Q3 2022 PennyMac Financial Services Inc Earnings Call (Pre-Recorded)

In our production segment purchase activity has been impacted by the affordability challenges created by higher mortgage rates and significant home price appreciation over the last several years reef.

Refinance volumes are expected to remain subdued as nearly all outstanding mortgages are currently out of the money.

In the correspondent channel, we are seeing our customers increasingly sell loan servicing released to stable capital partners like Pennymac as they seek to manage profitability and enhance liquidity.

We believe the challenging environment will continue in upcoming quarters as higher rates persist.

That said, we expect the decline in PFS size production revenue to be largely offset by disciplined expense management activities, which I will speak about later.

Turning to our servicing business. We are forecasting continued portfolio growth as we leverage our low cost structure and industry, leading position in correspondent lending to profitably at current higher note rate servicing our portfolio providing opportunities for recapture when interest rates decline we.

Also expect to see attractive opportunities to acquire bulk MSR over the next 12 to 18 months as originators look to monetize servicing due to decreased origination profitability.

According the top economists the probability for recession has increased in recent periods. While we recognize the challenges. This may present for our servicing business. We believe the risks are mitigated by the fact that consumers are financially in a strong position given the equity built up in their homes over the last couple of years combined with low.

<unk> of unemployment at present.

Turning to our Vista management segment credit spread widening in recent periods resulted in fair value declines in Pmt's credit investments translating to a decline in pmt's equity and lower base management fees for PFS side.

In addition, we do not expect performance based incentive fees to be earned in the foreseeable future due to pmt's losses in recent quarters.

Nonetheless has the largest correspondent lender with an orientation towards purchase money loans and strong fundamentals underlying its season investment portfolio. We believe pmt's long term return potential remains attractive.

As I mentioned earlier expense management continues to be a top priority for Pennymac financial we implemented meaningful expense savings and capacity reductions beginning early this year as shifts in the market. We're developing in fact quarterly operating expenses have been reduced by more than 170 million.

<unk>.

Our 37% compared to average quarterly 2021 levels and.

And we have taken additional actions in the fourth quarter to further align our expense base to the lower expected levels of activity.

We will continue to monitor the market and make additional adjustments as needed in order to rightsize our business appropriately.

Pennymac financial has produced strong results. So far this year with an annualized return on equity of 17%, which has driven growth in book value per share of 14% year to date.

Though I believe we are well positioned to successfully navigate the current market environment. It is our expectation that PFS is return on equity will decline from current levels before returning to our pre COVID-19 range over time.

Now I'll turn it over to Doug Jones, <unk>, President and Chief Mortgage banking Officer, who will review our market share trends in third quarter mortgage banking results.

Thanks, David.

Overall production was solid in the third quarter, given the market environment with total production volumes down only 3% from the prior quarter.

<unk> maintained its leadership position in correspondent lending is our strong capital position and consistent commitment to the channel provides our partners with stability and support they need to successfully navigate a challenging mortgage market.

We estimate that over the past 12 months, we represented approximately 14% of the channel overall.

Total correspondent loan acquisition volume in the third quarter was $22 4 billion.

Of which 46% were conventional conforming loans for which <unk> earns a fulfillment fees from PMT.

Government loan acquisition volumes were up 14% from the prior quarter, while conventional correspondent acquisitions were down only 1%.

Government correspondent lock volume was up 9% from the prior quarter.

Revenue per fallout adjusted government lock in the third quarter was 24 basis points down from 27 basis points in the prior quarter.

Scale, we have achieved in our correspondent business combined with our low cost structure and operational excellence in the channel allow us to operate efficiently through a volatile market environment.

In October we estimate correspond acquisitions will total $7 5 billion and locks will total $8 billion.

Turning to consumer direct we estimate that we accounted for approximately one 4% of total originations in the channel over the last 12 months.

Origination volume for the third quarter were $2 3 billion and interest rate lock commitments were $3 $8 billion.

Reflecting a steep decline in refinance volume.

<unk> lock volume for the quarter of $1 4 billion was 36% of total locks up significantly from 22% in the prior quarter.

