PennyMac Financial Services Inc

NYSE:PFSI

Earnings Call Analysis

PennyMac Financial's Strong Second Quarter and Future Outlook

PennyMac Financial reported net income of $98 million for the second quarter, reflecting an annualized return on equity of 11%. Excluding fair value changes and nonrecurring items, the operating return on equity was 16%. The company increased its quarterly dividend by 50% to $0.30 per share. Loan production pre-tax income rose to $41 million, driven by total acquisition and origination volumes of $27 billion. The servicing segment posted a pretax income of $89 million, with servicing fees up due to portfolio growth. PennyMac remains optimistic about the future, expecting high refinance volumes if interest rates decrease, supported by its robust, diversified business model.

Strong Financial Performance with Growing Profitability

PennyMac Financial Services (PFSI) announced robust financial results for the second quarter of 2024, achieving a net income of $98 million or $1.85 per share, representing an annualized return on equity (ROE) of 11%. The company's book value per share also rose to $71.76 from $70.13 in the previous quarter, driven by its profitability. Despite experiencing $72 million in net fair value declines on Mortgage Servicing Rights (MSRs) and hedges, as well as a $12 million non-recurring gain related to its closing services joint venture, PFSI's operating metrics remained strong.

Mortgage Origination and Acquisition Growth

PFSI reported substantial growth in loan origination, acquiring or originating over $27 billion in mortgage loans during the quarter, a 25% increase from the previous quarter. The company maintained its position as a leader in correspondent lending, with acquisitions increasing to $23 billion from $18 billion. The number of brokers approved to do business also grew to over 4,200, up more than 30% year-over-year. Furthermore, PFSI noted an uptick in refinance volumes driven by recent declines in mortgage rates, providing borrowers an opportunity to lower their mortgage payments.

Servicing Segment Generates Stable Income

The servicing segment of PFSI contributed significantly to its income, with a pretax income of $89 million. Excluding valuation-related changes and nonrecurring items, the pretax income was $149 million, supported by low delinquency rates and increased earnings on custodial balances. PFSI's servicing portfolio saw growth in recently originated mortgages with higher note rates, indicating potential for future refinancing as interest rates decline.

Capital Structure and Liquidity Improvement

In May, PFSI issued $650 million in new 6.5-year unsecured term notes, enhancing its liquidity and capital structure. The company ended the quarter with $3.4 billion in total liquidity, which includes cash and amounts available to draw on facilities. This strategic move reflects PFSI's continued focus on maintaining a strong and flexible liquidity position.

Guidance and Market Outlook

Looking ahead, third-party estimates project total mortgage originations of $1.7 trillion in 2024 and $2.1 trillion in 2025, influenced by expectations of lower interest rates and increased refinancing activity. PFSI believes it is well-positioned to benefit from either high or low rate environments due to its balanced business model. The company anticipates continued growth in its origination and servicing segments, driven by pent-up demand from key homebuying demographics and potential refinancing opportunities as interest rates decline.

Technological Advancements and Efficiency Improvements

PFSI highlighted advancements in its proprietary servicing system, which uses artificial intelligence to enhance operational efficiency and comply with regulatory changes. The company expects to be the first in the industry to integrate requirements for the Veteran Affairs Service purchase program directly into its technology. These technological developments have contributed to reduced operating expenses, which were at their lowest levels in PFSI's history at under 6 basis points of average servicing portfolio Unpaid Principal Balance (UPB) in the second quarter.

Dividend Increase Reflects Confidence in Future Performance

Reflecting its strong financial performance and confidence in future prospects, PFSI's Board of Directors approved a quarterly common stock dividend of $0.30 per share, up from $0.20 per share in the prior quarter, marking a 50% increase. This decision underscores the company's commitment to returning value to its shareholders while sustaining its growth trajectory.

Earnings Call Transcript 2024-Q2

[Operator]

Good afternoon, and welcome to PennyMac Financial Services, Inc. Second Quarter 2024 Earnings Call. Additional earning materials, including presentation slides that will be referred to in this call, are available on PennyMac Financial's 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 Financial's Chairman and Chief Executive Officer; and Dan Perotti, PennyMac's Chief Financial Officer.

