease of 7% from the previous quarter. Correspondent channel margins improved to 30 basis points in the third quarter, up from 25 basis points in the second quarter, maintaining revenue contribution despite lower volume and reflecting our margin management efforts. PMT has retained the right to purchase up to 100% of nongovernment correspondent loan production from PFSI's correspondent production volumes and acquired 17% of PFSI's conventional conforming correspondent production, consistent with the previous quarter. We anticipate that PMT will purchase around 15% to 25% of future conventional conforming correspondent production in line with recent quarterly levels. In our broker direct segment, we are witnessing solid trends and an increase in market share, positioning PennyMac as a robust alternative to leading channels. Originations and locks in this channel rose by 6% and 11%, respectively, from the last quarter, driven by a growing number of approved brokers who appreciate our unique value proposition. By the end of the quarter, we had nearly 5,200 approved brokers, a 17% increase from the same period last year. In broker direct, revenue contributions were $10 million higher than the previous quarter, driven by increased volume and better margins. Consumer direct also saw positive trends, with origination volumes up 12% and lock volumes up 57% from the last quarter, supported by declining rates late in the third quarter. Revenue from this channel surged by $29 million compared to the previous quarter, mainly due to increased refinancing activity. Although margins declined due to a higher proportion of larger first lien refinance loans relative to smaller second lien loans, revenue per loan remains higher. PFSI account revenues benefited from positive contributions from post-lock items, such as improvements in non-agency and specified pool spreads, which added $30 million in the third quarter compared to a $10 million loss in the previous quarter. Activity across all channels in October remained strong, with overall increases seen in comparison to the third quarter, particularly in the consumer direct channel. Production expenses, excluding loan origination costs, rose by 11% from the prior quarter due to both higher volumes and additional capacity in our direct lending channels, which positions us to quickly seize opportunities arising from lower mortgage rates. Shifting to servicing, our portfolio grew to $717 billion in unpaid principal balance by the end of the quarter. The servicing segment achieved pretax income of $158 million, nearly a threefold increase compared to the previous quarter. Excluding valuation-related changes, pretax income was $162 million, which amounts to 9.1 basis points of average servicing portfolio unpaid principal balance, up from $144 million or 8.3 basis points in the prior quarter. Loan servicing fees increased from the previous quarter largely due to the growth of PFSI's mortgage servicing rights portfolio. Custodial funds managed for our portfolio averaged $8.5 billion in the third quarter, up from $7.5 billion in the second quarter due to seasonal factors and higher prepayment activity, leading to increased earnings from custodial balances and other income sources. The realization of cash flows from mortgage servicing rights improved from the previous quarter due to continual growth and enhanced prepayment activity stemming from lower mortgage rates. Operating expenses for the quarter were $85 million, or 4.8 basis points of average servicing portfolio unpaid principal balance, showing a slight increase from the prior quarter. As noted earlier, we observed the operating return on equity and GAAP return on equity align this quarter, supported by strong hedge results that mitigated the majority of declines in the fair value of mortgage servicing rights. These achievements stemmed from adjustments made to our hedging strategies at the start of the quarter, which directly factor in recapture expectations, allowing us to lessen reliance on costlier options. Furthermore, the hedging environment has improved with reduced volatility, better option pricing, and anticipated declines in short-term interest rates compared to longer-term rates, leading to an improved hedge position. As a result, we expect hedge costs to remain manageable moving forward and aim to achieve outcomes closer to our targeted hedge ratio, currently set around 85% to 90%. In the third quarter, the fair value of PFSI's mortgage servicing rights fell by $102 million, with $94 million attributed to changes in market interest rates and $9 million linked to other assumptions and performance-related impacts. Adjusted for costs, hedge fair value gains stood at $102 million. Hedge costs decreased significantly to $4 million from $54 million in the second quarter. Corporate and other items accounted for a pretax loss of $44 million, an increase from $35 million in the prior quarter, mainly due to expenses associated with technology initiatives and higher performance-based compensation. PFSI also reported a tax expense of $55 million, resulting in an effective tax rate of 23.2%. We were proactive in managing our financing during the third quarter, successfully issuing $650 million of unsecured senior notes due in 2034 to increase long-term unsecured financing’s share within our non-funding debt. Additionally, we issued $300 million of Ginnie Mae mortgage servicing rights term notes due in August 2030 and repaid $200 million of the $680 million notes due in February 2028, significantly improving our financing costs on secured debt. At the end of the quarter, our total debt to equity ratio stood at 3.3x and non-funding debt to equity at 1.5x, both of which were slightly lower than the previous quarter as we consistently strive to meet our target leverage levels. We concluded the quarter with approximately $5 billion in total liquidity, comprising cash and available amounts under pledged facilities, providing us with substantial liquidity resources for strategic deployment or in response to challenging market conditions.

Operator, Operator

Your first question comes from Crispin Love with Piper Sandler.

Crispin Love, Analyst

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 timeframe 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?

Daniel Perotti, CFO

In the fourth quarter, there are a couple of factors to consider. Recently, we've had a rally and noticed an increase in volumes. If this trend continues, it could increase our volumes and operating ROEs to the higher end of the range. However, we typically experience seasonality effects in the fourth quarter related to purchases, which may cause a slight lag, along with lower custodial balances in our servicing portfolio. Therefore, if we maintain these rate levels, our operating ROE could move into the high teens to low 20s, but we do anticipate some of these usual seasonal effects as we progress through the fourth quarter.

Crispin Love, Analyst

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?

