PennyMac Financial Services, Inc. (PFSI) Earnings Call Transcript & Summary

Good afternoon. Thank you for joining us for this fireside chat with PennyMac Financial Services' CEO, David Spector; and CFO, Dan Perotti. We have a number of prepared questions we're going to be going through. But if anyone in the audience would like to ask a question, click on the Ask a Question button in the upper right-hand corner of your screen and follow the prompts to submit your question, and we'll do our best to address in the time we have today.

With that out of the way, let's get to the discussion. Thank you both for joining. You recently set out some market share goals at your Investor Day, including growing your lead as the #1 Correspondent lender, reaching top 3 market share in your direct to broker channel, top 5 in direct-to-consumer and becoming a top 3 servicer. Are there specific initiatives in place to achieve those targets? And can you remind investors as to the timeline you aim to achieve those goals?

Sure. Let me start by saying good morning to you, Mark, and to everyone joining us today, and thank you for taking the time to listen to us. I think in terms of our Investor Day, you're right. It was important for us to share with you our vision for success. I think in terms of the time line, we talked about the medium term, and I think it's important that we keep an eye on that because to go much beyond, call it, a 3.5-year period of time is pretty difficult in our sector. But I think it's important for people to understand what our initiatives are. And I think as we talk about it here, first of all, it's to continue to maintain our leadership position in Correspondent. We spent a lot of time and investment over the last year in creating Correspondent technology and enhancing the fulfillment process. We have a leading Correspondent organization, sales team fulfillment team. And I think by our belief, you're going to see consolidation take place in Correspondent. And we're going to continue to maintain our position as the #1 Correspondent aggregator. On the broker side, look, I think we're going to be introducing, we've started to introduce, and we'll continue to introduce technology to help brokers achieve their business goals. We're going to use a lot of our processes and our culture and kind of our B2B culture that we have in Correspondent to evolve in Broker Direct. We see a lot of things in that channel that get us excited. Quite frankly, I think that channel times lacks pricing sophistication, and there are things that take place that aren't very mature. But I think it's -- I think as we continue to evolve and enhance our thesis and our tools for brokers, we will continue to grow our share and our desired and stated goals to be the #3 broker lender in the medium term. On the consumer direct side, look, I think there, we're continuing to take some of the technology that we have in Broker Direct as well as technology that we believe is necessary for the consumer and combining that with some third-party technology to advance the new customer acquisition touch points. We have a lot of great technology in our proprietary servicing system of over 2 million customers that allows us to stay engaged with our customers as they're looking for refinances, as they're looking to move and take new purchase loans out. And in addition, we're going to be introducing marketing in our consumer direct channel to be able to drive leads to our consumer direct channel and our call center. And I think that over time, we're going to be the beneficiaries of what I consider to be smart investments in marketing. As I continue to say, you're not going to see our names on stadiums, but we're going to use investments in technology, in marketing to drive leads to our consumer channel. And look, I think this all touches upon kind of the flywheel nature of our balanced business model. As you think about Correspondent, we're buying $15 billion to $20 billion between the government business and PFSI and the conventional business in PMT, which are real leads. We have over 2 million customers, which provide real leads. We have former customers on our portfolio that we can market to that are real leads, and that's even before going out and starting the marketing and the advertising and the driving of more leads to our consumer direct channel. I think the Broker Direct channel allows us to participate in the purchase market in a really robust way. And I think that as we introduce new products, that will -- our Broker Direct channel will be really the beneficiaries of those products. And I think you're going to see the Broker Direct channel be the beneficiary of the synergistic relationship we have with PMT and PFSI. And then finally, I think, look, in maintaining our servicing, investing in the servicing, enhancing the customer experience in servicing is something that's also vital to be able to create this integrated model that we have, our balanced business model that allows us the customer experience to be one of similarity between the origination process and the servicing process.

