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) (NYSE: PFSI) is a leading mortgage banking company based in Westlake Village, California. The firm operates through two primary business segments: Production and Mortgage Servicing Rights (MSR). In its Production segment, PennyMac originates residential mortgage loans through retail, wholesale and correspondent channels, focusing on both purchase and refinance transactions. The MSR segment involves the acquisition and servicing of mortgage loans, whereby the company earns fees for managing loan portfolios on behalf of investors.

Since its founding in 2008, PennyMac has grown through a combination of organic origination and strategic acquisition of servicing rights, positioning itself as one of the largest residential mortgage loan servicers in the United States. The company completed its initial public offering in 2013 and has since expanded its capabilities to offer a full suite of mortgage products, including government-insured loans, conventional conforming loans and customized refinancing options. PennyMac’s platform integrates underwriting, closing, loan management and customer service functions to provide a streamlined borrower experience.

PennyMac serves homeowners and homebuyers in all 50 states, leveraging advanced technology and a nationwide network of fulfillment centers. The company’s leadership team is led by President and CEO David Spector, who brings extensive experience in mortgage finance and capital markets. Under his direction, PennyMac has strengthened its risk management practices, enhanced its digital origination platform and maintained a diversified servicing portfolio. Through its focus on operational efficiency and customer satisfaction, PennyMac continues to be a significant participant in the U.S. residential mortgage market.

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.'s Second Quarter 2025 Ernings 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 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 Daniel Perotti, PennyMac Financial's Chief Financial Officer. Please go ahead.

[David Spector, CEO and 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 3, PFSI. reported net income of $136 million, 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. As you can see on Slide 5, our consistent performance over recent periods of elevated mortgage rates demonstrates the strength of our organically built comprehensive mortgage banking platform.

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

The stability provided by our balanced business model, especially in this higher, prolonged 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 6, 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. 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 billion in unpaid principal balance, representing 2.7 million households.

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

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 a closed-end second mortgage to access their home equity while retaining their low-rate first lien mortgage. 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 expanding purchase market. The chart on the bottom of slide 7 illustrates the projected growth in overall volumes, which is primarily driven by the more consistent purchase market compared to the refinance market.

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

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 partners, as illustrated on slide 8. 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. 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 9, we proudly showcase our position as the outright leader in correspondent lending.

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

Over the last 12 months, we have generated approximately $100 billion in UPB of correspondent production, achieving an estimated market share of approximately 20% in the first half of 2025. This significant volume is a direct result of our more than 15 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 and 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 2026. 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 assure 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 11, we highlight the significant opportunity for our Consumer Direct division and why we are intensely focused on building on our successes in this channel.

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

We have a large network of more than 5 million 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 rates are already twice the industry average, which effectively protects from the impacts of lower MSR values as rates decline, and we will continue to leverage our strategic partnership with Team USA and the LA28 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 and Chairman at PennyMac Financial Services]

As of June 30, $267 billion in UPB, or 38% of the loans in our servicing portfolio, have a note rate above 5%, and $181 billion 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 multi-year 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.

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

On slide 13 you'll see we are not just building momentum, we are accelerating with breakthrough speed in the development of AI. 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 and 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. 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. Behind the scenes, our servicing AI processing solution is automating critical document workflows and streamlining operations. 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.

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

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 million. 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 illustrates PennyMac's ambitious, groundbreaking vision for artificial intelligence. We have already achieved significant milestones, from advanced coding productivity tools to sophisticated workplace tools and intelligent chatbots that are reshaping daily operations. Our roadmap is truly visionary. It includes sophisticated agent automation of complex loan processing activities, robust and intuitive self-service capabilities that empower our customers, and advanced lead generation processes that will redefine our outreach.

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

Our ultimate vision is a fully automated loan process, including a seamless self-service origination and servicing experience. This is not just technology, 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 investment. Throughout all of our operations, our intense focus on AI and technology is effectively driving down costs, contributing to our overall financial strength. 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.

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

I will now turn it over to Dan, who will review the drivers of PFSI's Second Quarter financial performance.

[Daniel Perotti, Senior Managing Director and CFO at PennyMac Financial Services]

Thank you David, PFSI reported net income of $136 million in the Second Quarter, or $2.54 in earnings per share, for an annualized ROE of 14%. These results included $93 million of fair value declines on MSRs, net of hedges and costs, and a non-recurring net tax benefit of $82 million. 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, pre-tax income was $58 million, down from $62 million in the prior quarter. Total acquisition and origination volumes were $38 billion in unpaid principal balance, up 31% from the prior quarter. Of this, $35 billion was for PFSI's own account and $3 billion was fee-based fulfillment activity for PennyMac Mortgage Investment Trust (PMT).

