PennyMac Financial Services, Inc. Common Stock Q2 2026 Earnings Call

Good afternoon. 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 star one to raise your hand. To withdraw your question, press star one 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. Before we begin, let me remind you that this call may contain forward-looking statements that are subject to certain risks identified on slide two 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. Thank you, operator.

Good afternoon, and thank you to everyone for participating in our second quarter 2026 earnings call. As shown on slide three, 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 remained 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.

Our 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 four, let's review several key business updates. First, 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. This technology deployment is already directly benefiting customer engagement and retention.

Conventional first lien refinance recapture rates increased seven percentage points from the prior quarter to 29%, while government first lien refinance recapture rates increased nine percentage points to 59%. Third, we continue to make excellent progress toward onboarding Cenlar's subservicing portfolio, with the transaction on track to close in the fourth quarter. 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 five, 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. Earlier this month, we took targeted actions to reduce our production footprint and adjust staffing levels to better align with the smaller market.

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 six, 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.

Our 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, where the meaningful increase in our recapture rates positions us to capture upside as the origination market normalizes. 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 seven highlights the opportunity in our consumer direct channel if interest rates decline, as well as our first lien refinance recapture rates over the five most recent quarters. As of June 30th, we serviced a combined $343 billion in UPB of loans with no rates above 5%, of which more than half had no 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 eight, our servicing segment continues to demonstrate the power of scale, combined with our advanced technology, otherwise known as PLACE. According 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. 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 of 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 sub-servicing portfolio. Slide nine details the transformative operational gains we are realizing in production. Consumer direct has facilitated a rapid implementation of process automated and AI agents. We are now beginning the transition of Vesta into our broker direct channel to deliver these same structural efficiencies and automation gains to our broker partners. Across 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. 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%-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. 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. I believe we are still in the early stages of this transformation. As we scale AI automation onboard Cenlar's capital light sub-servicing 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.

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

Thank you, David. PFSI reported net income of $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 sub-servicing 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, pre-tax 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. Of 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 and 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 towards 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. In Broker Direct, we continue to see strong momentum despite increasing levels of competition, the number of brokers approved to do business with us continues to grow, reflecting brokers who are increasingly leveraging our distinct value proposition. Broker Direct'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 higher interest rates resulted in lower refinance demand. Fallout 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 pre-tax loss, compared to $13 million of pre-tax 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. The Servicing segment recorded pre-tax income of $22 million. Excluding valuation related changes, pre-tax income was $99 million, or five and a half 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. An increase of $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. Corporate and other items recorded a pre-tax 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 four times at the end of the prior quarter, and non-funding debt to equity was 1.8 times, 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. We'll now open it up for questions. Operator? We 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 star one to raise your hand. To withdraw your question, press star one 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. Your first question comes from the line, Doug Harter with BTIG. Your line is open. Please go ahead.

Thanks, and good afternoon. Can you 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 rates to not kind of be caught short in capacity like you were late last year?

Yeah. Hi, Doug. Thanks so much for the question. Look, as you know, we've always been disciplined in how we think about expenses and capacity. 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 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. It's going to lead to really a meaningful reduction in costs. Really what the cost reduction that we're talking about is $60 million annually.

It's really coming about as a result of, one, rates being higher, also as we've gotten more and more confident with the technology, we feel very comfortable and convicted that the excess capacity that we brought on at the end of last year is no longer needed. 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. I think where also I think we've really shined these last few quarters is just the continued growth of recapture. When you look at the recapture rates that we're getting on both the government and the conventional servicing portfolios, they're very good.

I believe that 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 as we get into a bigger market.

Great. Appreciate that, David. 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?

Look, I think the path that we've laid out at this level, we're at very high levels of rates. Today I saw the 10 years at a-- I'm sorry, the 30 years at a 20-year high. At this level of rates, I would say that the path we've laid out is more weighted to an exit of 2027. Obviously, if rates were to decline, that would accelerate just getting there faster.

Great. Thank you. Your next question from the line of Mark DeVries with Deutsche Bank.

