The Largest U.S. Mortgage Originator Is Finally Going Public

Quicken Loans, the largest mortgage originator in the United States, has filed IPO paperwork under the Rocket Companies brand name, presumably to continue its emphasis on its Rocket Mortgage platform.

In this episode of Industry Focus: Financials, host Jason Moser and Fool.com contributor Matt Frankel, CFP, discuss what the company does, how it makes money, and what investors should expect when it goes public.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on July 13, 2020.

Jason Moser: It's Monday, July 13. I'm your host Jason Moser. Joining me today, my financial partner in crime, Certified Financial Podcaster and Certified Financial Planner Matt Frankel, CFP. There you go. You like that, Matt, don't you?

Matt Frankel: I do. How are you doing today?

Moser: I'm all right, man. You know, it's a new week, and I'm excited because I get to travel down to Georgia later this week to go see my mom and dad; haven't seen them in a while, get to play a little golf with my dad. And enjoy a couple of days off, you know, unwind a little bit, it's kind of a stressful year for some.

Frankel: Yeah, a little bit. I finally got down this weekend, it was the first time I didn't sleep in my own house since February.

Moser: Yeah. And how did you feel about that?

Frankel: It felt weird at first, but I got to give a shoutout. I was at the Harrah's Cherokee Casino in North Carolina; it's up in the mountains. Really cool place to stay in the middle of nowhere in the mountains. And I was nervous at first, and they really did a fantastic job of making people feel safe and comfortable. I didn't see anybody without a mask on or even giving a hard time. We've all seen the Facebook and Twitter videos of somebody throwing a fit in the store for being asked to wear a mask, and we just didn't see that. The cleanliness was just off the charts. There were guys in giant backpacks, like, yard sprayers with disinfectant, hosing down things as soon as people got up. You weren't allowed to sit in a chair until someone had cleaned it and put a sticker on it. I mean, it was very impressive. And everyone seemed honestly happy to be out. So, I got to give a shout-out to Caesars, the parent company of Harrah's Cherokee, for really taking the COVID precautions seriously and making everyone feel safe and comfortable, and getting me out of my house for a weekend, so.

Moser: [laughs] Yeah. Well, that's really good to hear. That is something where -- I'm sure it'll be different in different pockets of the country, but it's nice to see them taking it so seriously. And, I mean, at the end of the day, really, it's just up to all of us to do what we can. So, it sounds like a lot of people there were doing what they could, and that makes for a more enjoyable experience for everyone.

And speaking of enjoyable experiences, Matt, I think today's podcast is going to be second to none because we're talking about a company that hasn't even gone public yet. We're getting this thing on the radar early, on today's Financial show, folks, we're going to jump into Rocket Companies. Now, if you're not familiar with Rocket Companies, my bet is you are familiar with Rocket Mortgage or Quicken Loans; that's what this is. Rocket Companies recently filed its S-1 to go public. And as I mentioned, you probably know this for Rocket Mortgage, that's their flagship product.

Matt, we all know how important housing is to our economy, the opportunities it presents for building, to lending, to home improvement, giving consumers the ability to spend. I have to say, I was pretty excited to see this filing. And having worked in the lending industry before, you just know how powerful it is and you know how big of a market it is and the opportunity that exists there. So, let's just start out. First, tell us a little bit about what Rocket Companies does.

Frankel: Well, they are the U.S. market leader in mortgage originations. They have a little over 9% of the mortgage market, which doesn't sound like a ton, but like you mentioned, this is a huge, huge space. Just to, kind of, give you an example, statistics in 2019, there were $2.2 trillion of mortgages originated in the United States. So, a 10% share of that's pretty big. They make money from mortgage originations. They also have a servicing operation -- they don't actually own the mortgages, we'll get into that in a little bit. They have a servicing operation, they have a small personal lending business, they have a small auto lending business. But at the core of it, they're really a mortgage originator.

