As investors become more positive on the economy, the mortgage banking sector is becoming more negative on things. While 2020 was the best year for the industry since 2003, and 2021 should also prove to be almost as good, interest rates are rising. That means business will weaken into the latter half of the year and into 2022.
Are brokers better?
United Wholesale believes that "brokers are better." A mortgage broker is different from a typical mortgage banker. A mortgage banker works with one company and chooses the best option for the customer based on the company's offerings. A mortgage broker is beholden to no one. The broker will have relationships with all sorts of wholesale companies. So while a mortgage banker who works for Wells Fargo can only sell Wells products, a mortgage broker might be able to sell a loan to United Wholesale, loanDepot, or a whole host of other places.
It is important to distinguish United Wholesale's business model from the other models. United Wholesale works with loan brokers, who find the customer, do some preliminary work on the mortgage, and then send it to the wholesaler. Its customer is the broker, not the borrower. A primarily retail originator like Rocket finds the customer, does all the work on the loan, and then funds it. The main difference is that Rocket finds the borrower, while United Wholesale does not.
Since mortgage brokers generally source their borrowers from realtors, they tend to have a more purchase-driven business. This focus will help United Wholesale navigate the market going forward.
United Wholesale has a cost advantage
United Wholesale originated just over $49 billion in the first quarter of 2021. Based on the company's average loan size, this works out to be something like 155,000 loans. Total expenses for the company were $317 million, so the average cost per loan is about $2,040.
To put that in perspective, The Mortgage Bankers Association just released the first-quarter performance statistics for independent (in other words, non-bank) mortgage originators. The average cost to produce a loan was almost four times that amount, pushing $8,000 per loan. While some of that will be due to economies of scale, most of it is attributable to United Wholesale's investment in technology.
Interest rates have risen this year as investors see the economy recovering. The feast of easy refinancing activity that began with COVID-19 is beginning to wind down. The mortgage origination business is highly cyclical, and we are the part of the cycle where capacity has caught up with demand. If rates continue to rise, refinancing activity will dwindle further, and bankers will begin to lower margins to attract business.
The price war is beginning
United Wholesale's forward guidance during the first-quarter earnings conference call suggested that it sees a price war going forward. The company projected that gain on sale margins will fall from 2.19% in the first quarter to a range of 0.75% to 1.1%. At the same time, it guided that volume will increase. Most originators are more cautious.
United Wholesale recently announced a price match guarantee on quotes from a list of 15 major lenders. This would indicate the company is serious about winning a price war. Note that Credit Suisse recently downgraded the stock; however, it did mention the company's cost advantage as a positive.
The next few quarters could be difficult for the industry, but United Wholesale's focus on purchase and its lower relative costs to originate make it a likely survivor. The stock is trading at 15 times this year's expected earnings per share, which is pricey for a mortgage originator. The Street is looking for earnings to grow 37% from 2021 to 2022, while earnings for crosstown rival Rocket are expected to fall 27% over the same period. Analysts clearly see United Wholesale's business model as built to survive the coming price war.