PFSI Earnings Call

OperatorGood afternoon and welcome to PennyMac Financial Services Inc.'s second quarter 2026 earnings call. After today's prepared remarks, we will host a question and answer session. If you would like to ask a question, please press *1 to raise your hand. To withdraw your question, press *1 again. Additional earnings materials, including presentation slides that will be referred to in this call, as well as an Excel file with supplemental information, are available on PennyMac Financial's website at pfsi.pennymac.com.

OperatorBefore we begin, let me remind you that this call may contain forward-looking statements 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. I'd now like to introduce David Spector, PennyMac Financial's Chairman and Chief Executive Officer, and Dan Perotti, Pennymac Financial's Chief Financial Officer. Please go ahead.

David SpectorThank you, operator. Good afternoon, and thank you to everyone for participating in our second quarter 2026 earnings call. As shown on slide 3, Pennymac Financial generated net income of $22 million in the second quarter, or $0.41 in earnings per diluted share, representing a 2% annualized return on equity. While interest rate volatility during the quarter created non-cash MSR valuation headwinds that impacted our GAAP results, our underlying adjusted earnings per share came in at $1.39, or 7% annualized adjusted return on equity. Although our operational execution remains solid, these results fell short of our expectations as interest rates increased and origination demand declined. To address these rate headwinds, we have already taken proactive steps to align our cost structure with current market conditions and the operational capabilities provided by recent enhancements to our technology platform.

David SpectorOur results were also impacted by our current funding of major technology initiatives in AI and automation that will structurally lower our cost to produce and cost to service while enhancing the customer experience and expanding our origination servicing capacity. At the same time, I'm particularly encouraged by the strong underlying operational momentum across our platform, highlighted by the meaningful increase in our recapture rates. Turning to slide 4, let's review several key business updates. First, the transaction— the transition to our new consumer direct loan origination system has helped to facilitate our rapid deployment and development of process automating AI agents. Another example of our technology transformation is the recent launch of our proprietary Natural Language Virtual Agent, or NLVA, which handles 24/7 conversational voice interactions across both inbound and outbound customer calls.

David SpectorThis technology deployment is already directly benefiting customer engagement and retention. Conventional first lien refinance recapture rates increased 7 percentage points from the prior quarter to 29%, while government first lien refinance recapture rates increased 9 percentage points to 59%. Third, we continue to make excellent progress toward onboarding Cenlar subservicing portfolio, with the transaction on track to close in the fourth quarter. And finally, we expanded our strategic partnership with Amazon Web Services to further bolster our transformation as an AI-driven mortgage technology leader. Turning to slide 5, I want to address our financial outlook and the steps we are taking to right-size our cost structure. With a smaller projected origination market due to higher interest rates, we expect adjusted ROEs to remain in the high single digits through 2026 as we reduce our expense base.

David SpectorEarlier this month, we took targeted actions to reduce our production footprint and adjust staffing levels to better align with the smaller market. And because of our investments in technology, we are able to execute these expense reductions while preserving operational capacity when mortgage demand increases. With exciting new technology fully deployed in our consumer direct channel, and our AI agents expanding rapidly, we are laying the foundation for unprecedented operational capacity and long-term ROE expansion. Turning to slide 6, while our near-term outlook reflects high single-digit adjusted ROEs through the back half of this year, we see a well-defined and visible path back to mid-teens ROEs. The cost realignments we executed this month are expected to generate approximately $60 million of annualized cost savings, which will begin to be realized in the third quarter. We believe expansion in our ROEs will be driven by the structural operating leverage we are creating across the enterprise.

David SpectorOur proprietary AI agents and workflow automation are permanently lowering both our cost to produce and cost to service, expanding our operating margins without adding fixed overhead. Our trajectory towards higher returns is also based on the operational momentum we are building today with continued growth in broker direct and in consumer direct, with a meaningful increase in our recapture rates positions us to capture upside as the origination market normalizes. And while we are currently running at a higher expense base to fund our tech transformation, these technology expenses have begun to decline, and we expect they will continue trending lower. As we pair this technology foundation with the capital-light scale of Cenlar subservicing portfolio in the coming months, we expect to realize significant operating leverage. Slide 7 highlights the opportunity in our consumer direct channel if interest rates decline, as well as our first lien refinance recapture rates over the 5 most recent quarters.

David SpectorAs of June 30th, we serviced a combined $343 billion in UPB of loans with note rates above 5%, of which more than half had note rates above 6%. As you can see on the charts in the middle of the page, government refinance originations from our portfolio in the consumer direct channel have more than doubled from the second quarter of 2025, as our refinance recapture rates have grown to 59% from 44%. We are seeing even more success in conventional loans, where volumes are up nearly threefold from levels reported in the second quarter of 2025. Driven by a significant improvement in recapture rates to 29% from 17%. Given the size of our servicing portfolio, our technology foundation, and our accelerating recapture trends, we feel a high level of conviction in our ability to execute on this opportunity as refinance demand grows. Turning to slide 8, our servicing segment continues to demonstrate the power of scale combined with our advanced technology, otherwise known as PLACE.

