PennyMac Mortgage Investment Trust (PMT) Earnings Call Transcript & Summary

Thank you. Thank you. Thank you. All right, so we'll get started. I'm very pleased to have PennyMac Financial Services join me on stage. With me today, I have David Spector, Chairman and Chief Executive Officer. Welcome, David.

Thank you, Terry. Great to be here, and thank you all for joining us.

All right, so we'll get right into it. You guys filed a quarter-to-date update yesterday. Maybe just give us some color on that. What are you seeing around third quarter trends?

Yes, so clearly as we sit here today, we're seeing rates at a much higher level than we saw at the beginning of the quarter. Mortgage rates are up about 50 basis points and so, like you would expect in a rising rate environment, we're seeing production taper off as a result of that and that's leading to some, um, you know, obviously reductions in our forecast for originations on our in all three channels. Consumer direct channel, you know, we're seeing margins hold in, you know, which is good news. Obviously, with the increase in rates, we'll see a higher percentage of closed-end seconds getting originated. So the weighted average margin at a consumer could go up in the second quarter. But with originations down, though, we're seeing a lot of closed-end seconds, revenues will be down. Similarly, in our broker direct channel, we're seeing, you know, a little bit of margin pressure there, um, with production going down, and we'll be talking a little bit more about broker in a few minutes. And in the correspondent channel, we're seeing, you know, again, production down a bit there. Margins are holding in really nicely there. So there's good news there. On the servicing side, look, we continue to see a great story out of servicing. Our servicing portfolio continues growing to run at very low delinquency levels. Um, it's a portfolio that has, you know, close to $530 million of revenue or servicing fees every quarter, um, and we're seeing good results there. And on the corporate side, you know, we had some headwinds in Q2 from credits from AWS and some revaluation of incentive compensation. But, uh, you know, we should run flat to a year ago. And so it's a, you know, it's a story that given the increase in rates, you know, we're again going to be at a, what I call a post-COVID trough level, operating ROE, but again, it's going to be in that single, mid to high single digits, probably mid in Q3.

It helpful color. Forgot to mention we're going to be mostly discussing PFSI on this chat and then we'll address PMT a little bit at the end, right? So again, like helpful color, lots of impact there, but maybe like just taking a step back, the macro has been tough this year. Mortgage activity has remained pressured for most of this year. As you look across the balance of 2026 and 2027, what are your expectations for industry volumes? And what do you see as the biggest drivers of upside or downside?

From here. Yes, so as I mentioned earlier, being that we're at the higher rates, I think volumes are going to come in on the kind of the lower end of forecasts. I think that we, um, from an internal point of view, I think there's tremendous opportunity within the company. We're seeing a lot of good results coming out of our consumer direct channel on the deployment of our new technology, but more exciting about that is the fact that we're really beginning to see the benefits of having legacy-free technology and being able to build AI agents on top of it. And so on the mortgage fulfillment side, you know, which is our processing group, we're seeing processing costs down approximately 50% on a marginal loan basis. And on the loan origination side, we're seeing loan officer efficiencies is up about 20% and that's only going to grow. And so today as we sit here at the higher rates, you have the benefit on what you're originating. But in many ways, what's more exciting to me is the fact that we've been carrying a lot of excess capacity over the last few years to be able to really seize on an opportunity of lower rates. And what we're seeing with the technology, the need to maintain the levels of excess capacity that we've been holding have been greatly, if not eliminated, greatly diminished, if not eliminated. And that's what led to our reduction of production expenses of $60 million that took place in July. And so we really reduced that the capacity. And that should reduce the volatility of the earnings in our consumer direct channel. In our broker direct channel, we're doing the work rather quickly to use the technology that we deployed in our consumer direct channel to deploy it in our broker direct channel. Now, there's a little bit more work on top of that that we need to do. And the fact that when you run a broker direct business, there's a broker portal that has to go along with that that's being built. But that's something that I think is going to be a real exciting opportunity for our brokers. And, you know, the brokers that we deal with, you know, typically deal with the #1 in the market or the #2 in the market. And I think as we continue to be, you know, competitive with price while being able to offer a better product, that's going to lead to share growth within our broker direct channel. And our correspondent channel, you know, we've been the leading correspondent aggregator for many years. Um, that lead has shrunk a bit. We're going to get into the reasons why momentarily, but we're going to continue to be the leading correspondent aggregator. And so there, it's just a matter of, you know, when you're in the correspondent business, you're in it to buy servicing to really support the flywheel that we've created. And so as we see opportunities to participate in that market and we like the servicing values that we're seeing in that market and how those are being constructed, we're going to continue to see growth on the correspondent side. On the servicing side, you know, it's with great pride, I say there's not a lower cost servicer than us. And I think that's, you know, with our servicing portfolio, it's $700 billion and the cost of service that we have for that, you know, with the technology technology that we have in place in the work we're doing with our technology called Place, we're going to continue to drive down the cost to service. And that's something that I'm really excited about. And then with the [ Cenlar ] acquisition, look, we're going to add scale to our portfolio and that's only going to help us drive down costs further while equally as important, grow the capital-like parts of our business model. And that's something we're very focused on as we look out into the future. And then finally across what I call our shared services groups, technology, financial, capital markets, the benefits we're getting from AI and AI tools like Claude and Cursor and others are meaningful. And so the technology investments that we're making within the company, which I expect to crest in the third quarter, are really going to start coming down as we finish a lot of the work that we undertook at the beginning. Beginning of the year. So, you know, for all things considered, if you think about the beginning of the year, we walked in expecting 3 interest rate cuts. As we sit here today, we're expecting 3 interest rate increases. But, you know, by and large, I'm really happy and excited about what I'm seeing in the organization.

