PennyMac (PFSI) Q2 2025 Earnings Call Transcript

Image source: The Motley Fool.

DATE

Tuesday, July 22, 2025 at 5 p.m. ET

CALL PARTICIPANTS

Chairman and Chief Executive Officer — David Spector

Senior Managing Director and Chief Financial Officer — Daniel Perotti

Need a quote from one of our analysts? Email pr@fool.com

TAKEAWAYS

Net Income: $136 million in GAAP net income and diluted earnings per share of $2.54 for Q2 2025.

Annualized ROE: 14% reported for Q2 2025; operating ROE at 13% excluding fair value changes and a nonrecurring tax benefit.

Dividend: Declared at $0.30 per common share for Q2 2025.

Production Pretax Income: Pretax income was $58 million for Q2 2025, down from $62 million in the prior quarter.

Total Origination Volume: $38 billion in UPB in Q2 2025, an increase of 31% compared to Q1 2025.

Total Locked Volume: $43 billion in UPB, up 26% from the prior quarter.

Correspondent Acquisitions: $30 billion, up 30% sequentially; correspondent channel market share estimated at 20% for the first half of 2025.

Correspondent Channel Margins: 25 basis points in Q2 2025, down slightly from Q1 2025.

Broker Direct Originations: Up nearly 60% sequentially; locked volumes were up more than 30% from the prior quarter.

Brokers Approved: Nearly 5,100 as of Q2 2025, up 19% compared to Q2 2024.

Broker Direct Channel Margins: Down slightly compared to the prior quarter.

Consumer Direct Originations: Origination volumes up 6% in Q2 2025 compared to Q1 2025. Lock volumes down 2% in Q2 2025 compared to Q1 2025. Margins improved due to a larger mix of closed-end second liens.

Production Expenses: Increased 8% sequentially, partly reflecting expanded capacity in direct lending.

Servicing Portfolio: $700 billion in UPB, representing 2.7 million households.

Servicing Segment Pretax Income: $54 million; excluding valuation changes, $144 million or 8.3 basis points of average servicing portfolio UPB.

Loan Servicing Fees: Increased due to growth in the MSR portfolio.

Custodial Funds Managed: Averaged $7 billion, up from $6.2 billion sequentially.

Operating Expenses (Servicing): $80 million or 4.6 basis points of average servicing portfolio UPB, decreasing from the prior quarter.

MSR Fair Value Movements: $16 million net increase; $26 million from rate changes, offset by $10 million other impacts. Excluding costs, hedge fair value declines were $55 million with $54 million in hedge costs, much of which occurred in April.

Tax Benefit: $60 million, including a one-time $82 million gain from repricing deferred tax liabilities; future tax provision rate expected at 25.2%, down from 26.7% in recent quarters.

Unsecured Senior Notes: $850 million issued in May 2025, with proceeds partially used to redeem $6.65 billion notes maturing October 2025.

Ginnie Mae MSR Term Notes: $500 million redeemed and refinanced at a more favorable spread.

Total Liquidity: $4 billion, including cash and available facilities.

AI Initiatives: Over 35 tools/applications developed with a projected annual economic benefit of approximately $25 million.

Consumer Direct Refinance Recapture Rate: Consumer direct refinance recapture rate is already twice the industry average.

Portfolio Refinance Opportunity: $267 billion (38% of servicing UPB) with note rates above 5%, and $181 billion (26%) above 6% as of June 30, 2025.

Broker Direct Market Share: Currently approximately 5% market share in broker direct channel; company targets over 10% by end of 2026.

Hedging Approach: 80%-90% targeted hedge ratio maintained; approach adjusted for improved recapture capacity in Q3 2025, expected to lower future hedge costs and increase consistency.

SUMMARY

PennyMac Financial Services, Inc. (NYSE:PFSI) reported $136 million in net income in Q2 2025, including a notable nonrecurring $82 million tax benefit that contributed to a future tax rate reduction. The company’s $700 billion servicing portfolio and expanded direct lending capacity position it for continued volume growth and margin stabilization. Management highlighted successful execution of AI initiatives, forecasting approximately $25 million in annual economic benefits from over 35 deployed or in-development tools and applications. Liquidity, strengthened by $850 million in new unsecured debt issuance and refinancing of $500 million of Ginnie Mae MSR notes at improved spreads, supports the current growth strategy. The company anticipates that investments in technology, servicing scale, and enhanced hedge positioning will produce sustainably higher returns as market conditions evolve.

Perotti said, "our expectation as we're moving into the next couple of quarters in terms of our operating ROE is that we expect it to improve from the levels that we saw here in Q2."

Management confirmed the ability to increase production by approximately 50% from current levels with no increase to fixed expense. emphasizing scalable operations.

