UWM pays up for capital as it resets leverage targets

United Wholesale Mortgage (UWM) president and CEO Mat Ishbia is pitching the lender’s $2.05 billion capital raise with Oaktree Capital Management and his family as a long-term strategic partnership to support the company’s growth.

But the high cost of the structure and dilution are weighing on investors, alongside the fact that it follows several setbacks for the company. UWM’s stock traded below $1 on Thursday morning, the day after the deal was announced.

“Oaktree is not just capital; they’re strategic partners of ours,” Ishbia said Thursday during a 30-minute online Q&A with shareholders and analysts. “If it was just capital, I could put money in myself, or we could get random people to put capital.”

He added that the transaction “was a strategic partnership with Oaktree because of their MSR background” that was also tied their knowledge and sophistication around capital markets. 

UWM is raising $1.65 billion in preferred equity, including $1.5 billion from Oaktree and $150 million from the Ishbia family, plus a $400 million rights offering. Oaktree has designated Nicholas Basso as a director of the board and Dante Quazzo as a non-voting board observer. The transaction will make the company’s equity cross the $3 billion mark, Ishbia said. 

A good deal 

The preferred equity has a 10% cash coupon — 13% if paid in kind — and the liquidation preference increases by 10% per year. By comparison, Ishbia said much of the money UWM currently borrows costs between 6% and 8%. UWM plans to use the proceeds to repay 2027 senior notes and MSR financing facilities.

BTIG analysts said UWM is paying the price to deleverage the business: “Given the high cost of capital we expect UWMC to look to prioritize the repayment of the preferred,” analysts said in a note on Thursday.

Ishbia did not hide that Oaktree is getting an attractive opportunity, saying that when “Oaktree makes a lot of money, so does every shareholder, so does UWM.” He added that, “I’m sure we could have gotten cheaper capital elsewhere, but is that the right long-term benefit?”

Regarding the financial impact, the cost of the preferred equity will be $165 million but will be offset by an estimated $125 million in lower interest expenses, according to Keefe, Bruyette & Woods (KBW) analysts. They estimate the preferred financing significantly reduces the economic value available to common shareholders, implying roughly 55% dilution.

They said the impact could be reduced if the company quickly generates cash by selling mortgage servicing rights (MSRs) and uses that cash to repay the preferred shares. Otherwise, the preferred financing could remain a costly drag on shareholder value.

“This partly reflects the fact that the capital need was much larger than expected, reflecting the $600 million reduction in equity [from Q1 to Q2] plus the decision to bring leverage down to 1.2x versus the earlier target of 2x,” KBW analysts said.

The preferred equity also includes warrants — 165 million shares at $2 and 165 million shares at $6. Ishbia said the company chose preferred equity with warrants instead of issuing common stock because, at current trading levels, it would create “significant and immediate dilution.” In addition, “permanent capital is a better upside for the business in our belief system,” he said.

Ishbia acknowledged that the warrants do create dilution. But it’s only real “at a high level when the warrants are in the money, and the average of the warrants is $4, which is significantly higher than our stock price. A lot of the warrants are at $6. This structure balances near-term capital with long-term shareholder upside,” he added. 

As UWM focuses on building equity and deleveraging, dividends were suspended. Ishbia said the company will “always evaluate every quarter with our board of directors.” Estimates are that the leverage ratio — non-funding debt to equity — will decline from 5.6x to 1.2x.

A failed acquisition

The questions from stakeholders come after several setbacks for UWM. The company failed to acquire Two Harbors Investment Corp., which is waiting for final state approval to close a deal with CrossCountry Mortgage. Ishbia called the outcome “unfortunate” and said litigation can be expected over some things that Two Harbors “did inappropriately.”

“The Two Harbors transaction was one of the strategies of helping from a cash, liquidity and equity perspective,” Ishbia said. “When that did not go the way we expected, we had another option. And it’s great to have options. Once again, Oaktree wrote a massive-size check to be part of this, to be next to me and UWM, and help us grow together.” 

According to Ishbia, if the deal had closed, the Oaktree partnership might not have happened as quickly. The “silver lining,” he added, is that Oaktree is a much better partner for us “than Two Harbors or anything else would have been.”

A bet against the market

UWM also suffered losses on a hedge position against Two Harbors’ MSR book, which weighed heavily on its second-quarter earnings. Traditionally, the company does not hedge its MSRs, using its origination platform as a natural offset to the servicing business. But Two Harbors would have doubled the size of its MSR book, significantly increasing risk.

KBW analysts said the GAAP miss for UWM in the quarter was driven by a $603 million loss on interest rate derivatives, which hedged the Two Harbors MSR portfolio — a standalone impact that equates to a $0.16 loss in earnings per share.

“Hedging in general in the mortgage industry is expensive, and it’s something I actually don’t believe in general,” Ishbia said. “When we did put a hedge on to protect against that risk, a lot of things happened. Let’s just be real with whether it’s a war, a lot of different things that happened that created the 10-year [Treasury yield] to go up, and then obviously the Two Harbors transaction went away, and so a confluence of events that created a hedge loss.”

Ishbia said UWM hit a certain risk threshold where the company “didn’t want to have more of an equity drain,” so it removed the hedge.

“Oaktree has a strategic perspective on this, and I’ll go through that with them after this process and whether we hedge going forward or not,” Ishbia added. “Once you have $3 billion in equity, you’re really not at a risk of the MSR values going down $400 million for this quarter or going up $400 million. It’s less relevant. But when you’re hovering around $1.5 billion or $2 billion, it becomes a little bit more relevant.”

Ishbia said the “market moved against us, and it’s a one-time event that won’t happen again,” signaling the company does not plan to acquire another company with an MSR book like Two Harbors.