Margins in this channel expanded as we focused on meeting the needs of customers in our servicing portfolio and revenue per fallout. Adjusted lock was 366 basis points up from 355 basis points in the prior quarter.

We estimate total originations for our consumer direct channel in October will total $500 million and locks will total $700 million. We estimate the committed pipeline at October 31st will be $600 million.

Originations in our broker direct channel totaled $1 $3 billion and locks totaled $1 9 billion also down significantly from the prior quarter, reflecting intense competition from channel leaders.

Revenue per fallout adjusted lock was 70 basis points down from 77 basis points in the prior quarter.

We estimate that in the last 12 months, we represented approximately two 2% of the origination volume in the channel.

Despite elevated levels of competition currently we continue to see opportunity over the long term given our excellence in the correspondent lending and consolidation in the channel.

We remain committed to providing our broker partners and the customers that they serve new products and a superior mortgage experience.

To that end, we earlier this month announced the launch of power plus our next generation broker technology platform.

Combining a more efficient precise and convenient loan process with better data collection and communication capabilities. We believe this new technology provides brokers with the tools they need to successfully grow their business and convert leads into loans.

We estimate that broke originations in October will total $400 million and locks will total $500 million. We estimate the committed pipeline at October 31 will be $500 million as David discussed earlier these acquisition and origination volumes continue to drive the organic growth of our servicing portfolio.

I am pleased to report that we ended the quarter with a servicing portfolio of $539 billion or.

Only four 1% of all residential mortgage debt in the U S.

Prepayment speeds have slowed meaningfully given the rapid and significant increase in mortgage rates pending.

Pennymac Financial's owned servicing portfolio represented a prepayment speed of 9% in the third quarter down from 12% in the prior quarter.

Similarly, prepayment speeds and Pennymac financial subsurface portfolio, which includes mostly Fannie Mae and Freddie Mac mortgage servicing rights owned by PMT or.

Or six 9% down from nine 3% in the prior quarter.

PFS is Ellen servicing portfolio, which consists primarily of Ginnie Mae MSR had a 60 day plus delinquency rate of three 5% up from three 2% at the end of the prior quarter, while our sub servicing portfolio, consisting primarily of conventional loans reported a 60 day plus delinquency rate of 5%.

Change from June 30.

The <unk> have completed modifications was $2 $4 billion and the <unk> of ABL loan volume totaled $250 million, both down significantly as opportunities have declined due to higher mortgage rates.

We expect <unk> revenues to continue to decline in the coming quarters as lower overall volumes and redeliver gains are expected to be limited due to the higher interest rate environment.

I'll now turn it over to Dan who will review <unk> financial results stress scenarios for servicing advances and the new eligibility rules introduced by Ginnie Mae and buffer.

Thanks, Doug as David mentioned earlier, <unk> net income was $135 million or diluted earnings per share of $2 46.

Production segment pretax income was $39 million as you will see on slide 10, we provide a breakdown of the revenue contribution from each of PFS sized loan production channels net of loan origination expenses, including the fulfillment fees received from PMT for conventional correspondent loans production revenue margins were mixed with margins up in our <unk>.

Sumer direct channel and down in our correspondent and broker direct channels revenue per fallout adjusted lock for PFS is one account was 99 basis points in the third quarter unchanged from the prior quarter. This includes $36 million in gains realized related to the timing of revenue and loan origination expense recognition hedging pricing and execution changes and.

Other items as.

As David mentioned, we remain focused on expense management activities, given the current market environment and although fallout adjusted locks were down only 2% from the prior quarter production expenses net of loan origination expense were down 21%.

The servicing segment recorded pretax income of $145 million down from pre tax income of $168 million in the prior quarter and up from $8 million in the third quarter of 2021.

Pretax income excluding valuation related items for the servicing segment was $70 million down from the prior quarter as higher loan servicing revenue higher earnings on custodial balances in deposits and lower expenses were more than offset by higher realization of MSR cash flows and lower <unk> related income.

Operating revenues increased from the prior quarter as loan servicing fees grew by $11 million, primarily due to growth in our servicing portfolio.

