UWM Holdings: Making the Right Steps, but Risks Exist (NYSE:UWMC)
Following its IPO in January 2021 through a SPAC merger with Gores Holdings IV, UWM Holdings Corps (NYSE:UWMC) has lost 51% (year over year) in shareholder returns. It might seem like a potential downside considering the merger was hailed as the largest The SPAC transaction at the time, valued at approximately $16 billion. However, the company’s Q2 2022 revenue of $564.23 million beat consensus estimates by $64.45 million and was up 16.4% (YoY).
Despite the 31.35% (QoQ) revenue decline, UWMC expects its third-quarter credit production guidance to be between $23 billion and $28 billion and a higher margin of $75 billion to $90 billion for full-year 2022. UWMC’s management is single-minded on the growth of the brokerage channel as it appears to be the fastest way to lend to consumers as opposed to the retail channel. The company has also reduced its manual operations through the use of affordable technology and reduced lending costs to maintain a competitive edge. Overall, the company looks forward to recruiting more retail lending facilities and paying a regular dividend as it expects to continue to balance liquidity and profitability.
UWMC revenue declined 31.35% (QoQ) from a peak of $821.8 million in Q1 2022 to $564.22 million in Q2 2022. The decline was due to lower credit production earnings, which declined 38.13% (YoY) to $296.54 million in the three months ended June 30, 2022. Credit production earnings had in the six months as of June 30, 2021 peaked at $1.554 billion but was reduced by 56.21% (Y/Y) to $680.41 million. UWMC’s manufacturing earnings were reduced in the six months (December 2021 to June 2022) due to a decrease in the unpaid principal balance on the mortgage loans, the premiums paid on the mortgage loans and the fair value adjustment over this period. As a result, mortgage loans at fair value decreased 69.5% to $5.332 billion for the six months compared to a peak of $17.473 billion realized in the six months ended December 31, 2021.
It must be remembered that UWMC generates its income from three main sources of income: lending, loan servicing and interest income. The rising interest rate environment led to a decline in lending revenues amid increased competition in the markets. In a bid to reduce persistently high inflation, the US Federal Reserve announced a 0.75 percentage point rate hike in the third quarter of 2022, which led to a further increase in debt for credit cards, auto financing and other lending.
Rising interest rates have had little impact on fixed-rate mortgages over the years. However, customers getting a new mortgage or customers with adjustable-rate mortgages have noticed changes in their monthly payments. There is also a direct relationship between mortgage rates and the bond market.
Since the beginning of 2022, mortgage interest rates have risen from 3% to 6.6%. Analysts have calculated that this increase means that the monthly premium cost of, say, a $400,000 30-year fixed-rate mortgage (with a down payment) increases by almost $569 by 20%.
Returning to the production forecasts, UWMC stated in its Q2 2022 earnings call that it forecast production of $23 billion and $28 billion for Q3 2022. However, this forecast is lower than the mortgage production for Q2 2022, which came in at $29.9 billion. CEO Mat Ishbia explained that the purchased volume was $22.4 billion, indicating an increase of 17% (QoQ) and a profit range of between $30 and $60. In defense, management has expressed its desire to work on the company’s long-term investments, and specifically the brokerage channel, to build margins over time.
Broker channel and pricing strategy
CEO Mat Ishbia underscored his support for the broker channel as opposed to the retail method, demonstrating that it helps customers achieve savings. In his words, Mat noted:
The average borrower saves $9,400 over the life of the loan using the broker channel versus the retail channel. It’s even better for minority borrowers who are saving about $10,400 through a broker.”
It can be seen that large lenders like UWMC are working with brokers to get the benefit of having their profiles checked by a third party before loan applications are processed. Personal lenders like Rocket Companies, Inc (RKT) find customers and accept, block and process loan applications without the use of brokers. This explains why they have higher margins as they exclude additional brokerage fees from the lending rates.
From face value, UWM is willing to raise mortgage rates to accommodate brokers in this new environment. However, it appears that this wholesale lender intends to beat its rivals by continuing to offer brokers competitive rates (and compressing its margins), a move that will help them navigate the mortgage market.
In the second quarter of 2022, UWM announced that it had lowered its marginal interest rates by 50 to 100 basis points on all of its mortgage loan types. I believe the company is aiming to establish a strategic pricing platform that is twofold. It will first show a broker where to place a loan, i.e. convey the characteristics of an ideal client based on a pricing model and convert personal loan officers into wholesale brokers. The key focus for UWM is to match pricing to competitor credits, and I believe that’s what Game-on Pricing stands for.
Through its website, Game-on has launched a recruitment campaign for independent mortgage brokers, a scenario aimed at reducing its administrative costs. In the three months ended June 30, 2022; UWM’s total expenses increased 1.0% (QoQ) and 7.7% in the six months ended December 31, 2022. I expect the increase in independent mortgage brokers to result in lower operating expenses over the next few quarters. The goal is to help the company achieve more operational leverage by 2023. In addition, the introduction of this technology will increase efficiency among mortgage brokers, increase production income and provide customers with quality loan offers.
UWM announced in the second quarter of 2022 that it had fully diluted earnings per share of $0.09. The company has issued a regular dividend for the last 7 quarters, with the latest showing a yield of 12.42% (TTM). Despite the decline in credit production revenue, UWM’s cash position was just under $1 billion (at $958.66 million — a 31.13% increase in the six months ended December 31, 2021).
The company stated that the cash on hand is sufficient not only to meet its liquidity needs through the end of the year, but also to support the payment of dividends in the third quarter of 2022.
While I don’t think there’s a real estate recession in the US, dividend income wouldn’t be the best thing to consider if there is one. Analysts have taken the rise in mortgage rates as an indication that the housing recession is imminent. Demand for mortgages has also fallen by 30% (yoy) and sales transactions have also slowed. From an economic perspective, a fall in demand followed by a rise in supply will undoubtedly cause prices to fall.
2022 in particular is seeing a gradual increase in mortgage rates and as expected any drop in rates will attract more mortgage applications. For now, we can see that there have been lower credit production levels as reflected in UWM’s balance sheet. Still, we should keep in mind that the interest rate offered to customers depends on, among other things, creditworthiness, debt-to-income ratio, proof of steady income, and loan-to-value ratio.
UWMC is working to implement operational efficiencies across the mortgage business through its game-on strategy. The company’s pricing initiatives were also introduced to attract not only brokers but also potential clients. Investors have received regular dividends over the past 7 quarters, with the company excited by its robust liquidity through 2023. The biggest challenge for the company is the downturn in the housing market, which threatens to reduce demand. Nonetheless, the company is working to reduce operating expenses in order to stabilize cash flow during the year. For these reasons, we propose a Hold rating on the stock.