Earnings Call Transcript - PFSI Q3 2023

Operator, Operator

Good afternoon, and welcome to PennyMac Financial Services, Inc.'s Third Quarter 2023 Earnings Call. Additional earnings materials, including presentation slides that will be referred to in 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 two 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 material. I would like to remind everyone, we will only take questions related to PennyMac Financial Services, Inc. or PFSI. We also ask that you please keep your questions limited to one preliminary question and one follow-up question as we'd like to ensure that we can answer as many questions as possible. 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.

David Spector, CEO

Thank you, operator. PennyMac Financial produced outstanding results in the third quarter, returning to a double-digit annualized return on equity. While average mortgage rates were up 50 basis points from the prior quarter, we demonstrated the earnings power of our balanced business model with exceptionally strong operating income from our large and growing servicing business, combined with continued profitability and production. As a result, book value per share grew 3% from the prior quarter. As you can see on Slide four of the presentation, mortgage rates have continued to increase from record lows in recent years and are now near 8%. As a result, many borrowers who locked in a low fixed-rate mortgage have been incentivized to stay in their homes given their low mortgage payments. This has resulted in an extremely low inventory of homes for sale, driving expectations for the lowest unit origination volume since 1990. Additionally, we believe quarterly run rate origination volumes are trending lower than the average $1.6 trillion estimates from third parties for this year. Though the current origination market remains constrained, mortgage banking companies with large servicing portfolios are better positioned to offset the decline in profitability that has resulted from these lower origination volumes. Looking at Page five of our presentation, our balanced business model as a top five servicer and a top two producer of mortgage loans is a key differentiator that enables PennyMac Financial to profitably maneuver through varying interest rate cycles. Our servicing portfolio has steadily grown to nearly $600 billion in unpaid principal balance and 2.4 million customers. This consistent growth is driven by our ability to organically grow the portfolio through our strength as a leading producer of mortgage loans. The servicing segment drives the majority of our earnings in a higher rate environment, a large portion of which is cash earnings in the form of servicing fees and placement fee income on custodial balances and deposits. Our multichannel approach to production enables consistent access to the origination market. In the current high rate environment, our correspondent and broker direct channels of production provide strong access to the purchase market. As we add these higher note rate mortgages to our portfolio, we are creating additional opportunities for our consumer direct business to offer our customers a new lower-rate mortgage when interest rates decline. As of September 30, nearly 20% of our servicing portfolio consisted of mortgages with note rates in excess of 5%. Turning to Slide six. Revenue from servicing and placement fees has increased significantly in recent years due to growth in the portfolio and increasing short-term interest rates. At the same time, operating expenses as a percentage of total servicing portfolio UPB continue to decrease, demonstrating the operational scale and efficiency gains we have achieved. The substantial accumulation of home equity in recent years across the country has driven a large opportunity in the closed-end second lien product, enabling borrowers to tap the equity they have built up in their homes without relinquishing their low-rate first lien mortgage. The 2.4 million customers we have active servicing relationships with represent cost-effective leads for our consumer direct channel, and we've been actively marketing to those who would benefit from a closed-end second product. Since the launch of our closed-end second lien product last year to our servicing portfolio customers, we have originated for sale into the secondary market, approximately $450 million in unpaid principal balance, including approximately $200 million in the third quarter. I'm excited to announce that in the fourth quarter, we will be launching a marketing campaign to nonportfolio customers, representing a significant opportunity for our consumer direct group to attract additional customers given we currently service only about 4% of total U.S. mortgage debt outstanding. PennyMac Financial continues to lead the industry with strong financial performance given its large and balanced business model. I'm extraordinarily proud of this management team's ability to successfully navigate the challenging mortgage landscape while also positioning the company to generate increasingly stronger returns over time. I will now turn it over to Dan, who will review the drivers of PFSI's third quarter financial performance.

