PennyMac Financial Services Q2 2025 Earnings Report

PennyMac Financial Services EPS Results

• Actual EPS: $1.02
• Consensus EPS: $3.01
• Beat/Miss: Missed by -$1.99
• One Year Ago EPS: $1.85

PennyMac Financial Services Revenue Results

• Actual Revenue: $444.73 million
• Expected Revenue: $547.44 million
• Beat/Miss: Missed by -$102.71 million
• YoY Revenue Growth: +9.50%

PennyMac Financial Services Announcement Details

• Quarter: Q2 2025
• Date: 7/22/2025
• Time: After Market Closes
• Conference Call Date: Tuesday, July 22, 2025
• Conference Call Time: 5:00PM ET

PennyMac Financial Services (NYSE:PFSI), through its subsidiaries, engages in the mortgage banking and investment management activities in the United States. The company operates through three segments: Production, Servicing, and Investment Management. The Production segment is involved in the origination, acquisition, and sale of loans. This segment sources residential conventional and government-insured or guaranteed mortgage loans through correspondent production, consumer direct lending, and broker direct lending. The Servicing segment performs loan servicing for both newly originated loans that are under holding for sale and loans services for others. The segment performs loan administration, collection, and default management activities, including the collection and remittance of loan payments; responds to customer inquiries; provides accounting for principal and interest; holds custodial funds for the payment of property taxes and insurance premiums; counsels delinquent borrowers; and supervising foreclosures and property dispositions, as well as administers loss mitigation activities, such as modification and forbearance programs. The Investment Management segment is involved in sourcing, performing diligence, bidding, and closing investment asset acquisitions; managing correspondent production activities for PennyMac Mortgage Investment Trust; and managing acquired assets. The company was founded in 2008 and is headquartered in Westlake Village, California.

PennyMac Financial Services Q2 2025 Earnings Call Transcript

Key Takeaways

• Positive Sentiment: Strong Q2 financial results with $136M net income, $2.54 EPS and 14% ROE, and guidance for mid-high teens operating ROE if rates remain 6.5-7.5%.
• Positive Sentiment: Servicing portfolio grew to $700B UPB across 2.7M homes, leveraging scale as the firm’s balanced mortgage banking model drives stable performance.
• Positive Sentiment: Achieved ~20% market share in correspondent lending with $100B 12-month UPB and expanded broker direct share to ~5%, targeting >10% by end of 2026.
• Positive Sentiment: Accelerating AI deployment with 35+ tools already launched, aiming for a $25M annual boost and ultimately a fully automated loan origination and servicing process.

Presentation

[Operator]

Good afternoon, and welcome to PennyMac Financial Services Inc. Second Quarter twenty twenty five 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 materials. Now I'd like to introduce David Spector, PennyMac Financial's Chairman and Chief Executive Officer and Dan Parati, PennyMac Financial's Chief Financial Officer. Please go ahead.

[David Spector, CEO & Chairman at PennyMac Financial Services]

Thank you, operator. Good afternoon, and thank you to everyone for participating in our second quarter earnings call. For the second quarter, as shown on Slide three, PFSI reported net income of $136,000,000 or diluted earnings per share of $2.54 This reflects an annualized return on equity of 14%. Excluding the impact of fair value changes and a non recurring tax benefit, which Dan will talk about later, PFSI produced an annualized operating ROE of 13%. These results highlight the resilience of our balanced business model and our continued ability to produce solid financial results even during periods of extreme volatility, such as earlier in the second quarter.

[David Spector, CEO & Chairman at PennyMac Financial Services]

As you can see on Slide five, our consistent performance over recent periods of elevated mortgage rates demonstrates the strength of our organically built comprehensive mortgage banking platform. The stability provided by our balanced business model, especially in this higher for longer rate environment, is a real strategic advantage. We expect that if interest rates stay in the range of 6.5% to 7.5%, our operating returns on equity will continue to range in the mid to high teens throughout the remainder of this year. You can further see the strategic advantage of our comprehensive mortgage banking platform on Slide six as our business model functions as a very powerful flywheel. Because we are the second largest producer of mortgage loans and the sixth largest servicer, we operate with a significant scale advantage in both businesses.

[David Spector, CEO & Chairman at PennyMac Financial Services]

Large volumes of loan production consistently exceed our portfolio runoff, resulting in the continued growth of our loan servicing portfolio. At the end of the second quarter, our portfolio totaled $700,000,000,000 in unpaid principal balance representing 2,700,000 households. This large and growing customer base drives efficient cost effective leads to our Consumer Direct Group as we leverage our proprietary servicing platform to effectively service our customers' needs, whether it's a refinance when interest rates decline or if they're in the market for a new home purchase or closed end second mortgage to access their home equity while retaining their low rate first lien mortgage. And because we have instilled in our team a culture of continued process improvement and technology innovation, we believe we can continue to drive further scale and operational efficiencies into our platform. Our strategy also allows us to excel on capturing growth in the expanded in the expanding purchase market.

