PennyMac Financial Services, Inc.

Good afternoon and welcome to PennyMac Financial Services Inc's third quarter 2024 earnings call. Additional earnings material 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 Perriotti, Penny Mac's Chief Financial Officer. Please go ahead.

Thank you, Operator. Good afternoon and thank you to everyone for participating in our third quarter earnings call. PSSI reported net income of $69 million or an annualized return on equity of 8%. Excluding the impact of fair value changes, PSSI produced an annualized operating ROE of 20%. Our production segment pre-tax income nearly tripled from last quarter as lower mortgage rates provided us the opportunity to help many customers in our servicing portfolio lower their monthly mortgage payments by refinancing. At the same time, our servicing portfolio, now nearing $650 billion in unpaid principal balance and with nearly 2.6 million customers, continues to grow. driving increased revenue and cash flow contributions, as well as providing low-cost leads for our consumer direct lending division. Turning to the origination market, current third-party estimates forecast total originations of $2.3 trillion in 2025, reflecting expectations for mortgage rates to continue their decline from current levels, driving growth in both refinance and purchase volumes. As we have demonstrated, Our balanced and diversified business model, with leadership in both production and servicing, enables strong financial performance and a foundation for continued growth as an industry-leading mortgage company, regardless of the direction of interest rates. Because we retain the servicing rights on nearly all mortgage loan production and have been one of the largest producers of mortgage loans in recent periods, we are uniquely positioned in the industry with a large and growing portfolio of borrowers who recently entered into mortgages at higher rates, and who would stand to benefit from a refinance in the future when interest rates decline. Our strong results in Consumer Direct, with lots nearly doubling and originations up nearly 70% from last quarter, demonstrate the future earnings potential of our flywheel, providing outstanding service to our large and growing customer base, while offering them the home loan products best suited to their needs. On slide six of our earnings presentation, you can see as of September 30th, approximately $200 billion in unpaid principal balance, more than 30% of the loans in our portfolio had a note rate above 5%, $90 billion of which was government insured or guaranteed loans, and $108 billion of which was conventional and other loans. The opportunity ahead is highlighted in this slide as indicated by our historic refinance recapture rates, which have improved significantly from five years ago as a result of our ongoing technology enhancements and process improvements. We expect these recapture rates to continue improving given our multi-year investments combined with the increased investment in our brand and use of targeted marketing strategy. Notably, we see higher recapture rates for government-insured or guaranteed loans relative to conventional loans given the low cost and more efficient nature of streamlined refinance programs. In 2022, when mortgage rates rapidly increased, we acted quickly to introduce a closed-end second lien product to enable our borrowers access to the equity in their homes while also retaining their low-rate first lien mortgages. We believe offering this product was of significant importance for our customers, given our strong emphasis on providing our borrowers with a cost advantage when obtaining a second lien mortgage versus doing a cash-out refinance at prevailing mortgage rates. The light section of the bars on the two charts adjusts our refinance recapture rates to include the impact of our closed-end second lien program, highlighting both the success in retaining our customers as well as our commitment to doing the right thing for them. Our large and growing servicing portfolio continues to anchor our core operating results. And in this higher interest rate period, we continue to realize the significant contribution from placement fees on custodial balances due to higher short-term rates. Additionally, this management team has done a tremendous job enhancing 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 operational efficiencies. 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 the future. In total, We have built an operating platform that we believe is unmatched in the mortgage industry, able to handle large growing volumes of loans at the highest quality standards, while also delivering strong performance across various markets. Our ability to swiftly react to the increased opportunity in the loan production market reflects our significant and ongoing investments in technology, the operational enhancements we have made, and ultimately the scale we have achieved. PSSI stands stronger than ever, given the continued growth of our servicing portfolio and the higher efficient cost structure that sets us apart from our competitors. With a leadership position in the correspondent channel and growing market share and direct lending, we are the best position in the industry to capitalize on opportunities provided by growth in the origination market. In total, we expect to continue delivering strong financial results with annualized operating returns on equity in the high teens to low 20s in 2025. I will now turn it over to Dan, who will review the drivers of PFSI's third quarter financial performance.

