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

All right. Welcome, everybody, to the final day of the Barclays Global Financial Services Conference. My name is Carter Smith, and I'll be moderating this fireside chat with PennyMac CEO, David Spector; and PennyMac CFO, Dan Perotti. We will be covering both PFSI and PMT topics today. And given that there's a fireside chat, please feel free to participate and ask any questions. I'll pause a couple of times to add to -- to make sure everybody has a chance to ask a question. So first off, thank you for being here.

Thank you for having us.

We're going to start off with the PFSI side. I think that's kind of the topical interest right now with the mortgage market. So I guess, first, can you just please discuss the volume and margin trends quarter-to-date in PFSI?

Sure. Sure. And good morning, everyone, and thank you for joining us. So I would say that right now, we are -- volumes are clearly decreasing as we sit here today and mortgage rates at 6%. I would say, from a margin perspective, we are -- I would say, looking at the 3 divisions that we are, I would say, really very much unchanged from last quarter. Correspondent is kind of right in there and very much consistent with last quarter, both on the conventional, which we do in PMT and the government. In broker, we -- as I think everybody knows, there's irrational pricing taking place in broker at the moment by the market -- by the sector leader. And so we're -- and I'm sure we'll be talking about that a little bit more, but we're trying to participate in that market, but participate responsibly. I would say, on the consumer direct side, those margins are still hanging in at a good level of Q1. And look, I think the issue is volumes. The revenues are based on volumes times margin, and we continue to see the mortgage market decreasing. And as we sit here today, we're at a run rate of, call it, $1.8 trillion annualized, probably below that now given the sell-off that we're seeing in the marketplace. So it's a good -- it's just a matter of just kind of being responsible, pricing at appropriate returns. But clearly, the market size is having its effect in rates. Look, rates are having their effect on purchase market as well. Let's not kid ourselves here, but I think $1.7 trillion, $1.8 trillion market is kind of the run rate. And I don't think anybody knows what it's going to be in 2023.

All right. A lot to dig in with those comments. I guess, first, let's talk about wholesale a little bit more. You've seen actually some participants leave the market as a result of the competition. Can you talk about the opportunities there, both in the near term and long term with exiting participants?

Yes. Look, I think we're seeing market participants leaving who are capital constrained or really don't want to be in servicing for the long haul. I think that -- look, the broker market right now is running, I would say, mid-teens in terms of the percentage of originations of the market. And brokers are really good channel, especially in a purchase market. Brokers are very good at pursuing purchase opportunity, and that's been our thesis from when we entered the market. As I mentioned a few minutes ago, there is irrational pricing taking place by someone who wants to buy market share, and I think that, that's something that, as we've -- as of those who followed this sector knows that it doesn't have a long life to it. I mean, ultimately, you've got to price with an appropriate return. We are trying to opportunistically find pockets that we can participate in and do so in a way that is not -- that we're not going to be going out to lose money. I'm really, in the long run, very excited about broker. We were spending a lot of time developing technology to compete against the top 2 participants. We're going to be deploying that technology at the end of the year. They'll be fully deployed. And there's some really good features to it that I think that will allow us to not only provide tools to brokers, but will allow us to materially become more efficient. And I think that's in the broker space, it's a two-pronged issue that we want to be able to offer tools and technology to our brokers. We want to be able to continue to drive down costs, which I think -- my hope is that will be this low cost of providers at the top 2. And I think in the long run, it will be a very good opportunity for us.

Okay. Great. I guess thinking longer term on the purchase side, what are your expectations there for maybe, say, '24, '25, '26, given demographic tailwinds on...

