The past year has been awful for the mortgage origination business. After feasting on easy refinance activity in 2020 and 2021, mortgage originators got a punch to the gut when the Federal Reserve started hiking the federal funds rate in early 2022 to bring down outsized inflation. Those rate hikes slowed refinance activity to a crawl, and we have seen several big originators go bankrupt and exit businesses as a result.
The biggest originator in the United States is UWM Holdings (UWMC 0.73%), which is the parent company of United Wholesale. This company follows a somewhat different business model, which is helping it navigate this market better than its competitors.
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Using the broker model to manage in a crisis
There are three basic business models for mortgage originators. The most common model is the retail model, where the company employs loan officers who work on commission to find borrowers. This is the model that Guild uses. Other retail outlets use technology to find borrowers. This is how Rocket Companies finds its loans. Under the retail model, the lender does all the work to assemble the loan and then (usually) sells it to an investor.
The second type of broker model is a correspondent lender, which is Mr. Cooper Group's model. The correspondent buys a completed loan and then flips it into the market at a small profit.
Finally, there is the broker model, which is what UWM uses. UWM assembles the loan but doesn't use loan officers to find the borrower. UWM works with independent mortgage brokers, who interact with the borrower, gather the required information, and then give it to UWM to finish up the process.
The purchase business is different from the refinance business
The success of these different models depends a lot on what type of mortgage market we are in. During 2020 and 2021, interest rates were super-low, and everyone wanted to refinance their mortgage. Rocket's app was perfectly suited for this environment. Now that interest rates are much higher, the refinancing opportunities have disappeared. Mortgage lenders are forced to concentrate on the purchase business, which is a tougher nut to crack. The purchase business is more of a relationship-driven business, and real estate agents generally recommend someone they know. Often, that is a mortgage broker because a broker can deal with any wholesale lender, which gives the borrower the most options.
Declining volumes have been the story since the Federal Reserve started hiking interest rates over a year ago. According to the Mortgage Bankers Association, lenders, on average, lost $1,972 per loan. In the fourth quarter of 2022, it was even worse -- lenders lost $2,812 per loan. The declining volume and pricing pressures have forced many originators to exit the business. Loan Depot exited the wholesale business, while Wells Fargo got out of the correspondent business.
UWM is outperforming its crosstown rival
UWM reported an origination volume of $22.3 billion in the first quarter, down from $25.1 billion in the fourth quarter of 2022 and $38.8 billion a year ago. This was a decrease of 11% quarter over quarter and 43% from a year ago. In contrast, Rocket reported a volume of $16.9 billion, which was down 69% compared to a year ago. On a year-over-year basis, UWM reported an increase in purchase volume, which shows it is taking share from competitors.
The mortgage origination business is in a difficult place right now, and it is hard to see anything good happening until the Federal Reserve starts cutting rates. Until then, it will be a grind as capacity is wrung out of the system. UWM is expected to earn $0.21 per share this year, which puts the company on a price-to-earnings (P/E) ratio of 24. This is expensive for a mortgage company. However, the mortgage business is extremely cyclical. Companies operating in this sector will trade with big P/E ratios when times are tough, but when times are good, P/E ratios generally collapse to the mid-single digits.
The dividend is no sure thing
The bigger worry for UWM is the dividend. UWM pays a $0.10 per share quarterly dividend, which means that expected annual earnings of $0.21 won't cover the annual $0.40 dividend. Investors should view the 7.9% dividend yield as no sure thing. As a general rule, mortgage bankers pay miserly dividends due to cyclicality. UWM is a well-run company, but the environment for mortgages remains inhospitable right now.