And they are really trying to take advantage of the inefficiencies in the traditional mortgage market. If anyone has applied for a mortgage, it's not a quick process. I did my first one, I think, through Wells Fargo, I did one through a bank called Iberia [IberiaBank] in South Florida. And it's a complicated process, especially if your lender has not yet figured out how to leverage technology to their advantage. You know, the document processing could be really inefficient, the information requests, just the whole process was very inefficient. So, Rocket wants to make the most seamless, most user-friendly, you know -- a mortgage process that doesn't make you pull your hair out along the way. You are a homeowner; you know all too well how that is.

And they've been successful so far. Their consumer satisfaction scores are off the charts. Their app has almost a perfect rating in the Apple App Store. They're doing a great job of it. Like you said, since Rocket Mortgage was rolled out, over the past 10 years, Quicken Mortgage's market share has gone from 1.3% to 9.2%. That's a huge growth rate, that's almost a 90% annualized growth rate. So, they've really been successful in revolutionizing a highly inefficient and fragmented industry.

Moser: Yeah, I think you hit the nail on the head there -- inefficient. I mean, that is, whether you're buying a home or even refinancing, or if you're trying to open up a home equity line of credit or something, it is just a seemingly endless request for paperwork and pay stubs and documentation. And the only thing that really keeps you going at it is you know there's a light at the end of the tunnel and you really need to get to that point, but it does feel like, going through the process, you see all of these opportunities for it to be better.

And it certainly does feel like the company itself is working to do that. I mean, they have a number of businesses that exist well beyond just Rocket Mortgage. There's Amrock and Rocket Homes and Core Digital Media and Rocket Loans and whatnot. But when you look at the actual performance of this business compared to its competitors. I saw this in the S-1 -- they said, in 2019 we closed 6.7 loans per month per average production team member compared to the industry average of 2.3, according to the Mortgage Bankers Association, so that's significant on its own. Now, they also said, in 2020, as of now, year-to-date that average has grown to 8.3 loans per month. So, they're clearly doing more, seemingly with less. And from an investor's perspective, you have to like that, I think.

Frankel: Yeah. And that's just kind of what I was mentioning about really leveraging technology to your advantage. The average mortgage lender does not use technology nearly as much as Rocket does, which makes the process take longer. Now, to be fair, the 2020 number, you've seen a surge of refinancings, right? Interest rates have plunged to record lows, refinancings are going through the roof. And refinancings, they generally are a quicker form of mortgage than a purchase, there's lighter documentation requirements for people already own the home. So it's usually easier to document what you need to document and get the loan through the process. So that could be what explains the 2020 jump in numbers.

But 6.7 versus 2.3 per team member, that's a huge difference, and it really shows you the power of streamlining the process. And like you said, from an investor's point of view, that's really a nice thing to see.

Moser: Yeah, it really is. And talking a little bit about how they make their money, you mentioned that they typically sell most of those loans off in the servicing market. That's obviously something that happens quite a bit. So, the first question that really comes to mind is, how do they make their money? It sounds like they make their money mostly just from the origination of the loans, right?

Frankel: Right. Every time you get a mortgage, there's some sort of origination fee attached to it; think like $1,000 or so. And this is just a fee charged by the lender for the process of originating a mortgage. As you said, the average team member, Rocket is one of the most efficient companies, and [its] average team member can get through 6.7 of these per month. So, the origination fee is what pays those people and is the profit margin for Rocket Mortgage. They also sell the mortgages into the secondary market -- meaning to, like, Fannie Mae and Freddie Mac, you know, those types of agencies -- and get paid for that. Selling the mortgage means that the other party is buying the mortgage, so they get a little bit of revenue from that.

And there are some others -- like I mentioned, they have a servicing business. Servicing means that they collect payments from borrowers and make sure the owner of the mortgage gets paid, so they get a little bit of revenue from that. They have real estate referrals. I mentioned they also have an auto business; they have a personal lending business. These are all small compared to the origination business, but they have a pretty diverse revenue stream. Origination is their bread-and-butter. So when you're looking at Rocket Mortgage as an investment -- I mean, obviously we don't know how much the shares are going to cost yet, but when you're looking at it as a business, focus on the origination business because that's really the bread-and-butter of it.