Yes. I think there'll be purchase opportunity in '23 as well. We have in correspondent from when we started have always have had a focus on purchase originators. So in our correspondent business, I think we'll continue to be a -- I know we'll continue to be a market leader there, and having that purchase emphasis is going to be very important for us. I think that on the -- look, on the broker side, I'm very enthusiastic about the next year, as you can probably gather as we continue to deploy the technology as we continue to see people exit the broker channel. So I think there's going to be -- there'll be a good opportunity there. Brokers are very good at finding purchase leads and working with real estate agents to do so. In our consumer direct channel, I think that, look, over the last 2 to 3 years, I've said to many of you in the room, those are harvesting years, and we harvested low rates, and we participated meaningfully in refinancing our portfolio as well as other refinance opportunities. And at the moment, we're transitioning and deploying purchase initiatives that I'm hopeful that Doug and the team will grow our kind of our nonport business. We were -- we've been -- we were implementing marketing initiatives at the beginning of the year when rates started selling off, rates started increasing. And so we kind of put that on hold, and we'll see as things settle down, we'll be redeploying marketing strategies as well outside the port. And so we're in the process of moving to expanding our new customer acquisition strategies. And I'm -- again, I think it's very bright in our consumer direct channel. Just -- we're just in a period of transition at the moment, but ultimately, people have to buy homes. They will buy homes and people move. And so I think we're going to be an active participant in that sector of the market.

Okay. And how much of an impact do you think affordability will be in the purchase market over the next 12 to 18 months?

Yes, it's meaningful. I mean you go from a 3% mortgage to a 6% mortgage. And on a $400,000 loan, it's like a $700 a month increase in payments. And so you -- it's -- people don't have $700 -- a lot of people don't have $700 lying around when they're trying to buy a house. And so it's going to have a meaningful effect. You'll have people get into hybrid arms, and I think that will be helpful. And look, there's still -- in the sector of the market that we have been very active in, there's still a lack of supply issue. And so if you think about homes, sub-$750,000, there's still a lot of demand from homeowners to buy those homes. And so it's still -- there's still good opportunities. But look, real estate values are going to come under pressure in certain parts of the country. We're seeing price reductions at the high end, and I'm sure we're going to start to see it trickle down. But I do think the demand side of the equation is going to be very important for us, and I think it's going to hold in nicely.

Okay. Great. That's helpful. Thinking about some of your longer-term targets, you set targets to grow your correspondent production lead, reach top 3 in direct-to-broker, top 5 in direct-to-consumer, and top 3 -- and become a top 3 servicer. So how does the near-term interest rate volatility effect is going?

And the last one, though, is to continue to drive to a 20% ROE, which I always remind our organization. That's actually our #1 goal, it's ROE. It's ROE [ 13.53% ]. Look, I think I stand by those goals in the long term. I think that correspondent, we're going to continue to be a market leader, and we're going to see others exiting that. We'll see others exiting that channel, and we're going to -- I don't see the banks coming back anytime soon, specifically on the government side. On the conventional side, we're seeing still some good bank participation. On the broker side, look, we're going to be a top 5 broker lender, and I think we're only going to go up from there. As I mentioned, as we deploy -- as we look to deploy our technology and we grow that channel, we'll be a major player broker. Servicing the portfolios is -- it's [ turning ] about $530 billion in unpaid principal balance. We're a top 5 servicer, and we're going to see servicing portfolio growth over the next few years, both from our active channel business, as I think about it, but also from servicing acquisitions. I think we're going to see in the market many originators who were holding servicing in the last 2 years now want to do so because they have to sell the servicing due to the fact that margins will not be what they were in the last 2 years. So I think that in servicing, we're going to continue to grow the portfolio, and we'll be a top 3 servicer in the long -- in the medium-to-long term. I think on the consumer direct channel, I think that's where we're going to -- I think, it's going to be the hardest climb to get to be kind of a top 5 consumer direct originator, but I think we definitely have the foundation. We have the foundation in terms of the organization. We have the foundation in terms of capital. We have the foundation that we're building in terms of the technology. And I think when I look at the top consumer direct originators out there, I feel really good that we're making strides to narrow the gap. And so it's just going to -- that's the one that's going to take a little bit longer. But I'm -- and look, at the end of the day, it all comes down to return on equity for us. And so I'm not going to let a [ 13.53% ] take priority over meeting appropriate returns. And so I think our returns for the first half of this year have been really stellar, and they're going to come under a little bit of pressure kind of in the second half of the year, but it's always ROE of the [ 13.53% ].

Great. I guess off of that topic, can you just felt the impact of your previous investments in technology are going to apply in this newer market environment?