An expanded broker network, with nearly 5,100 approved brokers, underpins broker direct origination growth and future market share objectives.

Strategic focus on refinance opportunity remains, as $267 billion in UPB, or 38% of the loans in the servicing portfolio, had a note rate above 5%.

Servicing expenses are among the lowest in the industry and have come down from almost eight basis points in 2020 to less than five basis points in the last twelve months.

INDUSTRY GLOSSARY

UPB (Unpaid Principal Balance): The outstanding principal amount of loans serviced or originated, not including interest or other fees.

MSR (Mortgage Servicing Rights): Rights to service specific mortgage loans, entitling the holder to collect servicing fees and manage the collection and administration processes.

Correspondent Lending: Channel through which a lender purchases loans originated by third-party sellers, often local banks or mortgage brokers.

Broker Direct: Origination channel where the company works directly with mortgage brokers to generate loan volume.

Refinance Recapture Rate: The percentage of existing serviced borrowers who refinance and originate a new loan through the servicer rather than another lender.

Full Conference Call Transcript

David Spector: Good afternoon, and thank you to everyone for participating in our second quarter earnings call. For the second quarter, as shown on Slide three, PFSI reported net income of $136 million or diluted earnings per share of $2.54. This reflects an annualized return on equity of 14%. Excluding the impact of fair value changes and a nonrecurring tax benefit, which Dan will talk about later, PFSI produced an annualized operating ROE of 13%. These results highlight the resilience of our balanced business model and our continued ability to produce solid financial results even during periods of extreme volatility, such as earlier in the second quarter.

As you can see on slide five, our consistent performance over recent periods of elevated mortgage rates demonstrates the strength of our organically built comprehensive mortgage banking platform. The stability provided by our balanced business model, especially in this higher for longer rate environment, is a real strategic advantage. We expect that if interest rates stay in the range of 6.5% to 7.5%, our operating returns on equity will continue to range in the mid to high teens throughout the remainder of this year. You can further see the strategic advantage of our comprehensive mortgage banking platform on slide six. As our business model functions as a very powerful flywheel.

Because we are the second largest producer of mortgage loans and the sixth largest servicer, we operate with a significant scale advantage in both businesses. Large volumes of loan production consistently exceed our portfolio runoff, resulting in the continued growth of our loan servicing portfolio. At the end of the second quarter, our portfolio totaled $700 billion in unpaid principal balance, representing 2.7 million households. This large and growing customer base drives efficient, cost-effective leads to our consumer direct group as we leverage our proprietary servicing platform to effectively service our customers' needs.

Whether it's a refinance when interest rates decline or if they're in the market for a new home purchase, or closed-end second mortgage to access their home equity over retaining their low-rate first lien mortgage. And because we have instilled in our team a culture of continued process improvement and technology innovation, we believe we can continue to drive further scale and operational efficiencies into our platform. Our strategy also allows us to excel on growth in the expanding purchase market. The chart on the bottom of slide seven illustrates the projected growth in overall volumes, which is primarily driven by the more purchase market compared to the refinance market.

This trend underscores why our strategic emphasis on our relationship businesses with strong ties in their local markets is so vital. Our strong access to this growing market is achieved through our robust presence in correspondent lending and our rapidly increasing market share broker direct. Our market leadership is supported by our unmatched excellence and support for our business partnership illustrated on slide eight. This foundation provides a significant strategic alignment with our business partners that is difficult to replicate and has been organically and carefully built over time. We offer cutting-edge technology, a continued presence in markets, with reliable execution, and rapid closing and turn times.

Additionally, we have long-standing relationships with key partners and one of the lowest cost structures in the industry driven by our highly efficient fulfillment operation. Turning to slide nine, we proudly showcase our position as the outright leader of correspondent lending. Over the last twelve months, we have generated approximately $100 billion in UPB of course production, achieving an estimated market share of approximately 20% in the first half of 2025. This significant volume is a direct result of our more than fifteen years of operational excellence, technology innovation, and our deep partnerships with many of our nearly 800 active sellers across the country. A key aspect of our leadership in this channel is our exceptional operational leverage and scale.

In fact, we have the ability to increase production by approximately 50% from our current levels with no increase to our fixed expense. This capability underscores our fundamental strength as a highly efficient, low-cost provider in this channel, solidifying our truly dominant position and creating a substantial competitive advantage. Similarly, you can see on slide 10 that we are increasingly becoming more relevant in the broker direct channel. From our entry to this business in 2018, our broker direct market share has expanded significantly, currently standing at approximately 5%.

We have clearly established ourselves as a trusted partner for brokers, and though we are already the third largest in the channel, we see tremendous momentum to continue our growth to more than 10% market share by the end of 2026. This remarkable growth and our position as a trusted alternative are driven by our tech-forward platform with unmatched support throughout the origination process. This advanced infrastructure and dedicated assistance assure brokers that their customers will experience a seamless and efficient origination process, empowering brokers and reinforcing their trust in us as a reliable long-term partner.