Thank you, David. PFSI reported net income of $69 million in the third quarter, or $1.30 in earnings per share, for an annualized ROE of 8%. These results included $160 million of fair value declines on MSR's net of hedges as interest rates exhibited significant volatility during the quarter. The 10-year treasury yield declined approximately 60 basis points during the third quarter and ranged from a high of 4.5% to a low of 3.6%. The impact of these items on diluted earnings per share was negative $2.19. PFSI's Board of Directors declared a third quarter common share dividend of 30 cents per share, consistent with the prior quarter. Turning to our production segment, pretax income was $108 million, up from $41 million in the prior quarter, due to higher volumes across all channels, with the largest increase in consumer direct. Total acquisition and origination volumes were $32 billion in unpaid principal balance, up 17% from the prior quarter. $26 billion was for PSSI's own account, and $6 billion was fee-based fulfillment activity for PMT. PennyMath maintained its dominant position in correspondent lending in the third quarter, with total acquisitions of $26 billion, up from $23 billion in the prior quarter. Correspondent channel margins in the third quarter were 33 basis points, up from 30 basis points in the prior quarter due to less competitive pricing from certain channel participants. In the fourth quarter, we expect PMC to retain approximately 15 to 25% of total conventional correspondent production, a decrease from 42% in the third quarter. 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. Locks in the channel were up 24% from last quarter, and originations were up 8%. The number of brokers approved to do business with us at quarter end was over 4,400, up 25% 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, but remained near normalized levels. In consumer direct, block volumes were up 93% from the prior quarter, and originations were up 69%. Higher volumes were driven by an increase in refinance volumes, as David mentioned earlier. Margins in the channel were down given a higher percentage of refinance loans versus lower balance closed-end second liens. Activity in October across all of our channels remains in line with third quarter levels, and though mortgage rates have increased and we expect some impact from normal seasonality, we expect another strong contribution from our production segment in the fourth quarter. Production expenses, net of loan origination expense, increased 18% from the prior quarter. primarily due to increased volumes in the consumer direct channel. Turning to servicing, the servicing segment recorded a pre-tax loss of $15 million. Excluding valuation related changes and non-recurring items, pre-tax income was $151 million, or nine and a half basis points of average servicing portfolio UPB, unchanged from last quarter. Loan servicing fees were up from the prior quarter, primarily due to growth in PSSI's own portfolio, and earnings on custodial balances and deposits and other income increased due to higher average balances. Custodial funds managed for PFSI's own portfolio averaged $6.9 billion in the third quarter, up from $5.7 billion in the second quarter. Realization of MSR cash flows increased $25 million from the prior quarter due to higher prepayment expectations due to lower mortgage rates. Operating expenses increased slightly but remained low at approximately 6.4 basis points of average servicing portfolio UPB. The fair value of PSSI's MSR decreased by $402 million, driven by lower market interest rates from the prior quarter end. Hedging gains were $242 million and included significantly elevated hedge costs due to interest rate volatility and the inverted yield curve. Excluding hedge costs, hedging gains offset 78% of MSR fair value declines. We seek to moderate the impact of interest rate changes on the fair value of our MSRs through a comprehensive hedging strategy that also considers production-related income, which was up significantly this quarter versus last quarter, as David mentioned. The investment management segment contributed $700,000 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 $25 million, resulting in an effective tax rate of 26.1%. We ended the quarter with $3.8 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?

Thank you. I would like to remind everyone, we will only take questions related to PennyMax 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. And if you would like to ask a question during this time, simply press star 1 on your telephone keypad. And if you'd like to withdraw that question, again, press star 1. Your first question comes from Doug Carter with UBS. Please go ahead.