Sure. I mean, so David already went into what we're doing on the broker direct side. Just to remind everybody, we've had a fairly long history of deploying capital and successfully rolling out technology initiatives across our different business lines. So going back to 2019 with our rollout of our servicing system, which is really advantageous for us during the pandemic as we were able to take people seamlessly into forbearance with the changes that the government was imposing from the CARES Act, make those modifications on our system pretty seamlessly, get folks into forbearance, and on the tail end, take people out of forbearance. And we think that will be a really significant advantage, especially with a lot of scrutiny around all of the processes that people had in place during -- and dealing with those borrowers during the pandemic, and certain issues that other folks have had around how they treated borrowers during that period of time. In 2020, during the pandemic, we were able to implement our correspondent system. And we've had all of our correspondents on that since 2020, and that's allowed us to get even more efficient on our correspondent side and continue to support our #1 position in that channel. As David mentioned, in -- basically our focus over the last -- 2021 and here through 2022 into 2023 has really been on our broker system and then following that on our consumer direct systems. They're all using some of the same core technologies as our correspondent system as well, building upon each other and as part of the benefit of being able to work across the 3 different channels. At the same time as we're going to this period of time that's going to be a little bit more difficult in terms of activity and profitability on the mortgage side, we are very mindful of our investments in technology and appropriately pacing them to balance the advantages that we'll garner from them as we implement them into our businesses versus the spend and expense that they take. And calibrating that to, as David said, be focused on ROE, generating appropriate returns for the business through this period of time, but at the same time, continuing to invest in technology that will give us meaningful advantages for each of the channels.

That's great. One last one for me, and I'll open the floor to the audience for a second. But there's been a lot of interest in further understanding the finalized capital requirements from FHFA and Ginnie Mae. Considering PFSI is one of the larger Ginnie Mae seller servicers in the industry, can you give us your thoughts and walk us through how you're fairly positioned for us?

Sure. So I think in terms of the capital requirements and the liquidity requirements that were introduced, we are in a very good position across both entities really in terms of meeting those requirements on a pro forma basis. Looking at our 6/30 financials, liquidity requirements were increased. If you look at the FHFA and Ginnie Mae requirements, but versus our liquidity that we were holding at 6/30 at PFSI of over $1 billion, we're significantly in excess of the -- even the increased liquidity requirement. And our -- as we have disclosed that 6/30 had access to $2.8 billion of liquidity, if we were to sort of draw down on all of our warehouse lines, so have significant ability to meet standards on that front. In terms of the Ginnie Mae risk-based capital requirement where there's been a significant amount of discussion, we do feel that there is sort of punitive treatment for the MSRs in many cases. But looking at our particular position in PFSI, where we'd be subject to the Ginnie Mae requirement, we're currently in a very good position significantly in excess of the requirement. If you look at the capital of the issuer, the Ginnie Mae issuer, which is our servicing and origination subsidiary, we disclosed the capital of that entity in our 10-Q in the footnotes. And if you look at the balance of our MSR to that capital base, our overall risk-based capital ratio is in excess of 30% versus the 6% requirement. So we still have significant amount of room to be able to continue to grow our MSR portfolio and not run into any issues in terms of risk-based capital requirements.

Great. I'll stop there. It looks like we have one question up here.

[indiscernible]

We can hear you.

Just to follow on to capital -- Ginnie Mae capital requirement. Number one, what do you think the implications are for MSR creating values [indiscernible], given these requirements because some guys have [ tighter ] to the metric? Does that present an opportunity for you as a buyer or maybe -- some of these other people -- I realize it's tricky if they're your competitors, but opportunity is opportunity.

Yes. So look, I think we've seen some of the same commentary that you've seen about it, and I do think that you're going to see consolidation in the servicing space because of the issuance of these liquidity and capital guidelines. I think you got to think about the servicing space. There's opportunity -- there's going to be opportunities to buy low-rate servicing. And I think that's what many servicers have, and I think that, that will bring in -- I think that if you will see opportunities there, I think it's -- you're going to have a lot of existing servicers looking to exit. I think on a go-forward basis, I don't think -- I think you will see a little bit of pressure, but probably not as much. Like in our correspondence space, we compete daily against correspondents who are well capitalized, who are looking to buy servicing, who have run consumer direct channels to refinance that servicing, and even rates were to decline. But I generally believe for well-capitalized larger servicers, they're going to be -- they're going to see opportunities coming about as a result of these capital guidelines.