[David Spector, CEO & Chairman at PennyMac Financial Services]

The chart on the bottom of Slide seven illustrates the projected growth in overall volumes, which is primarily driven by the more consistent purchase market compared to the refinance market. This trend underscores why our strategic emphasis on our relationship businesses with strong ties in their local markets is so vital. Our strong access to this growing market is achieved through our robust presence in correspondent lending and our rapidly increasing market share in broker direct. Our market leadership is supported by our unmatched excellence and support for our business partnerships illustrated on Slide eight. This foundation provides a significant strategic alignment with our business partners that is difficult to replicate and has been organically and carefully built over time.

[David Spector, CEO & Chairman at PennyMac Financial Services]

We offer cutting edge technology, a continued presence in markets with reliable execution and rapid closing and turn times. Additionally, we have long standing relationships with key partners and one of the lowest cost structures in the industry driven by our highly efficient fulfillment operation. Turning to Slide nine. We proudly showcase our position as the outright leader in correspondent lending. Over the last twelve months, we have generated approximately $100,000,000,000 in UPB of correspondent production, achieving an estimated market share of approximately 20% in the first half of twenty twenty five.

[David Spector, CEO & Chairman at PennyMac Financial Services]

This significant volume is a direct result of our more than fifteen years of operational excellence, technology innovation and our deep partnerships with many of our nearly 800 active sellers across the country. A key aspect of our leadership in this channel is our exceptional operational leverage and scale. In fact, we have the ability to increase production by approximately 50% from our current levels with no increase to our fixed expenses. This capability underscores our fundamental strength as a highly efficient, low cost provider in this channel, solidifying our truly dominant position and creating a substantial competitive advantage. Similarly, you can see on Slide 10 that we are increasingly becoming more relevant in the broker direct channel.

[David Spector, CEO & Chairman at PennyMac Financial Services]

From our entry to this business in 2018, our broker direct market share has expanded significantly, currently standing at approximately 5%. 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 twenty twenty six. This remarkable growth and our position as a trusted alternative are driven by our tech forward 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.

[David Spector, CEO & Chairman at PennyMac Financial Services]

On Slide 11, we highlight the significant opportunity for our direct for our consumer direct business and why we are intensely focused on building on our successes in this channel. We have a large network of more than 5,000,000 current and former homeowners who know and trust PennyMac, and we are leveraging our industry leading team and data analytics to identify refinance and other opportunities so we are best positioned to help meet our customers' home finance needs. Our refinance recapture rate is already twice the industry average, which effectively protects from the lower impact from the impacts of lower MSR values as rates decline. And we will continue to leverage our strategic partnership with Team USA and the LA twenty eight Olympic and Paralympic Games along with targeted model driven campaigns to increase our visibility and recognition while driving growth in recapture and new customer acquisition. Turning to Slide 12, you can see the significant recapture opportunity for our Consumer Direct division when interest rates do decline.

[David Spector, CEO & Chairman at PennyMac Financial Services]

As of June 30, dollars $267,000,000,000 in UPB or 38% of the loans in our servicing portfolio have a note rate above five percent and $181,000,000,000 in UPB or 26% 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 and stand to benefit from a refinance in the future when interest rates do decline positions our consumer direct lending division for strong future growth. Our multiyear investments in technology and process innovation have already driven meaningful improvements in recapture rates, and we expect these to continue improving. Now let's turn to an area that is not just critical but truly transformative for our entire balanced business model, our unwavering intense focus on artificial intelligence. On Slide 13, you'll see we're not just building momentum, we are accelerating with breakthrough speed in the development of AI.

[David Spector, CEO & Chairman at PennyMac Financial Services]

We are aggressively advancing our AI capabilities, making targeted and strategic investments. This strategic commitment is a natural evolution of our history of investing in leading edge technology, and it is designed to enhance the customer experience, unlock new revenue streams and crucially, drive unprecedented levels of efficiency to dramatically reduce expenses. Our dedicated AI accelerator team is at the forefront, relentlessly focused on delivering and adopting AI applications and productivity tools faster than ever before. Our cloud based and flexible proprietary platforms have positioned us extraordinarily well to integrate AI, profoundly enhancing our capabilities and efficiency across our entire technology landscape. In production, we're seeing game changing advancements.

[David Spector, CEO & Chairman at PennyMac Financial Services]

Our proprietary chatbots aren't just tools. They're extensions of our loan officers and underwriters, providing instant compliant answers sourced directly from our deep well of comprehensive policies and procedures. This empowers our team members with unparalleled accuracy and allows them to focus squarely on what they do best, driving sales and closing more loans. And with our AI call summarization, we're automating critical after call work, bringing up valuable time and insights for our sales teams contributing directly to increased conversion. In servicing, our AI initiatives are equally impactful, enhancing both efficiency and the client experience.

