Despite the potential disruptions to the broader U.S. economy as a result of the war in Ukraine, the consensus of the market is that interest rates are still going up this year. As a result, mortgage banking stocks have been pummeled over the past several months as investors factored in higher and higher expected interest rates into their investing theses.
That headwind has not stopped UWM Holdings (UWMC 1.15%), the parent of the biggest mortgage broker in the U.S., United Wholesale, from forecasting that it will outperform its peers this year. Here's why.
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Brokers work on different models
Mortgage brokers have different business models than typical mortgage banks. The most common model is retail, where a lender hires loan officers to find the customer, assembles the loan in-house, and then sells it into the market. Guild Holdings (GHLD) is a good example of a company using this type of model.
Another business model is the correspondent model, where the lender buys completed loans from retail lenders and then flips them via securitizations. PennyMac Financial Services (PFSI 0.75%) is an example of a company using this type of model.
The final model is the broker model, which UWM uses. Here, United Wholesale works with mortgage brokers, who find the loans. The brokers then interact with the borrower, while United Wholesale assembles the loan. Unlike a retail loan officer, a mortgage broker can work with any wholesaler on a nonexclusive basis.
From a refinance market to a purchase market
The retail and correspondent models tend to do well in a refinance-heavy environment like we had in 2020 and early 2021. A company like Rocket Companies (RKT 1.32%) can send notifications directly to customers, allowing them to refinance via their phones. This additional volume helps the correspondent lenders increase earnings, as there are more loans to buy.
Mortgage brokers source their loans the old-fashioned way: by talking to Realtors, developing relationships with title and closing attorneys, and generally working the phones. This method works much better in a purchase market, which is why the company sees it outperforming the competition as rates rise.
United Wholesale's success won't be so much it increasing its lending as much as it will be its competitors shrinking. Many loan officers who started in the business over the past couple of years were able to get all the business they could handle just by answering the phone. In a rising rate environment, the phone stops ringing.
United Wholesale has spent a lot of money developing its technology, which increases the broker's visibility into the loan's status as it is being put together. Mortgage brokers know that the key to success is keeping real estate agents happy, and a big part of that is avoiding surprises.
United Wholesale was one of the few mortgage companies that reported an increase in volume in the fourth quarter of 2021. Rocket reported a decline of 29%. However, gain on sale margins fell from 3.05% to 0.80%. Gain on sale margins could be thought of as the gross margin of a mortgage banker. United Wholesale does see volumes declining; however, it believes gain on sale margins (which are at a record low) aren't going lower.
Investing sentiment is awful for the mortgage business
Stocks for mortgage bankers are a tough lot to love since their earnings tend to be volatile. 2020 and 2021 were the best years for the industry since the early 2000s. Those days aren't coming back anytime soon.
That said, United Wholesale pays a pretty hefty dividend of $0.40 per share per quarter, which gives it a yield of 9.2%. The company is expecting an EPS of $0.69 this year, which means the dividend payout ratio is 58%. That suggests the high yield is safe and not a red flag. At current levels, the stock has a P/E ratio of 6.8 times this year's earnings per share. A market leader trading under 7 times with a yield over 9% makes an interesting choice for an investor who is willing to accept that sentiment is highly negative for the sector this year.