David SpectorAccording to the latest MBA study, PennyMac's direct servicing expense per loan was $89 in 2025, down 8% from 2024 and far below both the large IMB average of $133 and the overall industry average of $185. And we've achieved these low costs despite our higher concentration of government loans, which are inherently more complex and costly to service. As you can see, our operating expenses remain extremely low at 4.5 basis points of average servicing UPB. The combination of our proven low cost to service and AI capabilities gives me confidence that we will continue to drive down unit costs and expand platform efficiencies as we prepare to onboard Cenlar subservicing portfolio. Slide 9 details the transformative operational gains we are realizing in production. Consumer Direct has facilitated a rapid implementation of process-automated and AI agents, and we are now beginning the transition of this to— into our broker direct channel to deliver these same structural efficiencies and automation gains to our broker partners.

David SpectorAcross our production workflows, we have mapped and standardized 150 discrete origination tasks. Today, approximately 25% of these tasks are being completed by automated logic or AI agents, and we are targeting 80% by year-end 2027. This technology is delivering immediate measurable benefits. We have already seen a significant reduction in our processing cost to produce a loan, and we are targeting an additional 20% or more by the end of the third quarter. Similarly, we've seen dramatic cycle time reductions of 40 to 80% across major loan programs, specifically from application to conditional approval on files where our autonomous AI agents are deployed. Speed is a direct cost saver, and closing loans faster allows us to price more profitably through shorter lock windows, drastically reduces fallout while delivering a best-in-class experience for our borrowers. And I believe we are still in the early stages of this transformation as we scale AI automation, onboard Cenlar's capital light subservicing portfolio, and capitalize on our consumer direct recapture momentum, we are establishing a permanent structural advantage that will compound across our platform for years to come.

David SpectorWe have the right strategy, the scale, and the technology to navigate current market headwinds while driving a clear return to mid-teens ROEs and delivering compelling long-term value for us, for our stockholders. I will now turn it over to Dan, who will review the drivers of PFSI's second quarter financial performance.

Dan PerottiThank you, David. PFSI reported net income of $22 million in the second quarter, or $0.41 in earnings per share, for an annualized ROE of 2%. Adjusted net income was $74 million, or $1.39 in adjusted earnings per share, for an annualized adjusted ROE of 7%. The $0.98 difference between our GAAP and adjusted EPS was driven by $77 million of fair value declines on MSRs net of hedges and costs, a $9 million valuation gain related to our minority interest in Vesta, and $1 million of expenses related to our acquisition of Cenlar Subservicing Business. PFSI's Board of Directors declared a second quarter common share dividend of $0.30 per share. On slides 11 and 12, beginning with our Production segment, pretax income was $38 million, down from $134 million in the prior quarter and $58 million in the second quarter of 2025. Total acquisition and origination volumes were $35 billion in unpaid principal balance, down 6% from the prior quarter and 8% from the second quarter of last year.

Dan PerottiOf this, $32 billion was for PFSI's own account, and $3 billion was fee-based fulfillment activity for PMT. PennyMac maintained its leading position in correspondent lending. The revenue contribution from the channel was down $9 million from the prior quarter. Fallout-adjusted lock volumes were down compared to previous periods due to higher rates in a highly competitive environment, which includes the GSEs. Correspondent margins were 29 basis points, up from 28 basis points in the prior quarter due to a shift in mix toward higher-margin government loans. Under its fulfillment agreement, PMT retains the right to purchase all non-government correspondent loan production from PFSI. However, In June, PMT elected to stop acquiring agency-eligible conventional loans through correspondent production, but will continue acquiring 100% of all non-agency loans. In July, correspondent volumes were down versus second quarter levels, reflecting our pricing discipline in a competitive environment and our continued focus on allocating capital to drive optimal returns.

Dan PerottiIn BrokerDirect, we continue to see strong momentum despite increasing levels of competition, and the number of brokers approved to do business with us continues to grow, reflecting brokers who are increasingly leveraging our distinct value proposition. BrokerDirect's revenue contribution was down $3 million from the prior quarter. Fallout-adjusted lock volumes were down 8%, but were up 21% from the second quarter of 2025, driven by market share gains and a larger origination market. Margins increased to 104 basis points from 99 basis points in the prior quarter. Non-QM locks in our broker channel more than tripled from the prior quarter to $515 million in UPB, underscoring the positive reception and rapid market adoption of our expanding product menu. The revenue contribution from our consumer direct channel declined $36 million from the prior quarter as a as higher interest rates resulted in lower refinance demand.