Your line is open. Please go ahead.

Thank you. David, when you think about kind of getting to your objective of the drive to 55, can 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?

Look, as we look at the drive to 55, we're really focused on cutting actual expenses without really leaning into growing the denominators you would talk about in terms of adding Cenlar. There is a lot of 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. My feeling is that there's a lot of deeper servicing integrations that need to take place. There's a lot of additional agents that need to be built. I think from the team's standpoint, when we look at it We look at it just in terms of the current effect of the activity vis-a-vis the current expense structure, not focusing necessarily on the scale itself.

As I said, the scale always helps.

Okay, that's helpful. Dan, I think you indicated that 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 the hedge is performing so far quarter to date?

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 our hedges. That was part of what contributed to 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 sort of calibrated our practices to minimize the amount of impact that has. 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.

Overall, tracking much better, especially on the hedge cost side, than what we saw in the second quarter.

Go ahead. Thank you. Your next question comes from the line of Crispin Love with Piper Sandler.

Your line is open. Please go ahead.

Thank you. Good afternoon. Appreciate you taking my question. 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 2026, that's pushed out now. Would you expect ROEs to grind higher from the end of the year into 2027? Looking at a low to mid double digits in 2027, or could there be a step function higher just based on the environment you just said? Just curious on how you're thinking about this.

Yeah, look, I think Crispin you have it identified correctly. I think, 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 kind of in the lower part of that range, call it high single digits to low double digits. I generally think that throughout the year of 2027, that's when you'll see the step up 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. 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. I think that we're going to continue to focus on driving down the cost to originate in our consumer direct channel. I think that, obviously as everyone on the call is aware of, the path to how quickly we get that, there is an interest rate component to that. Even without interest rates moving, I feel good about exiting 2027 at these levels, at the mid-teens levels that we talk about.

Great, David. I appreciate the color there. Just on the broker channel, you discussed the elevated competition. Looking in your deck, your market share over the past year or so is about 6%. Can you remind us of your targets here? Was it getting to 10% by the end of 2026? 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. Yeah. Look, I think that our view in terms of share growth and broker direct or TPOs, number one, we want to do it profitably.

We're being disciplined in 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 2026. I can tell you that the brokers, I think, are going to be really enthusiastic about what they're going to see when we get broker on there in mid 2027. We don't want to do anything irrational or do anything that's not disciplined, that's how we're thinking about the broker channel.

Great. Thank you, David. Appreciate you taking the questions.

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

Hey, thank you. Good evening. I guess maybe just on the ROE guide. Is it still? Is the target that high teens to low 20s the kind of right normalized ROE for the business going forward?

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?

Yeah. Look, the high teens to low 20s is a guiding principle of this company. It will 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 20 operating company. I think that it's going to continue to grind up there, I see that 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. 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 truly unique.

Our servicing technology is something that has, I think, served us really well. As we've talked about, we're the low-cost servicer by a meaningful amount. Industry parties see the low cost, they see the scale benefits. It doesn't go unnoticed. I think, 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. That's, by the way, with a heavy government portfolio. What we're in the midst of right now 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 at high levels as it pertains to this cycle. I think that you're going to see a company coming out of this.

I truly believe that we are going to live by the high teens to low 20 North Star that we've run this company on for the last 18 years.

Got it. That's helpful. On the recapture rates you guys show on slide seven, 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, after you kind of run rate all these improvements, just trying to figure out what the upside is. Thank you. Look, the target for us is we want to recapture every possible loan that we can.

The work that the team is doing, both operationally and analytically using AI, is allowing us to meaningfully grow our recapture levels. I think that as we deploy the work in Vesta to close loans faster, to close loans cheaper, those recapture rates are going to be growing even more. 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. I think we're looking at it as ways to drive down the cost to originate, drive down the days to close, and then the investment in technology and the consumer experience, I believe, we'll continue to see those recapture rates grow.

Your next question comes from the line of Bose George with KBW. Your line is open. Hey, guys.

Please go ahead. Hey, guys.