[David Spector, CEO & Chairman at PennyMac Financial Services]

Behind the scenes, our servicing AI processing solution is automating critical document workflows and streamlining operations. And for our clients, our advanced servicing automated assistant available instantly on web and mobile provides immediate access to loan specific information and answers to their questions. This empowers our clients with self-service convenience and speed, elevating their overall experience and allowing our team members to focus on more complex high value interactions. To date, we've already launched or are actively developing more than 35 AI tools and applications with a projected annual economic benefit of approximately $25,000,000 While this is far more than a strong start, this is just the beginning of what's possible, and we are incredibly excited about what the future holds. This brings me to Slide 14, which illustrate PennyMac's ambitious groundbreaking vision for artificial intelligence.

[David Spector, CEO & Chairman at PennyMac Financial Services]

We have already achieved significant milestones from advanced coding productivity tools to sophisticated workplace tools and intelligent chatbots that are reshaping daily operations. But our road map is truly visionary. It includes sophisticated agent automation of complex loan processing activities, robust and intuitive self-service capabilities that empowers our customers and advanced lead generation processes that will redefine our outreach. Our ultimate vision is a fully automated loan process, including a seamless self-service origination servicing experience. This is not just technology.

[David Spector, CEO & Chairman at PennyMac Financial Services]

This is the future of mortgage banking and PennyMac is leading the way. In conclusion, our balanced and diversified business model continues to deliver strong financial performance. We maintain our leadership position in the purchase market through our strong correspondent franchise and growing broker direct lending presence, which provides consistent business volumes. These volumes directly grow our servicing portfolio, creating a significant future opportunity in our consumer direct channel, further enhanced by our strategic brand investments. And throughout all of our operations, our intense focus on AI and technology is effectively driving down costs, contributing to our overall financial strength.

[David Spector, CEO & Chairman at PennyMac Financial Services]

Our strategic foundation solidly positions PennyMac for continued growth and strong performance in any market environment, and I'm incredibly excited about what our future holds. I will now turn it over to Dan, who will review the drivers of PFSI's second quarter financial performance.

[Daniel Perotti, Senior MD & CFO at PennyMac Financial Services]

Thank you, David. PFSI reported net income of $136,000,000 in the second quarter or $2.54 in earnings per share for an annualized ROE of 14%. These results included 93,000,000 of fair value declines on MSRs net of hedges and costs and a nonrecurring net tax benefit of $82,000,000 The contribution from these items to diluted earnings per share was $0.19 PFSI's Board of Directors declared a second quarter common share dividend of $0.30 per share. Beginning with our production segment, pretax income was $58,000,000 down from $62,000,000 in the prior quarter.

[Daniel Perotti, Senior MD & CFO at PennyMac Financial Services]

Total acquisition and origination volumes were $38,000,000,000 in unpaid principal balance, up 31% from the prior quarter. Of this, 35,000,000,000 was for PFSI's own account and $3,000,000,000 was fee based fulfillment activity for PMT. Total locked volumes were $43,000,000,000 in UPB, up 26% from the prior quarter. PennyMac maintained its dominant position in correspondent lending in the second quarter, with total acquisitions of $30,000,000,000 up 30% from the prior quarter. Correspondent channel margins in the second quarter were 25 basis points, down slightly from the first quarter.

[Daniel Perotti, Senior MD & CFO at PennyMac Financial Services]

While followed adjusted locks for PFSI's own account were up from the prior quarter, PFSI account revenues were impacted by a negative contribution from timing of revenue and loan origination expense recognition, hedging and pricing execution and other items, as well as a higher proportion of volume in the correspondent and broker direct lending channels relative to last quarter. PMT retained 17% of total conventional conforming correspondent production, down from 21% in the prior quarter. Of note, pursuant to our renewed mortgage banking agreement with PMT, effective 07/01/2025, all correspondent loans are initially acquired by PFSI. However, PMT will retain the right to purchase up to 100% of non government correspondent loan production. In the third quarter, we expect TMT to acquire approximately 15% to 25% of total conventional conforming correspondent production, consistent with levels in recent quarters.

[Daniel Perotti, Senior MD & CFO at PennyMac Financial Services]

In broker direct, we continue to see strong trends and continued growth in market share as we position PennyMac as a strong alternative to channel leaders. Originations in the channel were up almost 60% and locks were up more than 30% 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 5,100, up 19% from the same time last year, and we expect this number to continue growing as top brokers increasingly look for strength and diversification in their business partners. Broker channel margins were down slightly from the prior quarter. Trends were mixed in Consumer Direct with origination volumes up 6% and lock volumes down 2% from the prior quarter.