Dan PerottiFallout-adjusted lock volumes were down 32% from the prior quarter, and margins were up to 317 basis points from 267 basis points in the prior quarter, reflecting an increase in closed-end second lien production as refinance volumes declined. Post-lock impacts across the channels resulted in a $23 million pretax loss compared to $13 million of pretax income in the prior quarter. This $36 million shift was driven by adverse market price changes on specialized pools and other cross-channel impacts. Production expenses, net of loan origination expense, increased 6% from the prior quarter due to increased capacity and funded unit volume in the consumer direct lending channel. As David mentioned, the cost realignments we executed in July are expected to be reflected in our third quarter results. Turning to the Servicing segment on slides 13 and 14, our total servicing portfolio UPB ended the quarter at $731 billion, up 1% from the end of the prior quarter and 4% from June 30th, 2025, as production volumes more than offset runoff due to prepayments.

Dan PerottiThe Servicing segment recorded pretax income of $22 million. Excluding valuation-related changes, pretax income was $99 million,, or 5.5 basis points of average servicing portfolio UPB, up from $57 million, or 3.1 basis points, in the prior quarter. Average custodial deposit balances increased 7% from seasonal lows in the prior quarter, driving a $14 million increase in earnings on custodial balances and deposits. Realized prepayment speeds were 11.6%, down from 13.7% in the prior quarter. Realization of cash flows declined 9% as prepayment speeds declined. Operating expenses in the quarter were 4.2 basis points of average servicing portfolio UPB, or $76 million, both lower than prior quarters. Income from EBO activities was higher as buyout and redelivery volumes increased from the prior quarter. Including the provision for losses on active loans, the fair value of PFSI's MSR increased by $110 million.

Dan Perotti$96 Million was due to changes in market interest rates, and another $13 million was due to other model and performance-related impacts. Hedge fair value losses, including principal-only bond accretion changes, were $135 million. Hedge costs were $52 million, up from $14 million last quarter, reflecting elevated option pricing due to heightened interest rate volatility. While rate movements created some adverse impacts in May, our hedging strategy was highly effective for the remainder of the quarter. Our hedge ratio remains near 100% to proactively manage prepayment risk. Coming out of the quarter, hedge costs have moderated significantly, trending in the mid-single-digit millions of dollars. Maintaining a disciplined, continuous hedge is central to how we manage risk. Rather than leaving our balance sheet exposed to directional rate impacts, we prioritize book value preservation to protect stockholder capital across all market environments.

Dan PerottiCorporate and other items recorded a pretax loss of $29 million, down from $42 million in the prior quarter, as the prior quarter's expenses included elevated marketing expense related to the Olympic and Paralympic Winter Games. PFSI recorded a provision for tax expense of $10 million, resulting in an effective tax rate of 31%. Total debt-to-equity at quarter end was 3.6 times, down from 4 times at the end of the prior quarter, and non-funding debt-to-equity was 1.8x, up slightly from the end of the prior quarter. The decrease in total leverage from the prior quarter was driven by a decline in funding debt, reflecting lower overall production. The increase in non-funding leverage from the prior quarter was driven by higher interest rates, which drove increased utilization of our MSR credit facilities. We expect these leverage ratios to remain near these levels as interest rates remain high. Finally, 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.

Dan PerottiWe'll now open it up for questions. Operator?

OperatorWe will now begin the question and answer session. Please limit yourself to one question and one follow-up. If you would like to ask a question, Please press *1 to raise your hand. To withdraw your question, press *1 again. We ask that you pick up your handset when asking a question to allow for optimum sound quality. If you're muted locally, please remember to unmute your device. Please stand by while we compile the Q&A roster.

OperatorYour first question comes from the line of Doug Harter with BTIG. Your line is open. Please go ahead.

Doug HarterThanks and good afternoon. Um, just talk about how you're balancing kind of trying to take costs out that you mentioned with also kind of being prepared if we ultimately do get a reversal in rate. To not kind of be caught short in capacity like you were late last year?

David SpectorYeah. Hi, Doug. Thanks so much for the question. So, look, as you know, we've always been disciplined in how we think about expenses and capacity. And look, I think that one of the things that we did at the end of last year and we talked about was adding capacity in the event that the market did decline. What's, what's really exciting for me is that in the technology work that we've been doing on the new loan origination platform, we're creating that excess capacity. And so there's— it's going to lead to really a meaningful reduction in costs. And really what the cost, the cost reduction that we're talking about is $60 million annually. And it's, it's really, you know, coming, coming about as a result of one, you know, rates being higher, but also as we've gotten more and more confident with the technology, we feel, we feel very comfortable and convicted that the excess capacity that we brought on at the end of last year is no longer needed.

