Despite the potential disruption to the broader US economy as a result of the war in Ukraine, the market consensus is that interest rates will continue to rise this year. As a result, mortgage bank stocks have taken a beating in recent months as investors factored increasingly higher expected interest rates into their investment theories.
This headwind has not stopped UWM funds ( UWMC -5.46% ), the parent company of the largest mortgage broker in the United States, United Wholesale, to predict that it will outperform its peers this year. Here’s why.
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 in the marketplace. Guild Holdings ( GHLD -2.48% ) is a good example of a company using this type of model.
Another business model is the matching model, in which the lender purchases completed loans from retail lenders and then flips them through securitizations. PennyMac Financial Services (IFHP 0.32% ) is an example of a company using this type of model.
The final model is the broker model, used by UWM. Here, United Wholesale works with mortgage brokers, who source the loans. 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 non-exclusive basis.
From a refinancing market to a purchase market
The retail and correspondent models tend to work well in a refinancing environment like the one we experienced in 2020 and early 2021. A business like Rocket companies ( RKT 1.72% ) can send notifications directly to customers, allowing them to refinance through their phones. This extra volume helps correspondent lenders increase their income because there are more loans to buy.
Mortgage brokers get their loans the old-fashioned way: by talking to real estate agents, developing relationships with title and closing attorneys, and generally working on the phone. This method works much better in a buy market, which is why the company sees it outperforming the competition as rates increase.
United Wholesale’s success will not be so much in increasing its loans as in decreasing its competitors. Many loan officers who have started in the business over the past couple of years have been able to get all the business they can 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 status of the loan as it is built. Mortgage brokers know that the key to success is keeping real estate agents happy, and a big part of it is avoiding surprises.
United Wholesale was one of the few mortgage companies to report an increase in volume in Q4 2021. Rocket reported a 29% decline. However, the gain on sales margins fell from 3.05% to 0.80%. The gain on sales margins could be thought of as a mortgage banker’s gross margin. United Wholesale sees its volumes drop; however, he believes profit margins on sales (which are at an all-time high) are not declining.
Investment sentiment is terrible for the mortgage sector
Stocks for mortgage bankers are hard to like because their earnings tend to be volatile. 2020 and 2021 have been the best years for the industry since the early 2000s. Those days aren’t coming back any time soon.
That said, United Wholesale pays a fairly hefty dividend of $0.40 per share per quarter, giving it a 9.2% yield. The company expects EPS of $0.69 this year, which means the dividend payout ratio is 58%. This suggests that 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 less than 7x with a yield greater than 9% is an attractive choice for an investor who is willing to accept that sentiment is very negative for the sector this year.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a high-end advice service Motley Fool. We are heterogeneous! Challenging an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and wealthier.