PennyMac Financial Services Inc (PFSI) 2025 Q2 法說會逐字稿

Good afternoon and welcome to PennyMac Financial Services Inc's second quarter 2025 earnings call. Additional earnings materials, including presentation slides that will be referred to in this call, are available on PennyMac financials’ website at pfsi.pennymac.com.

Before we begin, let me remind you that this call may contain forward-looking statements that are subject to certain risks identified on slide 2 of the earnings presentation that could cause the company's actual results to differ materially, as well as non-GAAP measures that have been reconciled to their GAAP equivalent in the earnings materials.

Now I'd like to introduce David Spector, PennyMac Financials’ Chairman and Chief Executive Officer; and Dan Perotti, PennyMac Financials’ Chief Financial Officer. Please go ahead.

Thank you, operator. Good afternoon and thank you to everyone for participating in our second quarter earnings call. For the second quarter, as shown on slide 3, 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 non-recurring 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 5, 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 10s throughout the remainder of this year. You can further see the strategic advantage of our comprehensive mortgage banking platform on slide 6 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 down second mortgage to access their home equity while retaining their low rate firstly 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 capturing growth in the expanded, in the expanding purchase market.

The chart on the bottom of slide 7 illustrates the projected growth and overall volume, which is primarily driven by the more consistent 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 in Broker Direct. Our market leadership is supported by our unmatched excellence and support for our business partnerships illustrated on slide 8.

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 9, we proudly showcase our position as the outright leader of correspondent lending.

Over the last 12 months, we have generated approximately $100 billion in UPB correspondent 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 15 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 expenses. 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 assures 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 direct, 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 Penny. 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 refinanced recapture rates are already twice the industry average, which effectively protects from 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 LA28 Olympic and Paralympic Games, along with targeted model-driven campaigns to increase our visibility and recognition while driving growth and recapturing new customer acquisition.

Turning the 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 multi-year investments in technology and process innovation have already driven meaningful improvements and 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, bringing 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're 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 corresponding franchise and growing Broker Direct lending presence, which provides consistent business volumes. 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. PFSI reported net income of $136 million in the second quarter for $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 non-recurring net tax benefit of $82 million.

The contribution from these items to diluted earnings per share was $0.19. CFSI's Board of Directors declared a second quarter common share dividend of $0.30 per share. Beginning with our with our production segment, pre-tax 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 fulfilment activity for PMT. Total lock 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 the last quarter.

PMC 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 July 1, 2025, all correspondent loans are initially acquired by PFSI.

However, PMT will retain the right to purchase up to 100% of non-government 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%, and 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 5100, 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 and second lanes 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 pre-tax income of $54 million excluding valuation-related changes, pre-tax 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 own portfolio averaged $7.5 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 8 basis points in 2020 to less than 5 basis points in the last 12 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 assets 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 practices to align with our increased direct lending capacity, and we currently expect lower hedge costs and greater consistency of hedge performance with respect to the direction of rate movements in future periods.

Corporate and other items contributed a pre-tax 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 non-recurring tax benefit of $82 million which primarily consisted of a repricing of deferred tax liabilities due to state apportionment changes driven by recent legislation.

TFSI'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 of unsecured senior notes due in 2032, and utilized a portion of the proceeds to redeem our initial unsecured debt offering of $650 million that was due later this year in October.

Additionally, we redeemed $500 million of GNMA MSR term notes due in May of 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.

(Operator Instructions)

Crispin Love, Piper Sandler

Thank you. Good afternoon, everyone. 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.

Sure, Crispin. This is Dan. Thanks for your question. With respect to the operating ROE dipping a bit to 13%, really, I would say driven by two factors in the quarter. One was related to on the production side, related to the margins in the in the channel, so those 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.

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 this is on page 18 of the deck. We typically see that those cross channel impacts fluctuate. We had a bit of a negative impact due to some of the interest rate and spread volatility.

In the second quarter, we did see some of that reverse itself. 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 corresponding channel.

And so as we look out with respect to production, moving forward for the next for the next few quarters, we expect improvement from the on a on a margin basis and in terms of the overall income from that channel. Looking at the servicing, on the servicing side did see a reduction in the pre-tax 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 non-operating expense items, so payoff related expenses and interest expense.