On slide 11, we highlight the significant opportunity for our consumer direct business and why we are intensely focused on building on our successes in this channel. We have a large network of more than 5 million current and former homeowners who know and trust PennyMac. And we are leveraging our industry-leading team and data analytics to identify refinance and other opportunities so we are best positioned to help meet our customers' home finance needs. Our refinance recapture rate is already twice the industry average, which effectively protects in the lower impact from the impacts of lower MSR values as rates decline.

And we will continue to leverage our strategic partnership with Team USA and the LA 28 Olympic and Paralympic Games along with targeted model-driven campaigns to increase our visibility and recognition while driving growth in recapture and new customer acquisition. Turning to Slide 12, you can see the significant recapture opportunity for our consumer direct division when interest rates do decline. As of June 30, $267 billion in UPB or 38% of the loans in our servicing portfolio have a note rate above 5%. And $181 billion in UPB or 26% of the loans in our portfolio have a note rate above 6%.

This large and growing portfolio of borrowers who recently entered into mortgages at higher rates and stand to benefit from a refinance in the future when interest rates do decline positions our consumer direct lending division for strong future growth. Our multiyear investments in technology and process innovation have already driven meaningful improvements in recapture rates. And we expect these to continue improving. Now let's turn to an area that is not just critical but truly transformative for our entire balanced business model: our unwavering intense focus on artificial intelligence. On slide 13, you'll see we're not just building momentum. We are accelerating with breakthrough speed in the development of AI.

We are aggressively advancing our AI capabilities, making targeted and strategic investments. This strategic commitment is a natural evolution of our history of investing in leading-edge technology. And it is designed to enhance the customer experience, unlock new revenue streams, and, crucially, drive unprecedented levels of efficiency to dramatically reduce expenses. Our dedicated AI accelerator team is at the forefront, relentlessly focused on delivering and adopting AI applications and productivity tools faster than ever before. Our cloud-based and flexible proprietary platforms have positioned us extraordinarily well to integrate AI, profoundly enhancing our capabilities and efficiency across our entire technology landscape. In production, we're seeing game-changing advancements. Our proprietary chatbots aren't just tools.

They're extensions of our loan officers and underwriters, providing instant compliant answers sourced directly from our deep well of comprehensive policies and procedures. This empowers our team members with unparalleled accuracy and allows them to focus squarely on what they do best: driving sales and closing more loans. And with our AI call summarization, we're automating critical after-call work, freeing up valuable time and insights for our sales teams, contributing directly to increased conversion. In servicing, our AI initiatives are equally impactful, enhancing both efficiency and the client experience. Behind the scenes, our servicing AI processing solution is automating critical document workflows and streamlining operations.

And for our clients, our advanced servicing automated assistant available instantly on web and mobile provides immediate access to loan-specific information and answers to their questions. This empowers our clients with self-service convenience and speed, elevating their overall experience and allowing our team members to focus on more complex high-value interactions. To date, we've already launched or are actively developing more than 35 AI tools and applications, with a projected annual economic benefit of approximately $25 million. While this is far more than a strong start, this is just the beginning of what's possible. And we are incredibly excited about what the future holds. This brings me to slide 14, which illustrates PennyMac's ambitious groundbreaking vision for artificial intelligence.

We have already achieved significant milestones, from advanced coding productivity tools to sophisticated workplace tools and intelligent chatbots that are reshaping daily operations. But our roadmap is truly visionary. It includes sophisticated agent automation of complex loan processing activities, robust and intuitive self-service capabilities that empower our customers, and advanced lead generation processes that will redefine our outreach. Our ultimate vision is a fully automated loan process, including a seamless self-service origination servicing experience. This is not just technology. This is the future of mortgage banking, and PennyMac is leading the way. In conclusion, our balanced and diversified business model continues to deliver strong financial performance.

We maintain our leadership position in the purchase market through our strong correspondent franchise and growing broker direct lending presence, which provides consistent business volume. These volumes directly grow our servicing portfolio, creating a significant future opportunity in our consumer direct channel further enhanced by our strategic brand investments. And throughout all of our operations, our intense focus on AI and technology is effectively driving down costs, contributing to our overall financial strength. Our strategic foundation solidly positions PennyMac for continued growth and strong performance in any market environment. And I'm incredibly excited about what our future holds. I will now turn it over to Dan who will review the drivers of PFSI's second quarter financial performance. Thank you, David.