Dan Perotti, CFO

Thank you, David. PFSI reported net income of $93 million in the third quarter or $1.77 in earnings per share for an annualized return on equity of 11%. Book value per share was up 3% from the prior quarter to $71.56. PFSI's Board of Directors also declared a third quarter cash dividend of $0.20 per share. Production segment pretax income was $25 million in the quarter. Total acquisition and origination volume were $25.1 billion in unpaid principal balance from the prior quarter despite the continuation of a challenging origination market. $22.3 billion was for PFSI's own account, and $2.8 billion was fee-based fulfillment activity for PMT. As you can see on Slide 10, PennyMac maintained its dominant position in correspondent lending with total acquisitions of $21.5 billion, with margins in the channel unchanged from the prior quarter. Notably, the number of correspondent sellers we maintain relationships with increased to 829 from 800 at June 30. October volumes continue to be strong and correspondent with $8.9 billion in acquisitions and $9.4 billion in locks. In Broker Direct, we continue to see strong trends as volumes, margins, market share, and the number of brokers approved to do business with us, all increased from the prior quarter. Block volumes were up 6% from the prior quarter despite a smaller origination market, and we expect to continue gaining market share as the top brokers increasingly see PennyMac as a strong alternative to the two top channel lenders. October volumes in Broker Direct were $0.8 billion in originations and $1 billion in locks. In Consumer Direct, volumes remained low, but margins increased meaningfully from the prior quarter due to a greater proportion of closed-end second liens, which have lower average balances. Production expenses net of loan origination expense were up slightly due to the overall increase in volumes. Turning to Page 14, the Servicing segment performed very well in the third quarter, with a contribution of $101 million to pretax income, up from $47 million in the prior quarter. The increase was primarily driven by strong operating results and lower net valuation-related changes. Excluding valuation-related changes, servicing pre-tax income was $120 million or 8.2 basis points of average servicing portfolio UPB, up from $75 million or 5.3 basis points in the prior quarter. Loan servicing fees were up from the prior quarter, primarily due to growth in PFSI's owned portfolio as PFSI has been acquiring a larger portion of the conventional correspondent production in recent periods. EBO income increased $9 million from the prior quarter, driven by redeliveries of re-performing loans for certain EBO investors. We continue to expect the contribution from EBO to remain low for the next few quarters. Interest income for the quarter was up primarily from increased placement fee income on custodial balances due to higher short-term interest rates, while interest expense was down due to lower average balances of secured debt outstanding. Operating expenses increased slightly from the prior quarter but remain low as a percentage of average servicing portfolio UPB. The fair value of PFSI's MSR before realization of cash flows increased by $399 million during the quarter, driven by higher market interest rates, which resulted in projections for decreasing prepayments and an increased contribution from placement fees on custodial balances. Hedging losses were $424 million, also driven by higher market interest rates. The net impact of MSR and hedge fair value changes on PFSI's pretax income was negative $25 million, and the impact on earnings per share was negative $0.34. And finally, the Investment Management segment contributed $400,000 to pretax income during the quarter. Assets under management increased slightly from the prior quarter due to PMT's strong third-quarter results. This quarter demonstrates our ability to drive improvement in ROE now back to the double digits. While we expect normal seasonality and a higher rate environment to have some impact in the next couple of quarters, we expect our strategic position and the strength of our model to continue to drive our returns higher over time. We'll now open it up for questions.

Operator, Operator

We'll now take your first question from Kevin Barker of Piper Sandler. Your line is open.

Kevin Barker, Analyst

Great. Thanks for taking my question. Congrats on a good quarter. Just wanted to follow up on some of the margins and the growth in the origination side. It seems like correspondent was fairly strong with margins flat. We've seen one of your competitors mentioned that there's been a pickup in competition despite the pullback from several large banks. What are you seeing in that market? And do you feel like the competitive environment is increasing or fairly stable?

