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?