[Daniel Perotti, Senior Managing Director and CFO at PennyMac Financial Services]

Total lock volumes were $43 billion 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 billion, up 30% from the prior quarter. Correspondent channel margins in the Second Quarter were 25 basis points, down slightly from the first quarter, while funded 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.

[Daniel Perotti, Senior Managing Director and CFO at PennyMac Financial Services]

Of note, pursuant to our renewed mortgage banking agreement with PMT, effective July 1, 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 PMT to acquire approximately 15% to 25% of total conventional conforming correspondent production, consistent with levels in recent quarters. 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.

[Daniel Perotti, Senior Managing Director and CFO at PennyMac Financial Services]

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 locked volumes down 2% from the prior quarter. 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 lending and Broker Direct, and volumes in Consumer Direct similar to levels reported in the Second Quarter.

[Daniel Perotti, Senior Managing Director and CFO at PennyMac Financial Services]

Production expenses net of loan origination expense increased 8% from the prior quarter, partially due to increased capacity and direct lending, which is expected to drive our ability to rapidly address opportunities presented by lower mortgage rates. Turning to Servicing, as David Spector mentioned, our servicing portfolio continues to grow, ending the quarter at $700 billion in unpaid principal balance. The servicing segment recorded Pre-Tax income of $54 million excluding valuation related changes. Pre-tax income was $144 million, 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 own portfolio averaged $7.5 billion in the Second Quarter, up from $6.2 billion in the first quarter due to seasonal impacts and higher prepayments. As a result, earnings on custodial balances and deposits and other income increased.

[Daniel Perotti, Senior Managing Director and CFO at PennyMac Financial Services]

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. Operating expenses were $80 million 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 8 basis points in 2020 to less than 5 basis points in the last 12 months. This is a direct result of our proprietary technology, continuous process improvement, and platform scale.

[Daniel Perotti, Senior Managing Director and CFO at PennyMac Financial Services]

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. During the Second Quarter, the fair value of PFSI's MSR increased by $16 million. $26 million was due to changes in market interest rates, which was partially offset by $10 million of other assumption changes and performance related impacts. Excluding costs, hedge fair value declines were $55 million. Hedge costs were $54 million, 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.

[Daniel Perotti, Senior Managing Director and CFO at PennyMac Financial Services]

Corporate and other items contributed a pre-tax loss of $35 million compared to $34 million in the prior quarter. PFSI recorded a tax benefit of $60 million in the quarter, driven by a non-recurring tax benefit of $82 million, which primarily consisted of a repricing of deferred tax liabilities due to state apportionment changes driven by recent legislation. PFSI'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 million of unsecured senior notes due in 2032 and utilized a portion of the proceeds to redeem our initial unsecured debt offering of $650 million that was due later this year in October.

[Daniel Perotti, Senior Managing Director and CFO at PennyMac Financial Services]

Additionally, we redeemed $500 million of Ginnie Mae MSR Term Notes due in May of 2027 and replaced 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 billion 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 question, as we'd like to ensure we can answer as many questions as possible. If you would like to ask a question during this time, simply press Star followed by the number one on your telephone keypad. If you'd like to withdraw your question, it's Star one again. We'll take our first question today from Crispin Love, Piper Sandler.

[Crispin Love, Director at Piper Sandler]

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. 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 Managing Director and CFO at PennyMac Financial Services]

Sure. Crispin, this is Dan, thanks for the question. With respect to the operating ROE dipping a bit to 13%, really I would say driven by two factors in the quarter. One was related to, on the production side, related to the margins in the channel. Those came down a bit quarter over quarter.

[Daniel Perotti, Senior Managing Director and CFO at PennyMac Financial Services]

Some of that was driven, if you look versus the prior quarters, by a negative impact in some of the cross channel activities, which was down about $10 million this quarter. A negative contribution of about $10 million this quarter versus $17 million in the prior quarter. This is on page 18 of the deck. We typically 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.

[Daniel Perotti, Senior Managing Director and CFO at PennyMac Financial Services]

As we look out with respect to production moving forward for the next few quarters, we expect improvement on a margin basis and in terms of the overall income from that channel. Looking at the servicing side, did see a reduction in the pre-tax 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. Some of those, especially related to some of the prepayment activity, we don't necessarily expect to see at the same level that we saw this quarter.