Moser: Yeah, you're right, that is a big business. I mean, when you look at the year ended 2019, they originated $145 billion in mortgages, and 91% of those were actually sold to government-backed entities. I mean that's that selling that mortgage off, but I mean, you figure those government-backed entities, that's something they're used to doing, buying those loans. And you would imagine that they probably want to buy loans that are a little bit more [laughs] reliable than not. So that certainly gives Rocket, I think, the incentive to keep on writing good business.

And you mentioned something, and I wanted to talk a little bit about this, the shares. You know, we're not going to know [for awhile] what the share price [will be] when they go public. We can look at some of the numbers, at least, and get an idea of what kind of money the company makes. It does look like, at the end of the year 2019, they brought in $5.1 billion in revenue, and net income of $893.8 million. So it sounds like at least this is a business that would go public and it should be profitable from the get-go, I would imagine.

Frankel: Yeah. So, if their net income last year was almost $900 million, based on, let's just say a price-to-earnings ratio of 20 or thereabouts, you're looking at almost a $20 billion valuation for this company, is my guess on what it would trade at if it were to go public tomorrow, just based on that net income number. But they're definitely a profitable company, they're efficient. Mortgage lending, especially if you're just an originator, is usually not a very high-margin business. But like you said, their average employee is about 3 times as efficient as the industry average when it comes to mortgages originated per month. And that has translated into some nice profitability from these numbers.

Moser: Yeah. Now, in regard to the actual shares going public, I was kind of taken aback a little bit by this at first, but I mean I guess it's not really that surprising. This is a company that founder Dan Gilbert, who has been the one that really has spearheaded this company from the start -- he's going to remain really the one in control here. There are going to be four classes of shares. Now, there's not going to be four classes of shares that would go public.  I believe the IPO is going to bring the A shares to the market, but there's class A, B, C, and D shares. And at the end of the day, this is still going to keep power and control of the company firmly in Mr. Gilbert's hands; he'll have 79% of the vote. Talk a little bit about this extensive of a share class structure. What are the advantages, what are the disadvantages, is that something that gives you pause?

Frankel: Well, any time you have more than one class, the usual reason for it is to give a certain party voting power. So, it's kind of a weird class structure, like you mentioned. There's A, B, C, and D. Class A and C each have one vote per share in company matters. Class B and D each have 10 votes per share. So, that's not an uncommon thing. We call those the super-voting shares. But the weird part is that class A and B shares have economic rights, meaning that if the company pays a dividend, they would get the dividend; if the company were to sell, they would get a share of the money. Class C and D have no economic rights. So, really, they're just voting power. It's kind of the weird thing that I see.

And the big sentence in the S-1 that really stands out to me is it says, there will be no shares of class B common stock and no shares of class C common stock outstanding after the IPO. So, that means the only ones that would exist are class A, which has one vote and economic rights; meaning it's just normal common stock: and class D, which has 10 votes per share and no economic rights; meaning that just gives people voting power. And that's Dan Gilbert's shares. [laughs]

The super-voting shares go to insiders. Basically, it's the same thing you see from Facebook. That's how Mark Zuckerberg has total control. He has super-voting shares. Same with Zillow -- [it] has dual share structure, one has voting rights, one doesn't.

Moser: Yeah, I think Under Armour has that same base set up as well ...

Frankel: ... yeah, dual; Alphabet has the same thing. And a lot of times, the super-voting shares aren't available to the public. Those examples, Google, Under Armour, they all sell both classes to the public. Like, in Alphabet's example, the GOOGL is the share with voting rights, and they usually sell for a few dollars more per share than the ones without voting rights. But in this case, you won't be able to buy the super-voting shares. It's kind of the point. You know, the insiders control those, they're not willing to sell them to you. So, if you want voting rights and if you want your vote to count, because [laughs] public stocks are not always a democracy, your vote doesn't always count.