Dan Perotti: PFSI reported net income of $136 million in the second quarter, or $2.54 in earnings per share, for an annualized ROE of 14%. These results included $93 million of fair value declines on MSRs net of hedges and costs, and a nonrecurring net tax benefit of $82 million. The contribution from these items to diluted earnings per share was 19¢. PFSI's Board of Directors declared a second quarter common share dividend of $0.30 per share. Beginning with our production segment, pretax income was $58 million, down from $62 million in the prior quarter. Total acquisition and origination volumes were $38 billion in unpaid principal balance, up 31% from the prior quarter.

Of this, $35 billion was for PFSI's own account, and $3 billion was fee-based fulfillment activity for PMT. Total locked volumes were $43 billion in UPB, up 26% from the prior quarter. PennyMac maintained its dominant position in correspondent lending in the second quarter, with total acquisitions of $30 billion, up 30% from the prior quarter. Correspondent channel margins in the second quarter were 25 basis points, down slightly from the first quarter.

While followed adjusted locks for PFSI's own account were up from the prior quarter, PFSI account revenues were impacted by a negative contribution from timing of revenue and loan origination expense recognition, hedging and pricing execution, and other items, as well as a higher proportion of volume in the correspondent and broker direct lending channels relative to last quarter. PMT retained 17% of total conventional conforming correspondent production, down from 21% in the prior quarter. Of note, pursuant to our renewed mortgage banking agreement with PMT, effective 07/01/2025, all correspondent loans are initially acquired by PFSI. However, PMT will retain the right to purchase up to 100% of nongovernment correspondent loan production.

In the third quarter, we expect PMT to acquire approximately 15% to 25% of total conventional conforming correspondent production, consistent with levels in recent quarters. In broker direct, we continue to see strong trends and continued growth in market share, as we position PennyMac as a strong alternative to channel leaders. Originations in the channel were up almost 60%, locks were up more than 30% from the prior quarter, driven by a growing number of approved brokers who are increasingly recognizing and leveraging our distinct value proposition. The number of brokers approved to do business with us at quarter end was nearly 5,100, up 19% from the same time last year.

And we expect this number to continue growing as top brokers increasingly look for strength and diversification in their business partners. Broker channel margins were down slightly from the prior quarter. Trends were mixed in consumer direct with origination volumes up 6% and lock volumes down 2% from the prior quarter. Margins in the channel were up due to a larger mix of higher margin closed-end second liens during the quarter. Activity across our channels in July has been mixed, with increased activity across correspondent and broker direct and volumes in consumer direct similar to levels reported in the second quarter.

Production expenses, net of loan origination expense, increased 8% from the prior quarter, partially due to increased capacity in direct lending, which is expected to drive our ability to rapidly address opportunities presented by lower mortgage rates. Turning to servicing. As David mentioned, our servicing portfolio continues to grow, ending the quarter at $700 billion in unpaid principal balance. The servicing segment recorded pretax income of $54 million. Excluding valuation-related changes, pretax income was $144 million, or 8.3 basis points of average servicing portfolio UPB. Loan servicing fees were up from the prior quarter, primarily due to growth in PFSI's MSR portfolio.

Custodial funds managed for PFSI's owned portfolio averaged $7 billion in the second quarter, up from $6.2 billion in the first quarter due to seasonal impacts and higher prepayments. As a result, earnings on custodial balances and deposits and other income increased. Realization of MSR cash flows increased from the prior quarter, due to continued growth of the MSR asset, and higher realized and projected prepayment activity. Operating expenses were $80 million for the quarter, or 4.6 basis points of average servicing portfolio UPB, down from the prior quarter.

You can see on slide 21 in our servicing segment our per loan servicing expenses are among the lowest in the industry, reflecting unit costs that have been on a consistent decline since 2019. Our operating expenses measured as basis points of average servicing portfolio UPB have come down from almost eight basis points in 2020 to less than five basis points in the last twelve months. This is a direct result of our proprietary technology, continuous process improvement, and platform scale. We seek to moderate the impact of interest rate changes on the fair value of our MSR asset through a comprehensive hedging strategy that also considers production-related income.

During the second quarter, the fair value of PFSI's MSR increased by $16 million. $26 million was due to changes in market interest rates, which was partially offset by $10 million of other assumption changes and performance-related impacts. Excluding costs, hedge fair value declines were $55 million. Hedge costs were $54 million, the majority of which were incurred in April due to extreme interest rate volatility. As we moved into the third quarter, we strategically adjusted our hedging to align with our increased direct lending capacity. We currently expect lower hedge costs and greater consistency of hedge performance with respect to the direction of rate movement in future periods.

Corporate and other items contributed a pretax loss of $35 million compared to $34 million in the prior quarter. PFSI recorded a tax benefit of $60 million in the quarter driven by a nonrecurring tax benefit of $82 million, which primarily consisted of a repricing of deferred tax liabilities due to state apportionment changes driven by recent legislation. PFSI's tax provision rate in future periods is expected to be 25.2%, down from 26.7% in recent quarters. We were also active in the management of our financing in the second quarter.