[Daniel Perotti, Senior MD & CFO at PennyMac Financial Services]

Margins in the channel were up due to a larger mix of higher margin closed end second liens during the quarter. Activity across our channels in July has been mixed with increased activity across correspondent and broker direct and volumes in consumer direct similar to levels reported in the second quarter. Production expenses, net of loan origination expense, increased 8% from the prior quarter, partially due to increased capacity in direct lending, which is expected to drive our ability to rapidly address opportunities presented by lower mortgage rates. Turning to servicing. As David mentioned, our servicing portfolio continues to grow, ending the quarter at $700,000,000,000 in unpaid principal balance.

[Daniel Perotti, Senior MD & CFO at PennyMac Financial Services]

The servicing segment recorded pretax income of $54,000,000 Excluding valuation related changes, pretax income was $144,000,000 or 8.3 basis points of average servicing portfolio UPB. Loan servicing fees were up from the prior quarter, primarily due to growth in PFSI's MSR portfolio. Custodial funds managed for PFSI's owned portfolio averaged $7,500,000,000 in the second quarter, up from $6,200,000,000 in the first 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.

[Daniel Perotti, Senior MD & CFO at PennyMac Financial Services]

Operating expenses were $80,000,000 for the quarter or 4.6 basis points of average servicing portfolio UPB, down from the prior quarter. You can see on slide 21 in our servicing segment, our per loan servicing expenses are among the lowest in the industry, reflecting unit costs that have been on a consistent decline since 2019. Our operating expenses measured as basis points of average servicing portfolio UPB have come down from almost eight basis points in 2020 to less than five basis points in the last twelve months. This is a direct result of our proprietary technology, continuous process improvement and platform scale. We seek to moderate the impact of interest rate changes on the fair value of our MSR asset through a comprehensive hedging strategy that also considers production related income.

[Daniel Perotti, Senior MD & CFO at PennyMac Financial Services]

During the second quarter, the fair value of PFSI's MSR increased by $16,000,000 $26,000,000 was due to changes in market interest rates, which was partially offset by $10,000,000 of other assumption changes and performance related impacts. Excluding costs, hedge fair value declines were $55,000,000 Hedge costs were $54,000,000 the majority of which were incurred in April due to extreme interest rate volatility. As we moved into the third quarter, we strategically adjusted our hedging practices to align with our increased direct lending capacity, and we currently expect lower hedge costs and greater consistency of hedge performance with respect to the direction of rate movements in future periods. Corporate and other items contributed a pretax loss of $35,000,000 compared to $34,000,000 in the prior quarter. PFSI recorded a tax benefit of $60,000,000 in the quarter driven by a nonrecurring tax benefit of $82,000,000 which primarily consisted of a repricing of deferred tax liabilities due to state apportionment changes driven by recent legislation.

[Daniel Perotti, Senior MD & CFO at PennyMac Financial Services]

TFSI's tax provision rate in future periods is expected to be 25.2%, down from 26.7% in recent quarters. We were also active in the management of our financing in the second quarter. In May, we successfully issued $850,000,000 of unsecured senior notes due in 2032 and utilized a portion of the proceeds to redeem our initial unsecured debt offering of $650,000,000 that was due later this year in October. Additionally, we redeemed $500,000,000 of Ginnie Mae MSR term notes due in May 2027 and replace that debt with MSR financing from one of our lenders at a more attractive spread to optimize our costs. We ended the quarter with $4,000,000,000 of total liquidity, which includes cash and amounts available to draw on facilities where we have collateral pledged. We'll now open it up for questions. Operator?

[Operator]

Thank you. 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 We'll take our first question today from Crispin Love, Piper Sandler.

[Crispin Love, Director at Piper Sandler Companies]

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

[Daniel Perotti, Senior MD & CFO at PennyMac Financial Services]

Sure, Kristen. This is Dan. Thanks for the question. With respect to the operating ROE dipping a bit to 13%, really, I would say, by two factors in the quarter. One was related to on the production side, related to the margins in the channel.

[Daniel Perotti, Senior MD & CFO at PennyMac Financial Services]

So this came down a bit quarter over quarter. Some of that was driven, if you look versus the prior quarters, by a negative impact in some of the cross channel some of the cross channel activities, which was down about $10,000,000, this quarter, a negative contribution of about $10,000,000 this quarter versus $17,000,000 in the prior quarter. And this is on Page 18 of the deck. We typically we see that those cross channel impacts fluctuate. We had a bit of a negative impact due to some of the interest rate and spread volatility in the second quarter. We did see some of that reverse itself as we go into the third quarter, and overall margins toward the end of the second quarter and beginning of the third quarter have been trending higher, especially in the correspondent channel. And so as we look out with respect to production moving forward for the next, for the next few quarters, we expect, you know, improvement from the, on a on a margin basis and in terms of the, in terms of the overall income from that channel. Looking at the servicing, on the servicing side, did see a reduction in the in the pretax income excluding valuation related changes for the quarter. That was primarily driven by an increase in the realization of MSR cash flows quarter over quarter, which was driven by an uptick in overall prepayment speeds as well as an increase in the overall size of the MSR asset as well as a bit of an uptick in some of the non operating expense items, so payoff related expenses, and interest expense.