Thanks. I'm hoping you could share a little bit what you're seeing in terms of block volume and consumer direct, you know, in the past couple weeks as post the Fed as rates have started backing up.

I mean, look, look, clearly, you know, we've seen it come off of its highs, you know, from where, you know, from where we were a month ago. I think that, you know, it's a function, obviously, of the, you know, the higher rates. It's, you know, it's probably, I would say, down 30, 30-ish percent. But look, having said that, you know, I think we looked at the, we look at our direct lending businesses, both broker and consumer direct, as being able to react to markets as they present themselves. I can tell you in the broker direct channel, we continue to see nice share gains, and you could see that last quarter. where, you know, in the third quarter, you know, by our estimation, we're at 4% market share, which is up from a little above three a year ago. And I'm really encouraged by what I'm seeing in that business as well. On the, you know, on the consumer direct side, you know, we were able to really, you know, to really seize on the opportunity when rates presented themselves. We're still seeing some good refinance activity, but, you know, it goes without saying that, you know, with rates increasing that, you know, you're going to see a bit of a slowdown from, you know, from the highs.

And I guess along those lines, if you could just talk about, you know, capacity management, you know, kind of as volumes ramped up, you know, your ability to kind of meet that from capacity and then, you know, if volumes are off, you know, kind of how that plays through today.

Yeah, look, we're not going to get, you know, whips unnecessarily. by, you know, the movements in the market. Suffice it to say, we spent, you know, 22, 23 really running capacity tight. Earlier this year, we made the decision to increase capacity. And, you know, we're continuing to look to grow our capacity, just given the natural growth in the portfolio. And really, you know, versus the alternatives in hedging the MSR, it's the least expensive path that we can take with the most economic opportunity on the upside when rates do decline. And so we're going to be running a little bit more excess capacity, but you look at, as I said, volatility and the cost of hedging servicing, and it's a very straightforward solution for what we need to do to be able to manage the company.

You know, the other lever that we have is that we still do have a significant number of loans in our portfolio with equity embedded. And so as rates increase, and as we talked about previously, you know, our loan officers are focused more on second lien opportunities. As we're growing the capacity, there's still a lot of opportunity in our portfolio there. And then when interest rates decline again, we can redirect them, you know, back towards refinances of first lien loans.

Appreciate it. Thank you.

Your next question comes from the line of Crispin Love with Piper Sandler. Please go ahead.

Thanks. Good afternoon, everyone. First, let's speak to your near-term outlook for RLE following the really strong third quarter, just with rates have backed up a bit in recent weeks. And then, Then for 2025, presentation states expected ROEs in the high teens to low 20s. Can you just discuss a little bit what's implied in those estimates from the origination side? And then are ROEs expected to be higher as you move through the year in 2025? Thank you.

Sure. So, you know, as we're looking in the fourth quarter, as you implied there, the operating ROE is going to be somewhat dependent on what we see happen with rates I think if you look back, Pat, you know, prior to the third quarter, we saw our operating ROEs in the mid moving up, you know, toward the high teens. So, even at these rate levels, you know, we believe we can achieve the same, you know, type of or slightly higher ROEs than what we saw earlier in the year, given the, you know, the production levels that we're seeing today. If we see rates, you know, if we see rates go higher, we still would expect to be in the mid-teens. And if we see lower, that would obviously drive us back towards, you know, towards the level that we achieved in the third quarter. The outlook, you know, the ROEs, the operating ROEs that we cited in the low teens to – or in the high teens, I should say, to low 20s for 2025 really – you know, what's implied in there is, you know, somewhat of an increase, or I should say the range there sort of covers a similar level or market level of production to what we've seen, what we saw in 2024, you know, maybe a little bit higher if we're on the low end of that range, similar to the operating ROEs that we've seen earlier in the year or slightly above that. If we do see rates, you know, a bit lower as is embedded in the mortgage forecast that we've seen from other industry participants that David cited, you know, a $2.2, $2.3 trillion market and a bit, you know, a bit higher, a bit more refinance activity that would drive us up, you know, similar to what we saw here in the third quarter, which I would note, you know, generally speaking, really the impact of lower rates in the third quarter was probably really only felt for a, you know, two of the three months or a month and a half of the three months. So, if we saw a bit more of a sustained lower interest rate environment, you know, we think that would drive us up higher in that 20s range.