David SpectorAnd, you know, the And as we sit here today, as we've talked about, there's a lot of work that we're doing to continue to chip away at that. But I think where also I think we've really shined these last few quarters is just the continued growth of recapture. And so when you look at the recapture rates that we're getting on both the government and the conventional servicing portfolios, they're very, very good. And so I think, you know, I believe that, you know, as we get a normalized market, this work that we're doing, that we've done, is going to allow us to maintain the recapture levels, you know, as we get into a bigger market.

Doug HarterGreat. Appreciate that, David. And then just quickly, the ROE As you kind of laid out the path back to mid-teens, does that require lower rates, or do you think you can get there with the current rate environment?

David SpectorLook, I think, I think the path that we've laid out at this level, and, you know, we're, we're at very high levels of rates. You know, today I saw the 10 years at a— I'm sorry, the 30 years at a 20-year high. And so at this level of rates, I would say that the that the path we've laid out is more weighted to an exit of 2027. Obviously, if rates were to decline, that would accelerate, you know, getting there, just getting there faster.

Doug HarterGreat. Thank you.

OperatorYour next question from the line of Mark DeVries with Deutsche Bank. Your line is open. Please go ahead.

Mark DeVriesThank you. David, when you think about kind of getting to your objective of the drive to 55, you just talk about how much of that is coming from added operating efficiency versus just scale and how much does Cenlar kind of help get you there?

David SpectorBecause we, as we look at the drive to 55, we're really focused on cutting actual expenses without really leaning into growing the denominator, as you would talk about in terms of adding Cenlar. There is a lot of, you know, AI agents being developed to be put into place for us to be able to drive down the costs. Obviously, with the scale in place, not just from Cenlar but from our own activity, that will accelerate to get down to 55. But, you know, my feeling is, is that there's a lot of, you know, deeper servicing integrations that need to take place. There's a lot of additional agents that need, that need to be built. Um, and I think, you know, from the, from the team standpoint, when we look at it We look at it just in terms of the current effect of the activity vis-à-vis the current expense structure, not focusing necessarily on the scale itself. As I said, the scale always helps.

Mark DeVriesOkay, that's helpful. And then, Dan, I think you indicated that, you know, hedge costs have actually come down a lot since the end of the quarter. Although we've had another obviously big spike in rates and a lot of volatility, could you just talk about how, you know, the hedge is performing so far quarter to date?

Dan PerottiSo far quarter to date, the hedge overall has been more stable than what we saw in the second quarter. And especially with the emphasis on hedge costs, given what we saw in the second quarter, we've adjusted Some of our practices in terms of readjusting, readjusting our hedges, that was part of what contributed to our overall, the overall cost during the quarter was given the volatility and the overall realized volatility during the quarter and the impact that that has on the MSR adjusting fairly frequently. We've calibrated our practices to minimize that, the amount of impact that has. And that has been, despite the fact that we've had a little bit of uptick of volatility here in the last couple of days, has been beneficial. And we've been able to maintain a lower run rate of hedge costs going here into the third quarter. So overall, tracking much better, especially on the hedge cost side, than what we saw in the second quarter.

Mark DeVriesGood. Thank you.

OperatorYour next question comes from the line of Crispin Love with Piper Sandler. Your line is open. Please go ahead.

Crispin LoveThank you. Good afternoon. Appreciate taking my question. Just on the ROE outlook, how would you frame 2027 based on what you know today. Previously you were expecting getting back to that low to mid-teens by the end of '26, but that's pushed out now. So would you expect ROEs to grind higher from the end of the year into 2027? So looking at a low to mid-double digits in '27, or could there be a step function higher just based on the environment? Just curious on how you're thinking about this.

David SpectorYeah, look, I think, I think, Crispin, you you have it identified correctly. I think, you know, as we look at where we are in rates today, combined with the fact that we're going to be reducing expenses throughout the year, I view us leaving 2026, you know, kind of in the lower part of that range, call it, you know, high single digits to low double digits. I generally think that, you know, throughout the year, '27, that's when you'll see the step up to the mid, you know, to the mid-teens level that we spoke about. I think there's going to be real benefit to some of the key initiatives we're working on in 2027, you know, including things like getting our broker direct channel onto Vesta. That's going to be a key component that we should have them on by the middle of 2027. I think we'll begin the work in terms of transitioning Cenlar onto the servicing portfolio and achieving some of the efficiencies there.