[Daniel Perotti, Senior MD & CFO at PennyMac Financial Services]

Some of those, you know, especially related to some of the prepayment activity, you know, we don't necessarily expect to see at the same level that we saw, that we saw this quarter. Additionally, interest expense includes certain one time items related to the retirement of some of our debt. And so we expect that to maintain on a bit more of a level basis as we continue to increase our servicing portfolio. So all of that being said is that our expectation as we're moving into the next couple of quarters, in terms of our operating ROE is that we expect it to improve from the levels that we saw here in Q2.

[David Spector, CEO & Chairman at PennyMac Financial Services]

And I think, look, I shared the disappointment in kind of that lower number, but I will tell you what I've seen, it really was improving in the latter part of the quarter, July has been a continuation of the improvement. I think that we're seeing margins have clearly bottomed out and corresponding. We're seeing a slight increase there as well as what we're seeing in broker direct is something similar. And so I think that we're looking forward to continuing to participate in getting those margins up in both of those channels as well.

[Crispin Love, Director at Piper Sandler Companies]

Great. Thank you very much, Dan and David, for that color. Just a follow-up for me on hedging going forward. Dan, you commented some changes you made that you expect greater consistency. Can you dig a little bit more into that?

[Crispin Love, Director at Piper Sandler Companies]

What are you changing? Are you still targeting 80% to 90% hedge ratio? And then has the recent rate stability helped as well just on the hedging side?

[Daniel Perotti, Senior MD & CFO at PennyMac Financial Services]

Sure. So overall, as I commented, we've adjusted some of our approach to hedging to have a greater recognition of the potential for recapture coming from our overall production channels and specifically our consumer direct channel or our direct channels. And we've adjusted our staffing in our direct channels to ensure that if we do see rate volatility or dips in rates that we can very quickly and actively, you know, pursue those, recapture and origination opportunities that will serve as an offset to reductions in the value of the MSR portfolio. And that's allowed us to adjust some of the ways that we approach our hedging of the MSR portfolio, to be a bit more stable and less active in terms of adjusting our hedges with changes in rates. And so in doing that, we expect that we will have lower costs as we go forward.

[Daniel Perotti, Senior MD & CFO at PennyMac Financial Services]

You can see that we did have fairly significant costs in the quarter related to some of the interest rate volatility that we experienced in April. But we expect lower costs as we're moving forward as well as, you know, given the positioning the positioning that we have to have greater, consistency in terms of, you know, when interest rates increase, seeing a net increase in the value of the MSR versus the hedges and the opposite when interest rates decline. Overall, we are still targeting an 80% to 90% hedge ratio, at least in, sort of rates within a a in your band to, its current rate levels. And and so we haven't, you know, changed our posture from that perspective. But given the, our changes in the the way we've implemented the the hedging profile as we go forward, we do expect more stability in terms of the hedge position, which drives lower costs as well as greater sort of directional performance.

[Crispin Love, Director at Piper Sandler Companies]

Great. Thank you for taking my questions.

[Operator]

Up next is Bose George, KBW.

[Bose George, Managing Director at Keefe, Bruyette & Woods (KBW)]

Yes. Good afternoon. Just wanted to follow-up on the profitability questions. Just in terms of the servicing portfolio, what's a good run rate for the profitability there just in looking at it to some basis points? I mean, makes sense the amortization increased with the bigger MSR, conceptually, you might have thought that would be offset by a higher servicing fee.

[Bose George, Managing Director at Keefe, Bruyette & Woods (KBW)]

So, yes, just kind of a good way to think about what that number should be.

[Daniel Perotti, Senior MD & CFO at PennyMac Financial Services]

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

[Bose George, Managing Director at Keefe, Bruyette & Woods (KBW)]

Okay. Great. And the decline there or the increase, I guess, in that basis points would be largely on lower amortization?

[Daniel Perotti, Senior MD & CFO at PennyMac Financial Services]

Lower slightly lower proportional amortization. As I mentioned, some of the other impacts that we saw during the quarter, payoff related expenses, there was a slight uptick versus what our run rate has been in terms of the losses and provisions for defaulted loans and the interest expense contribution. Really some normalization across those different facets.

[Bose George, Managing Director at Keefe, Bruyette & Woods (KBW)]

Okay. Great. And then in terms of the cross channel volatility number on slide 17, is that mainly, like, that mainly hedging related on this quarter? Or are there other things kind of driving that as well?

[Daniel Perotti, Senior MD & CFO at PennyMac Financial Services]

It's prime it was primarily related in the quarter to really, volatility of, of spreads, at least at certain points in the quarter. So, you know, there was a fair amount of spread volatility during the quarter. We have increasing amounts of our portfolio or of our production that is not, you know, necessarily directly deliverable into, agency execution that's driving higher margins in a number of our channels. But, to the extent that we see spread volatility in in those channels, you know, can especially, you know, at certain points in the quarter can have a, you know, an impact in that other other line item.