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

Look, I think that 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. So that's a meaningful change from even Q4 of last year. We are maintaining our pricing discipline. We have a very large servicing portfolio with a lot of loans that would become refinanceable in the event of an interest rate decline. I think we want to maintain our dry powder should perhaps rates move higher and we need more leads, or we want to do more activity. Likewise, I think that we want to do so adhering to our margin discipline.

I do think that there are market participants at the time to time that perhaps are being a bit irrational. I wouldn't read too much into the correspondent decline. I think it's more, again, the combination of the GSEs and from time to time, other participants. We're still the leaders in this space, and we'll continue to be the leaders in this space.

Okay. It's helpful. Thanks. Actually, just looking at the difference between the GAAP and operating results, is there something structural like maybe Ginnie Mae convexity, which just makes it harder to hedge that asset? Are you comfortable that that gap will close in the mid-teens next year is both a GAAP and an operating ROE?

Yeah. Look, let me talk about the results and the hedge and where we sit today. As everyone knows, the hedge we have in place protects MSR values against interest rate moves. I know in this quarter we did that. The MSR rose by $110 million. The hedge offset as intended. We had $135 million loss on rate moves. What we had was $52 million of hedge costs. 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. Rather than an intentional attempt to perhaps hedge out, sell off gains. 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.

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%. Really, the net result really came down to this perfect storm and unusual volatility disconnect and really some specific headwinds. That was really a few things. One was volatility. In Q2, volatility traded in a tight 40-basis point range, primarily on the geopolitical tension and the widening distribution of monetary policy outcomes. 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. That drove a loss on the option holdings that we have. Furthermore, as we had to rebalance 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. To manage that, we had to reduce our positive carrying MBS holdings, which pushed hedge costs higher. Really, I think what we've done is 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. I think the hedging story is one that is not going to be unique to us. I think 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.

Okay, great. Thanks a lot for the details.

You bet. Your next question from the line of Don Fandetti with Wells Fargo.

Your line is open. Please go ahead.

Hi. 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?

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

Got it. Back to the ROE commentary. Thanks for all the detail, and you've covered a lot of angles. I guess I'm just trying to understand the sort of path to the increasing ROE. Can you do that in this type of rate market? Let's say 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?

I believe so. I truly believe that. I think number one, you take, for example, the $60 million cost reductions that we just announced. Look, there's going to be additional efficiencies that we're going to see both in our consumer direct channel and in our broker direct channels. We get broker direct onto Vesta. This is going to have a meaningful effect in terms of the cost to originate. I also believe that we're going to continue to grow share profitably in broker direct. I think, as we grow our servicing portfolio, you can't help but grow share a bit in the consumer direct channel. While being able to compete in a meaningful way and being the low-cost producer will allow us to grow profitability.

In addition, I don't want to say that there's a finite amount of tech initiatives. What I will say is we have a lot of tech initiatives taking place at the moment. As we wind those down, of course, there will be others that arise. I think generally speaking, our tech spend is going to come down in a meaningful way, not just from the number of tech initiatives, but also 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. I think you'll see tech expense coming down in a meaningful way. 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.

What's exciting about that is 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. We've been in the sub-servicing business for now four years. We added a couple clients ourselves this quarter. Obviously, it's going to come together as one platform, but I think we'll get real benefits there. 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.

I think just to add on to that, in terms of a lot of these initiatives, as David mentioned, in particular in servicing, reducing the cost to service, adding the equity-like flows are not rate-dependent. Bringing down the technology expense are not rate-dependent at all. Expanding our presence in the direct lending channels from the base that we are today is also not rate-dependent, but will expand our overall earnings. 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, we've shown that we can reach those levels even at these higher interest rate levels. We were at around the same level of rates at the beginning half of last year, and that's before we add some of these other additional drivers.

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

Hey, thanks. One more question on the expense side of things. I appreciate all the color you've given there and the expectation for near-term savings levels. I guess looking at slide nine, you have the target there for the year-end 2027 of getting up to 80% of the workflow automated. Is there a way to translate that goal of moving from 25% to 80% into expense savings in terms of the cost to produce per loan beyond the 20% near-term target you guys have shown there on the top right? Thanks. As we sit here today, I think the 25% is what I would call more low-hanging fruit.