[David Spector, executive]

Thank you, operator. Good afternoon, and thank you to everyone for participating in our second quarter earnings call. PFSI reported net income of $98 million or an annualized return on equity of 11%. Excluding the impact of fair value changes and nonrecurring items, PFSI produced an annualized operating ROE of 16%, with strong performance from both the production and servicing segment. Given our continued strong financial results and confidence in our outlook, I am pleased to note that PFSI's Board of Directors approved a quarterly common stock dividend of $0.30 per share, up from $0.20 in the prior quarter, representing an increase of 15% -- of 50%.

Turning to the origination market. Current third-party estimates for total originations averaged $1.7 trillion in 2024 and $2.1 trillion in 2025, reflecting projections for lower rates from current levels and increased refinance volumes. Given PFSI's balanced and diversified business model, we believe we are extraordinarily well positioned whether rates remain high or decline from current levels. With higher total industry volumes in the second quarter and given what we have seen thus far in the third quarter, we believe the origination market is resetting.

In the last couple of years, we estimate approximately $2.5 trillion of mortgages have been originated with a note rate of 6% or higher. As long as rates remain elevated, this group of borrowers is expected to continue growing, supported by a purchase market with strong pent-up demand from key homebuying demographics. It is our belief that when interest rates do decline, many of these borrowers will undoubtedly look to lower their mortgage rates, driving refinance volumes higher and total originations up to more normalized levels.

In loan production, our multifaceted approach to mortgage production and our position as one of the largest producers in the country provides us with unique access to originate and acquire newly originated mortgages in the current market, driving the continued growth of our servicing portfolio. We have gained a meaningful amount of market share in our purchase focused correspondent and broker direct lending channels and all of our channels have additional upside potential when refinance volumes return to more normalized levels.

In the second quarter, we acquired or originated over $27 billion of recently originated mortgage loans and in recent periods, we have added a meaningful volume of mortgages with higher note rates to our portfolio. As of June 30, $63 billion of mortgage loans in our servicing portfolio had a note rate of 5% to 6% and $113 billion at a note rate of 6% or higher. This population of loans consists primarily of recently originated purchase mortgages where the underlying borrowers will undoubtedly look to refinance when rates decline from their current levels.

We have also been very successful providing second lien mortgages to our customers that have secured a low coupon first lien mortgage and wanted to access the equity in their home in a more economic transaction than a cash out refinance. As rates decline, this population of borrowers may also seek to reduce their cost with a refinance to consolidate their loans, presenting an additional opportunity for our consumer direct division. So while volumes in our consumer direct channel are low today, I believe we are uniquely positioned for future success given this large population of borrowers that we maintain active ongoing relationships with that have higher mortgage rates.

In the current market environment, however, our large and growing servicing portfolio continues to drive earnings with meaningful cash flow and revenue generation given low delinquency rates and a significant contribution from placement fees on custodial balances due to higher short-term rates. Additionally, this management team has done a tremendous job developing our proprietary servicing system, which has the flexibility to rapidly adjust for regulatory changes and incorporate new and emerging technologies, including artificial intelligence, to drive operating efficiencies.

I am pleased to announce that PennyMac expects to be the first servicer in the industry to successfully incorporate requirements for the Veteran Affairs Service purchase or VAS program directly into its technology. This highlights our speed to change and the flexibility built into our SSC platform to adapt to new regulations and emerging government programs. Our strength in technology development, combined with the operational scale we have achieved, has driven our cost to service to among the lowest in the industry. And I am pleased to note that in the second quarter, operating expenses as a percentage of average servicing portfolio UPB, were at their lowest levels in our history at under 6 basis points.

Barring any meaningful increase in delinquencies, we expect to gain additional operating leverage as the portfolio grows and as we continue to look for opportunities to drive down expenses, providing us with a strong base level of profitability in future periods.

I will now turn it over to Dan, who will review the drivers of PFSI's second quarter financial performance.

[Daniel Perotti, executive]

Thank you, David. PFSI reported net income of $98 million in the second quarter or $1.85 in earnings per share for an annualized ROE of 11%. These results included $72 million of net fair value declines on MSRs and hedges and $12 million of nonrecurring -- of a nonrecurring noncash gain related to a transaction within our closing services joint venture which is included in our servicing segment. We believe this transaction is reflective of the additional opportunities and earnings potential that is achievable by providing additional services to our customers, including leveraging our large servicing portfolio with 2.5 million customers. The impact of these items on diluted earnings per share was negative $0.82. Book value per share was $71.76, up from $70.13 at the end of the prior quarter due to PFSI's profitability.