Great. Thanks for that. Just following up on one comment you made there just on the industry forecast, 1.7 trillion in 2024, but probably more importantly, I believe it's right around 2.3 trillion in 2025. You have said in recent quarters that those might be a little ambitious. Do you still believe that might be the case? Apologies if you said that earlier, but just wanted to double-click on that one.

I think a lot of it comes down to exactly what the interest rates are going to be in 2025. I think if we did see interest rates a little bit lower, similar to what we experienced, or if rates bounced around in the ranges that we saw during the third quarter, I definitely think a $2.2, $2.3 trillion market is achievable or would be in that range. If we see you know, rates that sustain at a higher level, then, you know, then that would probably be a little bit high, and we'd expect a little bit of a lower overall market size. But generally speaking, you know, we don't think that that range is unreasonable, but it does come down, you know, meaningfully to what happens with interest rates. I would say that in either case, as we've talked about before, whether interest rates are higher or lower, given our balanced business model, we are built to perform well. As I sort of gave the indication with the operating ROEs, we are built to perform well in either environment. If rates do stay higher for longer, that will allow us to build up a higher, a larger inventory of loans at higher mortgage rates that ultimately leads to even greater production income when rates eventually do decline. And in the meantime, we have really significant earnings generated by our servicing side of the business as well as meaningful income from our production side as we've exhibited over the past year. So, in either way, you know, we think we have a really great outlook for the company. But as I discussed previously, we could see a market ranging from probably the lower end, you know, slightly below $2 trillion up to, you know, the mid-$2 trillion, depending on what happens with interest rates next year.

Great. Thank you. I appreciate you taking my questions.

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

Hey, guys. Good afternoon. Actually, I wanted to go back to the MSR hedge. I mean, historically, your MSR hedge covered 80%. You know, at the mark, it was pretty close to that level this quarter, but, you know, you've been targeting higher levels recently. So, can you discuss the hedge performance this quarter, just relative to your expectations?

Sure, Boze. The hedge overall in terms of insulating the change from the MSR, the change in the MSR value as, you know, as I cited, covered about 80% before the hedge costs. That was in line with what we were targeting. I think in the hedge, you know, on the earnings call last quarter, we said we moved down from, you know, targeting a higher coverage level to So, 78%, you know, slightly lower than that. What we did see during the quarter was given the, really, for a lot of the quarter, the further inversion of the yield curve, meaning that long rates going down, and we didn't see, you know, short rates or financing rates go down until the very end of the quarter when, you know, the Fed lowered its target. as well as the pretty significant interest rate volatility during the quarter. So, I've mentioned, you know, covering, I think, over 100 basis points during the quarter. A lot of that was flowed through and implied volatility and option costs. We did see hedge costs that exceeded our normal 1 to 2% range during the quarter. And so, you know, as we continue to move through the next several periods, we are looking at how we adjust our hedge costs versus our overall coverage. As we move into the fourth quarter, you know, we've seen rates, you know, we've seen that very short rate to the long rates de-invert somewhat. We've seen our hedge costs come back down into our normal range. And we're still continuing to target overall coverage of around 80%. So the, you know, long story short, the overall hedge protection we think operated as expected as it was at a higher cost than, you know, than we've seen recently or would have targeted. But we've seen those costs come back into range for a similar level of protection here in the fourth quarter. Okay.

Great. And then, actually, just a related question. So, just your, you know, you talked about the targeted operating ROEs. You know, is that, should we assume your GAAP ROEs will be, you know, essentially the same target for your GAAP ROEs as, you know, as your hedge costs come down, that those two should be in line over time?

