Mortgage banking is a feast-or-famine business. The past two years have been a smorgasbord for the mortgage industry as the Federal Reserve lowered interest rates and bought mortgage-backed securities to support the economy.
The Fed recently announced that it will begin reducing its purchases of mortgage-backed securities, and the consensus seems to be coalescing around two or three rate hikes next year. This increase in interest rates will negatively impact origination volume. Here is how UWM Holdings (NYSE:UWMC) is planning to navigate the rougher waters ahead.
UWM Holdings believes "brokers are better"
UWM Holdings, known in the industry as United Wholesale, is the biggest mortgage brokerage firm in the U.S. It has a different business model than the typical originator. Most mortgage originators in the U.S. are retail lenders, which find their own borrowers, assemble the paperwork for the loan, fund it, and then either sell it or retain it. This is a relatively expensive business model.
United Wholesale deals with mortgage brokers who find the borrower and then pass the partially completed loan over to United Wholesale, which completes the assembly and funding. The big difference between United Wholesale and retail lenders (like Rocket) is that United Wholesale's customer is the mortgage broker, while for a retail lender it is the borrower.
This difference is not merely one of semantics. The typical homeowner is probably only going to do a handful of mortgages in their lifetime. A mortgage broker might do a dozen loans in a month. United Wholesale has invested heavily in technology that reduces costs and gives the broker visibility into the loan's status in real time. Brokers rely on their relationships with realtors to find borrowers, and execution/visibility is key to maintaining these relationships.
Home purchases will be a bigger percentage of loans going forward
The broker business model will help UWM Holdings as interest rates rise, because it relies heavily on home purchase activity. A homeowner with a 3% mortgage isn't going to refinance if rates increase to 3.5%, but that increase isn't going to factor much into the decision calculus of someone who wants to move to get closer to work, upsize, or downsize. During 2018, when much of the mortgage industry shrank volumes and workforces, United Wholesale continued to grow and was profitable.
Mortgage servicing will help offset the loss of refinance activity
As rates increase, UWM Holdings expects to see gains from its mortgage servicing book. Mortgage servicing is one of the few financial assets that increases in value as interest rates rise. Mortgage servicers handle all of the administrative tasks of managing the loan after it is made. They collect the monthly payments, ensure that the ultimate owner of the loan gets paid the required principal and interest, ensure property taxes are paid, and deal with the borrower if he or she gets into trouble and cannot make payments. As compensation, the servicer gets 0.25% of the outstanding loan balance annually. If rates rise, that mortgage will probably not refinance, so the servicer will collect the 0.25% fee for a longer time.
UWM Holdings is trading at just under nine times expected 2021 earnings per share, which is pricey for a mortgage originator in this environment. That said, the Street expects UWM's earnings per share to grow 8% between 2021 and 2022. Comparable bankers like Rocket, Guild, and Mr. Cooper are expected to see a decline in earnings. United Wholesale also pays a quarterly dividend, which gives the stock a dividend yield of 5.7%. It is hard to like the mortgage originators given the interest rate environment, but UWM looks to be the strongest one out there right now.