Rocket reports increased profitability on loans, but what happens when rates rise?
The last two years have been the best for the mortgage industry since the early 2000s. The COVID-19 pandemic prompted the Federal Reserve to cut interest rates, triggering a refinancing boom and unprofitable profitability. precedent for the industry.
Today, however, the lay of the land looks different as the Federal Reserve begins to reverse the measures it took at the start of the pandemic. These actions will have a negative impact on the entire mortgage industry.
Let’s see how Rocket companies (NYSE: RKT) plans to navigate these potentially stormy seas.
Image source: Getty Images.
The Fed is about to become a headwind for the industry
At the Federal Open Market Committee’s November meeting, the Fed announced that it would begin to cut back on its purchases of treasury bills and mortgage-backed securities. This decision had been telegraphed by the central bank for months, so it was expected.
The Fed’s purchases of mortgage-backed securities have artificially lowered mortgage interest rates. Mortgage rates have been rising steadily for months as the market adjusts to the new policy.
Rocket’s technology gives it a head start over its competition
Rocket Mortgage is the largest mortgage originator in the United States and its technology gives it a huge competitive advantage over other lenders. Rocket’s technology allows the business to reach the consumer directly, which means it doesn’t have to rely so much on loan officers to grow business. Loan officers typically receive between 0.50% and 2% of the mortgage amount as a commission, so the savings (which amount to thousands of dollars in fees) allow Rocket to lower the fees. or earn more on the loan.
Rocket is best known for his push button mortgage application. However, the company has diversified its revenue streams by partnering with other lenders and branching out into real estate, securities and auto loans. The company recently announced an agreement with Selling power (NYSE: CRM) which will help him to partner with banks and credit unions to offer Rocket products. Rocket has developed a system that adds value throughout the home buying process. On the earnings conference call, Rocket CEO Jay Farner explained the concept:
Through our integrated platform, clients can find their next home on Rocket Homes’ 50-state home search platform, get an agent from the company’s agent network, get financing through Rocket Mortgage, have Amrock do the work and title valuation for them, then after closing have their mortgage managed by Rocket Mortgage, all from one centralized platform.
Rocket is bracing for higher rates
The focus on real estate and title will help Rocket absorb the effects of higher interest rates. Once the Fed begins to hike rates, the number of homes that can be refinanced profitably is expected to drop sharply. Rocket has been working to reach home buyers in order to seize home purchase loans. These will be less sensitive to interest rates than refinancing.
That said, there will always be debt consolidation refinances, and these are much less rate sensitive. In this case, a borrower could take advantage of the appreciation in the price of a home to extract cash and use it to pay off high-interest credit card debt. This should be a breeding ground for the business going forward, even as rates rise.
Despite the rate hike, Rocket reported an increase in profitability per loan, which has been depressed for the industry as a whole. Rocket and Crosstown Rival UWM Corp. (NYSE: UWMC) has been fight for the part and lower prices. During the third quarter, income per loan (also known as gain on sale) increased from 2.78% to 3.05%.
This is far from the 4.52% that the company earned in the third quarter of 2020; However, 2020 was one of those years that rarely presents itself. Rocket forecasts a slight drop in margins in the fourth quarter to a range of 2.65% to 2.95%.
Rocket is trading at 7.2 times expected earnings per share in 2021, which is pretty high for a mortgage originator. Since the mortgage industry is incredibly cyclic, these companies often trade at average single-digit price-to-earnings ratios. The low multiple reflects the feast or starvation nature of mortgage banking.
Rocket is betting that his investment in ancillary businesses will help him reduce earnings volatility and increase the number of people willing to pay for the business. Rocket took action to make this happen; However, Wall Street will likely treat it as just a mortgage originator instead of a fintech until the company shows lower earnings volatility.
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Brent Nyitray, CFA has no position in the stocks mentioned. The Motley Fool owns shares and recommends Salesforce.com. The Motley Fool has a disclosure policy.
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