Generally speaking, we've seen, you know, as we talked about, their hedge costs, you know, in that 1% to 2% range, we've had instances where we actually get, you know, paid to hedge and it goes the other way. And it's dependent somewhat on the different factors of the interest rate, the different factors of the interest rate environment. So, over longer periods of time, we would generally probably expect those to converge fairly closely. You know, there's probably some amount of hedge cost that exists over time, so GAAP ROE, you know, could be slightly lower than the operating ROE, but generally speaking, those two should be fairly close.

Okay, great. Thank you.

Your next question comes from the line of Michael Kay with Wells Fargo. Please go ahead.

Hi. Is there anything that surprised you with that mini refi boom we just had, that one and a half months, for example? were the higher note rate borrowers more likely to refine than you thought?

Look, I think that I don't think anything surprised us per se. I'll tell you I was encouraged by the amount of, for example, inbound traffic we saw in the call center, our ability to get borrowers to take refinances and block loans I thought was was really impressive and really executed on the flywheel. I think, you know, the thing that in a way surprised me in the quarter is just the increase in jumbo activity that we've seen. You know, we had, you know, a year ago, you know, our locks for the quarter were $22 million. This quarter, they were a billion dollars. And I think, you know, we're, you know, broker was 11% of total production as we're seeing banks stepping back. So I thought that was, that to me was, you know, really interesting. And that also, I think, speaks to, you know, what's driving, you know, the share gains that we're starting to see take place in broker. You know, I think it's nice, you know, margins are, you know, are kind of holding in check to going up in consumer direct a bit. And I think that, you know, by and large, you know, the tripling of production, to me, kind of really speaks to the power of the flywheel. And so, you know, as we think about the hedging of the asset and the holes that get opened up, one of the things we often talk about as a team is to take into account that we have this production engine that's going to produce, you know, high levels of profitability, and we delivered on that front. So I thought it was a very good quarter for us.

I just wanted to give a subservicing update. I know you talked previously about expecting some subservicing deals to happen in Q4. I don't think I heard anything in the prepared remarks. Is there any update to that? Do you still expect that to happen? I'm excited about the opportunity.

We do. We do. We expect to have one or two smaller customers by year end. It's going to take a month or two to onboard them. We're in discussions with larger clients. Nothing to really report out yet in terms of you know, I would say, you know, in terms of, you know, diligence or things that are getting close to the finish line. But we're getting out there. You know, I think that, you know, we're getting a lot of interest in the technology. And look, a lot of it's because of the, you know, a few things. Number one, we're seeing a reduction in the expenses, as you see every quarter. And then there's things like, you know, last quarter, we introduced the VA VAS program to which we're able to sell 917 loans back to VA, totaling 267 million in UPB, that really we had a negative mark on the servicing of close to $4 million. And so, look, I think that people see what we're able to do with the technology. And by the way, we were the first ones out with the VAS program. I don't think too many others are out yet, but it just, It shows the power of the technology, and I think we're getting some really good inbound inquiry into subservicing and the opportunities. So, look, I'm hopeful that by the end of the year we'll have one or two smaller customers inked, and then we'll be able to continue to grow that business.

Okay, thank you. Your next question comes from the line of Mark DeVries with Deutsche Bank. Please go ahead.

Thanks. As you just highlighted, you've had some nice share gains in BrokerDirect. And as you point out in the presentation, approved brokers signed on is up like 25% year over year. I was just hoping you could talk about any kind of natural lag there is between getting someone signed up and kind of ramping to a full run rate, and maybe also a sense of the size of the brokers you've been signing recently, rather than the ones that help us think through kind of what other future share gains we could expect there.