David Spector, CEO

Kevin, yes. Look, I think in correspondent, we had a really strong quarter and correspondent. And I think it's really for a couple of reasons. One, clearly, we're seeing the banks stepping back. We saw that really started in the second quarter. It's continuing as a lot of banks are looking at the fatal issues that they're facing. And I think that you're going to see more of that business in correspondent. I thought it's kind of moved out of the bank, but it's going to continue to stay out of the banks. I think that another reason corresponding so strong is the fact that sellers are not retaining servicing. And so if you recall, during times of high margins, sellers would retain servicing because margins were at the higher levels and they could retain that servicing. But right now, we're seeing many sellers not retaining the servicing. And so they're selling the whole loans to corresponding aggregators versus selling to, for example, the GSEs where they could retain the servicing. From my perspective, as it pertains to PennyMac, I think we're seeing a flight to quality from the point of view that we're the leading correspondent aggregator, and we're seeing many of our customers continuing to deliver product to us and perhaps not delivering as much to some of the lower market share participants in the market. I was pleased with the increase in sellers. And while the sellers themselves are smaller, so it's not meaningful to the UPB, I think it speaks to the spike of quality issue. I mean, for us to add almost 30 sellers in a quarter is a pretty big number. And so I think that this all adds up to a really good quarter from a production standpoint, from a share perspective and also from a margin perspective, and I believe that the margin story should pay in there in Q4, and that's what we're seeing today. And I think from a correspondent perspective, we're in a very good place.

Kevin Barker, Analyst

Great. And then just a follow-up on the broker channel as well. We've seen an increase in fallout locks and then an increase in margin as well. Obviously, there's been quite a bit of attrition within that channel over the last year. Just love to hear a little bit more about what you're seeing from a competitive standpoint within the broker channel. Thank you.

David Spector, CEO

Yes. So on the broker side, we're seeing some very good traction, especially with the top brokers as data cells are getting concerned with the share of the top two participants. And so they're in need of a strong alternative. And so we're positioning ourselves as that strong alternative. And we're really between that and the technology that we've spent a long time creating to really address the needs of brokers, we're seeing very good feedback on the technology. And so I'm really happy to see that we saw margin growth and share growth last quarter. Some of that margin growth has to do with some execution enhancement after pricing, and I think the margins that we saw this quarter were very good. But I continue to expect them to stay at the high end. And like in all three production divisions, we're seeing pricing remain rational. And I think that, that is unlikely to change. If anything, over the next couple of quarters, if you do see consolidation, that could provide some additional margin expansion opportunity for us.

Operator, Operator

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

Bose George, Analyst

Everyone, good afternoon. I want to ask first, your servicing fee increased its 26.7%, so it was up 1.7 basis points. I mean could we see that go down if you do excess transactions? Or should we see the servicing fee kind of stay in this level going forward?

Dan Perotti, CFO

This is Dan. We generally expect the servicing fee to most likely go up over 10 basis points over the next few quarters. We could see some impacts from sales of excess. But overall, given the servicing that we're bringing on, the fact that the significant bulk of the overall servicing that we're generating since the conventional correspondent volumes are now going through to PFSI and they're retaining those as MSR, that rather than PMT retaining it over the last couple of quarters, that's contributed to the increase in the basis points of servicing fee. We do evaluate sales of excess, but we would only engage in those to the extent that we see that as a benefit in terms of our deployment of capital. Our overall lean, I would expect over the next few quarters as we're bringing on additional servicing, some of it at higher servicing fee levels would see that servicing fee basis points go up over the next couple of quarters.

Bose George, Analyst

Okay. Great. And then actually, going back to the gain on sale margin, in that Slide 11, the gain on sale margin by channel has gone up over the last quarter, last year. But then there's that other line item that kind of offsets that. So if I look at the total gain on sale margin, it actually went down a little bit quarter-over-quarter. So just curious what that line is? And also should we look at this on a bottom line basis? Or should we look at the line items?

Dan Perotti, CFO

Sure. Generally speaking, I would say you should look at the line items and that will generally tell you how the margins are performing on a channel-by-channel basis. The shift in the overall margin quarter-over-quarter was really based primarily on the mix of volume. So we had a greater proportion of correspondent loans coming through in the third quarter as opposed to some of the earlier quarters. I mean those are overall, if you look at the blend lower margin for that volume. And so that overall is what is driving down the basis points on an aggregate basis quarter-over-quarter.

Bose George, Analyst

Okay. Is that other line related to hedging, or what kind of flows are coming through there?

