PennyMac Financial Services, Inc.

good afternoon and welcome to penny mac financial services inc's third quarter 2023 earnings call additional earnings materials including presentation slides that will be referred to in this call are available on penny mac financials 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 material. 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 that we can answer as many questions as possible. Now, I'd like to introduce David Spector, PennyMac Financial's Chairman and Chief Executive Officer, and Dan Perotti, PennyMac Financial's Chief Financial Officer.

Thank you, Operator. PennyMac Financial produced outstanding results in the third quarter, returning to a double-digit annualized return on equity. While average mortgage rates were up 50 basis points in the prior quarter, we demonstrated the earning power of our balanced business model with exceptionally strong operating income from our large and growing servicing business combined with continued profitability and production. As a result, book value per share grew 3% from the prior quarter. As you can see on slide 4 of the presentation, mortgage rates have continued to increase from record lows in recent years and are now near 8%. As a result, many borrowers who locked in a low fixed-rate mortgage have been incentivized to stay in their homes given their low mortgage payments. This has resulted in an extremely low inventory of homes for sale, driving expectations for the lowest unit origination volume since 1990. Additionally, we believe quarterly run rate origination volumes are trending lower than the average $1.6 trillion estimates from third parties for this year. Though the current origination market remains constrained, mortgage banking companies with large servicing portfolios are better positioned to offset the decline in profitability that has resulted from these low origination volumes. Looking at page five of our presentation, our balanced business model as a top five servicer and a top two producer of mortgage loans is a key differentiator that enables PennyMac Financial to profitably maneuver mortgage through varying interest rate cycles. Our servicing portfolio has steadily grown to nearly $600 billion in unpaid principal balance and 2.4 million customers. This consistent growth is driven by our ability to organically grow the portfolio through our strength as a leading producer of mortgage loans. The servicing segment drives the majority of our earnings in a higher rate environment. a large portion of which is cash earnings in the form of servicing fees and placement fee income on custodial balances and deposits. Our multi-channel approach to production enables consistent access to the origination market. In the current high rate environment, our correspondent and broker direct channels of production provide strong access to the purchase market. As we add these higher note rate mortgages to our portfolio, we are creating additional opportunities for our consumer direct business to offer our customers a new lower rate mortgage when interest rates decline. As of September 30th, nearly 20% of our servicing portfolio consisted of mortgages with note rates in excess of 5%. Turning to slide six, Revenue from servicing and placement fees has increased significantly in recent years due to growth in the portfolio and increasing short-term interest rates. At the same time, operating expenses as a percentage of total servicing portfolio UPB continue to decrease, demonstrating the operational scale and efficiency gains we have achieved. The substantial accumulation of home equity in recent years across the country has driven a large opportunity in the closed-end second lien product, enabling borrowers to tap the equity they have built up in their homes without relinquishing their low-rate first lien mortgage. The 2.4 million customers we have active servicing relationships with represent cost-effective leads for our consumer direct channel, and we've been actively marketing to those who would benefit from a closed-end second product. Since the launch of our closed-end second lien product last year to our servicing portfolio customers, we have originated for sale into the secondary market approximately $450 million in unpaid principal balance, including approximately $200 million in the third quarter. I'm excited to announce that in the fourth quarter, we will be launching a marketing campaign to non-portfolio customers, representing a significant opportunity for our consumer direct group to attract additional customers, given we currently service only about 4% of total U.S. mortgage debt outstanding. PennyMac Financial continues to lead the industry with strong financial performance, given its large and balanced business model. I'm extraordinarily proud of this management team's ability to successfully navigate the challenging mortgage landscape while also positioning the company to generate increasingly stronger returns over time. 