Okay. Got it. Super helpful. So I want to talk about returns. Last quarter, you revised your operating ROE target to the mid-teens by year-end 2027. Can you maybe just walk us through the glide path from here and the major building blocks required to achieve that outcome? Maybe just more specifically, how should investors think about the relative contributions from technology-driven costs saves, just overall operating leverage, and then the market recovery piece. So...

But the glide path is, I think, one that we believe is very much achievable, and it is going to be achieved. With the increase in rates, that could get pushed out a quarter, but let's not get into the quarter-by-quarter gyrations. From where we started, if you look at the Q2 results, #1, you had this issue with the mortgage pipeline that has about a $20, $25 million loss that's not going to be repeated because as you start to see changes we've made along with some normalization that's taken place in the MBS market will eliminate that. But more importantly, in mortgage banking, you have this phenomenon when you take an interest rate lock, you recognize the revenue, but the expense associated with that lock gets recognized at the time that loans close. So as you see rates generally increasing, what happens is #1, as I mentioned, you recognized your lock earlier, and so you have your expense later. But more importantly, as production slows down, revenues are slowing down while you're incurring the expense. And then furthermore, your amortization is running higher than the current run rate that you're seeing from your locks. And so as you get a normalization, or more of a trip of revenue and expenses happening roughly at the same time, you're going to get an increase in ROE of a couple points. And so right off the bat, you're going to get the benefit of the increase there. Then as we start to see the continued improvement of efficiencies in our consumer direct channel, our broker direct channel we forecast to continue to see growth. Our market share is going to continue to grow there. Then you can start to see a couple points of ROE coming out of that. Then you layer in the fact that our technology expense right now is running at elevated levels because of the work we're doing in our production channel, in our servicing channel, in our drive to 55, as we'll be talking about shortly, working on the [ Cenlar ] acquisition, and really taking advantage of all of the AI tools that that cost is going to come down meaningfully. And so you can start to see a couple points taking place there in improvement in ROE. And then finally, as you start to see a normalization of the mortgage market, that will get it from the mid-teens to 20% and above just based on the size of the market. I believe that you're going to continue to see this company get more and more efficient and you'll continue to see our costs, whether it's in production or servicing or everything that an organization of the complexity of ours is required to run as efficiently as it runs, you'll see the costs come down in a very meaningful way.

That's helpful. Um, maybe just drilling down to the channel aspect. You've spoken in the past about being more selective and correspondent. Just given the competitive pressures and elevated GSE activity, can you provide an update on how you're approaching the channel today?

And what the optimal channel mix looks like, just given the current macro. Yes, so, look, I think as you all know, correspondent is the key strategic initiative we have to really load the flywheel up for when rates decline, we have loans that we can refinance into our portfolio. The issue around correspondent is that there are certain parts of the market that we believe are a little bit too aggressive in how they're viewing recapture and the recapture opportunity in MSRs. And so we saw this especially take place at the end of last year. And so we've made, you know, the strategic decision that we want to be very precise, as we have a reputation for being, in terms of how we look at loans in the correspondent market. Okay, are these loans coming from correspondents that have slow prepayment speeds? Or maybe, perhaps we recapture better out of brokers or loan characteristics surrounding the loan. And so we've just been a little bit more particular and been much more focused in our capital allocation views in terms of bringing on new MSRs. And so that's what's led to the market share dip that you've seen. Having said that, we see in correspondent certain market participants following our lead in terms of how we view servicing and how we view in particular the value of recapture of certain loans. And I expect the market to follow suit very, you know, you know, clearly by the end of the year and all it's going to take is one little rally and people see how quickly certain loans run off that they're going to wake up and they're going to understand how to, you know, how they should be viewing the loans. Having said that, you know, we are a leading government correspondent aggregator, we're growing our non-QM aggregation business, we're growing our jumbo business, and even, even on the GSE front, we're making a lot of inroads in terms of the loans that the GSEs don't want to buy. And so we are an active buyer of loans that are typically executing better outside the GSE footprint and that's in that business that we're continuing to, you know, grow and accelerate in our correspondent channel.

Got it. That's helpful. Turning to broker, that continues to be a focus and the eventual transition onto Vesta remains an important milestone. Absolutely. Investors think about the market share opportunities and competitive positioning in that channel?