You know, if you buy a share of Facebook, you have a vote, but Mark Zuckerberg's vote counts more than yours. So it's not a democracy. And Rocket Companies is not going to be a democracy. So take that into consideration if that matters to you. It doesn't really matter to most retail investors, but if it does.

Moser: Yeah. I mean, that is something, earlier in my investing life, I think I probably would have viewed it a little bit differently. But you're right, it's not a democracy and you would like to think that maybe your vote counts, but at the end of the day, really, you know, based on the structure of the business, you're going to be along for the ride. You're either OK with that or you're not. But we get questions from listeners and from members all the time in regard to share class structure: Should I buy the A or the B shares of whatever given company? And oftentimes, early on, there will be somewhat of a spread, there will be a disparity in the pricing, where the market might be assigning a higher valuation to the share class with the vote versus the share class without the vote, even though they represent the same economic interest.

And I've always just felt on the side, I mean, I'm not going to pay up for that vote. If I have a choice, if there's a big disparity there, I'm not going to pay up for that vote, because ultimately the vote doesn't mean anything. It doesn't matter. I mean, I don't mean to sound that straightforward about it, but it really is true. You've got an owner who's going to basically take the company in whatever direction they want to go. So, every investor has to come up with their own way of looking at it. But, really, what's the point of paying for that vote if that vote doesn't matter.

Frankel: Right. And in a case like this, just look at the company's track record since its 1995 founding. I don't mind having [laughs] the insiders totally in control. I trust their vote more than I trust mine. Same with Facebook -- I trust Mark Zuckerberg's vote more than I would trust my own. Look at the price that Facebook went public at and look where it is now. I really can't argue with how well he's monetized the site. [laughs] And I don't really want to tell him what to do.

Moser: No. I mean, I'd imagine he knows that business better than we do, and I'm OK with that.

Frankel: Right. I mean, there's a lot of -- like, say, AT&T or something like that, where nobody has the majority vote, you know the public's vote can count. And it's generally the funds that own it that really have the most pull. But the point is, it's the shareholders actually making the decisions, not the leadership. But in this case, it's going to be the leadership making the decisions, not the shareholders. So, it's just about how comfortable you are with that as an investor. But a 90% [annualized] growth rate in market share over the past decade, I mean, that's hard to argue with.

Moser: Yeah. And we talk about large and growing market opportunities -- this is certainly one of them.

I want to get your quick take on the use of the proceeds. I think whenever you see an S-1 filed, it's always helpful to -- and you know, they have this in the table of contents, so to speak. I mean, they need to list out the use of the proceeds, and oftentimes the use of the proceeds is to go toward growing the business, capital expenditures, whatever it may be. It seems like here that the use of proceeds is a little bit of a different setup. Can you talk a little bit about what the use of proceeds here will be, because it's a little bit confusing.

Frankel: I actually [...] I just lost that. It's worth pointing out to our listeners that this S-1 filing is 3,178 pages long. [laughs]

Moser: Yeah, it's a big one. And if I read this off -- I mean, I will read it, so that they can hear it ...

Frankel: I lost it when I was looking at the share structure.

Moser: [laughs] And, yeah, I slacked you to that one blurb earlier, where they say, "We intend to use the entire aggregate amount of the net proceeds from this offering to acquire a number of holdings units and corresponding shares of class D common stock from RHI, which is Rock Holdings, equal to the amount of such net proceeds divided by the price paid by the underwriters for shares of our Class A common stock in this offering."

So it sounds like this is going to be money that is used to ultimately solidify the ownership structure of the company as opposed to being money that they're going to be putting to use and growing the business necessarily. Was that your impression?

Frankel: Yeah, I found it, by the way, it was right under the page I was looking at out of the 3,000 whatever pages. Now, this is the longest financial document I've ever seen, by the way, but, no. Generally, when companies go public, there's one of two ways they can do it. You can see an IPO, which is what this is going to be, and then you could see a direct listing, which means they're just listing the existing shares.