In May, we successfully issued $850 million unsecured senior notes due in 2032 and utilized a portion of the proceeds to redeem our initial unsecured debt offering of $6.65 billion that was due later this year in October. Additionally, we redeemed $500 million of Ginnie Mae MSR term notes due in May 2027 and replaced that debt with MSR financing from one of our lenders at a more attractive spread to optimize our costs. We ended the quarter with $4 billion of total liquidity, which includes cash and amounts available to draw on facilities where we have collateral pledged. We'll now open it up for questions.

Operator: Thank you. I would like to remind everyone, we will only take questions related to PennyMac Financial Services, Inc. or PFSI. We also ask that you please keep your questions limited to one preliminary question and one follow-up question as we'd like to ensure we can answer as many questions as possible. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. And if you'd like to withdraw your question, it's star one again. We'll take our first question today from Crispin Love, Piper Sandler.

Crispin Love: First, just on the operating ROEs, they were 13% in the quarter, some of the lowest levels for several quarters. So curious if you can first discuss some of the puts and takes in the quarter, including margin trends and then your confidence of getting back to that mid to high teens level in the back half of the year as stated in your guidance?

Dan Perotti: Sure, Crispin. Thanks for your question. With respect to the operating ROE dipping a bit to 13%, really, I would say, driven by, you know, two factors in the quarter. One was related to, on the production side, related to margins in the channel. So this came down a bit quarter over quarter. Some of that was driven, if you look versus the prior quarters, by a negative impact in some of the cross-channel activities, which was down about $10 million this quarter, a negative contribution of about $10 million this quarter versus $17 million in the prior quarter. And this is on page 18 of the deck. You know, we typically see those cross-channel impacts fluctuate.

We had a bit of a negative impact due to some of the rate and spread volatility in the second quarter. We did see some of that reverse itself as we go into the third quarter, and overall margins toward the end of the second quarter and beginning of the third quarter have been trending higher, especially in the correspondent channel. So as we look out with respect to production, moving forward for the next few quarters, we expect improvement from a margin base and in terms of the overall income from that channel. Looking at the servicing side, we did see a reduction in the pretax income excluding valuation-related changes for the quarter.

That was primarily driven by an increase in the realization of MSR cash flows quarter over quarter, which was driven by an uptick in overall prepayment speeds as well as an increase in the overall size of the MSR asset. As well as a bit of an uptick in some of the nonoperating expense items. So payoff-related expenses and interest expense. Some of those, especially related to some of the prepayment activity, we don't necessarily expect to see at the same level that we saw this quarter.

Additionally, interest expense includes certain onetime items related to the retirement of some of our debt, and so we expect that to maintain on a bit more of a level basis as we continue to increase our servicing portfolio. So all of that being said, our expectation as we're moving into the next couple of quarters in terms of our operating ROE is that we expect it to improve from the levels that we saw here in Q2.

David Spector: And I think, look, I share the disappointment in that lower number, but I will tell you what I've seen, it really was improving in the latter part of the quarter, and July has been a continuation of the improvement. I think that, you know, we're seeing margins have clearly bottomed out in corresponding. We're seeing a slight increase there as well as we're seeing in broker direct is something similar. And so I think that, you know, we're looking forward to continuing to participate in getting those margins up in both of those channels as well.

Crispin Love: Great. Thank you very much, Dan and David, for that color. Just a follow-up for me on hedging going forward. Dan, you commented on some changes you made that you expect greater consistency. Can you dig a little bit more into that? What are you changing? Are you still targeting an 80% to 90% hedge ratio? And then has the recent rate stability helped as well just on the hedging side?

Dan Perotti: Sure. So overall, as I commented, we've adjusted some of our approach to hedging to have a greater recognition of the potential for recapture coming from our overall production channels and specifically our consumer direct channel or our direct channels. And we've adjusted our staffing in our direct channels to ensure that if we do see rate volatility or dips in rates, that we can very quickly and actively pursue those recapturing and origination opportunities. That will serve as an offset to reductions in the value of the MSR portfolio.

And that's allowed us to adjust some of the ways that we approach our hedging of the MSR portfolio to be a bit more stable and less active in terms of adjusting our hedges with changes in rates. And so in doing that, we expect that we will have lower costs as we go forward. We did have fairly significant costs in the quarter related to some of the interest rate volatility that we experienced in April.

But we expect lower costs as we're moving forward as well as, given the positioning that we have, to have greater consistency in terms of when interest rates increase, seeing a net increase in the value of the MSR versus the hedges and the opposite when interest rates decline. Overall, we are still targeting an 80% to 90% hedge ratio, at least in sort of rates within a near band to its current rate levels.