Look, we're doing, you know, the team is doing a great job in really making the case that you have numbers one and two who are going after one another on an exclusive basis. And, you know, our brokers are understanding that they need a second alternative at a minimum. And so we're able to provide that opportunity. We've got great tech supporting our brokers. And, you know, we spent a lot of time over the last two years developing that technology. The final piece will be coming out in Q4. Our share is in existing brokers who do large volumes, and we're adding to our sales force in a meaningful way. I've been, you know, pretty vocal about expecting share growth to continue at a pretty good pace, and the team understands that. I don't want to be too far ahead of myself here, as perhaps I have in the past by putting markers out there on a quarter-by-quarter basis. But I think that, you know, the fact that brokers need that strong second option, the fact we have a jumbo product that is providing consistent execution is meaningful. We've launched closed-end seconds into the broker channel. And I look at our tech versus the tech that's provided by to very well run organizations in the number one and two slots. And I think we're just as good if not better in our tech. So I am highly encouraged by what I'm seeing in that channel.

Got it. And then Dan, I was hoping you could clarify, I missed, I think you provided some forward looking commentary on the fourth quarter for the production segment. Could you just repeat that?

So, we didn't give anything in specific on the, in terms of guidance for the production segment. You know, we did say that overall, got a lot of the quarter left to go, but that in terms of our operating ROEs, you know, we, depending on what happens with rates for the rest of the quarter, would still expect to probably be in that, you know, high teams range with overall production. You know, we're still seeing some positive effects in terms of the total overall availability of loans to be refinanced and certain amount of production for correspondence that's sort of carrying over from the third quarter since that volume tends to lag a little bit before purchasing closed loans. So, you know, we do expect production income to still be, you know, strong and meaningful in the fourth quarter, but depending on race and the backup that we've seen might not be at the same levels as what we saw in the third quarter.

Okay, got it. Thank you.

Your next question comes from the line of Perry Ma with Barclays. Please go ahead.

Hi, thank you. Good afternoon. So your servicing margins kind of held steady at about nine and a half basis points the last two quarters. Can you maybe just talk about how sustainable that is into next year, even as kind of delinquencies continue to tick up?

Sure. So, overall, I think we've shown the ability over the last several quarters to maintain that, you know, that margin, and we do expect it to maintain at a, you know, similar level as we're moving into 2025. As you mentioned, To the extent that we do see, you know, delinquencies pick up somewhat, you know, that could contribute a bit in terms of our operating expense. I think the flip side of that is that we've shown our ability to drive down our operating expense over time through both a combination of efficiency enhancements, including those that we get through our SSE, our proprietary servicing platform. And, you know, that's driven that 30% reduction in servicing costs over time, you know, over the last few years. And then, and as we continue to increase scale by growing the servicing portfolio. So, I think the combination of those factors to the extent that we do see, you know, a bit of an uptick in delinquencies next year, you know, we'd see offsets from those continued efficiency enhancements and potentially even, you know, depending on what we see and we're not necessarily expecting or I should say we're not really expecting a meaningful uptake in delinquency next year. So, absent that, you know, absent an uptake, we think we'd be able to continue to drive down costs as we move through the next year.

Got it. And then for production, your correspondent, market share, and margins have held up pretty well in spite of some of the competitive pressures you've mentioned the last few quarters. Can you maybe just talk about what you've seen in that channel in the third quarter and also early on in the fourth quarter?

Look, I think that there's, to your point, in a period of some irrational pricing, we've managed to keep share pretty much flat to a year ago, we were up a decent amount in Q3. I would say that, look, margins were up from last quarter, margins continue to stay strong. We're obviously focused on profitability as well as maintaining share. And look, I think that given the size and the scale of this market, we can continue to grow share. We wanna do it in a meaningful way. But I think that the market knows that, you know, we're going to be the consistent bid out there. We're going to be in the market every day. And so, you know, we're, you know, we're back to, we're getting closer back to that 20, you know, the 20% sharing course on it. And, you know, we'll run above there. And, you know, if we see irrational pricing, we may fall below there. But I think, you know, by and large, I'm really, I'm really pleased with the, you know, You know, with the 20% Q over Q increase in locks and correspondence, you know, fundings were up a little bit less than that. But, you know, again, in that, you know, and, you know, we're still, you know, our seller base is still holding in strongly at close to 800. And so, you know, it's still an industry-leading powerhouse that we have in correspondence. Got it. Thank you.

