Mortgage origination is a feast-or-famine business, and business conditions can turn on a dime. Last year was the best for the mortgage industry since 2003, and a number of mortgage bankers went public. Yet in 2021, the mortgage banking sector has completely underperformed.
The stock price of UWM Holdings (UWMC -0.16%), also called United Wholesale Mortgage, has fallen 43% so far in 2021, despite the company having just reported the best quarter in its history. What is going on?
Despite a great environment, investors are negative on the sector
Last year, mortgage originations hit $3.83 trillion, according to estimates from the Mortgage Bankers Association. The MBA sees origination volume falling 14% in 2021 as rising interest rates take a bite out of refinancing volume. While 14% sounds like a big decline, the projected volume of $3.28 trillion would still be the third-best year ever. So why are investors so glum about the sector?
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Prepare for a price war
The short answer is that investors sense a price war is brewing as more and more originators fight to acquire market share. In its most recent earnings press release, United Wholesale's CEO Mat Ishbia gave a hint of what is coming:
The first quarter of 2021 was not only the best first quarter in our 35-year history, it also marked our first quarter as a public company and solidified our foundation for growth. We believe we now have the capital, liquidity, technology, campus and staffing necessary to further scale our business and grow to become the largest mortgage originator in the country. We welcome the shift to more of a purchase market and the pressure on margins as we believe our business model is built to outperform competitors under those conditions.
When Ishbia refers to "pressure on margins" he is saying that mortgage companies across the board expect to earn less per loan than they did last year. The company's second-quarter guidance shows how dramatic it believes the contraction will be: from 2.19% profit per loan in the first quarter to a range of 0.75% to 1.1% in the second quarter, a decrease of 58%. The good news is that United Wholesale sees an increase in volume, from $49 billion in the first quarter to a range of $51 billion to $55 billion in the second.
The mortgage business is feast-or-famine
The nature of the mortgage origination business is one of record high margins giving way to record low margins. This is a function of industry capacity. When rates move unexpectedly lower like they did last year, the mortgage companies are often understaffed and unable to handle all of the demand. Eventually, by the time they add the necessary capacity, the party is winding down, which causes originators to cut prices to get volume in the door. Eventually, the industry lays off people and margins normalize.
Ishbia said on the earnings call that the 0.75% to 1.1% profit per loan would probably turn out to be a low point, although it could last one or two quarters. Normalized margins would be something in the mid-1% range. Note that crosstown rival Rocket Companies also forecast lower margins, although nothing as dramatic as United Wholesale is predicting. While Rocket and United Wholesale do compete, Rocket is primarily a retail mortgage bank that does some broker business, while United Wholesale is 100% broker. United Wholesale recently told its brokers that they can do business with Rocket or UWM. They can't do both.
High yield, low payout ratio, and low P/E
The Street expects United Wholesale to earn $1.27 per share this year, which gives the company a price-to-earnings ratio of just under six times. The company has invested heavily in technology and its lower cost to originate gives it an advantage in a price war. United Wholesale also pays a quarterly dividend of $0.10 a share which gives the stock a yield of 5.9%. The payout ratio (dividend divided by earnings) is only 32%, so the dividend looks sustainable, even going into what could be a price war.
