We’re going to get started. Good afternoon, everyone. Welcome. Thank you for joining us. My name is Terry Ma. I'm the Consumer Finance I’m joined by David Spector, the CEO, and Dan Perotti, the CFO. so welcome, gentlemen.
Thank you.
Thank you for hosting this, Terry.
Yeah. So I think we'll just get right into it. Let's start with a mark-to-market in the third quarter. I think you guys put out the August update today. Can you maybe just touch on what you're seeing across each channel and then also just the competitive environment?
Sure, sure. Well, you know, as you pointed out, we released some August updates this morning, and, you know, we're seeing a very good opportunity for us. The market in and of itself is running at a rather anemic pace of $1.2-$1.3 trillion in originations. On the correspondent side, we're starting to see some, I think some perceived share growth. We'll find out when the numbers finally come out in October. But, you know, we're seeing some good activity there, both on the government and conventional side. You know, we had some issues in the second quarter with guarantee fee volatility of the GSEs and some irrational pricing on certain executions on the government side.
But on the correspondent side, you know, we have at the end of the second quarter, we were reporting share of about 18%-19%. I expect to be about 20% at the end of this quarter. Having said that, I, you know, we're seeing some good margin opportunities, and while they remain flat, I think given the size of the market, that in and of itself is a really good sign. On the broker side, there we're seeing margins remaining steady. You know, we're the number three broker originator, but number one is 50%, and number two is 40%. And so there's, you know, really good opportunity for us to continue to grow share.
We had increased production in August, both locks and fundings in broker, and I'm hopeful that that will continue. And on the consumer direct side, there it's... You know, we're really seeing the effects of the low volume of refinance activity in the marketplace. I'll say the real bright line in our consumer direct channels are closed-end seconds . We're doing over $100 million a month in locks there, and that's a product that we introduced for our portfolio. People with 3% mortgages who want to take equity out of the properties, whether it's to pay existing debt or to do home remodeling. There, you know, we're seeing very strong activity.
And all of this speaks to really supporting what we've built in PFSI, and that is, we have this large servicing portfolio. Our consumer direct channel serves as an integral part of the flywheel that we've created. And so, of course, on it right now, we're buying a lot of 6% mortgages, but ultimately rates will decline, and we'll have our consumer direct channel available to refinance those loans. And that's another value of our closed-end second product, and that will keep the capacity in place to be able to pivot to cash-out refinances or rate and term refinances when rates do decline.
Got it. So helpful color there. You touched on it a little bit. The origination market is running at a $1.2–$1.3 trillion run rate this year so far. I think MBA and Fannie are closer to $1.7 trillion in our estimates, and I think for 2024, they're $1.92 trillion. So I guess the million-dollar question is: What's your view on originations for 2024?
Well, personally, I think, I think we're going to be higher for longer, so my, my net would be below two. The important thing to remember is the managing both PFSI and PMT, we, we really think about managing these vehicles, these companies, you know, to a range of costs. I mean, what we've built in PFSI is really, is really unique in that we have this business model. So many-- in many cases, staying higher for longer, for us, gives the opportunity to, to buy more loans and to correspond and build the servicing portfolio with more half the money mortgages. But when rates do decline and we see, we see production increase, well, you will be able to participate in the refinance opportunity, that comes about as a result of that.
In the case of PMT, you know, we've got a very, very sticky balance sheet from our CRT investments, combined with the lower note-rate mortgages that, you know, whether it's higher for longer, I think by and large, it's going to have, you know, not as much of an effect. But I would, I would say that, you know, it's, it's going to be tough sledding for the next 12 months at least, I suspect.
Got it. That's helpful. And what did you say was the ideal operating environment? If you had to pick between the two, higher for longer or it's a rates coming down to maybe-
Yeah.
-next year.
I think, I think I'm a higher for longer person, given our moat. We have the ability to continue to operate efficiently with returns. We're, we're in a really good position at the, at both companies, but, you know, when you think about what we've gone through in the last year, there's been a lot of volatility and a lot of unknown. The scenario we're in now, where the consumer is very healthy and making their payments, housing is starting to appreciate again, delinquencies are remaining low, as I talked about, with the consumer. We still have an ongoing response to, but the servicing portfolio remains strong, and have the ability to add to that servicing portfolio, I think is very valuable to us.