And then just to touch upon that as well in terms of what we think the sort of financial overall assumptions around what we think that means in the medium term, where the medium-term is 2 to 4 years out, our expectation of the backdrop in that kind of a situation or that kind of an environment where the overall mortgage environment is normalized is really one where the mortgage market has declined from the significant near all-time highs that we're at today, down to really about a $2.3 trillion market. We think in that type of an environment, the 10-year, a few years out has potentially risen up to a 3% level. And in that environment, given the backdrop and advances that David mentioned, we think that we could generate in our Correspondent business around $130 billion a year, and our consumer direct increase up to $50 billion a year, and in our Broker Direct, up to $40 billion a year. And through all of that production as well as with some opportunistic purchases of potential opportunistic purchases of bulk MSRs, grow our servicing portfolio up to around $800 billion a year. And that's really sort of the size that we see as the -- in terms of those different channels as driving us to the goals that David mentioned in terms of our place in the lender and servicing rankings. In addition to that, given the developments and how we expect profitability to unfold and the improvements that we expect to make in both our processes and technology as well as how we believe that margins will evolve over time into a normalized environment, expect to be able to deliver 20% plus returns on equity to investors, and that includes, as you've seen with us previously in terms of our capital management to continue to repurchase shares as appropriate to manage our capital position and our equity and our return on equity going forward.

Excellent. David, you touched on this a little bit, but can you drill down on some of the investments you've made in your origination and servicing technology? And what role you see those playing achieving these market share goals?

Look, I think that the investment in technology is key to achieving these goals, and I couldn't be clear about that. I think that when you want to introduce marketing into the consumer direct channel, you need the technology to deal with the user experience. We've invested a lot over the last 5 years in terms of the back-end processes of the fulfillment of the loan origination process in Broker Direct and consumer direct. We're now completing out our investment in terms of the front-end experience for our consumer as well as our broker. And so it's very exciting to see the introduction of this technology, not just from an experience point of view, but from an efficiency point of view. And I'm really excited to see that we're just getting more efficient with the introduction of this front-end technology. And this is something that's -- some of it is proprietary in terms of creating it. And also some of it is working with other fintech companies who've come out with their own grade technology and having the partnership with some of these enterprises is very important from a speed to market standpoint is a way -- and also is a way to help avoid kind of the need to continue to increase this investment in technology. And it's cost efficient, it's faster innovation, it's faster speed to market. And look, I think we -- where we see opportunities to create our own technology, we do so as witnessed by our servicing system that has just been a tremendous benefit to us as a servicer. But at the same time, I think that we've -- we're investing hundreds of millions of dollars, we have invested hundreds of million of dollars over the last 3 to 4 years, and it's paying off nicely. And I think it's a key component to achieving these medium-term goals that we've set out.

Great. You just alluded to the decision a couple of years back to move off of MSP, and you just made some pretty going comments. Can you just talk about how the savings of that kind of comparing to what you expected when you make that move?

So look, I think that the financial savings has been exactly as we expected it. And I don't think -- but I think more importantly than that, our ability to be nimble and move quickly is something that has paid off even more so. And if you just look back to last year, when we had the pandemic begin, our ability to take our servicing system and be able to put the changes in place to deal with the modification -- with the forbearances that we knew were going to be coming down was really quite remarkable. I think our longest whole time day was about 26 minutes. And that -- and I think that quickly got down to less than 5 minutes. We were able to maneuver quickly. And I think that that's something that really has paid off nicely for us. And as people have come off of forbearance, the ability to do so without speaking to a person and be able to do it online is something that I think, as we've seen throughout our economy, the consumer is expecting online solutions. They're expecting online ways to be able to deal with whatever issues they have. And so that, to me, is the real benefit of our servicing system. It's made us more efficient. It's allowed us to be able to stay more in touch with our customer. And we see it also in terms of the amount of customer contact we're having, the amount of customer engagement we're having as servicing has increased. And I think a lot of this is because of the system and because of what the system can provide. So I think that the economic savings has been very good. But I think it's just -- I think from a consumer point of view, it's really, I would say, come out much better than even I expected when we introduced the system.

Okay. Very helpful. Moving to current trends. Can you discuss what you're seeing across the various origination channels so far in the third quarter?