Turning to our production segment. Pretax income was $41 million, up from $36 million in the prior quarter. Total acquisition and origination volumes were $27 billion in unpaid principal balance, up 25% from the prior quarter. $25 billion was for PFSI's own account and $2 billion was fee-based fulfillment activity for PMT. PennyMac maintained its dominant position in correspondent lending in the second quarter with total acquisitions of $23 billion, up from $18 billion in the first quarter. Correspondent channel margins in the second quarter were 30 basis points, down from 35 basis points in the prior quarter due to highly competitive pricing from some channel participants. Given PMT's recent capital raises, in the third quarter, PMT expects to retain approximately 30% to 50% of total conventional correspondent production, an increase from 18% in the second quarter.

Acquisitions in July are expected to total approximately $8.1 billion, and locks are expected to total $9.5 billion. 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. Locks in the channel were up 28% from last quarter, and originations were up 45%. The number of brokers approved to do business with us at quarter end was over 4,200, up more than 30% 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 essentially unchanged from the prior quarter and remain near normal levels.

In Consumer Direct, lock volumes were up 25% from the prior quarter and originations were up 3%. Higher lock volumes in the channel were driven primarily by an increase in refinance volumes as mortgage rates declined from their recent highs, providing us with an opportunity to lower mortgage payments for borrowers who previously locked in higher rates. The rate lock activity we have seen thus far in the third quarter has exceeded our run rates from the second quarter. Production expenses, net of loan origination expense, increased slightly from the prior quarter, primarily due to increased volumes in the direct lending channels.

Turning to servicing. The servicing segment recorded pretax income of $89 million. Excluding valuation-related changes and nonrecurring items, Pretax income was $149 million or 9.5 basis points of average servicing portfolio UPB. Loan servicing fees were up from the prior quarter, primarily due to growth in PFSI's owned portfolio as PFSI has been acquiring a larger portion of the conventional correspondent production from PMT in recent periods.

Earnings on custodial balances and deposits and other income increased primarily due to higher average balances. Custodial funds managed for PFSI's own portfolio averaged $5.7 billion in the second quarter, up from $4.6 billion in the first quarter. Realization of MSR cash flows was essentially unchanged.

As David mentioned, operating expenses decreased from the prior quarter and were at their lowest levels in our history at 5.9 basis points of average servicing portfolio UPB. EBO income was essentially unchanged, and we expect its contribution to remain low for the next several quarters. The fair value of PFSI's MSR increased by $99 million, driven by higher market interest rates at the end of the quarter. Hedge costs came in at the higher end of our 1% to 2% expected range at $35 million.

Other fair value declines on hedges during the quarter were $137 million, exceeding MSR fair value increases due to significant interest rate volatility. Combining these 2 components, total hedge declines were $172 million. The Investment Management segment contributed $4 million to pretax income during the quarter, and assets under management were essentially unchanged from the end of the prior quarter. Provision for income tax expense was $35.6 million, resulting in an effective tax rate of 26.6%.

Finally, in May, we issued $650 million of a new 6.5-year unsecured -- of new 6.5-year unsecured term notes at attractive terms and subsequently paid down other revolving secured borrowings. This transaction reflects our continued focus on the strength and flexibility of our liquidity and capital structure as the new notes have extended the duration of our liabilities and enhance our overall liquidity position. We ended the quarter with $3.4 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?

[Operator]

[Operator Instructions] Your first question comes from Terry Ma with Barclays.

[Terry Ma, analyst]

Any more color you can provide on what you're seeing in correspondent quarter-to-date? July looked pretty strong, but you mentioned in your prepared remarks that there was some competitive pricing from participants last quarter. So has that kind of continued into this quarter?

[David Spector, executive]

Yes. So look, it has continued. It's continued to be a little bit more exact more on the government side than the conventional side. And that's a function of a market participant who's been very aggressive in raising capital this year and using that high-cost debt to move aggressively to purchase loans in correspondent in specifically on the government side.

But look, having said that, I think the quarter in correspondent was a really great quarter for us. And I think that you look at the July walks, which we're projecting to come at $9.5 billion, and that's going to be estimating to get to $28.5 billion, $29 billion of production for the quarter. And while margins are under pressure, we continue to believe that the flywheel continues to operate as it has been operating for many, many years here. And these are loans that are going to be very valuable as rates decline and give us the opportunity to go in and refinance those loans.