Some of those, especially related to some of the pre-payment activity, we don't necessarily expect to see at the same level that we saw that we saw this quarter. Additionally, interest expense includes certain one-time 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 is that our expectation as we're moving into the next couple of quarters in terms of our operating, our operating ROE is that we expect it to improve from the levels that we saw here in Q2.

And I think, look, I share the disappointment in the in kind of that lower number, but I will tell you what I've seen. It really is improving in the latter part of the quarter, and in July has been a continuation of the improvement.

I think that, we're seeing margins have fairly bottomed out and corresponding we're seeing a slight increase there as well as what we're seeing in Broker Direct is something similar and so, I think that, we're looking forward to continuing to participate in getting those margins up in both of those channels as well.

Great. Thank you very much, Dan and David for that color. Just a follow up for me on hedging going forward. Dan, you commented 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 just has that the recent rate stability helped as well just on the hedging side?

Sure. So overall, as I commented, we've adjusted some of our, approach to hedging to have a greater recognition of the 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 recapture 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, see that we did have a fairly significant costs in the quarter related to some of the interest rate volatility that we 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 race within a, in your bands to current rate levels and so we haven't changed our posture from that perspective, but given the our 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.

Great. Thank you for taking my questions.

Bose George, KBW

Hey, good afternoon. Just wanted to follow up on the profitability questions. Just in terms of the servicing portfolio, 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, I'd have thought that would be offset by a higher, servicing fee. So yes, it's just kind of a good way to think about what that number should be.

If you look back over the past few quarters, this was a bid in terms of the pre-tax income excluding market, excluding valuation changes, with a bit of a dip from what we've seen historically. As I said, there were some one-time items or items that were specific to this quarter, that impacted that generally at these, at the rate levels that we're at currently, which are a bit higher, and assuming not great, 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 9 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 this at these rate levels.

Okay, great. And the decline there or the increase, I guess in the basis points would be largely on lower amortization.

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 and the interest expense contribution. So, really some normalization across those different facets.

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

It's, it was primarily related in the quarter to really volatility of spreads, at least at 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 necessarily directly deliverable into agency execution that's driving higher margins in a number of our channels, but to the extent that we see spread volatility in those channels, can especially at certain points in the quarter can have a impact in that other line item.

Okay. So things like non-agency and seconds getting marked through there?

Yes, to the extent that it occurs after we've lost the loan.

Yeah. Okay. Great. Thank you.

Eric Hagan, BTIG.

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?

Yeah. So you can look at the outstanding debt that we have that is related to MSRs, is almost all or MSR term notes as well as the repo related to MSRs, which is all basically all floating rate debt, would be tied, so far 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, 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.

Yeah. Okay, that's good. 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 community banks either use the cash window more frequently or they keep loans in the portfolio by financing them at the FHLB? Like what's the, what are the conditions that might drive that?

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 own 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 going to continue to see corresponding aggregators to be very active in this higher for longer environment where you see retention taking place is typically when margins are wider and rates are at a perceived bottom.

And so I think, we're just, I think, coming out of coming out of COVID, we've seen this phenomenon only grow. The cash windows can get busier from time to time, but that's at their, that's at their discretion. It's not at the discretion of the seller, and typically those who do sell to the cash when there are more mortgage bankers that perhaps will aggregate servicing and auction it off.

But again, given the volatility in the markets, 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, but look, I think this speaks to how we're growing share in correspondence and just the level of feedback we're getting from our customers is pretty impactful and I continue 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 we continue to focus on here the things we can control. And things like, growing share, becoming more efficient, and continuing to reduce our expenses and deploy technology or things that we that we're focused on, and look, that kind of, that's kind of news 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 sharing correspondence.

Great stuff. Appreciate your comments. Thank you.

Michael Kaye, Wells Fargo

I wanted to see if you could dig into the loan origination expense line item. It was up a lot quarter over quarter. Was that driven by the Broker Direct volume? What's happening over there?