Dan Perotti, CFO

The other line has a couple of components. The first is related to timing, specifically concerning locks and the income associated with them. From an accounting perspective, we recognize income only at the time of funding, which means some of this can be shifted to different periods. To assess what we expect the margin in that channel to be, we look at our projected lock gain for that period. If there is a timing difference, the results could change. Additionally, any hedging gain or loss, or other similar factors, could also affect that line.

Operator, Operator

Your next question comes from the line of Michael Kaye of Wells Fargo. Your line is open.

Michael Kaye, Analyst

Hi, good evening. On the Production segment, do you think you could keep the profitability at these levels, given we're entering the slower seasonal winter months, plus mortgage rates are much higher? Could that potentially swing back to losses?

David Spector, CEO

Well, look, I think the things we can't control and clearly, from what we're seeing in October, I would expect Q4 to be profitable in production. We've got an industry-leading correspondent franchise really coming under severe pressure to swing it to the unprofitable side. A similar story can be said on broker as well. I mean we're making inroads in the broker channel. While the current run rate of production is closer to $1.2 billion, $1.3 trillion market, it's still more than enough to keep us operating profitably. I'll tell you, I think the really interesting product that I'm enthusiastic about is closed-end seconds. We had a very good quarter in closed-end seconds where we originated $200 million in the third quarter alone. We've originated $450 million to date. The margins are very nice. It's a profitable product for us. We sell them all into the secondary market. We do retain the servicing on them as we currently service the first on these loans as well. One real added benefit is that it keeps capacity in place for our consumer direct channel. And lately, we will see a great decline in having that capacity in place will be very important for us to refocus on the opportunity to refinance borrowers in higher rate mortgages. I'm enthusiastic about what we're seeing in Q4. I think that we're setting ourselves up to continue to grow ROEs in an environment that's higher for longer or in an environment where rates decline.

Michael Kaye, Analyst

Good to hear. Just on expenses. I know you took a lot out, you were early, but I don't think anyone was expecting rates to be where they are now. Are you positioned okay on expenses in production? Or do you think there could be potentially more trending, just given the environment is probably worse than most of us were expecting?

David Spector, CEO

I believe we are very effective at adjusting our staffing levels based on the market conditions we encounter. From my viewpoint and that of the rest of the organization, we are maintaining our core capabilities. We are not overextended for a $1.2 trillion market, nor do we intend to be. That said, we are examining our technology infrastructure, and I anticipate we will look to reduce expenses in that area. For example, when there is attrition, our management team must meet certain criteria before hiring or replacing anyone. Overall, we addressed our challenges early on. We recognized the steps we needed to take and implemented them several times in 2022. This proactive approach has allowed us to concentrate on improving our return on equity, which we successfully increased to double digits this quarter.

Operator, Operator

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

Eric Hagen, Analyst

Hey, good afternoon, how are you doing guys? First question here. Can you talk about how you're maybe adjusting your pricing for different borrower credit characteristics? Any changes to the credit box even more generally as rates have moved up as high? Like whether you're intentionally targeting higher quality loans because rates are high and affordability is constrained?

David Spector, CEO

Yes, look, I think that the way we think about pricing mortgages is, number one, we only buy loans that are scalable to the GSEs or that meet FHA or USDA guidelines. Having said that, I would say in late in the third quarter of last year alone, we made some conscious decisions in terms of pricing risk attributes to take into account higher rates. Along those lines, a lot of the lower FICO FHA loans and VA and USDA loans, we believe we're going to acquire, I would say, a higher return in the investment for servicing, given that in a higher rate environment, typically, you see delinquencies increase. You see correspondent sellers stretching and while we diligence loans and we underwrite loans, inevitably, you do start to see delinquencies go up. I think this move while we got a little on the early side, I'd rather be early than late, as you can well imagine. I think it's bearing out. If you look at the FICO scores and the LTVs of our production versus the rest of the market, I think it's meaningful. It's something that the management team looks at regularly. But we're not arbitrarily making changes to the credit box.