And just to put it in perspective, I think you look at the share growth year-over-year of 1%. And it's really -- it continues to just reinforce our belief that we're the dominant force and correspondent. And these little blips, look, we've seen from time to time, people come in on a quarter-by-quarter basis after rationally or do things that we don't necessarily agree with. But I think that speaks to the strength of the brand and it speaks to the strength of the flywheel.

[Terry Ma, analyst]

Got it. That's helpful. And then on the hedge, any more color you can give kind of what happened intra-quarter? I think on the call last quarter, you guys mentioned you go pretty closer to 100% on the mark, quarter-to-date for the hedge. So maybe just any more color you can provide on kind of what happened intra quarter and maybe what you're doing to kind of fix it going forward.

[David Spector, executive]

Sure. So I mean, I think the first thing to note is that obviously, the differential there between last quarter and this quarter is pretty substantial. And so we did bring in that, excluding the hedge costs, the performance of the hedge versus the asset much closer to what we targeted, around the 100%.

During the quarter was a fairly volatile quarter for interest rates. Interest rates went up around 50 basis points, came back down and then we ended up, I think, around 20 basis points. But round for it, around 50 basis points up and down before going back up toward the end of the quarter. As we move through the quarter, given the significant overall moves in interest rates, we did reposition our hedges somewhat, and that did lead to a little bit of that miss during the quarter in terms of the differential between the change in the asset value and the change in the hedges, excluding the hedge cost.

In terms of the hedge cost, it is run on the higher end of our sort of expected range during the quarter, up toward 2%. I believe when we had the call last quarter, we had said we expect it to be in the range of 1% to 2%. And that is what we saw during the quarter, given some of the higher volatility and yield curve, shape of the yield curve during the quarter. As we've moved into the third quarter, we have, to date, seen volatility come off a little bit. And so that may reduce the hedge costs as we go through the third quarter.

The other piece that I'd say is that to the point David was making given the accumulation of loans and the fact that we've now moved a little bit lower in interest rates, we are currently targeting a hedge ratio closer to 80% to 90% rather than 90% to 100% given the accumulation of loans and the amount of loans that are closer to being in the money at this point.

[Operator]

Your next question comes from Bose George with KBW.

[Bose George, analyst]

Could you provide some color on that JV transaction? You said it's nonrecurring, but just curious what it was and if there is -- if this something we could see periodically?

[Daniel Perotti, executive]

Sure. Yes, it's not something that in this form and with -- that we would expect to recur exactly like this but basically has to do with -- we have a joint -- a closing services joint venture we've had for a period of time. We have mentioned some of these services, the ancillary services that we provide through the joint venture in our earnings materials previously. That joint venture had an appraisal management company subsidiary. And during the quarter, we entered into a transaction to sell that appraisal management company subsidiary to a larger appraisal management company for an ownership -- small ownership share in that company.

And so the accounting rules basically dictate that we have to value those -- the shares at their fair value, which we estimated to be $12.5 million. That's the income that you see flow through. It's obviously a onetime transaction. But to the extent that there eventually is a growth in business and a -- and so forth for that other appraisal management company, we could see upside to that ownership share in the future.

And really, that this transaction sort of speaks to the power of the overall platform that we've built and the potential to have further economic benefit from the relationships that we have with our 2.5 million customers in our servicing portfolio as well as the additional customers that we have through our originations.

[Bose George, analyst]

Okay. Great. And then can you remind us how the increase in the conventional loan percentage that's going to be retained by PMT in 3Q versus the current run rate? Is that going to have an earnings impact? Or just can you remind us how that works?

[David Spector, executive]

Sure. So it will likely have a small earnings impact in that the margin at which we purchased the loans, to the extent that PFSI is retaining or the loans are being sold through to PFSI and they're selling and securitizing them, then PFSI would earn the gain on sale and origination fees for those loans. Typically, those loans have, in aggregate, a total gain on sale that's going to be a little bit higher than what the fulfillment fee is that we would otherwise charge to do that same activity for PMT.