Yes, so look, I think that in the broker channel, we all, you know, we all understand what's happening in the channel today, but it's very early to tell what effect that's going to have come, you know, 3 and 6 months from now that, you know, we've established ourselves as a clear #2 to the 2 market leaders in the broker channel and that channel is an interesting one because as a broker you have to choose which one of those leaders you want to you want to you want to deliver to or you want to originally your loans. And so we're in a very good, unique position to be able to really have an opportunity to do business with all of our brokers. We have great technology that will be fully deployed by the middle of next year to the broker channel that is going to give brokers the opportunity to achieve the efficiencies that we ourselves are seeing in our consumer direct channel. And that's something that's going to be a meaningful effect. And as I talked about on the glide path, we expect to continue to grow share over the next 2 to 3 years in a very, very meaningful way. I think the broker direct channel is one that has been a little bit, you know, under a little bit of stress at the moment. But I think that it's too early to tell in terms of what that's going to mean. I believe that margins are going to have to come up in broker. And that's something that, you know, we'll see over time. I also think that some of the phenomenon that we saw in brokerage, broker that we saw in correspondent with how people were thinking about MSR values and recapture, we're starting to find their ways in the into the broker channel. And I think that that's getting mitigated rather quickly. But by and large, we're really bullish on the broker on the broker channel. And I think it's something that you're going to see us play a more meaningful role in as time goes on.

Got it. And just to be clear, 10% market share is still the goalposts.

Well, yes, it is. I don't think we'll, you know, I think suffice it to say we have 4 months left of this year, so we're not going to get there this year. But we're not going to, look, market share, from my perspective, is a guidepost for all of you to think about as you're building your models where we're going to be. I will tell you internally, you know, for me, the most important and only driving factor is the market share, factors return on equity and the amount of that and the amount of return we're achieving. And so I think that, you know, we're going to get to 10% share. I know that. It's just going to, you know, we've got to get through this little blip here.

Got it. So you've been reporting improving recapture rates across conventional and also government. How much of that improvement is being driven by tech? Are you seeing any early impacts from the trigger lead bill?

Yes, so, um, the recapture numbers are really good. Um, they're the best I've ever seen in my career. And, you know, under the leadership team that we have in our consumer direct channel, they're hyper-focused on recapping the portfolio. Um, you know, we're seeing conventional recapture rates approaching 30%, which I've never seen in my career, and the government side were north of 50%. And so the recapture numbers are really strong. I think it starts with leadership, and then it starts with the, you know, the workflows that we have in place and the marketing initiatives you have in place to get the recapture. Then, then you layer in what's happening with the technology. And as I pointed out earlier, just being able to be more efficient as a loan officer allows you to be able to go after more loans. And so that's the benefit of the Vesta and the loan origination technology that we have in place. Then, you know, we've introduced our natural language virtual assistant, or NLVA, that's allowing borrowers to self-serve. And that's leading to increased activity, you know, in nights and weekends and holidays. And that's something that we introduced in our consumer direct channel 60 days ago, uh... and that's something that we're already seeing some exciting results and that the goal, and we're going to get there, is to be able to have a, we call the driverless mortgage where borrowers can just self-serve and be able to originate a loan without dealing with a loan officer. And that's something that is going to be is going to be more and more prevalent throughout the industry. But I think, you know, look, I think there is something that, you know, we have in the fact that our technology that we're using is legacy-free. And it was built to allow for quick adoption of AI, and most importantly, that AI is being built and driven by the business. And that's something that throughout my 20 years, close to 20 years at PennyMac, I've always felt that the business should drive technology and they should own the building of it, and this is AI is allowing us to do it. And so there we're seeing real good results. And look, the trigger lead bill has helped. Okay, we shouldn't ignore that. And it's given us a little bit more value in terms of owning an MSR as opposed to when you when you pull credit, you have 60 different lenders calling the borrowers and hassling them. And so we're seeing good results coming out of that. And look, that's contributed to these historically high recapture rates.

Thank you. Got it. Um, just turning to technology, you've highlighted significant improvements in cycle times, also targeted 80% automation by year-end 2027. What are the most important benefits investors should expect as these initiatives scale both from cost, um, and a growth perspective?

Your position out there, the exciting part should be the volatility associated with the staffing up and laying off of human capital is getting greatly reduced and very quickly. And that should lead to more stable earnings in the company and reduce some of the volatility around the move in interest rates. And so as I talked about earlier, we were keeping excess capacity for potential rallies and the need for holding that has been greatly diminished. And so as we look at what our needs are going to be for a 50 basis point rally and 100 basis points rally, it's come down a big, big number. So right off the bat, I think that's to me is one of the most exciting parts about the technology that we're building in the organization. I think that, look from a technology expense standpoint, as I talked about, we walked into the year with a lot of initiatives, as we see those initiatives complete, we're going to get real benefits as a company. Obviously, we'll be spending less on technology, but more importantly, we're going to be getting the benefits of the technology that's being built that will lead to greater profitability in the company.