David SpectorAnd I think that, you know, we're gonna continue to focus on driving down the cost to originate in our consumer direct channel. But I think that, you know, obviously as you're, as everyone on the call is aware of it, you know, the path to how quickly we get that. There is a, there is an interest rate component to that, but even without interest rates moving, I, I feel good about exiting '27 at these levels, at the mid, you know, the mid-teens levels that we talk about.

Crispin LoveAll right, uh, great, David. Appreciate the color there. And then just on the broker channel, you, you discussed elevated competition. Um, looking in your deck, your market share over the past, uh, year or so is about 6%. Can you remind us of your, of your targets here? What was it, getting to 10% by the end of '26? First, is that still attainable? Is there investment needed there that may be now on hold just given the plans? And what would you need to do to get there? Thank you.

David SpectorYeah, so look, I think that our view in terms of share growth and broker direct or TPO is number one, we want to do it profitably. And we're being disciplined in how we, how we approach that. Obviously, that part of the market, it's been a little bit more volatile with some of the market participants. I will tell you that given the work we're doing in terms of getting broker onto Vesta, I don't see us getting to that 10% market share by the end of '26. But I can tell you that brokers, I think, are going to be really enthusiastic about what they're going to see when we get broker on there in mid-'27. So, you know, we don't want to do anything irrational or do anything that's not disciplined. And so that's how we're thinking about the broker channel.

Crispin LoveGreat. Thank you, David. Appreciate the question.

OperatorYour next question from the line of Terry Ma with Barclays. Your line is open. Please go ahead.

Terry MaHey, thank you. Good evening. I guess maybe just on the ROE guide, is it still the target that high teens, low 20s is the kind of right normalized ROE for the business going forward? And then as we kind of think about it, any reason why it can't be higher than that with all the enhanced efficiencies from tech investments that you're making?

David SpectorYeah, so look, it is the mid— the high teens to low 20s is a guiding principle of this, this company, and it will be— continue to be a guiding principle of this company. I think that what we're in the midst of now is, one, we're at the high of rates. Two, we're investing a lot in technology, and that's an investment for the long term to create a consistent high teens to low 20s operating company. And so I think that, you know, it's going to continue to grind up there, and I see that, you know, we are going to be one of a few winners because we can afford to make the investment in the technology and to build something clearly unique in the market. And when you combine what we're doing on the production side to what we're doing on the servicing side, that's something to me that is, that is truly, truly unique. You know, our servicing, our servicing technology is something that has, I think, served us really well, as you can see, as you know, as we've talked about.

David SpectorIt's, you know, we are, we're the low-cost servicer by a meaningful, meaningful amount. Industry parties see the low cost, they see the scale benefits. It doesn't go unnoticed. And I think, you know, as we, as we think about continuing to drive down costs, I think we are really the only ones who can get down to $55 a loan. And that's, by the way, with a heavy government portfolio. And so what, what we're in the midst of right now is a, is a perfect storm of negatively of sorts, where the fact that we are investing a lot in the future and in technology, combined with the fact that we see rates, you know, at, at high levels as it pertains to this cycle. And, and so I, you know, I, I think that you're going to see a company coming out of this. I truly believe that, you know, we We are going to live by the high teens to low 20s north star that we've run this company on for the last 18 years.

Terry MaGot it. That's helpful. And then on the recapture rates you guys show on slide 7, it's good to see the consistent improvement as you embark on this tech journey. I guess, is there a target or a goal in mind that you have, like, after you kind of run rate all these improvements? Improvements, just trying to figure out what the upside is. Thank you.

David SpectorYeah, so look, the, you know, the target for us is we want to recapture every possible loan that we can, and the work that the team is doing both operationally and analytically using AI is allowing us to meaningfully grow our recapture levels. And I think that as we deploy the work in Vesta to close loans faster, to close loans cheaper, though those recapture rates are going to be growing even more. Um, the idea that you can close a VA IRRRL in 14 days when the rest of the market is taking 34 days is a meaningful competitive advantage, and that's something that we're guiding towards. And so I think it's more, you know, we're looking at it as ways to, you know, drive down the cost to originate, drive down, drive down the days to close. And then the investment in technology and the consumer experience, I believe, will continue to see those recapture rates grow.

OperatorYour next question comes from the line of Bose George with KBW. Your line is open. Please go ahead.

Bose GeorgeOkay. Good afternoon. Actually, your volume in the correspondent channel, you know, looked like it declined again, or at least the share probably declined a little bit again. Can you just talk about the competitive, you know, dynamics there? Is it still the cash window? Are there other factors? And then, you know, when we just think about the share, do you think it kind of stays at this level, you know, for the foreseeable future until something changes?

