PennyMac Financial Services, Inc.

Good afternoon and welcome to PennyMac Financial Services Incorporated second quarter 2024 earnings call. Additional earning 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 Financials Chairman and Chief Executive Officer, and Dan Perotti, PennyMax Financial Chief Financial Officer.

Thank you, Operator. Good afternoon, and thank you to everyone for participating in our second quarter earnings call. PFSI reported net income of $98 million for an annualized return on equity of 11%. Excluding the impact of fair value changes and non-recurring items, PFSI produced an annualized operating ROE of 16%, with strong performance from both the production and servicing sector. Given our continued strong financial results and confidence in our outlook, I am pleased to note that PFSI's Board of Directors approved a quarterly common stock dividend of $0.30 per share, up from $0.20 in the prior quarter, representing an increase of 50%. Turning to the origination market, current third-party estimates for total originations average $1.7 trillion in 2024 and $2.1 trillion in 2025, reflecting projections for lower rates from current levels and increased refinance volumes. Given PSSI's balanced and diversified business model, we believe we are extraordinarily well-positioned whether rates remain high or decline from current levels. With higher total industry volumes in the second quarter, and given what we have seen thus far in the third quarter, we believe the origination market is resetting. In the last couple of years, we estimate approximately $2.5 trillion of mortgages have been originated, with a note rate of 6% or higher. As long as rates remain elevated, This group of borrowers is expected to continue growing, supported by a purchase market with strong pent-up demand from key home buying demographics. It is our belief that when interest rates do decline, many of these borrowers will undoubtedly look to lower their mortgage rates, driving refinance volumes higher and total originations up to more normalized levels. In loan production, our multifaceted approach to mortgage production and our position as one of the largest producers in the country provides us with unique access to originate and acquire newly originated mortgages in the current market, driving the continued growth of our servicing portfolio. We have gained a meaningful amount of market share on our purchase-focused correspondent and broker direct lending channels, and all of our channels have additional upside potential when refinance volumes return to more normalized levels. In the second quarter, We acquired or originated over $27 billion of recently originated mortgage loans, and in recent periods, we have added a meaningful volume of mortgages with higher note rates to our portfolio. As of June 30th, $63 billion of mortgage loans in our servicing portfolio had a note rate of 5% to 6%, and $113 billion had a note rate of 6% or higher. This population of loans consists primarily of recently originated purchase mortgages where the underlying borrowers will undoubtedly look to refinance when rates decline from their current levels. We have also been very successful providing second lien mortgages to our customers that have secured a low-coupon first lien mortgage and wanted to access the equity in their home in a more economic transaction than a cash-out refinance. As rates decline, This population of borrowers may also seek to reduce their costs with a refinance to consolidate their loans, presenting an additional opportunity for our Consumer Direct Group. So while volumes in our Consumer Direct channel are low today, I believe we are uniquely positioned for future success given this large population of borrowers that we maintain active, ongoing relationships with that have higher mortgage rates. In the current market environment, however, Our large and growing servicing portfolio continues to drive earnings, with meaningful cash flow and revenue generation given low delinquency rates and the significant contribution from placement fees on custodial balances due to higher short-term rates. Additionally, this management team has done a tremendous job developing our proprietary servicing system, which has the flexibility to rapidly adjust for regulatory changes and incorporate new and emerging technologies, including artificial intelligence, to drive operating efficiencies. I am pleased to announce that PennyMac expects to be the first servicer in the industry to successfully incorporate requirements for the Veteran Affairs Service Purchase, or VASP program, directly into its technology. This highlights our speed to change and the flexibility built into our SSE platform to adapt to new regulations and emerging government programs. Our strength in technology development, combined with the operational scale we have achieved, has driven our cost of service to among the lowest in the industry. And I am pleased to note that in the second quarter, operating expenses as a percentage of average servicing portfolio UPB were at their lowest levels in our history, at under six basis points. Barring any meaningful increase in delinquencies, we expect to gain additional operating leverage as the portfolio grows and as we continue to look for opportunities to drive down expenses, providing us with a strong base level of profitability in future periods. I will now turn it over to Dan, who will review the drivers of PFSI's second quarter financial performance.