Yes. So look, I think for the third quarter through the end of August, first off, in Correspondent, we were nearly $30 billion in Correspondent acquisitions. And I think that, that's a really nice number that I'm hopeful that we'll continue to see as we finish out the quarter and we move it in the fourth quarter. The fourth quarter is typically, there's some seasonality in there. So I would keep that in mind. But I think given where rates are, some of that seasonality will be mitigated with kind of heightened levels of refinances. In our direct-to-consumer business, at the end of August, we were at $7.3 billion, which is a really great number. We continue to see a good pace of activity in direct-to-consumer. And I think this decrease in rates that we've seen over the last 60 days has only been helpful to our call center business. And I think that, that's a -- when you look where we were even 3 years ago, that's a really big number. And in Broker Direct through the end of August, we are $2.6 billion. And we continue to grow that business. And I think as we introduce the technology, that business is going to really thrive. And I think it's something that we'll continue to see grow nicely.

Got it. And then margins, how have those held up this quarter? And how should we think about this trending over time?

So overall, what we've seen in terms of margins in the third quarter as compared to the second quarter, roughly stable across the board. But in our direct lending channels, we've actually seen a bit of margin expansion. So both in our consumer direct and Broker Direct, margins moving up a bit and a little bit less pressure than what we saw and experienced in the second quarter. Overall, in terms of what we expect for the trend over time, in CDL, we think that margins is pretty consistent still with our view from Investor Day back in June, but that -- in consumer direct, that margins, we think are still probably above what the normalized levels will be ultimately. And so as we move forward and assuming that there's not further declines in rates, that margins in the consumer direct space will compress a bit over time. In terms of the Broker Direct space, still think margins are a bit below what the ultimate normalized levels, ultimately will be. And so we do expect those to -- over time, it may take a period of time to trend up a bit from where they are today. And then in our Correspondent channel, we think margins have roughly normalized at the levels that they're at today. There's a fair amount of competition in the Correspondent space. However, you do have a little bit of different dynamics in the Correspondent space as in the consumer space, if margins do contract, that tends to lead to a little bit of a bolstering effect in the Correspondent space where you have more market participants wanting to divest of their loans in a way that they don't have to retain the mortgage servicing rights upfront and use up that capital. And so as margins get -- potentially get a little bit tighter on the consumer space, may lead to a bit more of a share of the overall market going to correspondent where that MSR comes off of folks' balance sheets upfront.

Got it. Turning to recapture rates. Can you just talk about success you're having there? Any initiatives to improve it? And also in a sense of what percentage of your servicing portfolio has -- still has a refinance incentive here.

Yes. I think our servicing portfolio still has a healthy amount of loans that are refinanceable. It's not as high as the 80% number it was a year ago, it's not as low as the 30% number it was back in 2019. But it's -- and it obviously moves -- as rates move, but there's still a good amount of refinance opportunity. And look, as we buy loans in Correspondent every month, we add to that. And those loans we buy are basically at the money mortgage servicing rights. So they're even more -- there's even more opportunity for recapture of those loans as those borrowers decide whether or not they want to refinance the loan. In terms of the trends of recapture, I'm really happy with what I'm seeing, both on the government portfolio as well as the conventional portfolio. I think Doug and the team have done a really great job in terms of kind of expanding out the product knowledge of our LOs. We've put in some great initiatives and routines and marketing disciplines to continue to drive leads to the call center. And I think that we are seeing increasing amounts of recapture. I think in terms of kind of the growth of our origination business, I do think that as rates go up, we're going to have an opportunity to continue to grow our product offering. We're seeing increasing amounts of cash-out refinances coming through in conjunction with PMT, we're looking to offer an enhanced jumbo loan program. I think that there'll be other opportunities to take advantage of the relationship that we have with PMT to offer products that will allow us to grow our consumer channel as well as our Broker Direct channel. And so I think that it's -- what's really important is that as we become a more sophisticated originator that, that will show itself in terms of the recapture and kind of the recapture economics that come with it.

