PennyMac Financial Services, Inc. Common Stock 2026 Q3 Earnings Call

Please go ahead. Thank you, operator.

Good afternoon, and thank you to everyone for participating in our third quarter 2026 earnings call. Before discussing our financial results, I want to take a few moments to address the important leadership transitions we announced earlier today. First, after a storied career in the mortgage banking industry spanning several decades, including more than 15 years of exceptional leadership at PennyMac, Doug Jones, our President and Chief Mortgage Banking Officer, has made the decision to retire on June 30, 2027. Doug has been an integral partner to me and a cornerstone of PennyMac since its early days. Over the next several months, Doug's roles and responsibilities will transition smoothly to other senior leaders across our organization. Second, effective January 1, 2027, Kevin Ryan, currently our Chief Strategy Officer, will assume the role of Chief Financial Officer.

Dan Perotti, our current CFO, will remain in his current role through the end of this year and will continue supporting the company in an advisory role through the first quarter of 2027. Kevin will continue to lead our strategy and business development teams in addition to his financial leadership responsibilities. I want to express my extraordinary gratitude to both Doug and Dan for their long service to PennyMac, their relentless dedication, and their enduring passion for our business. Both served in critical leadership positions, guiding PennyMac through dynamic market cycles and helping transform our organization into the premier mortgage company it is today. Their countless contributions have shaped our foundation, and they will be greatly missed. Having said that, we have an exceptional leadership team and a deep bench of talent that is fully prepared to lead PennyMac into its next chapter.

I have absolute confidence in this management team's ability to carry our strategy forward seamlessly while driving long-term value for our stockholders. Turning now to our third quarter results on slide 3, PennyMac Financial generated $29 million of net income, or $0.54 in diluted earnings per share, representing a 3% annualized return on equity. Adjusted net income was $56 million, or $1.05 per share for a 5% adjusted return on equity, down slightly from the prior quarter. Our production segment recorded a pre-tax loss in the third quarter, driven by three primary factors. First, revenues declined significantly as fallout-adjusted lock volumes were down across each of our channels in response to higher mortgage rates. Second, while production expenses came down, they declined at a slower rate than revenues.

Production expenses are largely driven by funded unit volume rather than locks. Throughout the quarter, we were still processing and funding higher volume loan pipelines established under the prior, more favorable interest rate environment. Third, we have not yet fully realized the full impact of previously announced cost reductions. Servicing segment pre-tax income in the third quarter was $99 million. Excluding MSR fair value changes net of hedging, servicing segment pre-tax income was $132 million, up from $99 million in the prior quarter, primarily driven by lower realization of MSR cash flows and an increase in loan servicing fees, partially offset by lower interest income from custodial balances and EBO loan-related income. Slide 4 illustrates the constrained origination environment we are currently operating in. The primary 30-year fixed rate mortgage rose more than 90 basis points from June 30, ending the quarter at approximately 7.4%.

This sharp increase in mortgage rates has impacted the housing market and has driven significantly lower origination demand, particularly for borrowers looking to refinance into a lower rate. According to secondary market data, industry-wide rate and term agency deliveries have declined approximately 80% from the first quarter of this year. As you can see by the current distribution by agency mortgages by coupon, less than 1% of homeowners currently possess an incentive greater than 50 basis points to refinance. All of this has created one of the most constrained origination environments our industry has seen since 2023 when rates sharply increased in response to high inflation as we emerged from COVID. Although the origination market remains challenging, higher rates have driven prepayment speeds down to very low levels.

This has caused our servicing business to continue to produce strong operating profitability as amortization has declined and fee income has increased. This dynamic highlights the natural hedge embedded in our balanced business model and the power of our large servicing portfolio. Turning now to slide 5 for key business updates. First, we continue to make progress on the acquisition of Cenlar subservicing business and now expect the transition to close in the first quarter of 2027. Second, given a smaller projected origination market and the realization of efficiencies due to technology, we are completing additional aggressive and proactive expense reduction initiatives, which we project will result in $160 million of annualized expense reductions from the second quarter of 2026 to the first quarter of 2027.

