One of the worst performing sectors in this current down market has been mortgage originators. After feasting in 2020 and 2021, the economic environment has turned into a famine as interest rates rise and stifle refinancing activity.
consumer credit giant Rocket companies (RKT 2.10%) has not been immune to a difficult environment, so he has adapted to it by focusing on the opportunities that still present themselves.
The fastest increase in mortgage rates in more than 30 years
Interest rates have risen at a rapid pace since the emergence of outsized inflation forced the Fed to chart an aggressive course for monetary tightening. Jay Farner, CEO of Rocket, said the increase was “the biggest in over 30 years.”
You can see in the chart below, the trajectory of mortgage rates over the past 30 years. Although we are not at the highs seen for most of the period, the rise in rates in such a short time has been exceptionally rapid.
Mortgage refinances dry up as rates rise
With interest rates rising so rapidly, one of the great pillars of mortgage origination – “rate and term” refinancing – has disappeared. No one will replace a 4% mortgage with a 6% mortgage. That leaves home purchases and cash refinances to take over. Although hitting record highs for Rocket, volumes are still down 48% year over year to $54 billion. In the second quarter, which is usually a seasonally strong quarter, Rocket forecasts further decline in the $35-40 billion range. Margins on Rocket’s production have plummeted, which acts as a double whammy to revenue (fewer loans and less profit on them).
Rocket’s management believes the company’s technology gives it a competitive advantage as younger first-time homebuyers tend to prefer using an app to create and manage a loan. In the meantime, Rocket is cutting costs like every other mortgage originator to adjust to the new world of lower volumes.
Rocket also has an asset called Mortgage Servicing Rights, which are tailor-made for this type of environment. Mortgage servicing rights are very sensitive to mortgage rates and increase in value as interest rates rise. Some of Rocket’s other businesses, such as Rocket Homes and Rocket Auto, have the potential to generate loans and diversify from the volatility of mortgage origination activity.
Is the stock at its lowest? Depends on inflation
Rocket’s share price is down 46% year-to-date, but it paid a special dividend of $1.01 per share in March. Is it cheap enough to buy? Rocket does not pay a quarterly dividend, so investors cannot count on stable income here. The company is expected to earn $0.98 per share this year, and Wall Street analysts are looking for EPS of $1.11 in 2023. That gives Rocket a P/E multiple of 8.1. For highly cyclical stocks like mortgage originators, 8.1 times earnings in a bad year is not great. This is especially true for a market leader like Rocket.
That said, the sentiment for the sector is terrible. It’s all going to come down to the Fed and whether those rate hikes end up working and taking care of inflation. If inflation seems to be coming down, the stock could be a buy.