[Bose George, Managing Director at Keefe, Bruyette & Woods (KBW)]

Okay. So so things like nonagency and seconds getting marked through there?

[Daniel Perotti, Senior MD & CFO at PennyMac Financial Services]

Yes. To the extent that it occurs after we've lost the loan.

[Bose George, Managing Director at Keefe, Bruyette & Woods (KBW)]

Yes. Okay. Great. Thank you.

[Operator]

The next question will come from Eric Hagen, BTIG.

[Eric Hagen, Managing Director at BTIG]

Hey, thanks. Maybe following up on the profitability, looking at the servicing profitability on Page 20. Is there a way to like sensitize the earnings on both the custodial balances and the interest expense line if the Fed delivers a rate cut? Like for a 25 basis point cut, how much are each of those lines changing? And are they changing by a proportional amount, if you will?

[Daniel Perotti, Senior MD & CFO at PennyMac Financial Services]

Yes. So you can look at the outstanding debt that we have that is related to MSRs is almost all to our MSR term notes as well as the repo related to MSRs, which is all basically all floating rate debt, would be tied to SOFR, which is very directly tied the Fed rate. Similarly, we would expect that earnings on custodial balances is tied very similarly or would move very similarly to how you know, the Fed rate moves. And we, you know, we've provided the balances of custodial funds here. So, you know, you could pass that through in terms of those outstanding balances, and that would be the impact of those two line items.

[Eric Hagen, Managing Director at BTIG]

Yep. Okay. That's good. If mortgage rates are higher from here, mean, sticky do you expect margins to be in the correspondent channel? I mean, do you think we could get a scenario where community banks either use the cash window more frequently or they keep loans in the portfolio by financing them at the FHLB?

[Eric Hagen, Managing Director at BTIG]

Like what's the what are the conditions that might drive that?

[David Spector, CEO & Chairman at PennyMac Financial Services]

Look. I think that I think that, you know, we're seeing actually the opposite in our correspondent channel in that we're seeing more of the production going to whole loan buyers like ourselves, primarily because, number one, the sellers don't have the margin to be able to retain the servicing. But more importantly, given the high rate of the servicing and the fact they don't hedge the servicing, it makes more sense for them to sell the whole loan. So I I think that, you know, we're gonna continue to see correspondent aggregators to be very active, in this hire for longer environment. Where you see retention taking place is typically when margins are wide are wider and rates are at a perceived bottom.

[David Spector, CEO & Chairman at PennyMac Financial Services]

And so I think, you know, we're we're just I think, you know, coming out of out of COVID, we've seen this phenomenon only grow. The cash windows can get busier from time to time, but that's their discretion. It's not at the discretion of the seller. And typically, those who do sell to the cash window are more mortgage bankers that perhaps will aggregate servicing and auction it off. But again, given the volatility in the market, aggregating servicing is not for the faint of heart.

[David Spector, CEO & Chairman at PennyMac Financial Services]

And I think if if if you're not hedging servicing, it could backfire pretty quick quickly on you. So I think look. I think this speaks to how we're growing share in correspondent and just the level of feedback we're getting from from our customers, is pretty impactful. And I continue and I continue to expect it to to stay that way for the foreseeable future. We're just in a really tough market in that we've been higher for a lot longer.

[David Spector, CEO & Chairman at PennyMac Financial Services]

And that's something, you know, we continue to focus on here, the things we can control. And, you know, things like, you know, growing share, becoming more efficient, and continuing to reduce our expenses and deploy technology are things that we've that we're focused on. And look, that that that kind of that's not kind of in the nearest to the benefit of those who are selling loans because we can just be, more active and more dynamic as we're looking to grow share and correspondent.

[Eric Hagen, Managing Director at BTIG]

Great stuff. Appreciate your comments. Thank you.

[Operator]

Michael Kay from Wells Fargo has the next question.

[Michael Kaye, Equity Research Analyst at Wells Fargo Securities]

I wanted to see if you could dig into the loan origination expense line item. It was up a lot quarter over quarter.

[Michael Kaye, Equity Research Analyst at Wells Fargo Securities]

Was that driven by the the broker direct volume? You know, what's happening over there?

[Daniel Perotti, Senior MD & CFO at PennyMac Financial Services]

Yeah. That's exactly that's exactly correct, Michael, and thanks for the question. So our production our origination expense line item, in in terms of our accounting includes the, the fee paid through to the broker. And so if you look at the, you know, if you looked at a individual transaction for our broker direct channel, we have a, you know, larger gain on sale that would be excluding the broker fee and then the broker fee, which is a pretty, meaningful component showing up in origination expenses. And so we'll see an outsized increase in, those origination expenses as, you know, compared to the overall total as broker becomes a greater percentage of our overall of our overall production or overall originations.

