The past year was extraordinarily difficult for companies in the mortgage space. The Fed aggressively hiked interest rates to help get inflation back under control, which translated into rapidly rising mortgage rates. To make matters worse, high home price appreciation in the aftermath of the pandemic created an affordability crisis for homebuyers, especially first-time buyers.
The stock for mortgage originators has been under selling pressure the entire year, but it appears mortgage rates might have peaked and may be beginning to fall. Here is what this rate reversal means for UWM Holdings (UWMC 1.63%).
Image source: Getty Images.
Mortgage companies have different business models
UWM is the parent company of United Wholesale, which is the biggest mortgage broker in the United States. A mortgage broker is a bit different from a traditional mortgage lender, so it makes sense to take a second to understand the different business models.
The most common mortgage-origination business model is the retail mortgage originator. The mortgage banker assembles and funds the loan and either holds it or sells it to another mortgage banker. This is the model that Rocket Companies (RKT 2.48%) uses.
The second model is the correspondent model, where the bank buys completed mortgages from retail lenders. This is the model that PennyMac Financial Services (PFSI 2.84%) uses.
"Brokers are better"
UWM goes down a third path, using something called the wholesale model where the company works with mortgage brokers that source loans for the company as independent agents. United Wholesale believes "brokers are better" and that this model is best for the borrower. The broker isn't obligated to work for a single lender, so it can find the right product from the right wholesaler for the client. These brokers tend to have a network of real estate agents, which is how they get their leads.
UWM has an army of brokers who are close to the home purchase market, which should be the dominant source of mortgage business in the near future. Companies like Rocket feasted on easy refinancing business during the pandemic when interest rates were extremely low. But now that rates have risen, there is little incentive for borrowers to refinance, as nobody is going to trade a 3.5% mortgage rate for a 6.5% rate. This means the mortgage business will be dominated by lenders who are in the best place to capture home-purchase loans.
Mortgage rates are peaking
The rapid rise in mortgage rates seems to have hit its peak, and it appears rates are beginning to fall. This will go a long way toward addressing the affordability issue.
30-year mortgage rate; data by YCharts.
The Mortgage Bankers Association (MBA) recently released its forecast for 2023, and while it sees volumes continuing to decline in the first quarter, originations should bounce back when the spring selling season starts around March. The MBA sees rates continuing to fall throughout 2023 and 2024. Purchase mortgages will dominate the space, and this is where UWM's business model shines.
The mortgage space has highly negative investor sentiment
Like Rocket, UWM has been subject to highly negative market sentiment, and both companies are among the most-shorted stocks on Wall Street. This short interest represents future buying of the stock, and it could be subject to short squeezes as the environment improves.
Not only that, but at some point, the company might decide it is better off being private again, and would be required to offer a premium over the existing share price to entice shareholders to vote for the deal. Betting on takeovers is generally a fool's errand, but that possibility should always be kept in mind.
The dividend is a worry
UWM pays a $0.40 annual dividend per share, which is covered by this year's expected earnings of $0.48 per share. Wall Street analysts estimate that the company will earn $0.19 per share next year, which would not cover the dividend. A dividend cut could be possible in 2023 if earnings don't rebound, and this is the biggest risk for the stock.
That said, the clouds are parting for the mortgage space, and the worst is probably behind the whole sector. It is hard to keep betting against the company at this point.