Usually, an IPO is done when the company wants to raise capital. Whereas a direct listing -- Slack went public with a direct listing not long ago; Spotify is another example. Those companies used that route because they didn't need to raise capital. It sounds like Rocket doesn't need to raise capital, but they're trying to get capital to essentially do some financial engineering with the share structure. But the key takeaway is they're not raising capital for the business.

Usually, you see a note, that we are using the amount of the proceeds for blah-blah-blah and for general corporate purposes; which means that they're raising capital. You're not seeing that here. It's not like they need this for working capital for the business. They don't need to go public, in other words.

Moser: Yeah. That's what it struck me as too. I mean, this is a business that's really already got its legs underneath it and been doing a lot of great stuff. And I think if we pivot away from the business side of things and look at the culture side of things, you can understand, at least a little bit, why. I think it's really interesting in the S-1, they have a page devoted to culture, and what they call their ISMs -- and that's not an acronym, it's not I-S-M, it's their ISMs. And it's a list of 19 things -- it's ultimately, these are the ideals they live by that drive the culture of the business. And, I mean, 19 things here; I think that's pretty encouraging to see. But then you look through those ISMs and you understand the ideals here. I'm at least encouraged to see a company with such a focus on culture with their own way of looking at things, the ISMs, for example. I mean, that seems, kind of, Foolish in my book. We do the same kinds of things with our culture.

You know, you develop a culture that's unique to your particular business, to your particular situation here. And I think that Rocket Companies has done that too. I mean, one of the ISMs there is "Always raising [our] level of awareness." another one is, "Every second counts." Another one is, [laughs] "A penny saved is a penny." But my favorite, and this is maybe the dog lover in me coming out, number 16: "We eat our own dog food." You know, it seems like just another way of just saying, they're doing what they say they're going to do, they're going to eat their own cooking, so to speak.

Frankel: Yeah, this definitely seems like a Foolish company. Well, I mean, just one thing that stands out to me about them is, they were J.D. Power's No. 1 ranked for mortgage servicing client service for the past 10 years in a row. And full disclosure, Rocket Mortgage was actually a sponsor of this podcast not long ago. They've been a sponsor of ours in the past, and it's probably because we share a lot of the same ideals and they are a very Foolish mortgage originator.

But I like the list of ISMs, I think that's a really cool touch. I think we need a list of ISMs.

Moser: Well, maybe we could get cracking on that, that we could help define these next decades of The Motley Fool with some ISMs of our own. Maybe we'll talk after we get done taping. A couple of other ones that I really like. 17, you know, I live my life, "Simplicity is genius." I love it. And then 18, "Innovation is rewarded, execution is worshipped." And I think that's exactly right; I think that's exactly right.

Frankel: That's a great rule for every investor to live by that one. I think that's my favorite out of them. An idea is great. If you can't execute it, then what do you got? So, you know, that kind of goes along with what I said before that a great product doesn't necessarily make a great business. If you have a great idea for a product, that's fantastic, people are going to buy it. But if you can't make it work as a business, you're never going to make any money off of it.

There's a few of those that I mention all the time, and I get a lot of flak for them, so I'm not going to say them again. All the companies that I think are great products but not great businesses that, you know, the stock keeps going up and up and up and up and up and up and up. I think you know what I'm talking about.

Moser: I do. I think I do. But we're not going to get into that on this show. That sounds like it'd be better for something like a Thursday maybe. You know, Matt, I want to ask you, in regard to Rocket Mortgage: Obviously, the housing market and financing mortgage and all that stuff -- are banks the main competitors here? Is that their main competitor, like a Wells Fargo or a JPMorgan?

Frankel: Yeah, their competitors are definitely other originators. It's worth mentioning that Rocket doesn't own its mortgages. It's not a buy-and-hold lender, so there's no credit risk involved -- and the reason I mention that is because some of the other lenders that you see retain some of their mortgages as investments. If you look at, like, Wells Fargo's loan portfolio, I believe there's some mortgages on it. If you look at some of these other big banks, they own some of their mortgages. You know, if you make what's called a conforming mortgage, which is under a certain amount of principal, you can sell it to Fannie Mae or Freddie Mac if it meets certain guidelines. If you originate what's called a jumbo mortgage, you can't do that. So, you could either sell it to a third-party investor or retain it on your balance sheet; just to name one example.