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 $93 million in the third quarter, or $1.77 in earnings per share, for an annualized return on equity of 11%. Book value per share was up 3% from the prior quarter to $71.56. PFSI's Board of Directors also declared a third quarter cash dividend of $0.20 per share. Production segment pre-tax income was $25 million in the quarter. Total acquisition and origination volume were $25.1 billion in unpaid principal balance up from the prior quarter despite the continuation of a challenging origination market. $22.3 billion was for PFSI's own account and $2.8 billion was fee-based fulfillment activity for PMT. As you can see on slide 10, PennyMac maintained its dominant position in correspondent lending with total acquisitions of $21.5 billion with margins in the channel unchanged from the prior quarter. Notably, the number of correspondence sellers we maintain relationships with increased to 829 from 800 at June 30th. October volumes continued to be strong and correspondent with $8.9 billion in acquisitions and $9.4 billion in locks. In BrokerDirect, we continue to see strong trends as volumes, margins, market share, and the number of brokers approved to do business with us all increased from the prior quarter. Lock volumes were up 6% from the prior quarter despite a smaller origination market, and we expect to continue gaining market share as the top brokers increasingly see PennyMac as a strong alternative to the two top channel lenders. October volumes in BrokerDirect were $0.8 billion in originations and $1 billion in locks. In consumer direct, volumes remain low, but margins increased meaningfully from the prior quarter due to a greater proportion of closed-end second liens, which have lower average balances. Production expenses, net of loan origination expense, were up slightly due to the overall increase in volumes. Turning to page 14, the surfacing segment performed very well in the third quarter, with a contribution of $101 million to pre-tax income, up from $47 million in the prior quarter. The increase was primarily driven by strong operating results and lower net valuation-related changes. Excluding valuation-related changes, servicing pre-tax income was $120 million, or 8.2 basis points of average servicing portfolio UPV, up from $75 million, or 5.3 basis points, in the prior quarter. 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 in recent periods. EBO income increased $9 million from the prior quarter, driven by re-deliveries of re-performing loans for certain EBO investors. We continue to expect the contribution from EBO to remain low for the next few quarters. Interest income for the quarter was up primarily from increased placement fee income on custodial balances due to higher short-term interest rates, while interest expense was down due to lower average balances of secured debt outstanding. Operating expenses increased slightly from the prior quarter but remained low as a percentage of average servicing portfolio UPB. The fair value of PFSI's MSR, before realization of cash flows, increased by $399 million during the quarter, driven by higher market interest rates which resulted in projections for decreasing prepayments and an increased contribution from placement fees on custodial balances. Hedging losses were $424 million, also driven by higher market interest rates. The net impact of MSR and hedge fair value changes on PFSI's pre-tax income was negative $25 million, and the impact on earnings per share was negative 34 cents. And finally, the investment management segment contributed $400,000 to pre-tax income during the quarter. Assets under management increased slightly from the prior quarter due to PMT's strong third quarter results. This quarter demonstrates our ability to drive improvement in ROE, now back to the double digits. While we expect normal seasonality and a higher rate environment to have some impact in the next couple of quarters, we expect our strategic position and the strength of our model to continue to drive our returns higher over time. We'll now open it up for questions. Operator?