[Daniel Perotti, Senior MD & CFO at PennyMac Financial Services]

You know, we do look to normalize for that. So in terms of the way that we think about, margin, we really think of, you know, our our gross margins or revenue margins being net of that broker that broker fee. And so the, you know, the presentation that we have in the earnings, in the earnings deck that we had been referencing on page 18 of the earnings deck nets the you know, nets all of the, origination expenses out of each of the individual lines. So that broker direct margin that's reflected there of 87 basis points in this quarter is net of that broker fee that is represented in origination expenses. But as we continue to grow our broker direct originations that, you know, those broker fees falling through to origination expense will have an outsized impact to the extent that broker is growing at a faster clip than, you know, the than our other than our other channels.

[Michael Kaye, Equity Research Analyst at Wells Fargo Securities]

My follow-up question, I don't think I've heard during the call, any update on the the subservicing initiatives? I know you had some early agreements last quarter you mentioned and and some negotiations still going on. Is there any anything meaningful there?

[David Spector, CEO & Chairman at PennyMac Financial Services]

Look. We're making we're making a lot of good headway on the subservicing. We don't have anything substantial to report. I can tell you that we've brought in a a major leader, into the organization to lead that effort, And we're continuing to work with our correspondence in particular, but we're looking to, starting with this quarter, expand out on the horizon in terms of different pockets of those who are on servicing. So I expect to see good activity before the end of the year on that front.

[David Spector, CEO & Chairman at PennyMac Financial Services]

Many of our correspondent customers who own servicing have either moved that servicing off their balance sheets or they're selling whole loans as I talked about a few minutes ago. I think also given the dynamics in the marketplace, I think larger holders of servicing who have their subservi who have who have their servicing place are waiting to see, you know, how things how things play out in the marketplace. And I think, you know, over the next six to twelve months, you'll see more servicing moving amongst subservicers. And so we're just positioning ourselves to be one of those subservicers to capitalize on the opportunity. Okay. Thank you.

[Operator]

Next up is Doug Harter from UBS.

[Douglas Harter, Equity Research Analyst at UBS Group]

Dan, as I look at Slide 23 on unleveraged, you talked that the nonfunding debt might sort of trend above your target. Can you just talk about, you know, how you're thinking about leverage and, you know, whether you view any, constraints, you know, from your current leverage level?

[Daniel Perotti, Senior MD & CFO at PennyMac Financial Services]

So, yeah, we we do not have any concerns from our current leverage level, at, you know, at elevated rates at the higher for longer, as David had kinda had mentioned earlier. You know, we do expect to run we have heavier emphasis on the servicing, side of the business and the MSR asset, and that's driving our nonfunding debt to equity levels a bit higher than our long term target and where we've run historically. At these levels, we don't have any concerns. We do think that we could run potentially a little bit above on the non funding debt to equity, as we mentioned here, a little bit above the 1.5 times. You can see our overall debt to equity at 3.4 times is consistent with the prior quarter,

[David Spector, CEO & Chairman at PennyMac Financial Services]

and with our overall, our overall debt to equity target. And so we don't have any concerns on the on the leverage side. You know, I I I shared Dan's point of view from the rating agency standpoint and from our business partner standpoint. Can tell you in our industry, we're always worried about leverage. And I think it's something that is always front and center in our minds.

[David Spector, CEO & Chairman at PennyMac Financial Services]

Think that to the point Dan's raising, we've been very focused and judicious in how we think about leverage and how we think about the that that nonfunding debt number. And I think we're we're it it factors into how we think about pricing for servicing and how we price for loans, and and I think it's something that, you know, we're very mindful of. But I think given given the environment we're in, it's something that has not come as a surprise to us to see it creep back up. But at the same time, we clearly have it front and center.

[Douglas Harter, Equity Research Analyst at UBS Group]

Great. I appreciate the thoughtful answer. Thank you.

[Operator]

We'll go next to Ryan Shelley from Bank of America.

[Ryan Shelley, High Grade & High Yield Credit Research - VP at Bank of America Merrill Lynch]

Hey guys, thanks for the question. Most of mine have been answered. I was just hoping to give any color around delinquency rates. It looks like they picked up a bit in the quarter, but still below the year ago period. So just any commentary or any specific end markets to call out there would be probably helpful. Sure.

[Daniel Perotti, Senior MD & CFO at PennyMac Financial Services]

Thanks for the question. So Page 32 has our trends for delinquency rates. You're correct that they did creep up during the quarter, although that's really consistent with what we see on a seasonal basis typically. I think the item of note is really that they decreased on a year over year basis, so down from 5.7% to 5.6%. And so overall, we are seeing relative stability in terms of delinquencies in the portfolio.