Dan Perotti, CFO

If you look on Page 33 of the deck, you can see the characteristics of the loans we are acquiring, particularly through correspondent channels over time. The FICO scores have risen significantly, largely in response to the factors David mentioned and some changes we implemented starting in the third quarter of last year.

Eric Hagen, Analyst

Yes, no, that's helpful. With the hedging results in the period, would you say that the function of the level of rates? Or is it interest rate volatility? Is there sort of like an ideal environment, you feel like for hedging the MSR and maybe even kind of teasing apart and talking through the hedging results in the quarter would be helpful. And any hedging through October as well. Thanks.

Dan Perotti, CFO

Sure. So we talked a little bit last quarter about the elevated hedging costs that we are seeing from volatility being very high and some of the impact of the inverted yield curve. As a lot of that abated here in the third quarter, we saw a pretty meaningful inversion of the curve as well as all come down. We saw our hedge costs decline meaningfully. Our overall profile and our strategy at this point is really given how high interest rates are, typically, when rates are lower or more balanced, I would say, in terms of the maintenance of our servicing portfolio. We targeted a hedge ratio that was less than 100% so that we would allow for gains in a selloff because origination volume would decline and for potential losses, limited losses in a reality because we would see an uptick in origination income. With rates at this level, where so much of the servicing portfolio is meaningfully out of the money, we've really flattened that hedge profile and are targeting a profile that's fairly close to 100%. When we take out the cost of servicing, I mean, the cost of hedging rather, and then look at what our hedge ratio was compared to the change in value. We actually come up to pretty close to 100%, given the change in value that we saw during the quarter. There was relatively little leakage given the size of the servicing portfolio and the MSR asset and the change in interest rates that we saw during the quarter. To your point, given where we are in rates and the fact that so much of our servicing portfolio is out of the money, we would expect this targeting of the hedge ratio closer to 100% is where we’d be probably at least for the next few periods, barring a meaningful interest rate rally. I think that sort of covers where hopefully what we saw during the quarter here as well as what you might expect to see going forward.

Eric Hagen, Analyst

Got it. Okay. So into October, there hasn't been a lot of slippage. It sounds like...

Operator, Operator

Your next question comes from the line of Kyle Joseph of Jefferies. Your line is open.

Kyle Joseph, Analyst

Good afternoon. Many of my questions have already been addressed, but I wanted to discuss the second lien product. I understand that you emphasize its significance, so could you explain its effects on the profit and loss statement and the balance sheet, particularly regarding volumes and margins? Additionally, do you anticipate this trend to continue?

Dan Perotti, CFO

So the second lien product, overall, as David mentioned, we originated about $200 million of it during the quarter. I think we mentioned in our presentation that we are also looking at opening that up to beyond our just originating for our servicing portfolio to market to the market at large, which is obviously an even greater opportunity than what we have in our servicing portfolio. We could expect to continue to increase. It's been increasing over the past few quarters. If you look at the margin trends that we've seen in consumer direct, which is the channel in which we're originating these loans, that's been increasing pretty meaningfully on a basis points basis over the past few quarters. A lot of that is due to the blend of the second lien product versus the first lien because we are originating a greater proportion of second liens. Given the smaller balance of the second lien product, we have a higher basis point target in terms of our gross margin there. Given the blend, it's a bit above what the blend was here, so up into the 500 or 600 basis points in terms of margin on a UPB basis, where the overall UPB of these loans can be $75 million to potentially $100,000. That’s really the revenue side on the production side. It's pretty similar expense-wise to what we see for a normal consumer direct loan. So on a normal scale, a little bit under in terms of basis points, what you would see in terms of what we collect in terms of the revenue. So there's a profitable contribution to the overall production business, but not as significantly profitable as if we were refinancing loans in a rally. To David's point, if we do see an interest rate rally, one of the benefits of the second lien product of production is that we're able to keep the staff on hand in a profitable enterprise. When we do see the interest rate rally, we'll be able to shift those resources over to refinancing loans into first liens from the higher rate balances that we've added over the past couple of quarters through corresponding.

Operator, Operator

Your next question comes from the line of Jay McCanless of Wedbush. Your line is open.