I think there's also potentially -- I mean there's some sort of lines in terms of the capital rule where you're not subject to the risk-based capital rule if you're below a certain size. So we may see folks try to divest of servicing and try to remain below that size, so potentially more just servicing generally trading in the market on that basis. I mean -- I think the other interesting sort of point is that although you're subject to the rule if you're a Ginnie Mae issuer over a certain size, it apply -- the punitive treatment to MSRs applies to all MSRs equally. So it doesn't necessarily just create opportunities or you won't necessarily see people just selling Ginnie Mae MSR because all MSRs is treated the same way under the capital rule. So may also spur people to -- spur folks to divest of other conventional servicing as well.

And just one more. Do you think in your conversations or based on your conversations, your interaction with Ginnie Mae, think there's going to be [indiscernible] the policy that they announced either in terms of content or timing of...

So we have not had conversations with Ginnie Mae since the announcement came out. I will say, I don't. I think -- look, I think Ginnie Mae, FHFA and those in D.C. are pretty thoughtful before they issue guidelines. I think that if we see anything, we may see a little timeline extension take place for implementation, but -- and that's just me speaking to you as without having the benefit of speaking to anyone in D.C. But I don't foresee them necessarily backpedaling for anything that got issues.

On the correspondent business with some of the -- well, as far as talking about getting out, some of the guys exiting, how much bigger can your business get there? I mean are their strength because you're already so big so people might choose to go elsewhere rather than just get bigger with yours? Or is there a real share opportunity in there going forward?

Look, so I think that we've seen [ Wells ] in particular stepping back since really the first of the year. And I would caution people that any big bank that's going to get out of the correspondent business is going to be a very long road to get there. I mean we saw this in many cases with another big bank where it just takes time. Having said that, I do think there's opportunity for us to grow share, but -- and also do so in a way that we can grow our best efforts business, which is higher-margin business. I think that you raised a good point that with some of our sellers, when we get to the share that we have, they're going to do what anyone is going to do and say, "Listen, I need to get 2 more behind PennyMac." But have a lot of sellers who were not #1, and I think that we do have share growth opportunity there. I would further say that from a PMT perspective, there's -- in the conventional space where it has been much more competitive, I think we have more share growth opportunities on the conventional side. But it's also a space that I see Wells is going to continue to participate when they have capital to deploy. It's a very similar strategy that we've seen with JP. And I think in the case of JPMorgan, they pick and choose the areas that they want to be very [ active ] participants in, so whether it's jumbo, whether it's high-balance agency eligible loans. And they're -- and it's in and out when they want to buy the assets. So -- but look, having said that, also I would say that the 2 agency cash windows are big active players in the conventional space as well. So it's always -- from a competitive standpoint, it's always a good thing with some -- when we see someone like a Wells step back, but there's a lot of competitors behind that I think we'll get our share, but there's enough capital liquidity to absorb.

Are there other -- I mean are there -- beside of the cash flow, are there other players who are looking to increase their share of correspondent? I keep thinking of -- only thing I can think of as people who want out. I mean...

No. There's -- look, I think we see very active participants in the case of -- I think of people like Lakeview, I think of people like Freedom. We've seen Truist kind of in that active role. AmeriHome is good correspondent who's going by Western Alliance. And look, at times like this, you get a new entrant or 2, but look, in the correspondent space, we are, as you point out, the #1 corresponding aggregator and there's room to increase that.

This environment, particularly the rate environment, what do you see for MSR portfolio [indiscernible] evaluation?