So there could be a bit of an earnings impact, given the same amounts of volume. But for that, along those lines, that activity that we would be doing for PMT as opposed to PFSI is a fee-for-service business. So as capital light means we're not deploying necessarily as much capital allows PMT to deploy capital and earn higher returns which can benefit over time in terms of the incentive fee and so forth that we earn at P&C.

And so it really -- again, it could go back a few years really shows the benefit of the synergy between these 2 companies in terms of being able -- PFSI being able to provide investments -- organic investment for PMT. And really, we see this as the best deployment of capital for PMT at the current point of time -- at this point in time and continues to show the benefit between the 2 entities.

[Operator]

Your next question comes from the line of Michael Kaye with Wells Fargo.

[Michael Kaye, analyst]

The industry, including PennyMac, has had a lot of headcount reductions since the cycle turned. So I'm wondering, are you going to have to hire back at the same pace as you did in prior cycles when the origination market finally comes back, especially in light of some of the advancements in technology? Just wondering, could this lead to better-than-expected normalized ROEs if you don't have to hire it back so aggressively?

[David Spector, executive]

Look, I think, Michael, to your point, we have worked for the last 3 years to continue to become more and more efficient, and we did. In our consumer direct channel, one of the main reasons we came out with our closed end second product was to keep capacity in place for our consumer direct channel as rates were to pivot down. And I think that that's something that we're already seeing taking place.

Similarly, we've been very, very active in modeling on out what we would need in certain interest rate environments while maintaining excess capacity so don't -- but we don't take 30 to 60 days to seize on an opportunity. We have 3 large classes of LOs already in the queue. They're going to be up and trained and ready to go. And I think that -- even if rates stay where they are, we believe there's value there, given the high note rate servicing that we have and given the fact that you can't really start to refinance those zones until their season 6 months.

So we're already increasing the LO capacity. But I think even more importantly, our modeling and our ability to add capacity and fulfillment is pretty -- is very tried and true. We've been at this now for a very long time and through a combination of onshore resources, but also more importantly, offshore resources, especially for correspondent, but also for broker direct and consumer direct we can add or reduce capacity very, very quickly and very, very efficiently.

And so I think I'm very confident that we're not going to be in the position we were back in 2020, where we got a bring on more physical capacity in terms of space and we've got to go out and try to hire 100 LOs tomorrow, and we're ready to go and we -- when we started that process.

[Michael Kaye, analyst]

Interesting. I was hoping you could give an update on the subservicing opportunity that you talked about last quarter. Just curious if you had any conversations maybe with some of your correspondent partners about what kind of the receptiveness are you taking on some of their retained servicing. And then any more color you could give on the potential financial impact, like how much the servicing -- subservicing UPB we're talking about and how much subservicing basis points this would be?

[David Spector, executive]

Look, we -- as you know, I have great hopes and beliefs that we're going to be a top subservicer in the industry. We are -- you just have to look at the results of our own servicing portfolio as well as PMT's portfolio, and that is giving us tremendous entree and gravitas as we go speak to other customers who use subservicers. I believe that we are going to have 1 or 2 smaller customers onboarded by the end of the year. And there is seemingly potential for larger clients over time. We've got great relationships with 800 correspondents. This management team has been in this industry for just about their entire careers and we know many in the industry who have reached out to us to express interest in understanding what the subservicing opportunity looks like.

We want to get 1 or 2 on board. We want to be able to work that transition before we really go full board here. But suffice it to say, we were using our correspondent sales force to help get us into their clients to be able to propose the thesis, to be able to talk about what their system has to offer. And between the co-branding, which is ready to go and the private label, which will be ready to go before the end of the year, we're going to be in really good shape to be able to really attack this in the way that investors and all of our stakeholders have come to expect of us. And so I think that, that to me is the exciting part.

As it pertains to size and P&L, I think it's a little early to begin to start throwing out numbers. For me, what's exciting is, at a minimum, we're just going to continue to add scale to the platform that's going to benefit the current investments in servicing. And as we, unlike many who are in this business who are always concerned about replenishment, we have replenishment opportunities with correspondent. And so the ability to front-load the scale benefits and have the replenishment opportunity with correspondent is what is unique in this industry in terms of what we're looking to maintain.

I think that SSE has provided tremendous benefit for our own servicing, and I think it's going to continue to provide benefit for others as we get into subservicing.

[Operator]

Your next question comes from the line of Crispin Love with Piper Sandler.