And obviously, as we look longer out, when rates do decline, we'll have more, more of a universe of refinancable mortgages to be able to-
... I think the other piece, too, is that given that the position we're in, where we have this balanced business model, you know, being higher for longer allows for some more consolidation of the industry, some reduction of capacity, and again, some renormalization of some of the, you know, margins and so forth. So that, you know, when we do having a sharp interest rate rally in the near term will be a feel good in, in sort of the short term, right? Everyone likes to see the production numbers go up, but we're probably in a better, you know, competitive position along in the higher for longer scenario as we look out further on what the ultimate, you know, the ultimate best case for a long time as we look at the franchises.
Got it. Absolutely. Can you talk about what the current rate environment means for servicing profitability? Are there any opportunities to add additional operating leverage to your businesses?
So, in terms of servicing profitability, having higher rates is, you know, is beneficial. Obviously, we have lower prepayment speeds, which benefits us from an operational point of view, and also from the point of view of a stability of cash flows. Generally speaking, you know, scenarios should be a lower, you know, a lower cost to service because you don't have as much sensitivity or a lower cost to hedge, rather, because you don't have as much sensitivity of the portfolio from a prepayment speed perspective. The other benefit that we see in the current rate environment is our earnings on the escrow balances that we manage for the borrowers or for the investors in the mortgage loans or the mortgage-backed securities.
You know, both principal and interest and taxes and insurance funds that come into us before we have to remit them, we hold in custody for those, you know, for those borrowers or for the agencies. And we receive, you know, placement fees for placing those deposits at different banks. And our general earnings rate there is, you know, Fed funds plus a bit of a spread. So you can see in our servicing profitability, that line item has increased from being pretty minimal, you know, just two quarters ago when, you know, when interest rates, short-term interest rates were so low, to approaching $100 million a quarter in the most recent quarter. And so that's been a really big benefit for us on the servicing side.
In terms of getting leverage on the business, you know, we have continued to focus on the expenses or the operational costs in our servicing division, continue to drive those down to get additional leverage out of our servicing business. We've also been taking on through our correspondent business at PFSI, an additional portion of the correspondent loans over the past few quarters. So, you know, PMT and PFSI, the correspondent business has traditionally been split, where PMT has retained the conventional correspondent loans, PFSI has retained the government correspondent loans. As PMT's portfolio has been in terms of MSRs, they've been selling through, actually a significant portion of the conventional correspondent loans. That's allowed us to grow our mortgage servicing rights portfolio at a more rapid pace in PFSI.
That gives us also some additional from a servicing profitability point of view in PFSI, and allows us to deploy our capital, you know, more in a quicker fashion.
Got it. So you talked a bit earlier about adding current note rate loans to your portfolio via correspondent channel. Maybe just talk about why that's the preference versus going to the bulk MSR market.
Sure. So if you look at the bulk MSR market, a significant portion of the loans in the bulk MSR market, especially the larger packages that have come out, are generally, you know, 2020, 2021 vintage, lower note rate, not likely to be refinanceable in the near future. As opposed to the loans that we bring into our portfolio via correspondents are all recently originated, high note rate, and have, you know, a decent amount of likelihood as interest rates bounce up and down over the next few years of having some ability to be refinanced through our Consumer Direct channel, and thus add additional sort of profitability or additional avenues of generating revenue from that customer that we're bringing on.
Additionally, you know, we prefer originated mortgage servicing rights, in which correspondent, you know, that classification, we're selling the loan and generating the mortgage servicing rights as opposed to acquiring, because provides a, a tax benefit to us. You know, we assume a, a deferred tax liability when we do that, hence that gain from recognizing the originated mortgage servicing rights is, you know, a gain for GAAP. We're bringing an asset onto our balance sheet, but, it's not recognized for tax, and so we're effectively deferring that income out into the future.