Yes. So I think -- look, I think there's going to be an increase in the amount of MSRs that come out, and we're going to participate. As I think about it kind of from a waterfall point of view, I think once rates settle in here, I think -- for us, in particular, let's start with PFSI. The best servicing for us to acquire in correspondent as well as our own originations because of the fact that, number one, we've underwritten the loans; number two, there's a tax benefit that we get by creating the originated mortgage servicing rights that you don't get when you buy servicing. So I think that, that's how I think about where we really want to look to deploy the capital. Now increasing correspondent is a -- I think we can do so in a way where if we buy $1 billion to $2 billion more a month, that's -- you're going to see over a 12-month period of time, that's a meaningful amount. And so if you think about $2 billion a month for 12 months, it's another $24 billion. That's versus buying bulk servicing. I think, number one, we'd rather go that route. I think that on the bulk servicing side, we're not -- where we'll see low rate servicing come out more inclined to kind of get a little higher in rate because I do think there's opportunity there to help feed our consumer direct channel as when we see rates decline, you see refinance opportunity. But look, having said that, we are going to see an increase in amount of bulk servicing. We will be participating in that -- in the bulk servicing acquisition business.

Right. Great. Let's take on the regulatory front for just a second. The FHFA actually just announced a comprehensive review of the FHLB system. It's still pretty early days of that comprehensive review. But could you talk about any opportunities you see for PFSI, PMT, if any?

So as you're probably aware, if we go back several years, there was a -- several market participants and nonbank market participants that were involved or had gotten involved with various FHLBs in terms of captive insurance companies and using them to sort of gain entrance to the FHLBs, it was subsequently shut down by FHFA or there was some grandfathering in and so forth. It may present -- to the extent that they undertake this review and sort of look at that decision again and present some opportunities for independent mortgage banks to participate in the FHLB system, it could present it an interesting opportunity, in particular, for something like PMT to be able to finance different types of mortgage assets with FHLB financing, which typically, at least from a cost perspective, has been fairly advantageous or competitive. I think there's a lot of questions still around what are the potential avenues that they'll go down if that's something that they will ultimately entertain, and what are the potential issues that, that could introduce. But it's certainly something that could present opportunities and advantages for probably, in particular, PMT as a sort of investment vehicle, if that were to be the case if they were to go down that road.

And then sticking with PMT here. Yesterday, CPI that kind of caught everybody by surprise and definitely changes the Fed outlook. So I'd just love to hear your thoughts on expectations for the Fed, and what impact that could have on PMT and the return outlook there?

Yes. So look, I think PMT is in certainly a very good place from the point of view that there's more investment opportunity. As rates go up, there's going to be investment opportunity that just got a higher return on it, which is something that PMT has struggled to find when rates were at 0%. But I do feel very good about the investment opportunity, and we've been active in looking at stack [indiscernible] deals, and there'll be other opportunities there. And I think in the correspondent space, we will -- with the market decline, you'll see the resulting volume decline in the correspondent space. But look, as the #1 aggregator, as I said before, if you want to add 1 or 2 other aggregators who you sell to, you're actually making sure that you're selling to your top 1 and 2 and really kind of keeping them in the flow. And so I do think, on the correspondent side, PMT is in a very good place to continue to operate in that environment to continue to create MSRs. And look, I think margins are holding in well in correspondent. So I feel good about our continued role in the correspondent space. And we're not -- look, we're not going to see the volatility and prepayment speeds that we saw when rates were lower. And so that's just going to -- PMT is sitting on a really good servicing asset that should produce a lot of good consistent earnings over the next few years.

Okay. And what are your expectations for kind of how that servicing profitability will ultimately ramp up to a more normalized level?

I mean, on the PMT side, I think as David said it in -- the servicing profitability is probably in sort of as good of a state from PMT's point of view as they could be, given that we have extremely low rate servicing. We're expecting -- prepayment speeds have slowed down significantly, expected to be slow for a long period of time for that base servicing asset, that core servicing asset that they have with extremely low note rates. And then in addition to that, we'll be seeing the placement fees or the interest on the escrow balances that they hold continuing to increase as the Fed increases its short-term rate. So the fees that we earn for placing those deposits with different banks move up pretty similarly to how we see short-term rates or Fed funds move. So as they were -- as that was effectively down near 0 for the last several years, they have not generated as much income, but as short-term rates have moved up with the few billion dollars of deposits that we have related to escrows and payments outstanding going from earning roughly 0% to potentially up to in excess of 4%. If the Fed raises that high, it's pretty significant impact to earnings, really for both PMT and PFSI in terms of their servicing earnings.