David SpectorYeah, look, I think that, you know, in correspondent, we have a combination of factors taking place. As you point out, we're seeing the GSEs continue to be aggressive, and on some days they're even more aggressive through the cash window. And so that's, that's a meaningful That's a meaningful change from even Q4 of last year. We are maintaining our pricing discipline. You know, we have a very large servicing portfolio with a lot of loans that would become refinancable in the event of an interest rate decline. And I think, you know, we want to, want to maintain our dry powder should, you know, perhaps rates move higher and we need more leads or we want to do more activity. And likewise, I think that, you know, we want to do so at, you know, adhering to our margin discipline. I do think that, you know, there are market participants at the time to time that perhaps are, are being, you know, a bit, a bit irrational.

David SpectorBut I wouldn't read too much into the correspondent decline. I think it's, it's more, again, you know, the combination of the GSEs and from time to time other participants, but we're still the leaders in the space and will continue to be the leaders in the space.

Bose GeorgeSo, okay, helpful. Thanks. And then actually just looking at the difference between the GAAP and operating results, I mean, is there, you know, something structural like maybe Ginnie Mae convexity which just makes it harder to hedge that asset? And, and do you, I mean, are you comfortable that that gap will close in the mid-teens next year? Is both the GAAP and an operating ROE.

David SpectorYeah, look, let me, let me, let me talk about, you know, the results and the hedge and where we sit today. You know, as everyone knows, the hedge we have in place protects MSR values against interest rate moves. And I think, and I know in this quarter we did that. The MSR rose by $110 million and the hedge offset as intended, which we had $135 million loss on rate moves. What we had was $52 million of hedge costs. And so that's what— so those two components are what resulted in our $77 million loss. Putting aside the $52 million of hedge costs for a minute, the underlying protection worked well. And, you know, rather than an intentional attempt to perhaps hedge out sell-off gains, or, you know, this was driven by a somewhat conservative positioning for an interest rate rally that ultimately didn't materialize, which naturally neutralized our sensitivity as rates moved higher. And I say interest rate rally, not that we're making necessarily market calls, it's just we're running a hedge coverage ratio of close to 100%.

David SpectorAnd so Really, what, what, you know, the net result really came down to this perfect storm and unusual volatility disconnect and really some specific headwinds. And that was really a few things. One was volatility. I mean, Q2 volatility traded in a tight 40 basis point range, primarily on the geopolitical tension and the widening distribution of monetary policy. Outcomes, and we saw a sharp diversion between implied and realized volatility. As a matter of fact, in the second quarter, this was a quarter that the largest quarterly drop in short-dated implied volatility in 15 years, where realized volatility didn't decline. And so this, that drove a loss on the option holdings that we have. And furthermore, as we had to rebalance as rates As rates went up, the rebalancing costs were elevated. At the same time, we had this kind of weird phenomenon where agency MBS spreads widened as rates moved higher, which further magnified our MSR's negative convexity.

David SpectorAnd to manage that, we had to reduce our positive-carrying MBS holdings, which pushed hedge costs higher. And so really, I think what, What we've done is we've seen, we've maintained our discipline, we're hedging the MSR. As Dan pointed out, hedge costs this quarter are down to the mid-single-digit millions, and we're keeping the book positioned for a wide range of rate and economic outcomes. And I think, you know, the hedging story is one that is not going to be unique to us. And I think when the, when the, when, you know, whenever, you know, when we see how everyone else has done I think you're going to see that we actually did a very good job with it. It was just the hedge cost that really in this perfect storm that led to the $77 million loss.

Bose GeorgeOkay, great. Thanks a lot for the detail.

David SpectorYou bet.

OperatorYour next question from the line of Don Fandetti with Wells Fargo. Your line is open. Please go ahead.

Don FandettiHi, can you talk about Q2 margins for broker and consumer direct? If you kind of strip out some of the non-QM and second lien, just sort of directionally, and where you think those could be going near term, just given a smaller market?

David SpectorSo look, I think that, you know, as we see in broker direct margins, margins have been pretty consistent. Pretty steady. You know, I think, you know, we, we have broker direct margins, you know, running roughly 100 basis points. And I think that, you know, there's, there's still, you know, from, you know, from, you know, from time to time we see some pressures from other larger market participants. Um, they were up in Q2, you know, from a, from 99 to 104. Um, but I, I generally think that you know, we're going to see rational pricing taking place. Obviously, the non-QM, as you, as you well pointed out, and jumbo margins are higher, and that, you know, leads to higher reported margins. But I would say, generally speaking, that the margin story in broker direct, and as well as correspondent consumer direct, are, you know, are staying very steady.

Don FandettiGot it. And I You know, back to the ROE commentary, thanks for all the detail and covered a lot of angles. I guess I'm just trying to understand, you know, the sort of path to the increasing ROE. Can you do that in this type of rate market? Let's say, you know, the 10-year goes up a little bit. Can you sort of still hit that upward slope through some of the efficiencies and things of that nature?