That allows us, you know, a better sort of leverage in the business from being able to recognize that deferred tax liability, and that is not an advantage that would accrue to us if we were to just purchase the mortgage servicing rights out in the market. And so that's really, you know, the aspects. I'd say the final, the final advantage there, too, is that in terms of the correspondent loans, you know, versus a package, we do diligence on all of the loans that come through our correspondent channel. We're able to sort of pick and choose on a loan level basis what types of characteristics we want to bring into our portfolio. You have a much more limited ability to do that when you're looking at bulk packages.
It's generally, you know, potentially there are some ways to carve out certain pieces, but generally speaking, you're sort of taking the package, you know, as it comes.
Got it. Got it. Can you maybe just touch on the bulk market itself? What, what are you seeing there in terms of, you know, potential returns on pricing?
Bulk MSR?
Yes, Bulk MSR.
Bulk MSR. Overall, our view in terms of the way that we analyze or look at the bulk MSR packages on an ROE, we're seeing returns probably in the double digits to potentially mid-double digits. We did buy for PMT one package of a little over $1 billion of unpaid principal balance that, you know, hit our target returns. But overall, we've been very judicious about sticking to our, you know, our target return levels and don't see any, you know, pull us straight away generally that we're, that we're looking at in that regard.
Good. So let's maybe switch gears to talk about, you know, overall ROE. I think ROE last quarter was 7%, and you talked about, you know, getting back to pre-COVID ranges over the near term. So can you maybe just provide some color on how you bridge from seven to double digits?
So, you know, if you look at the balance of our, of our business currently, given the overall mortgage origination environment, as David mentioned, in terms of the pace that we're seeing in the most recent month or 2, been at a $1-3 trillion pace. Overall, you know, that's constrained the production side of our, of our business somewhat. There's only so much mortgage volume to do, and especially consumer direct side, where there's a very limited number of and that's and their general, you know, their general thrust.
If, you know, as we look forward in time with overall mortgage volumes, you know, pushing back toward a $2 trillion market, you know, moving in that direction, gives us a little bit more sort of leverage, if you will, on the production side of the business. We have the ability to expand in, you know, in Broker Direct, where we're the, you know, the number 3 originator in that channel. There's additional opportunities in terms of Consumer Direct, both on the second lien side and if there's additional interest rate volatility, being able to capitalize on loans that we've brought in through the correspondent channel at these higher rates and refinance those loans gives us some additional upside in terms of that channel.
We probably have some ability to expand, certainly as the market expands, in correspondent, and we really like the competitive dynamics there. But overall, those three channels continuing to grow up really almost historic, you know, historically low levels of activity that we're seeing today, moves us back towards, our, you know, our pre-COVID ROEs, double-digit ROEs, and also normalizes us toward our, our target in a normalized environment of 20%.
Yeah. So the longer-term goal is 20+. Is that just what you need to get from double digits to 20%+, just a more normalized market, or are there any other levers or things?
You know, I'd say similarly to when we went through this in our investor day back in 2021, a normalized environment where probably market overall, you know, $2.2 trillion of overall market volumes is probably a sort of underlying condition that we would expect if we were to get to the 20 plus. But as the market is moving that way, you know, that gives us the firepower, if you will, to move our ROEs back to double digits.
And then just on the expense side of the equation, how do you think about that as you march back toward double digits?
On the expense side of the equation, we've really, you know, we really normalized pretty significantly over the past year. In 2022, we are very early in terms of bringing down our expenses. Went from headcount of over 7,000 to about 4,000 today. It's really reduced our our expense base. At this point, we are mostly at, you know, what we think of as core function out. And so, from a, you know, from a base expense perspective, we aren't expecting to continue to reduce significantly there. That being said, there are efficiencies that we can continue to gain. I would say, especially I mentioned on the, you know, on the servicing side, there's continued improvement in sort of the unit costs there. We continue to grow some ability to additional efficiencies into those areas.
And then, certainly as production continues to from these low levels, that's on a unit basis. So we see greater economies of scale and efficiencies as we get to greater levels of production.
Maybe switching gears again, maybe just the investments in technology that have been made in recent years.