And so we haven't changed our posture from that perspective, but given the changes in the way we've implemented the hedging profile as we go forward, we do expect more stability in terms of the hedge position, which drives lower costs as well as greater sort of directional performance.

Crispin Love: Great. Thank you for taking my questions.

Operator: Up next is Bose George from KBW.

Bose George: Yeah. Good afternoon. Just wanted to on the profitability questions. Just in terms of the servicing portfolio, you know, what's a good run rate for the profitability there just in looking at it to some basis points? I mean, it makes sense the amortization increased with the bigger MSR, but, conceptually, you might have thought that would be offset by a higher, you know, servicing fee. So, yes, just kind of a good way to think about what that number should be.

Dan Perotti: You know, if you look back over the past few quarters, this was a bit in terms of the pretax income excluding market excluding valuation changes, you know, was a bit of a dip from what we've seen historically. As I said, you know, there were some onetime items or items that were specific to this quarter, you know, that impacted that. Generally, at these rate levels that we're at currently, you know, which are a bit higher and assuming not very significant levels of rate volatility, we'd expect the basis points on the servicing portfolio to move toward what we've seen over the past few quarters. In the, you know, nine to 10 basis point range.

In any given quarter, there can be certain items that impact the overall result, but that would be our expectation generally going forward at these rate levels.

Bose George: Okay. Great. And the decline there or the increase, I guess, in that base points would be largely on lower amortization?

Dan Perotti: Lower slightly lower proportional amortization. As I mentioned, some of the other impacts that we saw during the quarter, payoff-related expenses, there was a slight uptick versus what our run rate has been in terms of the losses and provisions for defaulted loans. And the interest expense contribution. So really, you know, some normalization across those different facets.

Bose George: Okay. Great. And then in terms of that the cross-channel volatility number, you know, on slide 17, is that mainly like, was that mainly hedging related on this quarter, or are there other things kind of driving that as well?

Dan Perotti: It was primarily related in the quarter to really volatility of spreads. We've certain points in the quarter. So there was a fair amount of spread volatility during the quarter. We have increasing amounts of our portfolio or of our production that is not, you know, necessarily directly deliverable into agency execution that's driving higher margin in a number of our channels. But to the extent that we see spread volatility in those channels, you know, can especially, you know, at certain points in the quarter, have an impact in that other line item.

Bose George: Okay. So these things like nonagency and seconds getting marked through there?

Dan Perotti: Yes. To the extent that it occurs after we've lost the loan.

Bose George: Yeah. Okay. Great. Thank you.

Operator: The next question will come from Eric Hagen, BTIG.

Eric Hagen: Hey. Thanks. Maybe following up on the profitability, looking at the servicing profitability on page 20. Is there a way to like sensitize the earnings on both the custodial balances and the interest expense line if the Fed delivers a rate cut? Like, for a 25 basis point cut, how much are each of those lines changing? And are they changing by a proportional amount, if you will?

Dan Perotti: Yes. So you can look at the outstanding debt that we have that is related to MSRs is almost all. So our MSR term notes as well as the repo related to MSRs, which is all basically, all floating rate debt would be tied to SOFR, which is very directly tied to the Fed rate. Similarly, we would expect that the earnings on custodial balances is tied very similarly or would move very similarly to how the Fed rate moves. And we've provided the balances of custodial funds here. So you could pass that through in terms of those outstanding balances, and that would be the impact of those two line items.

Eric Hagen: Yep. Okay. That's good. You know, if mortgage rates are higher from here, I mean, how sticky do you expect margins to be in the correspondent channel? I mean, do you think we could get a scenario where, you know, community banks either use the cash window more frequently or they keep loans in the portfolio by financing them with the FHLB. Like, what's the what are the conditions that might, you know, drive that?

David Spector: Look. I think that, you know, we're seeing actually the opposite in our correspondent channel in that we're seeing more of the production going to whole loan buyers like ourselves primarily because, number one, the sellers don't have the margin to be able to retain the servicing. But more importantly, given the high rate of the servicing and the fact they don't hedge the servicing, it makes more sense for them to sell the whole loan. So I think that, you know, we're gonna continue to see correspondent aggregators to be very active in this hire for longer environment. Will you see retention taking place as typically when margins are wide or wider and rates are at a perceived bottom.

And so I think, you know, we're just I think, you know, coming out of coming out of COVID, we've seen this phenomenon only grow. You know, the cash windows can get busier from time to time. But that's at their discretion. It's not at the discretion of the seller. And, typically, those who do sell to the cash window are more mortgage bankers that perhaps will aggregate servicing and auction it off. But, again, given the volatility in the market, aggregating servicing is not for the faint of heart. And I think if you're not hedging servicing, it could backfire pretty quickly on you.

