Zillow Home Loans will lose significant business from iBuyer shutdown

The implosion of Zillow's iBuyer business will have an impact on both originations and revenues at Zillow Home Loans going forward, given that it contributed 70% of its purchase leads.

But even without that business, the Seattle-based firm intends to continue marketing its integrated services to home buyers and sellers.

Zillow purchased what was then called Mortgage Lenders of America in November 2018 specifically to provide financing to those buying homes through Zillow Offers.

The transaction, however, was controversial; the National Association of Federal Credit Unions even used the deal as the primary example of why fintechs must be federally regulated.

However, Zillow Offers was a financial disaster for the parent company; the business lost more than $380 million in the third quarter. Zillow blamed a faulty algorithm that caused it to overpay for homes at a time when price growth was slowing.

"Zillow still intends to pursue the Zillow 2.0 strategy but in a more 'asset-light' way," said Ygal Arounian, managing director, internet equity research at Wedbush Securities, in a report. "The vision needs to be rebuilt and in light of how iBuying transpired, management will need to rebuild credibility that it can successfully implement that vision over time."

Zillow's mortgages segment, which includes Zillow Home Loans, Mortech and its mortgage marketplace business, had a 30% year-over-year increase in revenue to $70.3 million in the third quarter, versus $54.2 million one year prior; in the second quarter, recorded $56.7 million.

The third quarter exceeded the company's prior outlook range, said Allen Parker, chief financial officer, on the earnings call. Approximately 54% of that annual increase is from origination volume more than doubling, while 43% came from growth in its lead generation businesses, Custom Quote and Connect.

"Mortgages segment [adjusted] EBITDA was a positive $5 million, compared to the midpoint of our outlook range of a loss of $9.5 million," he added. Investment banking company Stifel expected this line to show a loss of $8.2 million. The second quarter had a $5.9 million loss, while for the third quarter 2020, adjusted EBITDA was nearly $16 million.

But Zillow Group recorded a $5.6 million pretax loss from mortgages, improved from a $17.7 million pretax loss in the second quarter, but down compared with the $10.6 million pretax profit in the third quarter of 2020.

Origination volume was $1.1 billion in the third quarter, with $359 million in purchase and $753.6 million in refinance production. This is compared with $888 million in the second quarter, $658 million was refi volume and $230 million was purchase. In the prior year it originated $517 million, made up of $163.7 million of purchase and $353.4 million of refis.

Going forward, the shuttering of Zillow Offers will have an effect on Zillow Home Loans. In the third quarter, 70% of those its purchase leads were from the iBuying business, Parker said.

"That gives us comfort that financing is a very important part of the moving process and that having a financing factory that could help serve our customers in a variety of ways is a capability that we must have as we think about serving our customers as they move," Parker continued. "And that as we get volume, we're able to generate profitability that you would expect from a purchase company or I should say, a mortgage origination company as that volume grows."

But over the next two quarters, "choppiness" in the mortgage business is expected to harm its results. Still, "we do collect a ton of mortgage interest from consumers right now because of our way up funnel position," added CEO Rich Barton. "And we process only a small portion of that ourselves with Zillow Home Loans, and we have a marketplace for the balance of them, this puts us in a really good position to innovate here."

Mortgage segment revenue is expected to be between $47 million to $52 million in the fourth quarter.

"Our Q4 outlook reflects slower industry refinance activity from the recent move in interest rates, slight compression in gain on sale spreads and slower growth in purchase originations impacted by the wind-down of Zillow Offers operations," Parker said. "As a result of lower sequential revenue and continued investments to grow mortgage originations, we expect mortgages segment EBITDA to be between a loss of $16 million and $11 million in Q4."

Stifel cut its fourth-quarter mortgage revenue estimate for Zillow to $50 million from its prior $65.6 million; it also cited lower purchase origination volume as the reason, according to a report from analyst Scott Devitt.

For the full year 2021, Stifel reduced its mortgage revenue forecast for Zillow by 2.2% to $245 million, but the real impact will be seen in 2022, as Devitt's latest prediction of $266.9 million is 12.6% lower than his prior outlook calling for $305.5 million.

Yet, Zillow looks at the mortgage lending business as an integral part of its operations even as the original reason for buying MLOA no longer applies.

For example, a seller might start with marketing a property through Selling Time, which the company just acquired. "Next, the mover, the seller might want to pre-qual for the next mortgage or get a mortgage," said Barton. "Next, we want to route documents and do closings and title and escrow all integrated into the same fluid experience."

It was because of Zillow Offers that the parent company invested in each of these businesses in the first place, Barton said.