[Daniel Perotti, Senior Managing Director and CFO at PennyMac Financial Services]

Additionally, interest expense includes certain one-time items related to the retirement of some of our debt. We expect that to maintain on a bit more of a level basis as we continue to increase our servicing portfolio. 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 and Chairman at PennyMac Financial Services]

I share the disappointment in kind of that lower number. I will tell you what I've seen. It really was improving in the latter part of the quarter, and in July has been a continuation of the improvement. I think that we're seeing margins have clearly bottomed out in correspondent. We're seeing a slight increase there, as well as what we're seeing in Broker Direct is something similar.

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

I think that, you know.

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

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]

Great. Thank you very much, Dan and David, for that color. Just a follow-up for me on hedging going forward. Dan, you commented on some changes you made that you expect greater consistency. Can you dig a little bit more into that? What are you changing? Are you still targeting 80 to 90% hedge ratio? Has the recent rate stability helped as well, just on the hedging side?

[Daniel Perotti, Senior Managing Director and CFO at PennyMac Financial Services]

Sure. 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 division or our direct channels.

[Daniel Perotti, Senior Managing Director and CFO at PennyMac Financial Services]

We've adjusted our staffing in our direct channels to ensure that if we do see rate volatility or dips in rates, we can very quickly and actively pursue those recapture and origination opportunities that will serve as an offset to reductions in the value of the MSR portfolio. 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. In doing that, we expect that we will have lower costs as we go forward. 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.

[Daniel Perotti, Senior Managing Director and CFO at PennyMac Financial Services]

Given the positioning that we have to have greater consistency in terms of 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 near band to current rate levels. We haven't changed our posture from that perspective. Given our changes in the way we've implemented 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 directional performance.

[Crispin Love, Director at Piper Sandler]

Great, thank you for taking my questions.

[Operator]

Up next is Bose George, KBW.

[Bose George, Managing Director at KBW]

Yeah, good afternoon. Just wanted to follow up on the profitability questions. Just in terms of the servicing portfolio, you know, what's a good run rate for the profitability there? Just in looking at it to send basis points, I mean it makes sense. The amortization increased with the bigger MSR, but conceptually you might have thought that would be offset by a higher servicing fee. Yes, just kind of a good way to think about what that number should be.

[Daniel Perotti, Senior Managing Director and CFO at PennyMac Financial Services]

You know, if you look back over the past few quarters, this was a bit in terms of the pre-tax income excluding market, excluding valuation changes, you know, was a bit of a dip from what we've seen historically. As I said, you know, there were some one-time items or items that were specific to this quarter that impacted that.

[Daniel Perotti, Senior Managing Director and CFO at PennyMac Financial Services]

Generally, at these rate levels that we're at currently, which are a bit higher, and assuming not great, very significant levels of rate volatility, we'd expect the basis points on the servicing portfolio to move toward what we've seen over the past few quarters in the nine to ten basis point range. In any given quarter there can be certain items that impact the overall result. That would be our expectation generally going forward at these rate levels. Okay, great. The decline there or the increase, I guess, in that basis points would be largely on lower amortization. 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.

[Daniel Perotti, Senior Managing Director and CFO at PennyMac Financial Services]

Really, some normalization across those different facets.

[Bose George, Managing Director at KBW]

Okay, great.

[Bose George, Managing Director at KBW]

In terms of that, the cross channel volatility number, on slide 17, is that mainly like, was that mainly hedging related this quarter or are there other things kind of driving that as well?

[Daniel Perotti, Senior Managing Director and CFO at PennyMac Financial Services]

It was primarily related in the quarter to volatility of spreads, at least at certain points in the quarter. 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 necessarily directly deliverable into agency execution, that's driving higher margins in a number of our channels. To the extent that we see spread volatility in those channels, especially at certain points in the quarter, it can have an impact in that other line item.

[Bose George, Managing Director at KBW]

Things like non-agency and seconds getting marked through there.

[Daniel Perotti, Senior Managing Director and CFO at PennyMac Financial Services]

Yes, to the extent that it occurs after we've lost the loan. Yeah.

[Bose George, Managing Director at KBW]

Okay, great.

[Daniel Perotti, Senior Managing Director and CFO at PennyMac Financial Services]

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 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 Managing Director and CFO at PennyMac Financial Services]

Yes. You can look at the outstanding debt that we have that is related to MSRs is almost all 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 to the Fed rate. Similarly, we would expect that the earnings on custodial balances is tied very similarly or would move very similarly to how the FED rate moves.

[Daniel Perotti, Senior Managing Director and CFO at PennyMac Financial Services]

We have provided the balances of custodial funds here. 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]

Okay, that's good. If mortgage rates are higher from here, how sticky do you expect margins to be in the correspondent channel? 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? What are the conditions that might drive that?