Okay. That's helpful. David, a couple of times you've alluded to the benefits that PMT can provide in terms of product. Could you talk a little bit more about that? Is this more the ability to kind of go outside of both the conventional conforming and government and do non-QM and other stuffs because ultimately, PMT can hold that risk as -- agency?

Yes, Mark, I don't see us necessarily moving into non-QM. I don't think it's -- I don't -- it's not something that -- I mean we've looked at from time to time. I don't think it's necessarily the best product for what we're trying to focus on, which is more kind of a prime-based market. And I think that we want -- if we're going to invest in something or engage in the origination activity, we want it to be a market of real meaningful size. Where I do think that the synergistic relationship is vitally important is that, for example, when you looked at what PMT was doing CRT, PFSI was able to originate conventional loans and sell those loans to PMT to give PMT the investment opportunity in CRT and grow the investment book in PMT, which benefits ultimately PFSI. I think that as we get our technology deployed, you're going to see us introducing jumbo product, which I think is getting more and more important every day as we see home price appreciation increasing and you see more people and you see more demand for that product. And I think that there'll be other kind of products that are potentially on the horizon where, in fact, PFSI can offer it through the broker channel, they can offer through the consumer channel and they can sell those loans to PMT, where PMT can securitize those loans and maintain an investment. And so I think that we -- obviously, we're a big agency originator in PFSI, we securitize our loans and sell them to the agencies. But having those best execution out -- best execution opportunities to sell the PMT, I think benefits PFSI and it looks to grow its market share in the consumer direct and Broker Direct channels.

Great. Makes sense. Turning to servicing profitability. Can you just talk about what your expectations are for that in the second half of the year?

Sure. So with respect to servicing profitability, obviously, in the last several quarters, EBO, Ginnie Mae redeliveries of early buyout loans as well as holding loans on our balance sheet and earning -- the interest income from them has been a significant driver of profitability in the servicing segment. We expect that activity to continue as we go through the second half of the year. We've seen that the revenue from that declined somewhat from Q1 to Q2 as the overall size of the delinquent portfolio has declined. I mean there's a little bit less opportunity in terms of bringing folks out of forbearance given just the overall population of borrowers. We do expect, as we move through Q4 and into Q1, in October and November, we will be seeing the end, assuming that there's not an extension of the government-mandated forbearance periods for a lot of borrowers. And we do expect that given -- as that ends, that there will be a set of those borrowers that, that prompts to enter into a modification or to resume payments that have just been really either waiting for the end of the forbearance period to lapse or have not taken upon themselves to take themselves out of forbearance, and this will be sort of a triggering event. So we do expect some uptick in activity in relation to EBOs in those 2 quarters. And then to have some elevated level of EBO income as we move through 2020, given the borrower related to borrowers that take a little bit more time to get on their feet and get into a modification program or begin repayments and so forth. Prepayments, turning to prepayments. We've seen prepayments down a bit from the peak. We do expect prepayments to continue to be elevated compared to typical levels, but overall decline as we move through the next few quarters. And also, we -- as David mentioned, related to seasonality in the fourth quarter. Typically, we see some less -- some purchase transactions there. And then as those prepayments decline, we do expect to see a little bit more stability in terms of the fair value of the MSR portfolio as we don't have as fast as prepayment speeds impacting the overall runoff of the portfolio in -- potentially in the quarters to come.

Okay. Could you talk a little bit about how you're currently positioned in terms of the edge of your MSR?

Sure. So in terms of the hedge of our MSR, our overall strategy hasn't changed. Typically, when we look at the hedge of our MSR, we don't seek to hedge out the entirety of the interest rate sensitivity of the MSR, given that in an interest rate rally or decline, we will see -- we expect to see an uptick in terms of production activity and production revenue and production income. And so we -- it's not necessarily cost-efficient for us to seek to hedge out the entirety of the MSR sensitivity. So typically, we've sought to hedge out a fairly significant portion of the overall sensitivity, but allow for, in the case that interest rates do if they do decline, to experience some overall losses in terms of the MSR position, but conversely, in the case where interest rates increase, and we do see a bit of a decline in terms of production activity and production income that we do see an overall gain in the hedged value of the MSR portfolio, a meaningful gain that offsets that loss in production income as we go through the next few periods and the market normalizes.