Jay McCanless, Analyst

Hey, good afternoon, everyone. Two questions for me. I guess if you take the second lien loans that you're originating outside of your channel. I mean, what's kind of the annual market size or market opportunity you think could be out there?

Dan Perotti, CFO

I believe there is a clear opportunity for second lien expansion, as demonstrated on Slide 8. I would be disappointed if we didn’t see growth in production volumes in this area. Last quarter, we originated $200 million in second liens. Our servicing portfolio is substantial, holding considerable taxable equity. Around 60% of borrowers in the U.S. have mortgage loans with a note rate of 4% or lower. From my experience, as consumers become more familiar with financial products, acceptance increases, leading to higher demand. More individuals are taking out second liens, which is why we are introducing this product in our consumer direct channel for non-portfolio customers. We're also planning to test it in Broker Direct, likely late in Q4 or early in Q1. This product is here to stay, especially since many mortgages are below 4% and homeowners have significant equity. Events in people's lives will prompt them to access this equity, and as we remain in a high-rate environment, the number of second liens will likely increase. This product has become essential over the past few years as many have refinanced into lower-rate mortgages.

Jay McCanless, Analyst

Thank you for the detail. That's great. I guess the other question, share repurchase, any thought to doing that at these levels?

Dan Perotti, CFO

We have slowed down our share repurchase activity compared to previous levels. We did not buy back any shares this quarter, but we are continuing to evaluate this option. Several factors influence our decision, including our overall leverage ratio, which currently stands at 1.2x for non-funding debt this quarter. Historically, we've hovered slightly above 1x, and we want to keep our leverage ratio below 1.5x going forward to ensure we're positioned well for any potential unsecured debt opportunities. While the current stock price may appear attractive for repurchase, we must balance that against maintaining our leverage ratio and consider other capital deployment opportunities, such as the $25 billion in correspondent servicing we are adding quarterly or any other potential initiatives that may come up.

Operator, Operator

Your next question comes from the line of Priya Rangarajan of RBC Capital Markets. Your line is open.

Priya Rangarajan, Analyst

Hey guys, thank you so much for the call. On the second lien program that you have, are you seeing any consumer behavior difference between a cash-out refinance versus the second lien product? Are they leaning more towards one product than the other?

Dan Perotti, CFO

One of the reasons we came out with the product is I didn't like what I was seeing in the market, the people who are starting to refinance out of low-rate first liens. From my perspective, we needed the product to give borrowers the ability to tap their equity without getting out of first lien mortgages. When the borrower calls in for a cash-out refinance, we expose them and offer them the second lien product as a viable option. We pay the loan officer the same amount. There's no incentive for them to do a cash-out refinance versus a second lien mortgage. We want to focus on the compliance aspect of this product. I think it speaks to why we're doing some in the second lien versus cash refinances. Life events may take place that require cash-out refinances in the marketplace, but I generally view that if borrowers want to tap their equity, the second lien product is the most fitting solution. Now we do have minimum FICO requirements on the product. If you see cash-out refinances in the marketplace, that's probably due to those considerations. Generally speaking, given the high credit quality of our servicing portfolio, second lien is the product that I really want to see our borrowers using to tap equity.

Priya Rangarajan, Analyst

That's very helpful color. Secondly, on the origination side. As you look into 2024 to the extent that the markets don't change so much from an existing sales house market. How are you thinking about gain on sale margins? Do you think that the industry has rationalized enough that you should see stable margins? Or can gain on sale actually go higher as there is more consolidation?

Dan Perotti, CFO

Well, look, I think I didn't gain on sale margins remain relatively stable. There are some ebbs and flows that take place during the year. Overall, we are seeing gain on sale margins stabilize. As I mentioned earlier, I think in correspondent, we're starting to see a bit of opportunity with the banks stepping back for us to increase margin. Look, from a mortgage size perspective, the mortgage market size, given where the application index is showing right now, we're probably running at a $1.2 trillion to $1.3 trillion run rate. Given the average balance, we're at a unit run rate that we haven't seen since 1990. I generally think we will see rates come down. When, I don't know. I'm not in the prediction business. But look at the market as a whole, it's generally so in the second half of next year, you'll start to see some pressure come off of rates. Having said that, I'm very pleased with where margins are, there's rational pricing taking place in all three channels, and I suspect that in Q4 and a little bit in Q1, given the high level of rates, you're going to start to observe some more consolidation taking place, which will only lend itself to the margins remaining stable.

