PennyMac Financial Services, Inc. Q1 FY2025 earnings call

Management Statement and Operational Highlights

• Partnership with Team USA: Announced a four-year partnership with Team USA and the LA28 Olympic and Paralympic Games, aiming to elevate brand, boost portfolio recapture, and drive customer acquisition through integrated campaigns and athlete partnerships.
• Origination Market: Total originations forecasted at $2 trillion in 2025. Synergistic relationship with PennyMac Mortgage Investment Trust (PMT) provides a competitive advantage. Servicing portfolio UPB stood at $680 billion, up 2% from prior quarter.
• Servicing Portfolio: Grows organically via own production, with lower delinquencies compared to the broader industry. Focus on subservicing business, having signed first three clients and engaging with 20 additional prospects representing ~$65 billion in UPB.
• Technology and Efficiency: Deploying AI and technology to drive cost efficiencies. Examples include Mac Chat in Servicing saving ~$2 million annually and document processing systems in Broker Direct saving consumer out-of-pocket expenses.

Segment Performance

• Production Segment: Pretax income was $62 million in Q1 2025, down from $78 million in the prior quarter. Total acquisition and origination volumes were $29 billion in unpaid principal balance (UPB), down 19% from the prior quarter. Lock volumes were $34 billion in UPB, down 6% from prior quarter. Corresponding channel margins were 27 basis points. Broker Direct originations were down 21% from prior quarter but lock volumes up 23%, while Consumer Direct origination volumes were down 24% from prior quarter but lock volumes up 6%.
• Servicing Segment: Pretax income was $76 million. Excluding valuation-related changes, pretax income was $172 million. Loan servicing fees increased due to portfolio growth. Custodial funds managed averaged $6.2 billion, down from $7.3 billion in the prior quarter. Operating expenses were $81 million, unchanged from prior quarter. The fair value of PFSI's MSR decreased by $205 million in Q1, with $183 million due to lower market interest rates and $23 million due to faster prepayments and other factors.

Guidance

• Expect mid-teens operating ROE, contingent on stable delinquencies.
• PMT expected to retain 15%-25% of total conventional conforming correspondent production in Q2.
• Ample liquidity to retire $650 million in unsecured senior notes due in October 2025, with $4 billion total liquidity at quarter-end.

Risks

• Interest rate volatility impacting fair value of MSR and hedge effectiveness.
• Potential significant increase in delinquencies needed to impact ROE guidance if not offset by other factors.
• Market volatility and regulatory changes affecting origination and servicing operations.

Question and Answer

Q: There has been an uptick in M&A in the sector, particularly Rocket's acquisition of Mr. Cooper. I wanted to see if you felt this was a greater competitive threat, perhaps in a correspondent channel, and maybe perhaps on the contrary, it could create some more subservicing business.

A: David Spector stated he has respect for the involved management teams but is confident in PennyMac's balanced business model, emphasizing continued focus on organic growth of servicing portfolio and dominance in correspondent aggregator, with a strong subservicing value proposition.

Q: I wonder if you could talk about the impact on your unit economics with some of the changes in the FHA loss mitigation programs, including through partial claims and payment supplements.

A: David Spector mentioned new loss mitigation waterfalls are manageable, with mods prioritized over partial claims, and expects it to improve redefault rates and mark a return to orderly property disposition.

Q: Can you talk about your outlook for continued cost efficiencies on both the Servicing and the origination side -- the ability to continue to scale those businesses and what role technology, including AI might play in that?

A: David Spector discussed AI deployment in Servicing and origination to drive cost reduction, citing examples like Mac Chat in Servicing saving ~$2 million annually and document processing systems in Broker Direct saving consumer expenses.

Q: Can you talk about the MSR hedge in a little more detail?

A: Daniel Perotti explained that interest rate volatility impacted hedge costs, with increasing volatility leading to higher hedge costs in the quarter, but the team worked to insulate against rate impacts.

Q: Hey, guys. Good afternoon. Just wanted to follow up on the MSR hedging question. I mean, I can understand why certain backdrops create a lower hedge ratio. But it seems like in the past, there was -- some times where hedge ratio would be lower, sometimes it would be over 100%, and it would kind of net out over time. But based on the commentary on that slide, it seems like now the hedge ratio is probably ranging between 60% and 100%, which suggests that the GAAP ROE is going to be somewhat lower than the operating over time. So can you just talk about that?

A: David Spector explained that hedge ratio dynamics depend on rate environment and volatility, with periods of positive and negative impacts balancing out over longer periods, and GAAP ROE expected to align with operating ROE over multi-year periods considering yield curve and volatility.

Q: It looks like a really healthy recapture rate, but a couple of questions there. Are most of the loans that you're currently recapturing because of rate and term refinances? Or are they purchase recapture because borrowers are moving from one home to another? And on the loans that you're not recapturing, like what is the explanation, maybe for that?

A: David Spector stated most recaptures are from rate and term refinances, with efforts to increase purchase recapture through brand investment, and improvement in recapture rates due to lead-gen technology and processes.

Q: You guys just mentioned the mid to high-teens ROE guidance, but it contemplates stable delinquencies. Can you quantify where you would need to see delinquencies rise to make an impact on the ROE guidance?

A: Daniel Perotti said a significant or concentrated increase in delinquencies, outside recent ranges, would be needed to meaningfully impact ROE guidance, especially in the absence of offsetting interest rate decreases.

Q: Hey, thanks. It looks like a really healthy recapture rate, but a couple of questions there. Are most of the loans that you're currently recapturing because of rate and term refinances? Or are they purchase recapture because borrowers are moving from one home to another? And on the loans that you're not recapturing, like what is the explanation, maybe for that?

A: David Spector stated most recaptures are from rate and term refinances, with efforts to increase purchase recapture through brand investment, and improvement in recapture rates due to lead-gen technology and processes.