Thank you. 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, again, it's star one. We'll now take your first question. from Kevin Barker of Piper Sandler. Your line is open.

Great. Thanks for taking my questions. Congrats on a good quarter. Just wanted to follow up on some of the margins and the growth in the origination side. It seems like correspondent was fairly strong with margins flat. We've seen one of your competitors mention that there's been a pickup in competition despite the pullback from several large banks. What are you seeing in that market and you feel like the competitive environment is

know increasing or fairly stable thank you kevin how are you um look i think i think in correspondence um we had a really strong quarter in correspondence and i think it i think it's really for a couple reasons one you know clearly we're seeing the bank stepping back uh we saw that really start in in the second quarter and it's continuing as as a lot of banks are looking at the basel uh the vital issues that they're facing. And I think that, you know, you're going to see more that business and correspondent, you know, it's kind of moved out of the banks, but it's going to continue to stay out of the banks. I think that, you know, another reason correspondents so strong is the fact that sellers are not really retaining services. And so if you recall, during during meteor times of margins, sellers would would retain service saying because margins were at kind of the higher levels. and they can retain that servicing. But right now we're seeing many sellers not retaining the servicing, and so they're selling the whole loans to correspondent aggregators versus selling to, for example, the GSEs where they could retain the servicing. From my perspective, as it pertains to PennyMac, I think we're seeing a flight to quality from the point of view that we're the leading correspondent aggregator, and we're seeing many of our customers continuing to deliver product to us. and perhaps not delivering as much to some of the lower market share participants in the market. I was generally, you know, I was very pleased with the increase in sellers. And while the sellers themselves are smaller, so it's not meaningful to the UPB, I think it just, it kind of talks to this fight to quality issue. I mean, for us to add, you know, almost 30 sellers in a quarter is a pretty big number. And so I think that, you know, This all adds up to a really good quarter from a production standpoint, from a share perspective, and also from a margin perspective. And I believe that the margin story should hang in there in Q4, and that's what we're seeing to date. And I think from a correspondent perspective, we're in a very good place.

Great. Thank you. And then just follow up on... The broker channel as well, seeing an increase in fallout locks and then an increase in margin as well. Obviously, there's been quite a bit of attrition within that channel over the last year. I'd love to hear a little bit more about what you're seeing from a competitive standpoint within the broker channel. Thank you.

Yeah, so on the broker side, you know, we're seeing some very good traction being made in, you know, especially with top brokers, as they themselves are getting concerned with, you know, with the share of the top two participants. And so they're in need of a strong alternative. And so we're positioning ourselves as that strong alternative. And we're really, between that and the technology that we've spent a long time creating to really, in working with brokers to address their needs, we're seeing very good feedback on the technology. And so I'm really happy to see that we saw margin, that we saw share growth last quarter. We saw margin growth now. Some of that margin growth has to do with some execution enhancements after pricing. And so I think, you know, that, you know, the margins that we saw this quarter were very good. But I continue, I would expect them to continue to stay at the high end. And like, you know, in all three production divisions, we're seeing pricing stay rational. And I think that that's a, I don't see that, I don't see that changing. And I think if anything, you know, over the next couple of quarters, if you do see consolidation, that could provide some additional margin opportunity, margin expansion opportunity for us.

Great. David, thank you for all the detail. Very helpful.

Thanks, Kevin. Your next question comes from the line of Boast George of KBW. Your line is open.

Everyone, good afternoon. I wanted to ask first, your servicing fee increased. It's 26.7, so it's up 1.7 basis points. I mean, could we see that go down if you do excess transactions, or should we see the servicing fee kind of stay in this level going forward?

This is Dan Hippos. are expecting the servicing fee most likely to go up over, in basis points, to go up over the next few quarters. You know, we could see some impacts from sales of excess, but overall, given the servicing that we're bringing on, the fact that the significant bulk of the overall servicing that we're generating since the conventional correspondent volumes are now going through to PFSI, and they are retaining those as MSR, the bulk of those, rather than PMT retaining it over the last couple of quarters. That's contributed to the increase in the, you know, in the basis points of servicing fee. You know, we do evaluate sales of excess, but, you know, those, we would only, or we only, we would only engage in those to the extent that we see that as a, you know, as a benefit in terms of our, you know, our deployment of capital. And so our overall lean I would expect over the next few quarters as we're bringing on additional servicing, some of it at, you know, higher servicing fee levels would be to see that servicing fee and basis points go up over the next couple of quarters.

Okay. Okay, great. Thanks. And then actually going back to the gain on sale margin, you know, in that slide 11, So the gain on sale margin by channel has gone up the last, you know, over the last quarter, last year. But then there's that other line item that kind of offsets that. So if I look at the total gain on sale margin, it, you know, actually went down a little bit, quarter over quarter. So I was just curious, like, what that line is. And also, should we look at this on kind of a, at that bottom line basis, or should we look at the, you know, the line items?