So, they compete with them in the origination business. They don't compete with them in the sense that don't own any of their mortgages -- they're purely an originator/servicer. A lot of these other companies, like Axos Financial, a company we've talked about a lot on the show, I know owns a ton of its jumbo mortgages, and collects the interest payments themselves. And if a borrower defaults on the loan, they lose money, so it's a different dynamic than some of the banks, but most banks do big origination operations. So, in that sense they're competitors.

Moser: Yeah, and I mean, I guess it goes without saying that when you're an originator, you're selling that loan off to, typically it sounds like, a government-backed entity. It takes a lot of risk off your balance sheet as well -- you're not stuck holding that bag when we run into the next financial crisis, so to speak. And I think that's always something worth keeping in mind.

I mean, it reminds me a little bit of, like, your Visa or MasterCard, you know, they see a lot of money flow through that network. They're not really on the hook for any of the debt, but they get a nice little service charge for making that business work and facilitating the deals. Rocket seems to be kind of that same sort of business model, I think.

Well, Matt, I mean, at the end of the day, is this a business you feel like you're going to be interested in considering for your portfolio or for the service? And obviously, we want to wait and let the company go public and learn a little bit more about how they report and how they behave as a publicly traded company, but I mean, it seems to have a lot of the qualities that we certainly look for in a good Foolish investment, don't you think?

Frankel: Sure. Well, I mean, to be clear, we don't know when it's going public, we don't know at what price it's going to go public; we don't know the ticker symbol yet, I don't believe ...

Moser: We do actually, I'll say it, it's going to trade on the New York Stock Exchange, the ticker is going to be RKT.

Frankel: OK, there you go. But we don't know when, we don't know how much -- those are the two things that we don't know just yet. And we'll find out how much a day or two beforehand. So, I love the business, I love the leadership. My fear is that it's going to be one of those IPOs that doubles the day of the IPO and becomes really too expensive, like, think of the Lemonade IPO. I can see something like that happen with Rocket, just because it's such an anticipated IPO. Fintech IPOs, and especially profitable ones, have really soared. So I'm worried about it more from a valuation standpoint. I'd love to be able to get in on the IPO, but, I mean, let's be honest -- that usually doesn't happen.

I love the business, I like that they don't take credit risk, I like that they're purely an originator. I think it's a great business, especially in a low-interest environment. So I'm just curious as to the valuation; that's really going to be the question for me.

Moser: Yeah, I think that's a really good point. We do see a lot of times that, you know, that big pop that just fades away over time. And, you know, if they happen to report a bad quarter or throw out some questionable guidance, then the market really, really gives it back. But, yeah, I'm generally thinking I'm with you. I feel like this is a large, large market opportunity. It's one that I understand, it's one that I think should remain large and growing for some time. So, hey, I'm all for making a system like this more efficient, it sounds like that's what Rocket Companies is set to do, and it sounds like they have the opportunity to go even really beyond housing. So, we'll see how that shakes out, but we will keep an eye out for that IPO.

And, Matt, I appreciate you joining us this week and talking more about this upcoming IPO and giving us your thoughts.

Frankel: Yeah, always a pleasure. Hopefully, see you again in a couple of weeks and safe travels.

Moser: Absolutely, absolutely. Thanks so much.

And that's going to do it for us this week, folks. Remember you can always reach out to us on Twitter @MFIndustryFocus. You can drop us an email at [email protected] Let us know what you think about Rocket Companies impending IPO, because it sounds like it's going to be a big one.

As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear.

Today's show is produced by Tim Sparks, so thanks for making it happen, Tim. For Matt Frankel, I'm Jason Moser, thanks for listening and we'll see you next week.