[Crispin Love, analyst]

First on kind of where do you think the mortgage rate level is where you think that we could see a significant pickup in refi activity? You mentioned the amount of mortgages at a 6% plus level a few times in your remarks. So do you think that is the magic level? And what kind of opportunity could that give you for a recapture if rates do get to those levels as you look at your servicing portfolio today?

[David Spector, executive]

Look, I think it's -- I think that when I look at our portfolio, we -- it's really like about the 6.5% level where you really -- the decline down to 6.5% is meaningful. So let me start there. When you get to 6.5%, there is where I really see it really kind of accelerating. When you get to 6%, it's a meaningful number. It's a meaningful number because you have everyone that we've ordered in the last year, which is in the hundreds of billions. And then combined with the fact that many have taken out second liens and incurred other debt, which makes cash out refinances to consolidate the loans for people with 5% mortgages and 4% mortgages become meaningful.

And so it's this kind of piling on effect to some degree in terms of that it really begins to get going. But I think it's down to 6.5%. But I think also prior to, I would say, even 2008, historically, this market has always been volatile. And we know it's a volatile after that, but the volatility historically has been kind of in the very near-term moves. So you have people who would do multiple refinance, so they would refinance down a quarter and down another quarter, down another half. So I think that you have to look at it from the point of view that we're not going to have an event like we had in 2008 or during COVID where it just goes down 200 basis points. It's going to be a general decline down with a little bit ups along the way. And I think that that's what I remind the team around here is more back to the future type of scenarios.

[Crispin Love, analyst]

And just one more for me. Just on the CFPB proposed rule from earlier this month on services needing to work more closely with homeowners prior to foreclosing. Can you just give us your initial thoughts on the rules, how it could impact you in servicing costs and if there could be any unintended consequences here if the rules do impact go through?

[David Spector, executive]

Look, I'm not -- that pertains to working with customers and on defaulted or troubled mortgages, this is something that is so engrained in our culture in this company. And this is how we started PennyMac. And we've been validated by our audit results from the 50 states and the other regulatory audits that we've had, and we've come through those very well. I am not at all concerned about doing what's right by the customer because we've been on the right side of that from when we started the company. So there's nothing that I'm seeing or hearing that gives me any concern as it pertains to how we service loans, to our cost structure, the effect it's going to have on the profitability of servicing.

[Operator]

Your next question comes from Doug Harter with UBS.

[Douglas Harter, analyst]

Dan, you mentioned kind of the strong liquidity position with the unsecured offering plus the more capital-light manner of PMT buying more loans. How do you think about what PFSI is going to be doing kind of with that incremental liquidity and what type of investments are you looking to make?

[Daniel Perotti, executive]

I think we're continuing to make the same types of investments that we have been, and I think there's 2 pieces to look at. So we do have a significant amount of liquidity available to us that we noted, the $3.4 billion, including what's on balance or the cash that's on balance sheet as well as what's available on our financing lines that is undrawn, but we have collateral pledge to be able to draw.

We aren't necessarily looking at that as dry powder that we expect to utilize. And one of the things that we are very cognizant of is our leverage ratios as we move forward, where we expect in terms of our nonfunding debt-to-equity ratio to stay near the range that we are today, below -- at or below that 1.5x one is really what we're targeting. So we're not expecting to go out on a spending spree here.

We do expect to continue to generate investments for PFSI or deploy capital for PFSI in the mortgage servicing rights. We still think that is a very significant opportunity that the best avenue for that is through our correspondent business given some of the volumes that you've seen that we've been doing in the second quarter, I believe that we can generate plenty of that investment, both for ourselves as well as for PMT.

[Operator]

Your next question comes from the line of Derek Sommers with Jefferies.

[Derek Sommers, analyst]

Just wanted to talk a little bit more about servicing expenses. Not only has the servicing portfolio grown a significant bit over the past few quarters, it seems like you've managed to take out a good chunk of operating expenses as well. Wondering if you could share any more color on that dynamic.

[David Spector, executive]

Look, I think that it's just -- there's just this general decline in servicing expenses that we've seen over the last 5 years since we implemented our technology and we've been able to use that technology to drive down those costs. And by the way, I expect those expenses to continue to decline. I think that look, some of it we can say is because of the increased scale in the portfolio, but you can't look at what's happened in the decline in servicing costs and not say it's because of what we've been able to do with implementing the technology and implementing what we -- what, in fact, has taken place. I think that as I said, I expect those costs to continue to decline. Look, there's a meaningful increase in delinquencies, then yes, you're going to see some effect.