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

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. 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. I think that, you know, we're going to continue to see correspondent aggregators be very active in this higher for longer environment. Where you see retention taking place is typically when margins are wider and rates are at a perceived bottom.

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

I think, you know, we're just, I think you know, coming out of COVID, we've seen this phenomenon only grow. The cash windows can get busier from time to time, but that's at their discretion. It's not at the discretion of the seller. Typically, those who do sell to the cash window are more mortgage bankers that perhaps will aggregate servicing and auction it off. Given the volatility in the markets, aggregating servicing is not for the faint of heart. I think if you're not hedging servicing, it could backfire pretty quickly on you. I think this speaks to how we're growing share in correspondent and just the level of feedback we're getting from our customers is pretty impactful. I continue to expect it to stay that way for the foreseeable future.

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

We're just in a really tough market in that we've been higher for a lot longer and that's something we continue to focus on here. The things we can control, things like growing share, becoming more efficient, and continuing to reduce our expenses and deploy technology are things that we're focused on. That kind of nurse 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 in correspondent.

[Eric Hagen, Managing Director at BTIG]

Great stuff. Appreciate your comments. Thank you.

[Operator]

Michael K from Wells Fargo has the next question.

[Michael K. Fung, Analyst at Wells Fargo]

I wanted to see if you could dig into the loan origination expense line item.

[Michael K. Fung, Analyst at Wells Fargo]

It was up a lot quarter over quarter. Was that driven by the Broker Direct channel?

[Michael K. Fung, Analyst at Wells Fargo]

Volume, what's happening over there?

[Daniel Perotti, Senior Managing Director and CFO at PennyMac Financial Services]

Yeah, that's exactly correct, Michael, and thanks for the question. Our production or origination expense line item in terms of our accounting includes the fee paid through to the broker. If you looked at an individual transaction for our Broker Direct channel, we'd have a 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. We'll see an outsized increase in those origination expenses compared to the overall total as broker becomes a greater percentage of our overall production or overall originations. We do look to normalize for that. In terms of the way that we think about margin, we really think of our gross margins or revenue margins being net of that broker fee.

[Daniel Perotti, Senior Managing Director and CFO at PennyMac Financial Services]

The presentation that we have in the earnings deck that we had been referencing on page 18 of the earnings deck nets all of the origination expenses out of each of the individual lines. 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. As we continue to grow our Broker Direct originations, 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 our other channels.

[Michael K. Fung, Analyst at Wells Fargo]

My follow up question, I don't think I've heard during the call.

[Michael K. Fung, Analyst at Wells Fargo]

Any update on the subservicing initiatives?

[Michael K. Fung, Analyst at Wells Fargo]

I know you had some early agreements last quarter you mentioned and some negotiations still going on. Anything meaningful there?

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

Look, 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 major leader into the organization to lead that effort, and we're continuing to work with our correspondents in particular. We're looking to, starting with this quarter, expand out on the horizon in terms of different pockets of those who own servicing. I expect to see good activity before the end of the year on that front. Many of our correspondent customers who own servicing have either moved that servicing off their balance sheets or they're selling whole loans.

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

As I talked about a few minutes ago, I think also given the dynamics in the marketplace, larger holders of servicing who have their servicing in place are waiting to see how things play out in the marketplace. I think over the next six to twelve months you'll see more servicing moving amongst subservicers. We're just positioning ourselves to be one of those subservicers to capitalize on the opportunity.

[Michael K. Fung, Analyst at Wells Fargo]

Okay, thank you.

[Operator]

Next up is Doug Jones from UBS.

[Doug Jones, Investment Advisor at UBS]

Thanks, Dan.

[Doug Jones, Investment Advisor at UBS]

As I look at Slide 23 on unleveraged, you talk that non-funding debt might sort of trend above your target. Can you just talk about how you're thinking about leverage and whether you view any constraints from your current leverage level?

[Daniel Perotti, Senior Managing Director and CFO at PennyMac Financial Services]

Yeah, we do not have any concerns from our current leverage level at elevated rates at the higher for longer. As David had mentioned earlier, we do expect to run, we have a heavier emphasis on the servicing side of the business and the MSR asset, and that's driving our non-funding debt to equity levels a bit higher than our long-term target. 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.

[Daniel Perotti, Senior Managing Director and CFO at PennyMac Financial Services]

You can see our overall debt to equity at 3.4 times is consistent with the prior quarter and with our overall debt to equity target. We don't have any concerns on the leverage side.

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

You know, I share Dan's point of view from the rating agency standpoint and from our business partner standpoint. I 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. I 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 that non-funding debt number.