Okay. Got it. I think you did a good job talking about the pace at which you expect kind of the EBOs to wind down. But can you further discuss the opportunity advantages of -- created by selling EBOs to partners rather than retain them on balance sheet.

Yes, sure, Mark. I think, look, I think it starts out by as a Ginnie Mae servicer, when a loan goes 90 days delinquent, you have the option of buying a loan out of a pool. And banks who service Ginnie Mae loans just buy every loan out because they have a lower cost of funds than the pass-through rate on the underlying security that the loan is in, which is what you have to advance at. We historically have been looking at ways to be able to take advantage of lower-cost financing versus leaving a loan in a pool. And so we've seen kind of the growing amount of lines of credit from banks being offered to be able to do so. And the advantage of buying a loan out of a pool is, first and foremost, as I mentioned, you can take advantage of a lower cost of funds but in addition, if that loan reperforms, you can redeliver it at a gain into a security or when you modify the loan, you redeliver it into security. I think many people are putting loans on lines, and we have been as well, but I think the lines of credit come on with capital requirements to be able to deal with haircuts and I think they -- comes with capital requirements to deal with margin calls. And I think that while every one of those loans that we buy out has a government guarantee on it, there is the chance that you can get margin called. And so one of the things that we like about the whole loan sales is it allows us to sell the loans to whole loan buyers where you basically have risk-managed away the margin call risk. And you basically have removed the need for capital to be able to support the lines of credit. So I think that it's really exciting, the amount of whole loan sales that we put into place for our EBOs. We've had to give up a little bit of the redelivery economics that come with that. But I think we have to keep that in perspective. It's really important that we have this perspective that many of these loans were never bought out of pools before and there were 0 redelivery economics associated with that because when you leave a loan in the pool and it just self cures, it just stays in the pool. And there are many loans that do self-cure. So it allows us to retain the MSR where we have the option to repurchase the loan if it self-cures or modifies and then we would deliver and then we redeliver it into a security to gain. While at the same time, keeping our leverage low, keeping our margin call risk out of this thesis and deploying our capital in a more meaningful way than supporting the lines of credit.

Okay. Got it. That's very helpful. Next question. Can you discuss any risk or opportunities created by the proposed Ginnie Mae capital plan that would increase whether it will increase capital requirements as a Ginnie Mae servicer.

So overall, I think it helps to start with the backdrop that we're very supportive of Ginnie Mae and other entities in the mortgage space that have looked at this or been involved. Regulators in terms of putting out capital standards and financial -- overall financial standards to the industry, we think that helps minimize risk in the overall industry. And for -- from our own perspective, we've historically managed -- one of the great underpinnings of our business is really our risk management practices, and we've managed many aspects of the business similar to how banks are managed, looking at our liquidity and capital positions and creating different reserves for different types of stress scenarios and so forth. In terms of the specifics around the Ginnie Mae proposal and specifically, the risk-based capital, we do think similar to what other folks in the industry have noted that there are certain tweaks or modifications that could be made that would probably be more supportive of the state of the industry and the overall independent mortgage banks that it's seeking to govern and that there are certain aspects, particularly of the way that mortgage servicing rights are treated that seem to be over -- potentially overly punitive and could create some disruptions in the market. Overall, for ourselves and what the impact would be, given our strong capital position and the risk management practices that I noted previously, I don't think that this would -- the implementation of it, even if it were to be unadjusted that it would have a -- we don't believe it would have a significant impact on our business overall. But and that these changes generally would favor overall scaled businesses with significant amounts of capital such as ourselves, but that we do think that it does make sense to examine certain aspects of the proposal and potentially adjust them given the overall impact to the industry.

