PennyMac Financial Services, Inc. (NYSE:PFSI) Q3 2023 Earnings Call Transcript

PennyMac Financial Services, Inc. (NYSE:PFSI) Q3 2023 Earnings Call Transcript October 26, 2023

PennyMac Financial Services, Inc. beats earnings expectations. Reported EPS is $1.77, expectations were $1.57.

Operator: Good afternoon, and welcome to PennyMac 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 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 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.

A woman signing papers with her banker for her first home mortgage.

David Spector: 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 from the prior quarter, we demonstrated the earnings 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 four 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 has resulted from these lower 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 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 multichannel approach to production enables consistent access to the origination market. In the current high rate environment, our correspondent and broker direct channels of production provides 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 30, 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 and 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 nonportfolio 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.

Dan Perotti: 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 pretax income was $25 million in the quarter. Total acquisition and origination volume were $25.1 billion in unpaid principal balance 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 correspondent sellers we maintain relationships with increased to 829 from 800 at June 30. October volumes continue to be strong and correspondent with $8.9 billion in acquisitions and $9.4 billion in MAX. In Broker Direct, 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. Block 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 Broker Direct were $0.8 billion in originations and $1 billion in locks. In Consumer Direct, volumes remained 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 Servicing segment performed very well in the third quarter, with a contribution of $101 million to pretax 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 UPB, 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 owned 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 redeliveries 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 remain 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 pretax income was negative $25 million, and the impact on earnings per share was negative $0.34. And -- and finally, the Investment Management segment contributed $400,000 to pretax 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?

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