We're seeing the expense reduction coming in about 25%, 30%. I think it's that 80% number, 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, I think, depend on volumes to some degree. 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 think that we'll have a better sense of that in the coming quarters.

Got it. That makes sense. Okay. Thank you. Thanks, Trevor.

Good question. Your next question comes from the line of Kyle Joseph with Stephens.

Your line is open. Please go ahead.

Hey, good afternoon. Thanks for taking my questions. Wanted to refresh, going over to the balance sheet. You guys have been drawing down a little bit more on your bank lines. Looks like you're up to $1.5 billion. What's driving that? Refresh us how the balance sheet looks when Cenlar closes.

Sure. Overall, as we've mentioned in some of the commentary, as interest rates increase, everything else being equal, we have a couple of impacts to the balance sheet. Overall, as the production environment shrinks and production volumes decline a bit, our overall leverage declines. Went from four times to 3.6 last quarter to 3.6 times this quarter. If you look at the non-funding leverage of sort of the opposite movement where as interest rates increase, that drives an increase in our overall MSR valuation and a decline in our hedge. The decline in our hedge generally leads to a margin call, which needs to be funded. We draw on our bank lines to fund those amounts that are driven by the increase in the MSR value. Of course, we have more collateral in terms of our MSR to draw against.

It does lead to upward pressure in terms of our non-funding leverage ratio. It ticked up slightly from 1.7 to 1.8, but in the context of the overall balance sheet and leverage on the balance sheet that declines. We look at those two things in conjunction or in balance and are comfortable at the levels that we're at today and expect our overall leverage to remain in that area 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 terms of leverage. Given that the Cenlar transaction will include a bit of goodwill and intangibles. Around $200 million, $230 million-$240 million of goodwill and intangibles we would expect to recognize on the balance sheet in conjunction with the transaction.

That overall will have the effect, looking at tangible equity, of slightly increasing the reported leverage ratios. That, of course, will be offset by the increased cash flow and earnings from the Cenlar transaction. We'd expect that to both contribute positively to the ROE over time and also help to reduce the leverage ratio as we move forward from that point in time.

Got it. Really helpful. Thanks for taking my question.

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

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

Hey, Ryan. Can you speak up a bit?

Yes. Sorry, is that better?

Yeah. Yes. Sorry. Just I'll quickly recap.

On the Cenlar, there's a comment in the deck around potential additional product offerings. Obviously, it's early, it hasn't closed yet. Could you just give us some color on what potential additional products you might like to build using the capabilities you get with Cenlar?

Yeah, look, I think that we have some ancillary businesses in title and appraisal that I think can lead some to some additional ancillary income. I think that there's other things we can do vis-a-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 other product offerings that as we think about sub-servicing and when we started sub-servicing, we thought of things that we can bring to our sub-servicing clients including potential warehouse financing or servicing advanced financing. That's down the road. There's a good amount of that available in the market today.

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

Got it. Thank you. Just one more quick one, if I may. EBO loan volume was up sequentially about $600 million. Can 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. With respect to EBO volume.

Overall, EBO volume is as we're moving into the next quarter, we are seeing that slow slightly. What a couple of factors there. One, at higher levels of rates the overall sort of modifications that can be done at market rates are slightly higher, and the gains related to redelivery of that are potentially lower for a lower level of rate, however you want to think about that. 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 driven by some of the changes in the FHA.

Some of the changes that we previously discussed around FHA modifications and the fact that they now require a trial payment and that there's lower ability to remodify loans also has a bit of a dampening effect, or we're expecting a bit of a dampening effect of modifications in EBOs as we go into the second half of the year.

Thank you very much. There are no further questions at this time.

I will now turn the call back to David Spector for closing remarks.

I 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. Again, thank you so much for the time.

This concludes today's call. Thank you for attending.