Sure. Generally speaking, I would say you should look at the line items and that will generally tell you how the margins are performing on a channel by channel basis. The shift in the overall margin quarter over quarter was really based primarily on the mix of volume. So we had a greater proportion of correspondent loans coming through in the third quarter as opposed to some of the earlier quarters. I mean, those are overall, you know, if you look at the blend, a, you know, a lower margin for that volume. And so that overall is what, you know, is driving down the basis points on an aggregate basis quarter over quarter.

Okay. And that other line, is that hedging or what kind of flows through there?

The other line has a couple of components. The first is really just hedging. you know, time it really some timing elements when we're looking at, you know, when we're looking at locks and these are income associated with locks. There are certain elements from an accounting point of view where, you know, we only earn the income at time of funding. So those could get shifted to a different period. But in order to track what we're expecting to, you know, what we see is the margin in that channel, we're really looking at what our expectation is for the, you know, the lock gain in that period. And so if we have a timing difference, that could shift. And then if we do have, to your point, any sort of hedging gain loss or other, you know, elements of that nature, that can also, you know, enter into that line.

Okay. Okay, great. Thanks a lot.

Your next question comes from Michael Kay of Wells Fargo. Your line is open.

Hi. Good evening. on the production segment, do you think you could keep the profitability at these levels? Because given, you know, we're entering the slower seasonal winter months, plus mortgage rates are much higher, could that potentially swing back to losses?

Well, you know, look, I think under the things we can control, and clearly from what we're seeing in October, I would expect Q4 to be profitable in production. You know, we've got We've got an industry-leading correspondent franchise that continues to operate at the levels that you saw in the third quarter. We have rational pricing taking place in the market. And so I don't see the margins really coming under severe pressure to swing it to the unprofitable side. And a similar story can be said on broker as well. I mean, we're making inroads in broker. And while the current run rate of production is closer to a $1.3 trillion market, it's still more than enough to keep us operating profitably. I'll tell you, I think that really in the consumer direct channel, the product that I'm really enthusiastic about is closed-end seconds. We had a very good quarter in closed-end seconds where we originated $200 million the third quarter alone we've originated 450 million today um you know and the margins are the margins are very nice it's a profitable profitable product for us um we sell them all into the secondary market so there isn't you know we're not we're not retaining them we do retain the servicing on them as we currently service the first on these loans as well and and one of one of the real added benefits is that it keeps capacity in place for our consumer direct channel and it also we will see a rate decline. And having that capacity in place will be very important for us to be able to seize on the opportunity to refinance borrowers in higher rate mortgages. And so I'm enthusiastic about what we're seeing in Q4. And I think that we're setting ourselves up to continue to grow ROEs in an environment that's higher for longer or in an environment where rates are declining?

It's good to hear. Just on expenses, you know, I know you took a lot out your early, but I don't think anyone was thinking or anyone was planning for mortgage rates to be where they are now. I mean, are you positioned okay? on expenses in production, or do you think there could be potentially more trimming just given the environment is probably worse than most of us were expecting?

I think on the production and servicing side, we are very good at being able to bring up staffing or take down staffing based on the gearing ratios that we see for the market we're in. I think that there's a, you know, from my perspective and the rest of the organization, we're running a core functionality, and we're not, you know, we're clearly not sized for a $1.2 trillion market, nor are we going to put ourselves in that position. Having said that, you know, we're doing some things like, you know, looking at our technology infrastructure, and I suspect, you know, we're going to be looking to reduce expenses there. We're doing things like, you know, if there's attrition, we make our management team jump through hoops before we hire to replace that. But, you know, by and large, to your point, we did, you know, we took our medicine early. We knew what we needed to do. We did it, I think, three or four times in 22 alone. But, you know, having said that, it's given us the opportunity to focus on growing ROE, which we did this quarter, getting it back up into the double digits.

Yeah, that's great. Thank you so much for answering my questions.

Your next question comes from the line of Eric Hagen of BTIG. Your line is open.