So I think, look, I think this speaks to how we're growing share in correspondent just the level of feedback we're getting from our customers is pretty impactful. And I continue to expect it to stay that way for the foreseeable future. We're just in a really tough market in that we've been higher for a lot longer. And that's something, you know, we continue to focus on here, the things we can control.

And, you know, things like, you know, growing share, becoming more efficient, and continuing to reduce our expenses and to deploy technology are things that we've that we're focused on and looked at that kind of that's now kind of in the nearest to the benefit of those who are selling loans because we can just be more active and more dynamic as we're looking to grow share and correspondence.

Eric Hagen: Great stuff. Appreciate your comments. Thank you.

Operator: Michael Kaye from Wells Fargo has the next question.

Michael Kaye: I wanted to see if you could dig into the loan origination line item. It was up a lot quarter over quarter. Was that driven by the broker direct volume? You know, what's happening over there?

Dan Perotti: Yeah. That's exactly correct, Michael. Thanks for the question. So our production our origination expense line item in terms of our accounting includes the fee paid through to the broker. And so if you look at the, you know, if you looked at an individual transaction for our broker direct channel, we have a, you know, larger gain on sale that would be excluding the broker fee, and then the broker fee which is a free meaningful component showing up in origination expenses. And so we'll see an outsized increase in those origination expenses as, you know, compared to the overall total as broker becomes a greater percentage of our overall of our overall production or overall originations.

You know, we do look to normalize for that. So in terms of the way that we think about margin, we really think of, you know, our gross margin or our revenue margins being net of that broker fee. And so the, you know, the presentation that we have in the earnings in the earnings deck that we had been referencing on page 18 of the earnings deck nets all of the origination expenses out of, you know, each the individual lines. So that broker direct margin that's reflected there of 87 basis points in this quarter is net of that broker fee that is represented in origination expenses.

But as we continue to grow our broker direct originations, that, you know, those broker fees falling through to origination expense will have an outsized impact to the extent that broker is growing at a faster clip than, you know, our other channels.

Michael Kaye: I don't think I've heard during the call, any update on the subservicing initiatives? I know you had some early agreements last quarter you mentioned and some negotiations still going on. Is there anything meaningful there?

David Spector: Look. We're making a lot of good headway on the subservicing. We don't have anything substantial to report. I can tell you that we've brought in a major leader into the organization to lead that effort. And we're continuing to work with our correspondents in particular, but we're looking to starting with this quarter, to expand out on the horizon in terms of different pockets of those who own servicing. So I expect to see good activity before the end of the year on that front. Many of our correspondent customers who own servicing have either moved that servicing off their balance sheets or they're selling whole loans as I talked about a few minutes ago.

I think also given the dynamics in the marketplace, I think larger holders of servicing who have their servicing placed are waiting to see, you know, how things play out in the marketplace. And I think, you know, over the next six to twelve months, you'll see more servicing moving amongst subservicers. And so we're just positioning ourselves to be one of those subservicers to capitalize on the opportunity.

Michael Kaye: Okay. Thank you.

Operator: Next up is Doug Harter from UBS.

Doug Harter: Thanks. Dan, as I look at Slide 23 on unleveraged, you talked that the nonfunding debt might sort of trend above your target. Can you just talk about, you know, how you're thinking about leverage and, you know, whether you view any constraints from your current leverage level?

Dan Perotti: So, yeah, we do not have any concerns from our current leverage level. At elevated rates, the higher for longer is as David had kind of had mentioned earlier. You know, we do expect to run have a heavier emphasis on the servicing side of business and the MSR asset. I mean, that's driving our nonfunding debt to equity levels a bit higher than our, you know, our long-term target and where we've run historically. At these levels, we don't have any concerns. We do think that we could run potentially a little bit above on the nonfunding debt to equity as we mentioned here, a little bit above the 1.5 times.

You can see our overall debt to equity at 3.4 times is consistent with the prior quarter. And with our overall debt to equity target. And we don't have any concerns on the leverage side.

David Spector: You know, I share Dan's point of view from the rating agency standpoint from our business partner standpoint, I can tell you in our industry, we're always worried about leverage. And I think it's something that is always front and center in our minds. I think that, you know, to the point Dan's raising, you know, we've been very focused and judicious in how we think about leverage and how we think about that nonfunding debt number, and I think, you know, it factors into how we think about pricing for servicing and how we price for loans and I think it's something that, you know, we're very mindful of.

But I think given the environment we're in, it's something that has not come as a surprise to us to see it creep back up. But at the same time, you know, we clearly have it front and center.

Doug Harter: Great. I appreciate the thoughtful answer. Thank you. We'll go next to Ryan Shelley from Bank of America.