[Daniel Perotti, Senior MD & CFO at PennyMac Financial Services]

Part of what has allowed us to hold in delinquencies in the portfolio is our judicious underwriting of the loans that we are bringing into the portfolio. And so you can see the performance of for the more greatly exposed credit areas of servicing portfolio in terms of more recent vintage government loans, FHA and VA loans. Our delinquencies are significantly lower than the overall, the overall industry. And I think that really speaks to our ability to shape the portfolio and ensure that we are, less exposed to some of the lower, you know, the lower credit portions of, of the universe, of the of the the mortgage loan universe and ensure that

[David Spector, CEO & Chairman at PennyMac Financial Services]

we have greater stability in terms of the delinquencies in our portfolio. But I think that, while the delinquencies are up, advances are down, borrowers have a lot of equity built up in their in their, properties. And there's still, even with the cutback of a few government programs, there's still good government programs to help keep borrowers in their homes. And the thing that, you know, the number that I'm, encouraged by is the delinquencies of our recently originated vintages are low are lower than the overall industry, and that speaks to the point Dan made about our ability to diligence our loans to correspondent and to underwrite in broker and consumer direct. And that's and that speak you know, that speaks to the risk management culture that we have here at the company.

[Ryan Shelley, High Grade & High Yield Credit Research - VP at Bank of America Merrill Lynch]

Got it. Thank you. Thanks for the question. Very helpful.

[Operator]

And we'll go to Trevor Cranston from Citizens JMP.

[Trevor Cranston, Director, Mortgage Finance Equity Research at Citizens JMP]

Hey, thanks. Follow-up question on the change in the hedging strategy. If I understood correctly, you said it was mainly increasing the capacity at Consumer Direct to improve recapture. So looking at Slide 18, there's a note that says part of the increase in production expenses was related to increased capacity in direct lending. Related Is to the change in hedging strategy?

[Trevor Cranston, Director, Mortgage Finance Equity Research at Citizens JMP]

Or should we be thinking about some incremental increase in production expenses in 3Q, specifically related to that change in hedging strategy? Thanks.

[Daniel Perotti, Senior MD & CFO at PennyMac Financial Services]

No. That's exactly correct. So the hedging or the sorry. The production expenses for q two do incorporate most of the, additional capacity that we have brought on that has allowed us to, feel comfortable repositioning our hedge or approaching our hedge strategy a bit differently. The, overall, in you know, we've been building that capacity through this quarter.

[Daniel Perotti, Senior MD & CFO at PennyMac Financial Services]

Most of the expenses are reflected here in the second quarter. There may be an additional 1,000,000 to $3,000,000 that of that since we didn't have the capacity on for the entire quarter. That would be increased on a, you know, completely flat basis, as we go into the third quarter, but most of it's reflected here in these expenses for the second quarter.

[David Spector, CEO & Chairman at PennyMac Financial Services]

You know, if you look at if you look at the hedge performance of the $8,084,000,000 dollar negative, 54,000,000 of it is hedge costs. And so, you know, one of the one of the areas that we've spent a lot of time on is really getting our getting our arms around what is the recapture opportunity that we have in the portfolio and how do we factor that into how one, we value the servicing and how does that affect the hedge. And, obviously, it should bring down the hedge costs. Now if you have that in if you have that in your methodology, you wanna make sure you're gonna recapture the loans. And to do that, we have to put on the capacity.

[David Spector, CEO & Chairman at PennyMac Financial Services]

But the capacity is a fraction of the hedge cost that we've been experiencing over the prior quarters. And so I'm encouraged by what I'm saying, really, this quarter in terms of that hedge cost number driving significantly lower. And so I think it's something that's that's going

[David Spector, CEO & Chairman at PennyMac Financial Services]

gonna to lend itself to more consistent ROEs as we look forward.

[Operator]

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

[David Spector, CEO & Chairman at PennyMac Financial Services]

Well, I want to thank everyone for joining us here today and for giving us their time. And as always, if you have any questions, please don't hesitate to reach out to our IR team and Isaac and the team. And thank you all very much for the time and thoughtful questions and looking forward to speaking to all of you soon. Take care.

[Operator]

And thank you all for joining us this afternoon. We encourage investors with additional questions to contact our Investor Relations team by email or phone. Thank you. You may now disconnect.

Participants

Executives

• Daniel Perotti, Senior MD & CFO

Analysts

• David Spector, CEO & Chairman at PennyMac Financial Services
• Crispin Love, Director at Piper Sandler Companies
• Bose George, Managing Director at Keefe, Bruyette & Woods (KBW)
• Eric Hagen, Managing Director at BTIG
• Michael Kaye, Equity Research Analyst at Wells Fargo Securities
• Douglas Harter, Equity Research Analyst at UBS Group
• Ryan Shelley, High Grade & High Yield Credit Research - VP at Bank of America Merrill Lynch
• Trevor Cranston, Director, Mortgage Finance Equity Research at Citizens JMP