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

Hey, thanks. Looking at the chart of the servicing operating expenses on slide seven, you know, there's been a pretty consistent improvement there over the last few years. I guess as you look forward, you know, would you say we're at a point where, that improvement starts to level out a little bit? Or, you know, as you think over the next couple of years and some of the new technology on board, comes on board, you know, how much lower do you think the expense efficiencies can realistically get on the servicing side? Thanks.

So, yeah, we think there's still a significant amount of room left to run in terms of servicing efficiencies and continuing to drive down. you know, that operating expense metric. You know, it may not be at quite the, you know, quite the clip that we've seen over the past few years, which is pretty substantial, but we do think that there is a lot of runway, and we're going to continue to, you know, progress on that in a meaningful way. You know, we don't really want to set a, you know, we don't want to set a specific floor necessarily, but looking at, what we think we could achieve through a combination of both continued scale as well as increased operating efficiencies. We believe there's at least, you know, 30%, you know, further reduction that could be achieved in that operating expense metric over time. That's not all going to be, you know, next year, but we can continue to move that down in a meaningful way as we move through the next several periods.

Got it. Okay, that's helpful. Thank you.

Your next question comes from the line of Derek Summers with Jefferies. Please go ahead.

Hey, good afternoon, everyone. Just looking at the production expenses, I think in your prepared remarks, you attributed the increase to the Consumer Direct channel. And kind of plugging the gap there, you know, how should we think about Broker Direct? kind of volume related or variable expenses as that channel continues to gain market share?

Our overall variable expenses on the broker side, you know, are I guess the way to think about it is sort of mid you know, what we've disclosed previously is really in terms of basis points, say, in the mid-range around, you know, the mid-range of double digits. So, that's as we increase, you know, we should continue to get these meaningful scale from that channel. As David mentioned, we are, That's probably on the variable expense side. You know, we are continuing to grow our overall platform there. And so, that may not all be, you know, realized in, as you would see it as we're sort of continuing to ramp up share in a meaningful way as we're bringing on additional resources to grow the channel. But as, you know, from a pure variable standpoint, that's what we would expect.

Got it. Thanks. And then on consumer direct volume expectations, do you expect kind of product mix from 3Q to kind of filter over to 4Q, or are we going to see kind of more of a reversion back to second lean mix?

If rates stay higher, we would expect a bit of a reversion back to more of a second lean mix. So, it'll be a bit rate dependent. You know, if we see more interest rate volatility and dips in rates, then we would see a bit of a shift back toward, you know, toward first lean refinances. And that's really, as we discussed, part of our strategy is being able to toggle between those products and maintain our capacity in the channel by, by rotating between the second liens in the higher interest rate environment and the refinances or first lien refinances as rates decrease or when rates decrease. Got it. Thank you.

Your next question comes from the line of Eric Hayden with BTIG. Please go ahead.

Eric, your line is open.

Your next question comes from the line of Brian Violino with Wedbush. Please go ahead.

Great. Thanks for taking my question. Just one quick one for me. I wanted to get your view on custodial balance earnings. I know there's probably going to be some seasonal declines in the fourth quarter, but just thoughts on how that part of the business trends next year if we do see a steeper decline in short-term rates. You know, is that something that could have an impact on servicing profitability, and how does that factor into your ROD expectations for next year?

Brad, can you repeat that?

Yeah, just views on the custodial balance earnings in terms of, you know, how that could impact servicing profitability if we do see a bigger decline in short-term rates next year.