But absent a meaningful increase in delinquencies, I just -- I expect the trend to continue.

[Derek Sommers, analyst]

To my second question here, in the investor preso, it looks like there's a little bit of oscillation in the past 2 quarters with -- in the delinquency buckets. Anything to point out there? Or are we just going to kind of continue to trend where we are for the moment?

[Daniel Perotti, executive]

Yes. I mean, in the second quarter, we did have a little bit of an interesting phenomenon, and there's some other sort of market research and color out there that I've seen where we had a bit of an uptick in delinquencies quarter-over-quarter. Some of that is seasonal. The end of the first quarter tends to be the lowest delinquency point in the year. You can see that going back to the previous quarter, obviously, COVID sort of obfuscated that type of trend a bit. But typically, you're going to see an uptick from the first quarter to the second quarter. It was a little bit larger this year than it has been typically. Two sort of reasons for that. One is that the number of business days in June was particularly small, so 19 business days. And then also that the -- June ended on a Sunday, and folks that pay on the last 8 months, their payment is going to get processed the following months.

And so we generally have seen the delinquencies thus far in the quarter trend very similarly to -- on par with the prior month or with May, and so don't see any really significant changes or trends in delinquencies. I think it was really more of a calendar effect in June. And then really, again, if you look at our delinquency level compared to a year prior, we're right in the same sort of range. So really haven't seen any meaningful changes in delinquency year-over-year if we're looking at it on a sort of seasonally adjusted basis.

[Operator]

Your next question comes from the line of Eric Hagen with BTIG.

[Eric Hagen, analyst]

Maybe just following up a little bit more on the margin conversation. I mean, how stable do you expect the gain on sale margins to be in the correspondent channel if rates were to be either higher or lower from here? I mean, when we look at almost 30% of the portfolio with a note rate of 5% or higher, I mean, is there a sense for how much would potentially get replenished through the correspondent channel versus maybe the other 2 and how the cost to replenish those MSRs would compare?

[Daniel Perotti, executive]

So I'll point you back to, if you look at our history in terms of replenishment, even through the pandemic when prepayment speeds were lightning fast at all-time highs and our portfolio was running off very quickly, we're still able to replenish through our production channels, primarily correspondent. Since then, Broker Direct has grown larger. Consumer Direct, to the extent that there is a significant amount of refinance volume, would also contribute more to the replenishment through recapture, which is really, its sort of bread and butter. And so we really don't see a situation in which the increased runoff from the higher note rate loans exceeds our ability to replenish, especially given that the overall market size would increase. And basically, our correspondent volumes are very keyed into, at this point, given the scale that we have there into the overall market size. So we don't see an issue sort of replenishing there.

On the margin side, especially in correspondent, margins tend to be a little bit more driven, I would say, by the motivations of the participants in the channel than necessarily whether rates are going up or going down. Clearly, if there's a really large, as there was in the pandemic, a really large market or a really large swing in the market, that will widen out margins meaningfully. But as we, assuming that they're just sort of incremental moves up or down, don't necessarily expect that to significantly drive margins in the correspondent channel. I think it's more driven by the motivations of the sort of the market participants.

[David Spector, executive]

One of the great, I would say, one of really -- one of the great things that's come out in the last 2 or 3 years has really been the rational -- the maintaining of rational pricing on the production side. In absence kind of these one-offs of kind of irrational pricing of people who have money to burn, I think that you have seen rational pricing and broker. We're seeing rational pricing that steps -- that's been in place for well over a year.

Consumer Direct, I think many of the consumer direct originators own servicing and they're not as desperate as we've seen in prior periods of rising rates. And I think to Dan's point, if rates decline, you're going to see people who want to get loans off their warehouse funds quickly, looking to correspondent aggregators to sell those loans. And there's typically less margin sensitivity, combined with the fact that there's less capacity. And those 2 things in a declining rate environment lends itself to increasing margins.

Correspondingly in correspondent, in a rising rate environment, I don't think you're going to see margins jumping around like we've seen quarter-over-quarter and where we've seen historically, but I don't expect anything anomalous in that sector.