David SpectorI believe so. And I truly believe that. I think number one, you take, for example, the $60 million cost reductions that we just announced. And look, there's gonna be additional efficiencies that we're gonna see both in our consumer direct channel and in our broker direct channels. We get broker direct onto Vesta. And so this is gonna have a meaningful effect in terms of the cost to originate. I also believe that we're going to continue to, you know, grow share profitably in broker direct. And I think, you know, as we grow our servicing portfolio, you can't help but grow share a bit in the consumer direct channel while, you know, having a very— being able to compete in a meaningful way and being the low-cost producer will allow us to grow profitability. In addition, I think, you know, there's a— there's— I don't want to say there's a finite amount of tech initiatives. Well, I will say is we have a lot of tech initiatives taking place at the moment, and as we wind those down, of course there will be others that arise.

David SpectorBut I think generally speaking, our tech spend is going to come down in a meaningful way, not just from the, the number of tech initiatives, but also the cost The cost to develop AI agents, the cost for developers to do their work is dramatically decreasing as they use AI tools like Claude Code and Cursor. And so I think you'll see tech expense coming down in a meaningful way. And then this is even before we start bringing on the benefits coming out of the Cenlar transaction. And that's going to have a meaningful effect. And what's exciting about that is it's, you know, it's capital-light fee growth, which is an area of our company that has real potential to continue to grow. Cenlar is going to continue to add clients. Um, we've, we've been in the subservicing business for now, you know, 4 years. We, we added up a couple clients ourselves this quarter. Obviously it's going to come together as one platform.

David SpectorBut I think we'll get real benefits there. And as we bring the Cenlar clients onto our platform, we're going to get the efficiencies that come from being a higher-cost platform to a lower-cost platform.

Dan PerottiAnd I think just to add on to that, in terms of, you know, in terms of a lot of these initiatives, as David mentioned, are, you know, in particular in servicing, reducing the cost to service adding the equity-like flows are not rate dependent and bringing down the technology expense are not rate dependent, you know, are not rate dependent at all. Expanding our presence in the direct lending channels, you know, from the base that we are today is, you know, is also not rate dependent, but will, you know, expand our overall earnings. And I'd say if you look at our historical operating ROEs going back to the first half of last year where we were in the mid-teens returns, you know, it's, it's a— we've shown that we can reach those levels even at these higher, you know, these higher interest rate levels. We were at around the same level of rates, you know, at the beginning half of last year, and that's before we add some of these other additional drivers.

OperatorYour next question comes from the line of Trevor Cranston with Citizens JMP. Your line is open. Please go ahead.

Trevor CranstonHey, thanks. One more question on the expense side of things, and I appreciate all the color you've given there and the expectation for near-term savings levels.

Trevor CranstonLooking at slide 9, you know, you have the target there for the year-end '27 of getting up to kind of 80% of the workflow automated. Is there a way to sort of translate that goal of moving from 25% to 80% into kind of expense savings in terms of the cost to produce per loan sort of beyond the kind of 20% near-term target you guys have shown there on the top right? Thanks.

David SpectorYou know, I think that, you know, as we sit here today, I think the 25% is what I would call more low-hanging fruit. We're seeing, you know, the expense reduction coming in, you know, about 25-30%. I think it's, you know, You know, that 80% number, you know, I would be remiss if I had a ballpark number. I think, look, a lot of it is going to depend on the scale of the organization and it's going to further, you know, I think depend on volumes to some degree. But suffice it to say that should come down. Look, the cost to originate should come down by more than 50%. Okay, that's a given. Whether it's 60, 65, I don't— you know, I think that we'll have a better sense of that in the coming quarters.

Trevor CranstonGot it. That makes sense. Okay, thank you.

David SpectorThanks, Trevor. Good question.

OperatorYour next question comes from the line of Kyle Joseph with Stephens. Your line is open. Please go ahead.

Kyle JosephHey, good afternoon. Thanks for taking my questions. Um, just kind of wanted to refresh, going, going over to the balance sheet, uh, you guys have been drawing down a little bit more on, on your bank lines. Um, looks like you're up to $1.5 billion. Just kind of what, what's, what's driving that? And then kind of refresh us how the balance sheet looks after, uh, when Cenlar closes.

Dan PerottiSure. So overall, as we mentioned in some of the commentaries, as interest rates increase, you know, everything else being equal, you know, we have a couple of impacts to the balance sheet overall. As you know, the production environment shrinks and production volumes decline a bit, our overall leverage— our overall leverage declined, so went from 4 times to 3.6 last quarter to 3.6 times this quarter. And we have a bit, if you look at the non-funding leverage of sort of the opposite, opposite movement where as interest rates increase, that drives an increase in our overall MSR, MSR valuation and a decline in our hedge.