Hey, good afternoon. How are we doing, guys? First question here, I mean, can you talk about how you're maybe adjusting or pricing for different borrower credit characteristics, any changes to the credit box? Even more generally, as rates have moved up this high, like whether you're intentionally targeting higher quality loans because rates are high and affordability is at this constraint. Thank you.

Yeah. Hey, Eric. Well, look, I think that, you know, the way we think about pricing mortgages is, number one, we only buy loans that are saleable to the GSEs or that meet FHA, VA, or USDA guidelines. Having said that, I would say in the third quarter of last year alone, we made some conscious decisions in terms of pricing risk attributes to take into account higher rates. And so along those lines, a lot of the lower FICO FHA loans and VA and USDA loans, we believe, we're going to require, I would say, a higher return in the investment for servicing, given that in higher rate environments, typically you see delinquencies increase, you see correspondence seller stretching, and while we diligence loans and we underwrite loans, Inevitably, you do start to see delinquencies go up. I think this move, while, again, it was a little bit on the early side, I'd rather be early than late, as you can well imagine. And I think it's bearing out. If you look at the FICOs and the LTVs of our production versus the rest of the market, I think it's meaningful. It's something that the management team looks at on a regular basis. But I don't see if, you know, we're not arbitrarily making changes to the credit box.

And you can see, Eric, if you look on page 33 of the deck are the characteristics of the loans that we're acquiring, especially through correspondent over time. The FICO has increased significantly, and a lot of that is in response to some of the factors that, you know, David was talking about and some of the changes that we made. you know, going back to the third quarter of last year.

Yep, no, that's helpful. Hey, with the hedging results in the period, would you say that's a function of the level of rates or is it interest rate volatility? Is there sort of like an ideal environment you feel like for hedging the MSR and maybe even kind of teasing apart and talking through the hedging results in the quarter would be helpful? And any hedging through October as well? Thanks, guys.

Sure. So, you know, we talked a little bit last quarter about the elevated hedging costs that we were seeing from volatility being very high and some of the, you know, impacts of the inverted yield curve. As a lot of that abated here in the third quarter, we saw, you know, pretty meaningful, you know, de-inversion of the curve as well as vol come down. We saw our hedge costs, you know, decline meaningfully. Our overall profile and our strategy at this point is really given how high interest rates are, typically, you know, typically when rates were lower or more balanced, I would say, in terms of the moneyness of our servicing portfolio, you know, we targeted a hedge ratio that was less, you know, less than 100%. so that we would allow for gains in a sell-off because origination volume, you know, would decline, and for potential losses, you know, limited losses in a rally because we would see an uptick in origination income. With rates at this level where so much of the servicing portfolio is, you know, meaningfully out of the money, we've really flattened that hedge profile and are targeting a profile that's fairly close to 100%. So when we take out the cost of servicing, I mean the cost of hedging rather, and then look at what our hedge ratio was compared to the change in value, we actually come up to pretty close to 100% given the change in value that we saw during the quarter. So overall, there was relatively, from our perspective, little leakage given the size of the servicing portfolio and the MSR assets. in the change in interest rates that we saw during the quarter. To your point, and given how, you know, given where we are in rates and the fact that so much of our servicing portfolio is out of the money, we would expect that the, you know, that this targeting of the hedge ratio closer to 100% is where we'd be probably at least for the next few periods, barring a, you know, meaningful interest rate rally. Yeah, I think that, you know, that sort of covers where hopefully what we saw during the quarter here as well as what you might expect to see going forward.

Got it. Okay. So into October, there hasn't been a lot of slippage, it sounds like.

No, October's been pretty contained as well.

Okay, great. Thank you guys very much.

Your next question comes from the line of Kyle Joseph of Jefferies. Your line is open.