David Spector, CEO

Yes, we are always prepared for a variety of outcomes within the company, and we have experience handling these situations. Our main priority is to ensure we have sufficient commitment authority with Ginnie Mae to continue issuing Ginnie Mae securities, aiming for at least nine months of commitment authority. Regarding delinquency, we currently have a few thousand borrowers in forbearance due to the government shutdown, and we are receiving two to two and a half times that number of inquiries related to it. However, I do not anticipate any significant impact. Our technology and infrastructure enable us to adapt to challenges, whether they stem from a government shutdown, a natural disaster, or even severe events like COVID-19. The team is always ready to respond to whatever challenges may arise.

Operator, Operator

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

Bose George, Analyst

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?

Daniel Perotti, CFO

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.

David Spector, CEO

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.

Bose George, Analyst

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.

Daniel Perotti, CFO

Exactly. As I mentioned earlier, the consumer direct segment is influenced by the mix of products. The second lien loans typically have higher basis points, while refinances have lower. However, first lien refinances generally involve larger loan amounts. This means that on a revenue per loan basis, we actually achieve higher revenues per loan despite lower basis points for those loans. We have experienced fluctuations in this area before, but with decreasing rates, we see an increase in refinances, which are usually more profitable in the consumer direct channel on a per loan basis. Additionally, both correspondent and broker channels have seen margins rise. In the correspondent channel, our margins increased even though volumes decreased slightly, resulting in slightly higher revenues than the previous quarter. This reflects our margin discipline in that area. Meanwhile, the broker channel remains strong, and we continue to capture market share and build momentum there.

Operator, Operator

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

Douglas Harter, Analyst

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?

Daniel Perotti, CFO

Certainly. Regarding our capital deployment, both items reflect our proactive approach to capital allocation in PFSI. When it comes to share repurchases, we evaluate this against other capital deployment opportunities. As our share prices decreased to a level we found attractive compared to other options, we entered the market. Although prices have fluctuated since then, we continue to see appealing opportunities in deploying capital into high-rate MSRs, which exhibit strong recapture potential, especially as rates decline. Our past actions demonstrate our willingness and ability to repurchase shares, and this will remain part of our capital allocation strategy whenever we identify such opportunities. Concerning the Annaly transaction, we plan to allocate the capital raised from that toward acquiring additional high note-rate servicing opportunities with recapture potential. We believe that the future returns from the Annaly transaction will be at the lower end of our target range, enabling us to invest in higher note-rate servicing with improved recapture potential, which is beneficial for PFSI.

David Spector, CEO

Yes, Doug. The two 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 growth 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, 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.

Douglas Harter, Analyst

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?

Daniel Perotti, CFO

This quarter's results were a bit below our expectations for the future. Part of this was due to option executions during the quarter, which created a lasting tax difference that lowered our tax rate for this period. Overall, we anticipate that our tax rate will increase slightly over time, by a couple of hundred basis points, though we did benefit from this lower rate in the quarter.

Operator, Operator

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

Trevor Cranston, Analyst

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?

David Spector, CEO

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.

Daniel Perotti, CFO

Yes. Generally, we've noticed that some individuals are responding a bit faster than in the past, particularly those who bought homes at higher interest rates and are eager to take advantage of slightly lower rates. As a result, the responsiveness has been a bit higher than what we've typically experienced. Regarding the recapture rate, it has continued to improve in the third quarter, as David noted. Looking ahead to the fourth quarter, we expect to see the benefits of our enhanced focus on recapture, especially from loans that were locked in during the third quarter and will lead to payoffs in the fourth quarter.

Operator, Operator

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

Eric Hagen, Analyst

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?

David Spector, CEO

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 three channels because whether it benefits us in correspondent or broker or our call center, we will be able to participate.

Eric Hagen, Analyst

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?

Daniel Perotti, CFO

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.

David Spector, CEO

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, Operator

Your next question comes from the line of Ryan Shelley with Bank of America.

Ryan Shelley, Analyst

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 two and not you guys? Any changes to call out there?

David Spector, CEO

I believe our rapid growth in the broker direct channel is a result of our team's dedicated efforts in developing technology that meets the needs of brokers and provides a strong alternative to the top two brokers. This commitment is resonating well with our broker partners. We are uniquely positioned as the only mortgage bank that is not distracted, allowing us to focus on our broker partners’ needs and growing our market share. I am confident we will achieve a 10% market share by the end of 2026, and I anticipate continued growth. This quarter’s growth is notable due to increases in both share and margin, which is essential. The broker market is experiencing a meaningful margin increase, positively impacting our company’s results. Additionally, our involvement in all three segments of the production ecosystem enables us to engage in various parts of the origination lead system, which keeps us active in both the purchase and refinance markets. I am very optimistic about this progress.

Ryan Shelley, Analyst

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?

David Spector, CEO

Yes, I believe there are areas of the market where we might see more consolidation than others. By the end of this year, we will have completed our 18th year, and nearly everything we've accomplished has been through organic growth. Our management team focuses on organic development, having built our three production divisions and our servicing platform this way. I don't anticipate that changing. We will continue to operate and grow organically. While others may prioritize consolidation or other corporate activities, that gives us the opportunity to grow at a faster pace and do so profitably. One of the key highlights of this quarter for me is our commitment to capital allocation, specifically focusing on deploying capital into higher returning assets and identifying assets that aren't meeting our return goals. Our management team excels at this, and I aim to keep this focus moving forward.

Operator, Operator

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

David Spector, CEO

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.

Operator, Operator

This now concludes today's call. Thank you for attending. You may now disconnect.