Thank you, David. PFSI reported net income of $98 million in the second quarter. or $1.85 in earnings per share for an annualized ROE of 11%. These results included $72 million of net fair value declines on MSRs and hedges, and $12 million of a non-recurring non-cash gain related to a transaction within our closing services joint venture, which is included in our servicing segment. We believe this transaction is reflective of the additional opportunities and earnings potential that is achievable by providing additional services to our customers, including leveraging our large servicing portfolio with 2.5 million customers. The impact of these items on diluted earnings per share was negative 82 cents. Book value per share was $71.76, up from $70.13 at the end of the prior quarter due to PFSI's profitability. Turning to our production segment, pre-tax income was $41 million, up from $36 million in the prior quarter. Total acquisition and origination volumes were $27 billion in unpaid principal balance, up 25% from the prior quarter. $25 billion was for PSSI's own account, and $2 billion was fee-based fulfillment activity for PMT. PennyMac maintained its dominant position in correspondent lending in the second quarter, with total acquisitions of $23 billion up from $18 billion in the first quarter. Correspondent channel margins in the second quarter were 30 basis points, down from 35 basis points in the prior quarter due to highly competitive pricing from some channel participants. Given PMT's recent capital raises, in the third quarter, PMT expects to retain approximately 30 to 50 percent of total conventional correspondent production, an increase from 18 percent in the second quarter. Acquisitions in July are expected to total approximately $8.1 billion, and locks are expected to total $9.5 billion. In BrokerDirect, we continue to see strong trends and continued growth in market shares. We position PennyMac as a strong alternative to channel leaders. Locks in the channel were up 28% from last quarter, and originations were up 45%. The number of brokers approved to do business with us at quarter end was over 4,200, up more than 30% 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 essentially unchanged from the prior quarter and remain near normal levels. In Consumer Direct, lock volumes were up 25% from the prior quarter and originations were up 3%. Higher locked volumes in the channel were driven primarily by an increase in refinance volumes as mortgage rates declined from their recent highs, providing us with an opportunity to lower mortgage payments for borrowers who previously locked in higher rates. The rate lock activity we have seen thus far in the third quarter has exceeded our run rates from the second quarter. Production expenses net of loan origination expense increased slightly from the prior quarter, primarily due to increased volumes in the direct lending channels. Turning to servicing, The servicing segment recorded pre-tax income of $89 million. Excluding valuation-related changes and non-recurring items, pre-tax income was $149 million, or 9.5 basis points of average servicing portfolio UPV. Loan servicing fees were up from the prior quarter primarily due to growth in PFSI's own portfolio, as PFSI has been acquiring a larger portion of the conventional correspondent production from PMT in recent periods. Earnings on custodial balances and deposits and other income increased primarily due to higher average balances. Custodial funds managed for PFSI's own portfolio averaged $5.7 billion in the second quarter, up from $4.6 billion in the first quarter. Realization of MSR cash flows was essentially unchanged. As David mentioned, operating expenses decreased from the prior quarter and were at their lowest levels in our history, at 5.9 basis points of average servicing portfolio UPB. EBO income was essentially unchanged, and we expect its contribution to remain low for the next several quarters. The fair value of PSSI's MSR increased by $99 million, driven by higher market interest rates at the end of the quarter. Hedge costs came in at the higher end of our 1 to 2% expected range at $35 million. Other fair value declines on hedges during the quarter were $137 million, exceeding MSR fair value increases due to significant interest rate volatility. Combining these two components, total hedge declines were $172 million. The investment management segment contributed $4 million to pre-tax income during the quarter, and assets under management were essentially unchanged from the end of the prior quarter. Provision for income tax expense was $35.6 million, resulting in an effective tax rate of 26.6%. Finally, In May, we issued $650 million of new six-and-a-half-year unsecured term notes at attractive terms and subsequently paid down other revolving secured borrowings. This transaction reflects our continued focus on the strength and flexibility of our liquidity and capital structure, as the new notes have extended the duration of our liabilities and enhanced our overall liquidity position. We ended the quarter with $3.4 billion of total liquidity which includes cash and amounts available to draw on facilities where we have collateral pledged.