Hey, good morning, guys. Or sorry, good afternoon. A lot of my questions have been answered, but I just wanted to walk through the second lean product. And I know you emphasized that it's really been, you know, catching ground and whatnot. But just walk us through the kind of the impacts on the P&L and the balance sheet specifically.

know what it will in terms of volumes and margins and whatnot and you know whether you'd expect that to continue so the second lean product overall as david mentioned we originated about 200 million of it during the quarter um you know i think we mentioned in our um we mentioned in the the presentation that we are also looking at opening that up to beyond our you know, just originating for our servicing portfolio to market to the mark to the market at large, you know, which is obviously an even greater opportunity than what we have in our servicing portfolio. So, you know, we could we do expect that to continue to increase. It's been increasing over the past over the past few quarters. If if you look at the margin trends that we've seen in in consumer direct, which is the channel in which we're originating these loans, you know, that's been increasing pretty meaningfully on a basis points basis over the past few, over the past few quarters. So a lot of that is due to the blend of the, you know, the second lien product versus, you know, versus the first liens because we are originating a greater proportion of second liens. And so given the smaller balance of the second lien product, You know, we have a higher basis point target in terms of our, you know, in terms of our gross margin there. So, you know, just given the blend, it's, you know, a bit above what the blend was here. So up into the, you know, 500 or 600 basis points in terms of margin on a UPB basis. where the the overall upds of these of these loans can be you know 75 to potentially a hundred thousand dollars um and so that that's you know that's really uh the revenue side on the you know on the production side they it's pretty similar uh expense wise to what we see um for a normal consumer direct loan um you know so a uh on a normal scale, you know, a little bit under in terms of basis points, what you would see, you know, in terms of what we collect in terms of the revenue. So we have a, it's a profitable contribution to the overall production business, but not as significantly profitable as if we were, you know, refinancing loans in a rally. But to David's point, if we do see an interest rate rally, one of the benefits of the second lien product or production is that we're able to keep the, you know, the staff on hand in a profitable enterprise. And then when we do see the interest rate rally, we'll be able to shift those resources over to refinancing loans, you know, into first liens from the, you know, the higher note rate balances that we've added over the past couple of quarters through correspondence.

Got it. Very helpful. Thanks for answering my question.

Your next question comes from the line of Jay McCandless of Woodbush. Your line is open.

Hey, good afternoon, everyone. Two questions for me. I guess if you take the second lien loans that you're originating outside of your channel, I mean, what's kind of the annual market size or market opportunity you think could be out there?

So look, I think, I think that clearly is if you go to slide eight, you can, you can see the opportunity for second lean expansion. I think, I think that, you know, I would, I would be, I would be disappointed if we didn't see production volumes grow in the, in the second lean space. We did 200 million last quarter. We have a very big servicing portfolio with a lot of tapable equity on its own. You know, we have 60% of the borrowers in the United States have a mortgage loan with a no rate of 4% or lower. And I think that one of the things in my years of experience is products, as people get, as people understand products more and get more generally accepted in the marketplace, you just see demand for them go up. And you're seeing more and more people taking out second liens. And this is one of the reasons why we are introducing it in our consumer direct channel for non-portfolio customers. We are going to test it out in broker direct. And I would expect that to be sometime late Q4, early Q1. But I think suffice it to say, the product that's here to stay given the fact that we do have so many mortgage loans below 4% and people have a lot of equity in their properties. And so it's, it's, it's something that they're going to want to, you know, life events are going to take place that they're going to want to tap the equity. Um, I think that as we stay higher for longer, you know, obviously you'll see more and more second liens being done. Um, but I think that, you know, I think, I think it's just, it's just, it's a product that's necessary. Really, given what's taken place the last three or four years with people just refinancing to low rate mortgages.

That's great. Thank you for the detail. I guess the other question, share repurchase, any thought to doing that at these levels?

