The mortgage business is one of the most cyclical businesses out there. It can pivot from feast to famine almost overnight. 2021 versus 2022 is a great example of this pivot in action. In 2021, mortgage bankers feasted on easy refinances courtesy of Federal Reserve policy to keep rates near zero to support the economy. These easy refinances evaporated in 2022 as the Fed began to hike rates to defeat inflation.

Mortgage bankers have been fighting to secure their piece of a shrinking pie as 2022 progresses, and virtually every big banker is reporting declines in origination volume. That is, except for one: UWM Holdings (UWMC -1.19%), the parent company of United Wholesale Mortgage. What is it doing differently?

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Not all mortgage shops have the same business model

United Wholesale took the lead as the top mortgage originator in the third quarter of 2022. It operates in the wholesale channel, which is a different business model than the typical mortgage shop. There are three basic business models for mortgage originators: retail, correspondent, and wholesale. 

Retail shops find the borrower and assemble the loan. The most well-known retail shop is Rocket Companies. Rocket uses its app to source borrowers, puts together the loan, and then sells the completed loan to the market. Retail shops are the most common business model. The second model is correspondent lending, where the company buys completed loans from smaller retail lenders and then sells them at a small markup. The best example of this model is PennyMac Financial Services.

Wholesalers serve a different customer

The wholesale model is different in that it gets its loans from brokers. The broker finds the borrower, collects the required data, and then sends it to a wholesale shop like United Wholesale, which does the assembly and then sells the loan once it is funded. The biggest difference is that in a retail shop, the customer is the borrower. For a wholesale shop, the customer is the broker. The secret to a wholesaler's success is to get that broker to send all of his or her loans to that particular wholesaler. Accomplishing that is a function of pricing and service. 

Brokers generally get their leads by developing relationships with real estate agents, title attorneys, closing agents, and other people in the field. This means that the broker is much more in touch with the purchase market than, say, a retail shop that relies primarily on technology to solicit borrowers. This is an advantage in the current market, where there is little financial incentive for borrowers to refinance their loans. In this market, it's all about the purchase business. 

We have seen major exits from the wholesale channel

The wholesale business is highly competitive, and some of UWM's biggest competitors have exited it. The most notable name is loanDepot; however, other lenders have folded entirely, gone bankrupt, or exited wholesale. This has driven brokers to do business with UWM, and the company's Game On program is about selling loan officers on the benefits of becoming a broker. On the most recent earnings conference call, United Wholesale CEO Mat Ishbia said that about 17,000 loan officers have become brokers this year.

UWM's focus on purchases and developing the broker space have paid dividends. In the third quarter of 2022, the company reported a 12% increase in volume compared with the second quarter. To put that into context, the entire industry saw a 19% decrease in volume. That said, UWM priced aggressively to gain that volume and market share. Gain on sale margin fell from 0.99% in the second quarter to 0.52%. 

Don't expect multiple expansion

UWM is trading at about 8.7 times expected 2022 earnings per share. While this may appear to be a low multiple, mortgage lenders generally don't command big multiples since their income streams are so volatile. In good times, you will see mortgage companies trade at mid-single-digit multiples. UWM is one of the few mortgage banks that pays a decent dividend yield, with the stock paying 9.7% currently. 

It is hard to get excited about the mortgage business given that refinance activity is at multidecade lows and housing affordability is low. That said, if the Fed pivots and some of the volatility in the bond market subsides, we could see a sizable drop in mortgage rates. That should stimulate home purchase activity, which is where UWM shines. In the meantime, the company pays a nice dividend and is one of the leaders in the mortgage space.