Okay. Makes sense. So earlier this week, you priced $500 million of 10-year senior unsecured notes. Can you tell us more behind your decision-making process there and talk about your other priorities when it comes to deploying cash you've generated.

Sure. So I think, look, it starts from the fact that about -- I think it was about a year ago, we started to issue unsecured debt. We felt it was very important for us to sophisticate our liability structure and be able to create an unsecured debt instrument and be able to issue unsecured debt to allow us to be able to toggle between secured and unsecured debt. As we looked at the market, we saw one of very strong high-yield market. And I think that as our point of view that being able to issue 10-year debt would just be great. And I think everybody -- anybody would feel that way, but we also felt that on -- really only the strongest mortgage market participants can do so. And we felt that we are 1 of 2 that could do so. And so we went into the market from that point of view. Look, it's viewed favorably from the rating agencies as I said, and it allows us to toggle between secured and unsecured. We can't issue secured debt going out 10 years at the rate that we did. And I think Dan and the team did a phenomenal job navigating this deal that allowed us to really have, as I said, 10-year debt at sub 6% to be able to invest in our business to be able to invest in technology, to be able to invest in the growth of Broker Direct and consumer direct. Look, I think we've always had dry powder available to be able to deal with market conditions as they arise. It allows us -- it's because of our capital position that we had a year ago that when this -- that when COVID began, we were able to deal with issues of forbearance. We're able to deal with issues of advances, albeit there weren't that many. It's just -- it gives us the ability to confidently execute in different market environments. And I think that finally, I think you're going to continuous to see to look for ways to return excess capital share to shareholders. We've been actively buying back our stock, and we just increased the stock buyback authorization to another $1 billion. And I think that we do think that the stock remains attractive given our expectations for ROEs over the medium term. And so I think you add all that up, and I think this is just a fantastic issuance of debt. We don't run our business with high leverage. We never have and nor will we in the future. Typically, we've been in the 3% to 3.5% range. I think we got a little bit higher last year when we saw a lot of loans coming off forbearance that we bought out of pools to redeliver. That's starting to find its way back down to where it's historically been. And those are -- and that's going to stay there. But I think that it's important that we have an active secured debt opportunity and active unsecured debt opportunity. And I think we've shown that we're really good at raising capital in both enterprises and I think as Dan leads us in the finance area in terms of sophisticating our liability structure this is something that we will continue to strategically take advantage of.

Okay. That's great. We did get one question from the audience. What is your appetite to expand the mortgage broker channel and would you consider buying a larger platform to get more scale?

I don't -- I think for those of you who know us well, that's not a path we typically take. We've organically built this company. And I think with the investment in the broker technology and with the growth of broker, we have over 2,000 brokers now on our platform. And I think that's only going to continue to grow. I think there's not much for us to really see in terms of getting distracted by buying another platform. I think we have all the tools in place to continue to grow organically and that's something that we're set up to do from a management point of view, from a cultural point of view and I -- and that's just who and what we are as a company.

Would you consider doing any M&A on whether it's services that you don't currently provide that might be complementary? Anything else that could kind of add to the franchise value and maybe -- feed the funnel as you're seeing some of your larger competitors do?

Yes. Look, I think there's opportunities for us to serve our servicing customer with opportunities for things like less expensive homeowners insurance. I think there are products that we can offer our servicing customers. Getting into like title and appraisal, I think it's something historically we've shied away from given the regulatory climate that we've operated under. We're always looking at ways to grow PFSI. We're always looking at ways to enhance the customer experience at PFSI as well as PMT with own servicing. But I don't -- it's not at the top of our list of initiatives to grow PFSI through M&A or acquisitions or things of that nature. But look, having said that, it's -- from time to time, things get presented to us, we always look at things. And if it makes economic sense, we'll continue to look at it. But I think for those of us who know us well, for those of you that know us well, we are organic builders through and through. And that's just something that we'll continue to pursue.

Okay. Great. Well, on that note, I think we're out of time. Let me thank you very much, both of you for your time and insights. We really appreciate it.

Thanks, Mark, and thank you, everyone, for joining us today.

Thank you.