Third quarter earnings of Pennymac Financial Services show the double-edged sword of declining interest rates for corporate borrowers. It can improve loan origination and recovery but harm their servicing portfolio.
When including both impacts on its earnings, the California lender posted a profit of $69.4 million from July to September. That was below its $98 million profit in the second quarter of 2024, according to the data Securities and Exchange Commission (SEC) on Tuesday.
With lower rates and more opportunities to refinance loans, Pennymac generated $108 million in taxable income in Q3 2024 for its manufacturing segment, up from $41.3 million in Q2 2024 and $25.2 million in Q3 2023.
This was a reflection of increased volume rather than higher margins. Overall, loan originations and originations had an outstanding principal balance (UPB) of $31.7 billion in Q3, up 17% quarter-over-quarter and 26% year-over-year.
For the segment, production in its communications channel increased 19% quarterly to $28.3 billion in Q3 2024, while margins increased from 30 basis points to 33 bps. In the merchant channel, volumes increased by 23.2% from the second quarter to reach $5.3 billion, but margins decreased from 103 bps to 97 bps. The direct-to-consumer channel had a 92% increase in production to $5.2 billion, with margins falling from 393 bps to 323 bps.
“Pre-tax manufacturing segment income nearly tripled from last quarter as lower mortgage rates gave us the opportunity to help more customers in our servicing portfolio lower their monthly payments through refinancing,” Pennymac chairman and CEO David Spector told analysts on an earnings call.
“At the same time, our servicing portfolio – now close to $650 billion in outstanding balances and nearly 2.6 million customers – continues to grow, increasing revenue and cash flow contributions and providing lower cost leads to our direct consumer lending segment.”
The company’s services segment posted a pre-tax loss of $14.6 million in Q3 2024, compared to a pre-tax profit of $88.5 million in Q2 2024 and $101.2 million in Q3 2023.
Lower borrowing levels resulted in a decrease in the fair value of its servicing assets of $402.4 million, which was partially impacted by $242.1 million in hedge gains. When rates fall, prepayments rise as borrowers refinance, damaging the fair value of these assets. Pretax earnings were $151.4 million, excluding non-recurring items.
“Interest rates showed a lot of volatility during the quarter. The 10-year Treasury yield fell nearly 60 basis points in the third quarter and went from a high of 4.5% to a low of 3.6%,” Chief Financial Officer Daniel Perotti told analysts.
Perotti said the company “will seek to balance the impact of interest rate changes on the fair value of our MSRs through a comprehensive hedging strategy,” and will look at “production-related income, which increased significantly this quarter compared to last quarter.”
The management said that the company still aims to hedge an average of 80% of its rights to provide real estate. Relief assets will continue to be used to create more opportunities for recovery.
“As of September 30, nearly $200 billion in outstanding loans, more than 30% of the loans in our portfolio, had a rate above 5%, $90 billion of which was insured or guaranteed by the government, and $108 billion of which . it was a standard loan and others,” said Spector.
The company’s repayment rate is 52% for government loans and 34% for conventional loans. “We expect these acquisition rates to continue to improve given our multi-year investment, combined with increased investment in our brand and targeted marketing strategies,” Spector said.
He added that Pennymac made a decision earlier this year to increase capacity and will continue to look to grow, “given the natural growth of the portfolio.”
The company’s total expenses were $317.9 million in Q3 2024, up from $272.3 million in the previous quarter. The increase was “primarily due to an increase in manufacturing segment costs due to higher volume and share-based compensation expense,” the company said.
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