Dan PerottiThe decline in our hedge generally leads to a margin call, which needs to be funded. And so we draw on our bank lines to fund those amounts that are driven by the increase in the MSR value. And of course, we have more collateral in terms of our MSR to draw against, but it does lead to upward pressure in terms of our non-funding leverage ratio. So ticked up slightly from 1.7 to 1.8, but in the context of the overall balance sheet and leverage on the balance sheet, you know, that declines. And so we look at those two things in conjunction or in balance and are comfortable at the levels that, you know, that we're where we're at today and expect our overall leverage to remain in that area to the extent that overall— to the extent that rates remain in this vicinity. In terms of the impacts of Cenlar, when we close the Cenlar transaction versus tangible equity, we would expect a slight increase in terms of our, you know, terms of leverage.

Dan PerottiGiven that the Cenlar transaction will include, you know, a bit of goodwill and intangibles. So around $230 to $240 million of goodwill and intangibles, we would expect to recognize on the balance sheet as a, you know, in conjunction with the transaction. And so that overall will have the effect looking at tangible equity of slightly increasing the, you know, the reported leverage ratios. That, of course, will be offset by the increased, you know, the increased cash flow and earnings from the Cenlar transaction. And we'd expect that to, you know, both contribute positively, you know, to the ROE over time and also help to, you know, reduce the the leverage ratio as we move forward from that point in time.

Kyle JosephGot it. Really helpful. Thanks for taking my question.

OperatorYour next question from the line of Ryan Shelley with Bank of America. Your line is open. Please go ahead.

Ryan ShelleyHey guys, thanks for the question. Um, number one, on, um, Cenlar, there's a comment in here hear about expanding B2B relationships and potential for additional product offerings post-close there. Obviously, it hasn't closed yet, but could you just provide us any insight on potential areas you might like to expand with the capabilities of Senlar?

David SpectorHey, Ryan, can you speak up a bit?

Ryan ShelleyYes, sorry, is that better?

Ryan ShelleyYeah. Yes, sorry, just a quick recap on the Cenlar. There's a comment in the deck around potential additional product offerings. Obviously it's early, you know, hasn't closed yet, but could you just give us some color on what potential additional products you might like to build using the capabilities you get with Cenlar?

David SpectorYeah, look, I think that, you know, we have, we have some ancillary businesses and title and appraisal that I think can lead to some additional ancillary income. I think that there's other things we can do vis-à-vis our technology to be able to offer technology solutions to reduce the cost to the 100 Cenlar clients that they're incurring because they have to do certain middle office work and other reconciliations that through AI and other tools we can help to reduce the costs. I do think that there's, you know, there's, there's other, there's other, you know, product offerings that, you know, as we, as we think about subservicing, when we started subservicing, you know, we thought of things that we can bring to our subservicing clients, including where potential warehouse financing or servicing advance financing. But that's, you know, that's, that's down the road. There's a good amount of that available in the market today.

David SpectorBut I think there is, there really is real opportunity to work with our business partners that we're going to have once we close the Cenlar transaction.

Ryan ShelleyGot it. Thank you. And then just one more quick one, if I may. So, EBO loan volume was up sequentially about $600 mil. Could you give us some color on how that's trended post-quarter and then just any color on if there's any particular drivers to call out there? Thank you.

Dan PerottiWith respect to EBO volume, overall EBO volume is You know, as we're moving into the next quarter, um, we are seeing that, uh, you know, slow slightly, uh, what, you know, a couple of factors there. One, at higher levels of rates, um, you know, the overall sort of modifications that can be done at market rates are, are slightly higher, and so somewhat similar to, and the gains, uh, you know, related to redelivery of that are, you know, potentially lower for, or for a lower level of rate, however you want to think about that. And so that is a bit of a dampening effect in terms of the EBO gains and activity. We've also seen a little bit of slowing in terms of modification volume, you know, driven by some of the changes in the FHA You know, some of the changes that we previously discussed around FHA modifications and the, the fact that they now require a trial payment and that they are, you know, there's lower ability to re-modify loans also has a bit of a dampening effect in terms— or we're expecting a bit of a dampening effect of, you know, modifications and EBOs as we go into into the second half of the year.

Ryan ShelleyThank you very much.

OperatorThere are no further questions at this time. I will now turn the call back to David Spector for closing remarks.

David SpectorI just want to take these last few minutes and thank you all for joining us and to remind you, if you have any additional questions, please reach out to our investor relations team. And again, thank you so much for the time.

OperatorThis concludes today's call. Thank you for attending. You may now disconnect.