Yeah. So we've invested a lot in technology going back to the last, you know, 7 years. If Dan—as Dan talks about efficiencies, clearly that investment has just allowed us to be our investment in service, in our servicing system, that proved to be invincible when COVID—allowed us to do things from a technology standpoint that we otherwise would not have been able to do. And that technology continues to grow and evolve, and we continue to drive down certain costs as a result of the technology. In our production channels, we've had varying degrees of investments in technology in all three channels. In the correspondent channel, we introduced a new system back in 2020. Allows us to deal with, you know, different market sizes and different scale issues.
It allows us to be able to more granular pricing and different margin components based on where the seller is. On the Broker side, we introduced new technology earlier this year. This has been very well received by all of our broker customers, and we're getting a lot of good feedback. And this is, again, something that was really tailored to the originator. And then in Consumer Direct, we have client-facing technology. It's not that new anymore. We introduced it about a year ago, but, again, it's allowing borrowers to self-serve more if they want to. But get to the fulfillment side in a minute. But what's really important, as we think about technology, production technologies, is we go through these periods of rate declines.
We want to be able to opportunities as possible, the most efficiently possible. Historically, this has been bogged down by either issues state and people, and that's how we think about technology. Is there a way to leverage the people that we have in the organization to be able to bring out more firepower and more origination capabilities? Similarly, on the fulfillment side, we're uniquely structured in that we have one fulfillment group for all of our production channels, and a lot of the lion's share of our investment in technology has been on the fulfillment side. And that's using, you know, introducing new technology like OCR technology, the ability to involve third parties in the. And really there, you know, we have a little bit more technology investment that we'll be making in the consumer direct channels fulfillment.
I am very confident that when we go through periods of interest rate declines, our technology and our investment in technology will allow us to become even more efficient than we were coming the end of the last year.
Got it. That's helpful. You mentioned the broker channel. Can you maybe just dig in a little bit deeper, talk about, I guess, your share in the broker channel now, where you maybe hope to get to longer term, and maybe how technology helps you get there?
Yeah. So the broker channel is an interesting channel that we have. You know, the number one broker originator is a 50% market share, the number two is a 20% market share. And they try to tell their customers not to sell to the other person. And that's allowed us to be able to be, you know, kind of a third option. I think, as I said, the technology has been table stakes, and we have technology that really allows the broker to do a lot of what the broker needs to do, very quickly and very efficiently. We've built this technology in coordination with brokers to meet their demands and their needs. And, you know, from, you know, as we sit here today, our market share is at, you know, 3%.
I don't think getting to 5% or 10% necessarily is a huge stretch. I think it's a function of we have to continue to bring on more brokers. We have to continue to evolve our, you know, our pricing methodologies and evolve how we operate with those brokers. But I'm really confident and really happy to see what I'm seeing with the new technology, and we're making good inroads. And I think, as I often say to investors, if you and I were delivering all of our, all of our loans to one counterparty, we would look to one another and say, We need to find a number two and number one, till you get to number two.
So I think, you know, that I think is clearly getting into the heads of large broker originators, and it's something that we're hearing from them, and we want to continue to institute a lot of the disciplines that we've instituted in our correspondent channel and bring it over to our broker channel.
Got it. That's helpful. So I think I'm going to pause here and go to the two audience response questions that I have. So if you can just queue the first question, if you want to participate. So relative to Fannie and MBA forecasts and total market originations, $1.6-$1.8 trillion in 2023, and $1.9-$2.1 trillion in 2024. You expect 2024 originations of? Hey. Any comments there?
You know, I think it's gonna be, it's gonna be... I don't like to be a prognosticator, but I think it's gonna be a little bit tougher in 2024 to see rates decline. And so I think somewhere between number one and number two, that's where I'd be.
Yeah, I'm probably with the crowd. I'm a little—I think there's going to be some volatility. We've got more higher rate mortgages—that, that we hit number two.
You can see why we managed to arrange a ballot, actually.
Okay, so let's move on to the second. Over the next year, would you expect your position in PFSI to, one, increase, two, decrease, or three, stay the same? Okay, so pretty bullish. Pretty bullish. So before we move on to PMT topics, I'll just open the floor to Q&A if anyone has any questions. We have one up here.
Hi, just a couple questions. On the second mortgage product that you're rolling out, who carries the credit risk of that, or how is it sold off, or how is it funded?