Yeah. That's exactly correct, Michael and 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, if you look at an individual transaction for our Broker Direct channel, we have a larger gain on sale that would be excluding the broker fee and then the broker fee, which is a pretty meaningful component showing up in origination expenses.

And so we'll see an outsize increase in those origination expenses as, compared to the overall total as broker becomes a greater percentage of our overall production or overall originations. We do look to normalize for that.

So in terms of the way that we think about margin, we really think of our gross margins or revenue margins being net of that broker that broker fee, and so 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 each of the individual lines so that broker direct margin that's reflected there of 87 basis points in this quarter is a net of that broker fee that is represented in origination expenses.

But as we continue to grow our broker direct originations that 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, than our other channels.

My follow up question. I don't think I've heard, during the call and any update on the subservicing initiatives? I know you had a, some early agreements the last quarter you mentioned and some negotiations still going on. Anything meaningful there?

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 are on servicing.

So I expect to see good activity before the end of the year on that front. Many correspondents, many of our correspondent customers who own servicing have either moved that servicing off their balance sheets or they're selling home 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 subservice who have who have their servicing place are waiting to see you know how things play out in the marketplace, and I think you know over the next 6 to 12 months, you'll see more servicing moving among subservices. And so we're just positioning ourselves to be one of those sub servicers to capitalize on the opportunity.

Doug Harder, UBS.

Thanks, Dan. As I look at slide 23 on unleverage, you talk that non-funding, the non-funding debt might sort of trend above your target. You just talk about, how you're thinking about leverage and, whether you view any constraints, from your current leverage level.

So yeah, we do not have any concerns from our current leverage level at elevated rates at the higher for longer as David had kind of had mentioned earlier. We do expect to run, we have a heavier emphasis on the servicing side of the business and the MSR assets. I mean that's driving our non-funding debt to equity levels a bit higher than 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 non-funding 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 so we don't have any concerns on the leverage side.

I share Dan's point of view from the rating agency's standpoint and from our business partner's 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 to the point Dan's raising, we've been very focused and judicious in how we think about leverage and how we think about the, that non-funding debt number, and I think, we're, it factors in how we think about pricing for servicing and how we price for loans and I think it's something that, 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 there are, we clearly have it front and center.

Great. I appreciate the thoughtful answer. Thank you.

Ryan Shelly, Bank of America.

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 period. So just any commentary or any specific, and Marcus to call out, there would be probably helpful. Thank you.

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, we are seeing relative stability in terms of delinquencies in the portfolio. Part of what has allowed us to hold in delinquencies in the portfolio is our judicious underwriting of the loans that we're bringing into the portfolio and so you can see the performance of for the more greatly exposed credit areas of the 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, and 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 the delinquencies in our portfolio.

But I think that while the delinquencies are advances are down, borrowers have a lot of equity built up in their properties, and they're 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 the number that I'm encouraged by the delinquencies of our recently originated vintages are low, lower than the overall industry, and that speaks to the point Dan made about our ability to diligence our loans and correspondent and to underwrite in broker and consumer direct, and that's, and that speaks to the risk management culture that we have here at the company.

Got it. Thank you. Thanks for the question. Very helpful.

Trevor Cranston, Citizens JMP.

Hey, thanks, follow up question on the change in the hedging strategy. If I understood correctly, you said it was mainly increasing the capacity at consumer direct, to improve recapture. So looking at slide 18, there's a note that says part of the increasing 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.

No, that's exactly correct. So the hedging or the -- the production expenses for Q2 to incorporate most of the additional capacity that we have brought on that has allowed us to feel comfortable repositioning our hedger or approaching our hedge strategy a bit differently. The overall 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 million to $3 million that of, 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.

If you look at the hedge performance of the $84 million, negative $54 million of it is hedge costs. And so, 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 costs.

Now, if you have that in your methodology, you want to make sure you're going to recapture the loans and 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, by what I'm saying, really even this quarter in terms of that hedge cost number, driving significantly lower, and so I think it's something that's going to lend itself to more consistent ROEs as we look forward.

Right. Okay. That makes sense. Thank you, guys.

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

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. Take care.

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