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

I think you know we're, we're.

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

It factors into how we think about pricing for servicing and how we price for loans, and I think it's something that, you know, we're very mindful of. I think given the environment we're in, it's something that has not come as a surprise to us to see it creep back up. At the same time, we clearly have it front and center.

[Doug Jones, Investment Advisor at UBS]

Great. I appreciate the thoughtful answer.

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

Thank you.

[Operator]

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

[Ryan Shelley, Vice President at Bank of America]

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. Any commentary or any specific markets to call out there would be probably helpful. Thank you.

[Daniel Perotti, Senior Managing Director and CFO at PennyMac Financial Services]

Sure. Thanks for the question. 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 decrease on a year-over-year basis, down from 5.7% to 5.6%, and overall, we are seeing relative stability in terms of delinquencies in the portfolio. 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. You can see the performance for the more greatly exposed credit areas of the servicing portfolio in terms of more recent vintage government loans, FHA and VA loans. Our delinquencies are significantly lower than the overall industry.

[Daniel Perotti, Senior Managing Director and CFO at PennyMac Financial Services]

I think that really speaks to our ability to shape the portfolio and ensure that we are less exposed to some of the lower credit portions of the mortgage loan universe and ensure that we have greater stability in terms of the delinquencies in our portfolio.

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

I think that while the delinquencies are up, advances are down, borrowers have a lot of equity built up in their properties, and there's still, even with the cutback of a few government programs, good government programs to help keep borrowers in their homes. The number that I'm encouraged by is the delinquencies of our recently originated vintages are lower than the overall industry. That speaks to the point Dan made about our ability to diligence on loans in correspondent and to underwrite in Broker Direct and Consumer Direct. That speaks to the risk management culture that we have here at the company.

[Ryan Shelley, Vice President at Bank of America]

Got it. Thank you. Thanks for the question, very helpful.

[Operator]

We will go to Trevor Cranston from Citizens JMP.

[Trevor Cranston, Managing Director at Citizens JMP]

Hey, thanks. Follow up question on the change in the hedging strategy.

[Trevor Cranston, Managing Director at Citizens JMP]

If I understood correctly, you said it was mainly increasing the capacity at Consumer Direct to improve recapture.

[Trevor Cranston, Managing Director at Citizens JMP]

Looking at slide 18, there's a note that says part of the increase in production expenses was related to increased.

[Trevor Cranston, Managing Director at Citizens JMP]

Capacity in direct lending. Is that related to the change in hedging strategy, or should we?

[Trevor Cranston, Managing Director at Citizens JMP]

Be thinking about some incremental increase in.

[Trevor Cranston, Managing Director at Citizens JMP]

Production expenses in three, two specifically related.

[Trevor Cranston, Managing Director at Citizens JMP]

To that change in hedging strategy? Thanks.

[Daniel Perotti, Senior Managing Director and CFO at PennyMac Financial Services]

No, that's exactly correct. The hedging or the production expenses for Q2 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. Overall, we've been building that capacity through this quarter. Most of the expenses are reflected here in the Second Quarter. There may be an additional $1 to $3 million of that, since we didn't have the capacity on for the entire quarter, that would be increased on a completely flat basis as we go into the Third Quarter. Most of it's reflected here in these expenses for the Second Quarter.

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

If you look at the hedge performance of the $84 million negative, $54 million of it is hedge costs. One of the areas that we've spent a lot of time on is really getting our arms around what is the recapture opportunity that we have in the portfolio and how do we factor that into how we value the servicing and how that affects the hedge. Obviously, it should bring down the hedge cost. Now, if you have that in your methodology, you want to make sure you're going to recapture the loans. To do that, we have to put on the capacity, but the capacity is a fraction of the hedge cost that we've been experiencing over the prior quarters. I'm encouraged by what I'm seeing, really, even this quarter in terms of that hedge cost number driving significantly lower.

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

I think it's something that's going to lend itself to more consistent ROEs as we look forward.

[Trevor Cranston, Managing Director at Citizens JMP]

Right. Okay, that makes sense. Thank you, guys.

[Operator]

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

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

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

[Operator]

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

• Doug Jones, Investment Advisor
• Daniel Perotti, Senior Managing Director and CFO

Analysts

• Eric Hagen, Managing Director at BTIG
• Michael K. Fung, Analyst at Wells Fargo
• Trevor Cranston, Managing Director at Citizens JMP
• Ryan Shelley, Vice President at Bank of America
• David Spector, CEO and Chairman at PennyMac Financial Services
• Crispin Love, Director at Piper Sandler
• Bose George, Managing Director at KBW