Priya Rangarajan, Analyst

Got it. And then finally, from a credit perspective, you guys obviously did not do a dividend this quarter. Given where your debt trades, have you thought about doing open market purchases, tender like your CN25 financing? Anything would be helpful color. Thank you so much.

Dan Perotti, CFO

We did declare a dividend this quarter and issued a quarterly dividend. We have not conducted any share repurchases this quarter, but we are exploring potential opportunities in the unsecured debt or high-yield space, and we haven't taken action on that yet. Additionally, we are looking at potential opportunities on the secured side to manage some of our debt maturities. Unless a compelling opportunity arises in the high-yield market, we may consider addressing the maturity of our unsecured debt, which is due later in 2025, but that is still some time away. We believe there is a significant window of opportunity between now and when that maturity arrives, and we do not anticipate any changes in the near term.

Operator, Operator

And your last question comes from the line of Kevin Barker of Piper Sandler. Your line is open.

Kevin Barker, Analyst

Thank you. I just wanted to follow up on the interest income, which has been fairly strong. Obviously, you have some different moving parts with higher interest rates, higher custodial balances, and then some seasonality associated with it, combined with some decline in debt. So could you just provide us a little bit more color on what you expect from the direction of interest income, just given higher custodial balances? And then interest expense on the other side, given lower origination volume just seasonally? Thanks.

Dan Perotti, CFO

Overall, when we look at the interest income to your point, there are a number of different moving pieces. We tend to look at it on the interest income related to production and then the interest income related to servicing. Interest income related to production, given some of the changes in the yield curve toward the end of last quarter, at the beginning of this quarter, would tend to push up the note rate of mortgage rates; versus the short-term rates have remained relatively stable. We would expect that relationship between our financing lines and the note rate on the loans that are coming in to increase that interest spread, which would generally move the interest income on the production side positively. On the servicing side, a couple of factors. One, as we noted in our servicing income sort of disclosure, our servicing profitability slide, Slide 14, we did see interest expense decline quarter-over-quarter due to a lower draw on our servicing financing lines. We're keeping somewhat less cash. You may have seen the cash balance on our balance sheet decline somewhat. We have begun to reduce the overall cash that we're holding on the balance sheet. We've been holding somewhat elevated levels due to some of the market conditions we saw earlier in the year. So we've begun to reduce that, resulting in a decline in interest expense, which could also reduce the interest income earned on that cash. But overall, since we're paying a spread of 300 to 400 basis points on the servicing lines, that would bring down interest expense and create an overall positive benefit. On the interest on the custodials, we expect that to probably come down a little bit quarter-over-quarter due to seasonal tax payments that typically occur toward the end of the year or very beginning of the year. So hopefully, I know that was a lot of different components, but I would say that interest income ends up in a pretty similar place to what we saw in this quarter if we're looking out into the next quarter.

Kevin Barker, Analyst

Yes, that's very helpful. Just from a seasonality perspective, what percent of the cost dial balance would you expect to decline in the fourth quarter and then in the first quarter just due to seasonality?

Dan Perotti, CFO

Yes. Typically, the average is lowest in the first quarter because the tax payments happen through the fourth quarter. I think compared to the third quarter, I don't know the percentages off the top of my head. But I think roughly in the fourth quarter, down 10% to 15%. Then in the first quarter, a bit higher than that, probably down 20% or a little bit more.

Operator, Operator

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

David Spector, CEO

Well, thank you, everyone, for joining today. We appreciate the time and the thoughtful questions. If you have any additional questions, please don't hesitate to reach out to our IR team, and I look forward to speaking to all of you soon. Take care.

Operator, Operator

This concludes today's conference call. You may now disconnect.