Ryan Shelley: Hey, guys. Thanks for the question. Most of mine have been answered. I was just hoping to give any color around delinquency rates. It looks like they picked up a bit in the quarter, but still below the year-ago period. So just any commentary or any specific end markets to call out there would be probably helpful. Thank you.

Dan Perotti: Sure. Thanks for the question. So page 32 has our trends for delinquency rates. You're correct that they did creep up during the quarter, although that's really consistent with what we see on a seasonal basis typically. I think the item of note is really that they decrease on a year-over-year basis. So down from 5.7 to 5.6%. And so overall, you know, we are seeing relative stability in terms of delinquency in the portfolio. Part of what has allowed us to hold in delinquencies in the portfolio is our, you know, our judicious underwriting of the loans that we are bringing into the portfolio.

And so you can see the performance of, you know, for the more greatly exposed credit areas of the servicing portfolio in terms of more recent vintage government loans, FHA and VA loans. Our delinquencies are significantly lower than the overall industry. I think that really speaks to our ability to shape the portfolio and ensure that we are less exposed to some of the lower, you know, the lower credit portions of the universe. Of the mortgage loan universe and ensure that we have greater stability in terms of delinquencies in our portfolio.

David Spector: But I think that, well, the delinquencies are advances are down. Borrowers have a lot of equity built up in their properties, and there's still even with the cutback of a few government programs, there's still good government programs to help keep borrowers in their homes. And the thing that, you know, the number that I'm encouraged by is the delinquencies of our recently originated vintages are lower than the overall industry. And that speaks to the point Dan made about our ability to diligence on loans to correspondent and to underwrite in broker and consumer direct. And that speaks to the risk management culture that we have here at the company.

Ryan Shelley: Got it. Thank you. Thanks for the question. Very helpful.

Operator: And we'll go to Trevor Cranston from Citizens JMP.

Trevor Cranston: Hey. Thanks. Follow-up question on the change in the hedging strategy. Understood correctly, you said it was mainly, you know, increasing the capacity at consumer direct to improve recapture. So looking at slide 18, there's a note that says part of the increase in production expenses was related to increased capacity in direct lending. Is that related to the change in hedging strategy, or should we be thinking about some incremental increase in production expenses in 3Q specifically related to that change in hedging strategy? Thanks.

Dan Perotti: No. That's exactly correct. So the hedging or the sorry, the production expenses for Q2 do incorporate most of the additional capacity that we have brought on that has allowed us to feel comfortable repositioning our hedge or approaching our hedge strategy a bit differently. The overall in we've been building that capacity through this quarter. Most of the expenses are reflected here in the second quarter. There may be an additional $1 to $3 million that of that since we didn't have the capacity on for the entire quarter, that would be increased on a completely flat basis as we go into the third quarter. But most of it's reflected here in these expenses for the second quarter.

David Spector: You know, if you look at the hedge performance of the $84 million negative, $54 million of it is hedge costs. And so, you know, one of the areas that we've spent a lot of time on is really getting our arms around what is the recapture opportunity that we have in the portfolio and how do we factor that into how, one, we value the servicing and how does that affect the hedge. And, obviously, it should bring down the hedge cost. Now if you have that in your methodology, you want to make sure you're going to recap the loan. But to do that, we have to put on the capacity.

But the capacity is a fraction of the hedge cost that we've been experiencing over the prior quarters. And so I'm encouraged, you know, by what I'm saying, you know, really, even this quarter in terms of that hedge cost number, you know, driving significantly lower. And so I think it's something that's going to lend itself to more consistent ROEs as we look forward.

Trevor Cranston: Right. Okay. That makes sense. Thank you, guys.

Operator: And we have no further questions at this time. I'll now turn it back to David Spector for closing remarks.

David Spector: I want to thank everyone for joining us here today and for giving us their time. And as always, if you have any questions, please don't hesitate to reach out to our IR team and Isaac and the team and thank you all very much for the time and thoughtful questions, and looking forward to speaking to all of you soon.

Operator: And thank you all for joining us this afternoon. We encourage with additional questions to contact our investor relations team by email or phone. Thank you. You may now disconnect.

Where to invest $1,000 right now

When our analyst team has a stock tip, it can pay to listen. After all, Stock Advisor’s total average return is 1,055%* — a market-crushing outperformance compared to 180% for the S&P 500.

They just revealed what they believe are the 10 best stocks for investors to buy right now, available when you join Stock Advisor.

See the stocks »

*Stock Advisor returns as of July 21, 2025

This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. Parts of this article were created using Large Language Models (LLMs) based on The Motley Fool's insights and investing approach. It has been reviewed by our AI quality control systems. Since LLMs cannot (currently) own stocks, it has no positions in any of the stocks mentioned. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see our Terms and Conditions for additional details, including our Obligatory Capitalized Disclaimers of Liability.

The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.