Okay. And at PMT, what's the expectation for the dividend level going forward?

So we've communicated that in terms of the taxable earnings outlook, we see the $0.47 dividend supported through the end of 2022. So we move into 2023, we expect that the overall -- the dividend level will really be driven more by what we see as the medium-term outlook for earnings on the company. Obviously, at some point, the dividend level and the GAAP earnings kind of have to -- or at least the GAAP earnings expectations kind of have to converge. So we've seen our -- what we call our run rate outlook that we put out with earnings at about $0.40 was what we released with Q2 earnings. We've seen that increase over the past couple of quarters. As David noted, we've -- that doesn't include any potential opportunistic investments in credit risk assets, which we've seen as being pretty attractive in the current environment. And so there's some potential upside to that outlook. And so as we move into 2023, we'll be evaluating what we see the outlook as versus the dividend, but those 2 things are pretty close within striking distance at this point. So we'll have to evaluate, but we expect it to be in a pretty similar range to where we have been.

Okay. And I believe I asked the same question last year, but can you discuss the opportunity you see for PMT with the resumption of lender-based CRT transactions?

Yes. So look, I think that we are -- I know we're talking to both GSEs about doing lender CRT. Lender CRT has been a great product for us for all the reasons that we've spoken about. I generally think it's something that you're going to -- that we're going to hopefully be doing a small transaction with both if things work out. But I don't know if the GSEs have the bandwidth to really focus on this. The GSEs are very focused on a lot of mission-critical affordable issues. They're very focused on capital issues. This is a capital issue, but it's just -- conversations are engaging, and we're trying to drive towards doing a transaction with both, but we'll see what happens.

All right. Great. And before we hit time here, I'd like to actually open it up to the audience for audience response questions. We have some preloaded questions that we'd like to get the audiences' thoughts on. So if you could poll for the first one? What do you view -- you have question front of you. If you don't mind, just type in an answer in all the [indiscernible], but what do you view as the biggest catalyst for PFSI over the next 12 months? One, better-than-expected origination volume; two, better-than-expected gain on sale margin; three, better-than-expected servicing growth and profitability; four, capital returns; and five, other? All right. Servicing growth and profitability. Any initial thoughts on that?

Look, as Dan spoke about, we have -- servicing portfolio is for both, particularly for PFSI in this case is one that's really in a great place. I mean you've got at a lower rate servicing that is going to be very consistent over time. We're coming out of COVID in very good shape. The profitability of it, I'm really hopeful that we're going to continue to see that increase. There's a lot of focus in servicing and in the organization of expense management. And again, I think that we're going to continue to see improvements there. And look, I think this servicing, as rates go up, has a lot of escrows associated with it, and those escrows we are going to be -- are going to continue to produce a lot of income for PFSI.

Number two, please. What do you view as the biggest catalyst for PMT over the next 12 months? Growth in servicing portfolio; two, better-than-expected correspondent production; three, outperformance of interest rate sensitive investments; or four, other? Unfortunately, we will have to cycle through these. All right. Outperformance of interest rate sensitivity. Number three, please. What is the biggest risk of PFSI shares? One, weaker-than-expected origination volume; two, weaker-than-expected gain on sale margin; three, weaker-than-expected servicing growth; four, less-than-expected capital returns; and five, other? Interesting, goes both ways.

Welcome to the mortgage business. That's our biggest number.

Number four, please. What is the biggest risk to PMT shares? Weaker-than-expected loan origination; two, interest rate volatility; three, elevated foreclosure activity; or four, other? All right. And then number 5, please. Maybe a couple more. What is the best piece of excess cash flow at PFSI? One, special dividends; two, buy back shares; three, M&A; four, reinvestment marketing; five, other? All right. Interesting. Unfortunately, it looks like we're coming up on time. So I believe we'll have this -- one more? Okay. Great. We got one more. Over the next year, you would expect your position in PFSI to, one, increase; two, decrease; three, remain the same?

I'll take it. I'll take it.

All right. Well, we will stop there. Interesting results to see from the audience, as always. David and Dan, thank you for your time as always.

Thank you so much.

Thank you all for joining us.

Thank you very much.