How Pennymac navigates the double-edged sword of lower rates
The financial data for the third quarter for Pennymac financial services illustrate the double-edged sword of falling interest rates for mortgage companies. It may improve credit production and acquisitions, but hurt their servicing portfolios.
Factoring in both earnings impacts, the California-based lender posted a profit of $69.4 million from July to September. That was less than the profit of $98 million in the second quarter of 2024, according to documents with the American newspaper The Guardian Securities and Exchange Commission (SEC) on Tuesday.
With lower rates and more options to refinance mortgages, Pennymac generated pre-tax income of $108 million in the manufacturing segment in the third quarter of 2024, compared to $41.3 million in the second quarter of 2024 and $25.2 million in the third quarter of 2023.
This was a reflection of higher volume rather than higher margins. Overall, acquisitions and loan originations had an unpaid principal balance (UPB) of $31.7 billion in the third quarter, up 17% quarter-over-quarter and 26% year-over-year.
By segment, correspondent channel production increased 19% quarter-over-quarter to $28.3 billion in Q3 2024, with margins increasing from 30 basis points to 33 basis points. In the broker channel, volumes increased 23.2% compared to the second quarter to $5.3 billion, but margins fell from 103 basis points to 97 basis points. The direct-to-consumer channel saw a 92% increase in production to $5.2 billion, with margins declining from 393 basis points to 323 basis points.
“Our pre-tax income in the manufacturing segment nearly tripled from last quarter as lower mortgage rates gave us the opportunity to help many customers in our servicing portfolio reduce their monthly mortgage payments through refinancing,” said Pennymac Chairman and CEO David Spector to analysts in an earnings call.
“At the same time, our servicing portfolio – now nearly $650 billion in unpaid principal and nearly 2.6 million customers – continues to grow, driving higher revenues and cash flow contributions and providing low-cost leads for our direct consumer lending division.”
The company’s services segment delivered a pre-tax loss of $14.6 million in the third quarter of 2024, compared to a pre-tax profit of $88.5 million in the second quarter of 2024 and $101.2 million in the third quarter of 2024 2023.
Lower mortgage rates resulted in a $402.4 million decrease in the fair value of assets under management, which was partially offset by $242.1 million in hedge gains. When interest rates fall, prepayments increase as borrowers refinance, hurting the fair value of these assets. Pre-tax profit amounted to $151.4 million, excluding valuation and one-off items.
“Interest rates showed significant volatility during the quarter. Ten-year Treasury yields fell about 60 basis points in the third quarter, ranging 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 moderate the impact of interest rate changes on the fair value of our MSRs through a comprehensive hedging strategy,” and that it will also take into account “production-related revenues, which were significantly higher this quarter than last quarter . ”
Executives said the company is still targeting a coverage ratio of about 80% on its mortgage liens. Servicing assets will continue to be used to create more refinancing opportunities.
“As of September 30, approximately $200 billion of unpaid principal, more than 30% of the loans in our portfolio, had interest rates above 5%, of which $90 billion were government insured or guaranteed loans, and $108 billion of which were conventional and other loans,” Spector said.
The company’s refinancing rate is 52% for government loans and 34% for conventional loans. “We expect these recapture rates to continue to improve given our multi-year investments, combined with increased investment in our brand and use of targeted marketing strategies,” Spector said.
He added that Pennymac made the decision earlier this year to increase capacity and will continue to pursue growth, “simply given the natural growth in the portfolio.”
The company’s total expenses were $317.9 million in the third quarter of 2024, compared to $272.3 million in the previous quarter. This increase was “primarily due to higher manufacturing segment costs due to higher volumes and stock-based compensation expenses,” the company said.