Share repurchase, it's obviously something that we've slowed down on. from the levels that we had been at previously with that, you know, that we haven't done any share repurchases this quarter. Something that we continue to look at, but a couple of factors that we take into account, you know, one is our overall, you know, our overall leverage ratio. So we are, you know, targeting to be, if we look at our non-funding debt, you know, we're at 1.2 times leverage ratio this quarter. We've been in this area slightly above one times, and we're very cognizant that we want to, you know, maintain that leverage ratio below one and a half times as we look out into the next few periods and ensure that our leverage ratio is in a good position to be able to facilitate any unsecured debt opportunities that we might see or might want to engage in. So while certainly where the stock price has been recently, it's a more attractive proposition, it's something that we're weighing against, you know, maintaining our leverage ratio in the area, you know, that it currently is, as well as, you know, other potential, you know, capital deployment, whether it's in the $25 billion of correspondence servicing that we're, you know, that we're adding a quarter you know, or any other potential opportunities that might arise.

Okay. That sounds great. Thanks for taking our questions.

Your next question comes from the line of Priya Rengarajan of RBC Capital Markets. Your line is open.

Hey, guys. Thank you so much for the call. On the second lean program that you have Are you seeing any consumer behavior difference between, you know, a cash-out refi versus a second lien product? Are they, like, you know, going one for the other? Like, do they have a preference in terms of which product they choose?

Well, one of the reasons, I agree with David, one of the reasons we came out with the product is I didn't like what I was seeing in the market with people who were starting to refi out of low-rate first liens. And so... from my perspective, we needed the product to give borrowers the ability to tap their equity without getting out of first lien mortgages. When a borrower calls in for a cash-out refinance, we expose them and offer them the second lien product as a viable product. We pay the loan officer the same amount, so there's no incentive for them to do a cash-out refi versus a second lien mortgage. We want to We want to really be focused on the compliance aspect of this product. And I think it's meaningful in terms of, and I think it speaks to why we're doing so many second liens versus cash out refinances. There are life events that do require cash out refinances or refinances to take place. But I generally am of the view that if borrowers want to tap their equity, the second lien product is the place for them to go. Now, we do have minimum FICOs on the product, so for the lower FICO product, if you see cash out refinances in the marketplace, that's probably the reason why. But generally speaking, given the high credit quality of our servicing portfolio, second liens is the product that I really want to see our borrowers using to tap the equity.

That's a very helpful color. Secondly, on the origination side, As you look into 2024, to the extent that the markets don't change so much from an existing sales of house market, how are you thinking about gain on sale margins? Do you think that the industry has rationalized enough that you should see stable margins or can gain on sale actually go higher as there is more consolidation?

Well, look, I think the gain on sale margins have through this year may, you know, remain relatively stable. There's some ebbs and flows that take place during a month or so. But I think generally speaking, we are seeing, you know, sale margins stabilize. And as I mentioned earlier, I think in correspondent, you know, we're starting to see a little bit of opportunity with the banks stepping back, you know, for us to increase margin. I think that, look, from a mortgage size perspective, mortgage market size, given where the application index is is showing, you know, right now we're probably, you know, running at a 1.2, 1.3 trillion dollar run rate. Given the average balance, we're at a unit run rate that we haven't seen since 1990. I generally think, you know, we will see, you know, rates come down when. I don't, you know, I'm not in the prediction business, but I think, you know, when you look at the market as a whole, It's generally thought of in the second half of next year. You'll start to see some, you know, some pressure come off of rates. Having said that, as I said, I'm generally I'm very pleased with the margins are there's there's rational pricing taking place in all three channels. And I and I suspect that in Q4 and a little bit in Q1, given the high level of rates, you're going to start to see some more consolidation taking place, which will only lend itself to margins at a minimum staying stable.

Got it. And then finally, from a credit perspective, you guys obviously did not do a dividend this quarter. Given where your debt trades, have you guys thought about doing open market purchases, tender, like your 2025 refinancing? Anything would be really helpful. Thank you so much.