[Eric Hagen, analyst]

Appreciate that answer very much. Maybe just continuing with that, just one last question here. I mean, looking at the prepayment assumption of the CPR, which is definitely slow and pretty stable for the MSR, we also have this really sweet opportunity connected to lower rates. And so when you think about the mark-to-market impact on the MSR at the same time, like what do you feel like is the ideal mortgage rate from that perspective?

[Daniel Perotti, executive]

I think we've talked about it before in some of the earnings calls. Potentially for us, higher in looking -- taking a long-term view, higher mortgage rates for a longer period of time, despite the fact that it isn't necessarily in the specific period going to optimize our ROE could be better for us over the long term, continue to build up a higher proportion of mortgage loans in those higher note rates especially in our service portfolio where we are efficient at recapturing them and then that provides greater benefit for us when rates eventually do decline. At the same time to the extent that rates, and we have the servicing portfolio, which continues to build, continues to grow in terms of profitability and provide a significant base in terms of the overall return on equity of the company.

On the flip side, to the extent that rates do decline over the next several quarters or few quarters that we think that we've built up a meaningful opportunity already with the loans, as we've talked about, to be able to drive significant upside for the company in these periods. So I think either way, we're positioned to perform really well. I think probably the best overall outcome is if rates stay a bit higher for longer and we continue to accumulate, but we have sort of meaningful opportunity either way.

[Operator]

Your next question comes from [ Shana Hugh ] from Barclays.

[Unknown Analyst]

I know you mentioned that you were targeting corporate debt to equity of less than 1.5x and you ended this quarter at 1.4x. How should we think about managing your leverage going forward? Would you guys consider pulling back on originations in the corresponding channel given some of the competitive pressures you guys highlighted or maybe change the hedging strategy? And I guess, also, would you guys consider selling lower WACC MSRs to kind of accelerate the originations and higher WACC MSRs that you believe you could recapture going forward?

[David Spector, executive]

Well, look, I don't view us being capital constrained. We can continue to operate and grow the servicing portfolio at the pace that we've been growing at. We can continue to originate loans in a lower rate environment, which would mean more mortgage loans on the balance sheet, which would mean more usage of warehouse lines. I think that we're in that sweet spot where I think we're really trying quite successfully, might I add, to keep that leverage at a level that that's viewed favorably by the rating agencies and by our high-yield investors while at the same time be able to operate and do so profitably and mid-teens returns in our production servicing business.

Correspondent, even with the margin pressures, is a highly profitable business. The reason are very acceptable, and it allows us to grow the servicing portfolio where we increase the scale. And when rates do decline, we have the ability to participate in the refinance of those mortgage loans. Similarly, I would say that given PMT's capital raise, we are in PFSI getting -- moving a little bit more of the correspondent business over to PMT, which is a more capital-light business. But both companies are in the best shape they've been in from a capital perspective in many years. And there's a PMT as $3.4 billion liquidity and a lot of available capital to invest.

So I continue to I continue to believe and operate this company that we're going to continue down the road that we set out to do when we put goals out there for ourselves of [ 135320 ] plus. That's to be the largest correspondent aggregator to be a top 3 broker direct lender, to be a top 5 consumer direct lender, and to be a top 3 servicer while delivering a 20% ROE, and we're getting there. And we've worked very hard to build up the capital structure to do it in the most efficient way possible. And we've come through a period of tremendous disruption in the industry where we have continued to be the bright shining light in this industry and our performance.

[Daniel Perotti, executive]

Just to add a little bit on to what David is saying. When we look out in terms of our expectations for the market and our participation in the production channels, we don't -- we believe that we are still able to manage our debt-to-equity, our nonfunding debt-to-equity ratio at that -- at or below that 1.5x that we talked about before. So that is something that we monitor and that we look at, but we don't see it given our plans and our forecast as a constraint to our business currently. And wouldn't -- don't see a need to adjust our sort of business plan in order to be able to adhere to that level of leverage.

[Operator]

We have no further questions in our queue at this time. I'll now turn it back to Mr. Spector for closing remarks.

[David Spector, executive]

Well, I want to thank you all for joining us this afternoon. I encourage investors with any additional questions to contact our Investor Relations team by e-mail or phone. And again, thank you very much.

[Operator]

This concludes today's conference call. Thank you for your participation, and you may now disconnect.