... So, as we treat it today, and I said we've seen a change that's really taking place, the financing of the development of our existing warehouse lines, it's an eligible asset for the warehouse line. It originated only through our consumer direct channel. It's offered only to our existing portfolio. That's not to say we wouldn't think about bringing it into broker or correspondent, if it made economic sense for those channels. But today, it's just in the consumer direct channel. We're selling that product as whole loans. All of the credit risk goes, travels to the new investor, and we're servicing those mortgages. As I said, it's these are second liens that are only offered to customers where we have the existing first lien.
So it's something that, you know, I think is an advantage to those who are buying home loans. We're getting very good distribution of the whole loans. We're getting it, you know, we've sold some to insurance companies, to private equity, as well as to Wall Street. So there's a pretty good demand for it as well. So it's not, you know, there's the only risk we have is, as I said, is the servicing risk, which we already have, as well as, you know, we're servicing the first lien. So I think that's the alignment of interest for that particular product and is strong.
Any other questions? We got another one up here.
There's talk about all these regional banks potentially being forced sellers of MSR assets as they try to rightsize to, you know, the new kind of new regulatory regime. That creates a material opportunity for you guys. Is that something that you actually see happening yet, or can you quantify that?
So we haven't seen forced selling, and I generally think that regardless of what happens with the new capital regulator that came out, I don't think you'll see forced selling. We're seeing certain banks slow down their pace of activity and correspondent, which is a servicing acquisition business. And so I generally believe you'll continue to see that kind of slowing down process. You know, maybe they'll go as far as Wells did, where they got out entirely. But I, you know, I'm generally seeing a trend in terms of the slowing down on the new MSRs. In terms of the bulk MSRs, it's not happening at the pace that we thought it would at the beginning of the year.
We've seen some large packages come out of, you know, some banks. We're seeing some conventional MSRs come out of very small originators, but not as much as we thought would take place. And on the Ginnie servicing side, we're seeing little to nothing, MSR coming out. And I think that speaks a lot to where the industry, the mortgage banking industry is. Many of these mortgage banks made a lot of money in 2020 and 2021, so the industry is very well capitalized, and many of them created their own version of the balanced business model, where they retained some MSRs. And so in a way, those MSRs are allowing them to stay up and, you know, to wait for rates to decline, make origination income. We'll see what happens.
You know, if you stay higher for longer, there may be a capitulation of sorts in the small mortgage banks. The larger banks, I think it's going to be a very slow process. I don't see, unless there's a real kind of unique issue, I don't see them being forced sellers.
Any other questions for PFSI? Okay, so we'll move on to PMT. So can you just remind everyone about PMT's significance in the overall PennyMac complex? Just maybe tell us a little bit more about its current investment portfolio.
So the PMT-PFSI relationship is an—you know, has been an incredibly unique, successful, and synergistic relationship that I think that both these have benefited from. As we sit here today, PMT operates under three different investment channels. One is its interest rate-sensitive channel, which invests in mortgage servicing rights. It's really our correspondent business, which is the second channel, is really run through PMT, and that's a legacy issue, where all the loans are sold to PMT, who then sells the government loans to PFSI and many of now the conventional loans that Dan was referring to earlier. But on the sensitive side, it's MSRs, and on the correspondent side, it's engaging in correspondent activity on conventional loans and the gain on sale on those loans.
The third channel is its credit-sensitive strategies, which historically was investing in its own lender risk share securities. But since that program has been suspended by the GSEs, it now engages in buying securities off of the agencies' shelf STACR or CAS, as well as buying subordinate bonds off of securitizations, primarily jumbo securitizations. So it's, you know, through those, you know, it's operated, and it's allowed the PMT is the beneficiary of having PFSI's operating capability in terms of fulfillment activities on the correspondent business and providing sub-servicing and recapture opportunities off of the servicing portfolio that it owns. PFSI has been a beneficiary in just having this investment vehicle that it could use its scale for and help, you know, just work under a larger universe of loans.
And I think as we sit here today, you know, I think PMT has had a terrific track record of really managing its credit risk and interest rate risk in a way that, you know, has allowed us to be able to, you know, term out our CRT debt. We hedge our MSRs in PMT like we do in PFSI. And it's really run, I think, as a best-in-class, you know, risk management-focused REIT.