Sure. To the extent that we see a decline in short-term rates next year, that would impact the earnings that we've been earning on custodial balances, which is generally driven or somewhat driven by what we see in short-term rates. We would also see, and you can sort of see it, you know, this quarter as well, some reduction in terms of our floating rate debt and the expense that we see there, you know, which has somewhat of an offsetting impact The other aspect to take into account is relating to our realization of servicing cash flows. So part of our, you know, when we project out the cash flows for the servicing asset and look at what should sort of fall off in any given period, that's, you know, really what flows into our, you know, realization of servicing cash flows line, that amortization line. And so, since we are projecting lower, given what at least recently the forward curve has projected lower short-term rates over time, you know, that would drive a lower amount of cash flow to be realized in any given period, which, you know, maintaining a yield in terms of our cash flow would result in a lower realization of cash flows. So those two, you know, impacts we would expect to offset the lower custodial balances or the lower earnings on custodial balances, I should say.

Great. Thank you very much.

Your next question comes from the line of Shanna Chu with Barclays. Please go ahead.

Hi, guys. Thanks for taking my question. It looks like delinquencies increase sequentially by 70 base points in FHA and 50 base point in USDA portfolios. I know you mentioned it remains within expected levels and on a prior question you had it that you don't expect a meaningful uptake in delinquencies next year. Can you just comment on what drove that sequential increase in delinquencies and, you know, kind of what gives you confidence on delinquency formation going forward for more more of the recent Jenny Mae originations if rates stay elevated?

You know, I would say that, you know, a lot of delinquency, you know, what we would call the noise around the increase in delinquency has to do with, for example, how many business days in a month, or where does the month end, or are there five Fridays in a month because people get paid on every other Friday? I would say, by and large, delinquency rates continue to remain at very, very low levels. And I think that when given the state of the economy, combined with the lack of supply in the marketplace, that to me gives me great confidence in terms of the continued profitability in servicing. I think that for borrowers who do find themselves struggling, there are a tremendous amount of forbearance programs offered by FHA, VA, USDA, Fannie, Freddie, really with the ultimate goal to keep borrowers in their homes until they can get back on their feet. I think that's one of the great lessons learned out of the great financial crisis that we want to give borrowers every opportunity to stay in their homes. In the event that's not the case, given the supply issues in the marketplace, orderly dispositions are clearly to be expected, which will help... continue to provide lower servicing costs for borrowers who do go into foreclosure. And so, you know, by and large, I think it's one of the, you know, great stories. And then also the fact there's so many low rate, firstly, mortgages in the marketplace. So the alternatives for borrowers are pretty slim if they're in mortgages below 5%. Given what we're seeing in the rental markets and the alternatives, I think that, you know, staying in their homes is probably at the top of their list in terms of, you know, what they want to do. So by and large, I think that, you know, you know, we'll see some, we'll see some gyrations, you know, monthly, quarterly, but, you know, we, I expect that they'll continue to run at these historically low levels.

Great. Thank you. And then last one for me, how should we think about refinancing the five and three bonds? October 2025. I mean, those are, you know, fairly low coupon, but they're now current. So, how should we think about, you know, financing costs going forward?

Sure. So, as you mentioned, we've got the maturity for that five and three-eighths bond later in the year next year. As we're moving through 2025, or through the next few quarters, we will be looking to see if there are, you know, good opportunities to be able to issue debt and refinance that bond. But as you mentioned, it is at a pretty attractive coupon, and so we are not necessarily in a rush to refinance it. We do have, as we mentioned, mentioned in the prepared remarks, $3.8 billion of liquidity available, including amounts available to be drawn on our secured lines against our MSRs, for example, which which we have a really significant amount of capacity and committed capacity available on. So, to the extent that we don't see an opportunity or an attractive opportunity to be able to refinance, we do have the ability to draw on those lines to retire the debt at maturity. It's that, you know, if we don't see an opportunity to issue before then, but it is our expectation that we would issue between now and the maturity to refinance that issue.

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

Well, thank you. I'd like to thank everyone for joining us today on this call. If you have any additional questions, as always, please feel free to contact our investor relations department. And we will be at your availability to answer those questions. And again, thank you for joining us.