Sorry. So we did. We did do a dividend this quarter, just to be clear, in case I misheard you. So we did, you know, we did issue a quarterly dividend. But, you know, we're not currently, you know, we're not currently, as I mentioned, we are looking at potential opportunities in the, you know, in the unsecured debt space or in the high yield space, you know, have not seized upon that yet. We've additionally been raising, we've increased some of our, we're in the process of looking at potential opportunities on the secured side to replace or move out some of our debt maturities there. The, you know, unless we are, To the extent that we see an opportunity that makes sense for us in the high yield market, we potentially would look at if there's how to address our maturity for unsecured debt that's coming up not till later in 2025. But that still is a bit off. And we think that there's a pretty large window of opportunity here between here and you know, when that maturity comes. And so, we're not, we don't necessarily expect anything in the near term.

Thank you. And I mentioned my back. Sorry. Thank you.

And your last question comes from the line of Kevin Barker of Piper Sandler. Your line is open.

Thank you. I just wanted to follow up on the interest income, which has been fairly strong. Obviously, you have some different moving parts with higher interest rates, higher custodial balances, and then some seasonality associated with it, combined with some decline in debt. So maybe could you just provide us a little bit more color on what you expect from the direction of interest income, just given higher custodial balances, and then interest expense on the other side, given lower origination volume just seasonally?

So overall, you know, when we look at the, you know, the interest income, to your point, there's a number of different moving pieces. So we tend to look at it on, you know, the interest income related to production and then the interest income related to servicing. Interest income related to production, given some of the changes in the, you know, in the yield curve, you know, toward the end of last quarter, the beginning of this quarter, would tend to push up, you know, the note rate of mortgage rates versus the short-term rates have stayed relatively stable. So we'd expect, you know, that relationship between our financing lines and the note rates on the loans that are coming in to increase that, you know, that interest spread. So that, you know, would generally move the interest income on the production side in a positive direction. On the servicing side, a couple of factors. So one, you know, as we noted in our servicing income sort of disclosure, our servicing profitability slide, slide 14, this, you know, in the slide deck, we did see interest expense decline quarter over quarter due to a lower draw on our, you know, on our servicing financing line. We are keeping somewhat less cash. You may have seen the cash balance in our, you know, the cash balance on our balance sheet decline somewhat. So we have begun to reduce the overall cash that we're holding on the balance sheet. We had been holding somewhat elevated levels due to the, you know, some of the market turmoil that we saw earlier in the year. So we've begun to reduce that. That really, you know, reduces some of the interest expense that we're seeing on the financing lines. would also reduce somewhat the interest income that we're earning on that cash. But overall, since we're paying a spread of 300 to 400 basis points on the servicing lines, you know, would bring down that interest expense and create an overall positive benefit. On the interest on the custodials, you know, we do expect that to probably come down a little bit quarter over quarter, just as, to your point, the overall custodial balances or the escrow. account balances tend to come down in the fourth quarter and be a little bit lower in the fourth quarter and first quarter due to seasonal tax payments that typically occur toward the end of the year or very beginning of the year. So hopefully, I know that was a lot of different components, but a couple of different countervailing effects. But overall, I would say, you know, probably interest income ends up in a pretty similar place with all those effects is what we saw in this quarter if we're looking out into the next quarter.

Yes, that's very helpful. Just, you know, from a seasonality perspective, what percent of the cost deal, the balance, would you expect to decline in the fourth quarter and then in the first quarter just due to seasonality?

Yeah, typically the average is lowest in the first quarter. because the tax payments happen through the fourth quarter. So I think compared to the third quarter, you know, I don't know the percentages off the top of my head, but I think roughly, you know, in the fourth quarter down 10 to 15%, and then in the first quarter, you know, a bit higher than that, probably down 20% or a little bit more. Okay.

Thanks for taking my questions, Dan.

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

Well, thank you. Thank you, everyone, for joining today. We appreciate the time and the thoughtful questions. And if you have any additional questions, please don't hesitate to reach out to our IR team. And I look forward to speaking to all of you real soon. Take care.

This concludes today's conference call. You may now disconnect.