So, what's the overall investment environment look like right now for PMT? What's the opportunities that look like for new investments?
So it, you know, look, PMT always, always has the opportunity to invest in MSRs, and, and that can be, you know, through, through the conventional correspondent. Given, given the capital constraints, which is that, you know, difficult environment to raise capital, it's, it's focusing a little bit more on investing in credit strategies. We're very much focused on looking at CRT bonds, on looking at, subordinate bonds off of, off of securitization. But I think with the new capital that are coming in, you're going to see more jumbo loan securitization. When PMT was created back in 2009, it really was with a vision that you'd see securitization come back, and there would be a need for an investment vehicle to invest in subordinate bonds.
I think given what we're seeing in the jumbo loan market, we're seeing you know some of that product finding its way into non-banks. So I'm hopeful that over time, we'll see a return to securitization, and we can participate in buying jumbo loans, and whether it's through the broker channel at PFSI or whether it's through its own correspondent channel, that we can see an ongoing program of securitization of jumbo loans.
Got it. Helpful. And then touch on the credit portfolio. Are you seeing anything with respect to delinquencies or anything concerning?
So, in terms of delinquencies, we've really seen, delinquencies decline pretty significantly since the height of the pandemic down to, you know, a fairly low level, now hovering around, % total. Not really seeing any stress in PMT's portfolio. In terms of the bulk of the investment where PMT exposed from a credit point of view, meaning, you know, where, the credit risk transfer, where they've taken the credit risk on those loans. You know, those loans are currently sitting on very low LTVs as well, generally in 50%-60% mark-to-market LTV range.
So even if we do have, you know, a handful of borrowers that have some kind of stress that they can't, you know, they're delinquent and can't resolve in some other way, they would be able to sell their home and get out with, you know, limited losses to the credit risk transfer. So overall, you know, that investment and the delinquencies that we're seeing there are really, you know, at very, you know, very low levels, and we expect that to be, you know, due to the home price appreciation over the past few years, the credit characteristics of those loans be really well supported as we move forward.
That's helpful. So just to switch gears and touch on the dividend. PMT's dividend is $0.40 a quarter. Your earnings run rate's been closer to $0.30. So how should investors think about that gap in coverage?
So the $0.40 dividend, you know, we, we down $0.47 to $0.40 a few quarters ago. Generally speaking, we, our dividend in place is expected to remain there for, for a period of time. As you mentioned, in the last quarter, when we look at our GAAP and our run rate earnings, in the current environment, brought down to a $0.30 level in terms of what we were seeing, our expectation for GAAP earnings over, that's really over the, the next year in the current environment.
The primary place where we were seeing sort of a reduction or compression of earnings was really in our interest rate sensitive strategies, which was largely, or which is largely driven by, you know, the inversion of the yield curve, looking at financing versus the yields, you know, the fair value yields on those investments, MSRs and MBS, and sort of the capitalization carry there. As you know, we do expect over time for the yield curve to normalize. We've seen some of that in the current quarter. You know, that's beneficial to those, our expectations for those strategies.
And so to the extent that we've seen, you know, a little bit of a reversal there in terms of our expectations and the ability to have a greater earnings, a greater earnings profile from the interest rate-sensitive strategies, you know, could see that, you know, that projection, that projection improve. You know, absent that, if we do see... You know, so we're not very quick to, you know, reduce the dividend there. We still see that there's potential upside. And certainly, we just announced, you know, relatively recently, you know, $0.40 dividend for the third quarter. If we do see our run rate maintained at that $0.30 level, you know, eventually those two things need to converge, and, you know, we would bring down the dividend.
But, we still think that there's a potential for that to, over the next couple of quarters, that we do see a normalization of the yield curve.
Got it. I'll pause. So I'll pause there and just go to the last ARS question. Can you, operators, can you queue that up? Over the next year, would you expect your position in PMT to, one, increase, to decrease, or stay the same? Okay, so pretty bullish. I'll just open the floor up to Q&A for any PMT questions. Well, there are no more questions. I think I'll just end it there.
Thank you, Terry.
Thank you so much.
Thank you all for taking the time. We appreciate it.
Thank you.