Earnings on custodial balances and deposits increased by more than $30 million as rates continue to rise the earnings on these custodial balances will rise as well with a meaningful contribution to overall servicing profitability and largely offsetting the expected decline in <unk> revenue operating expenses as a percentage of average servicing portfolio <unk> decreased.

Payoff related expenses, which include interest shortfall and recording and release fees related to prepayments decreased by $9 million.

Realization of MSR cash flows increased by $20 million driven by higher average MSR values during the quarter.

In order to protect the value of our MSR asset we utilized our comprehensive hedging strategy. This strategy is designed to moderate the impact of interest rate changes on the fair value of our MSR asset and also considers production related income.

On Slide 14, you can see the fair value of our MSR increased by $237 million in the third quarter, driven by higher mortgage rates, which resulted in expectations for lower prepayment activity in the future.

<unk> losses totaled $165 million, primarily driven by higher interest rates.

Finally, our investment management segment delivered pretax income of $1 $6 million up from $247000 in the prior quarter.

Net assets under management totaled $2 billion as of September 30th down 3% from June 30th.

Segment revenue was $10 $4 million up 7% from the prior quarter.

Now I would briefly like to review the projected needs for servicing advances in different market scenarios.

For delinquent borrowers PFS Sai has the responsibility to fund servicing advances for its own portfolio of predominantly Ginnie Mae MSR for the subsurface portfolio any servicing advances are the responsibility of the MSR owner or PMT.

For the owned portfolio. This obligation includes principal and interest or P&I advances advances related to property taxes, and insurance or TNI advances and default related or corporate advances.

While we fund TNI and corporate advances throughout the delinquency of alone delinquent principal and interest payments are often offset by other prepayment activity in the portfolio and do not require us to fund P&I advances, except in adverse scenarios, where high rates of extended delinquencies combined with low prepayment speeds.

On the left side of the table on Slide 15, we have presented the current advanced balances for our own portfolio as of September 30th as well as the current delinquency rate in prepayment speed.

On the right side of the table, we have presented projections of peak advanced balances over the next 12 months in both an adverse and high stress scenario and our high stress scenario, we assumed delinquencies followed the trajectory we observed during the onset of the COVID-19, pandemic, where payment forbearance was mandated to be available to all borrowers who claimed hardship in combination with prepayments.

<unk> declining to the lowest monthly level observed in the last 30 years, even in such a scenario. We project peak advanced balances would be less than $2 billion over the next 12 months or an increase of about $1 6 billion from the current level of advances.

With total available liquidity of $2 $8 billion as of September 30th and the ability to borrow up to $600 million against Ginnie Mae servicing advances, we believe PFS is well positioned to address the potential impact servicing advances may present in a recessionary environment.

Finally, though they are not required to be implemented until September 2023, or later I'd like to briefly speak about the new eligibility standards recently introduced by Ginnie Mae and the FHFA.

As discussed in note 22 of our second quarter Form 10-Q. These eligibility requirements are assessed at the servicer entity and not at the holding company or <unk>.

Pennymac loan services or Pls is a wholly owned subsidiary of P of Assai and as the approved issuer and servicer of securities guaranteed by Ginnie Mae.

<unk> also holds the licenses required to sell and service Fannie Mae and Freddie Mac mortgage loans.

As you can see on slide 17 of our slide presentation on a pro forma basis Pls is well in excess of all prospective capital liquidity and leverage requirements for both Ginnie Mae and the FHFA.

And with that I would like to turn it back to David for some closing remarks.

Thank you Dan.

We remain focused on the broader challenges facing our industry in the near term.

We will remain vigilant in our risk management discipline and continue to actively pursue opportunities to further improve efficiency across our businesses.

I continue to believe Pennymac is strategically well positioned in the mortgage market given our strong levels of capital are large and growing servicing portfolio and our efficient and low cost operating platform run by a best in class management team.

We encourage investors with any questions to reach out to our investor relations team by email or phone. Thank you.

This concludes Pennymac financial services, Inc. 's third quarter earnings discussion.

For any questions. Please visit our website at IR Dot Pennymac financial Dot com or call our Investor Relations Department at 8182644907. Thank you.