We expect a modest sequential reduction from the third to the fourth quarter of this year, followed by a much more pronounced step down in the first quarter of 2027 as these initiatives fully run rate. While these actions reflect necessary staffing and operational reductions in response to a smaller origination market, significant process improvements driven by our continued technology enhancements have given us confidence in our ability to address our customers' needs, even if rates were to meaningfully decline. After quarter end, we entered into an agreement to sell $29 billion UPB of low coupon MSRs with an expected close in the fourth quarter. Net proceeds of approximately $490 million will primarily be used to pay down outstanding debt, lowering financing costs. I would also note we maintain an active share repurchase authorization from our board of directors.

Given where our common shares have traded relative to book value, as we've done historically, we will continue to opportunistically utilize our share repurchase authorization to create long-term value for our stockholders. Turning to slide 6 and looking ahead, while the near term presents cyclical origination market headwinds, we are aggressively executing on structural initiatives to permanently lower our cost structure and position PennyMac appropriately for the size of the market we're currently operating in. Given the smaller origination market and the ongoing execution of our expense adjustments through year-end, fourth quarter adjusted ROE is expected to remain near current levels. Turning to slide 7, we continue to rapidly accelerate AI automation across our origination business. Across our production workflows, process automation has progressed meaningfully, with 37% live in production and the remaining 28% currently in development expected to be completed by year-end.

Our automation efforts will continue into 2027, focused primarily on advancing our AI voice agent capabilities and deploying AI agents into our broker direct channel once live on our next generation loan origination system. We have already developed 22 proprietary AI agents that are live in production, which have completed more than 205,000 automated agent executions and over 200,000 automated document reviews with an additional 17 agents currently in the development pipeline. Our proprietary AI voice agent is already driving meaningful origination volume. In the third quarter alone, it supported more than 15,000 transfers and contributed to over 1,600 rate locks. Just as importantly, this voice agent provides us the ability to rapidly add capacity to meet the demand generated by a market rally, enabling borrower self-service and thereby reducing hold times and lost sales opportunities.

By automating labor-intensive fulfillment workflows, we are permanently lowering our cost to produce and uncoupling platform capacity from staffing requirements. This will allow us to maintain lean operation in today's constrained environment while ensuring substantial operating leverage when origination volumes normalize. Turning to slide 8, this highlights the opportunity in our consumer direct channel when interest rates decline, as well as the meaningful improvement in our first lien refinance recapture rates in recent periods. As of September 30th, we serviced a combined $355 billion in UPB of loans with note rates above 5%, of which more than 60%, or approximately $220 billion in UPB, had note rates above 6%. As shown on the right, our first lien recapture rate remained near record highs at 44%, up nine percentage points from the prior year.

The slight decline from the prior quarter reflects a broader market shift towards more credit-sensitive cash-outs versus rate and term refinances, where we can traditionally see our highest conversion rates. Given the size of our servicing portfolio, our technology foundation, and our accelerating recapture trends, we are highly confident in our ability to execute on this opportunity, driving towards our long-term ROE targets when interest rates do decline. Now I'd like to introduce our current Chief Strategy Officer and incoming CFO, Kevin Ryan.

Thank you, David. I am honored and excited to assume the CFO role here at PennyMac, and I want to thank David and the board for their trust and confidence. I also want to express my sincere gratitude to Dan. Over his years of leadership, Dan has built an exceptional world-class finance organization and established a remarkably resilient balance sheet. He and I will be working closely together over the coming months to ensure continuity and a seamless operational handoff. Having spent the past year leading our corporate strategy and business development initiatives, I've had the privilege of working alongside our leaders in production, servicing, and technology. Bringing finance, strategy, and business development together under one umbrella allows us to tightly integrate our long-term vision with real-time capital allocation and financial execution.