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Why Rocket Will Benefit from New Government Policy

By Brent Nyitray, CFA – Updated Jul 26, 2021 at 11:39AM

Key Points

  • The government reversed a fee charged to bankers, which will get passed on to consumers.
  • The change will increase refinance activity, which is a positive for the sector.

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The Street may be too negative on the mortgage banking sector.

Mortgage bankers have been through a whirlwind of changing government policies this year. During the Trump administration, the Federal Housing Finance Agency (FHFA) implemented several changes that threw the industry for a loop. Under the Biden administration, it looks like some of these changes are being reversed. What does this mean for big mortgage originators like Rocket (RKT -0.26%)?

A rocket taking off.

Image source: Getty Images.

Intensifying competition and a letdown year

Last year was one of the best for mortgage originators in almost 20 years. The COVID-19 pandemic caused the Federal Reserve to cut rates down to the floor and reinstate its purchases of mortgage-backed securities. These two actions triggered a wave of mortgage refinance activity, which drove volumes to near-record levels. In addition, profits were high as bankers felt little need to compete with each other for borrowers. Capacity was maxed out for the industry.

In anticipation of expected losses due to COVID-19-related forbearance plans, the FHFA instructed the government-sponsored entities Fannie Mae and Freddie Mac to charge a special fee of 0.50% on all loans they bought. This was called the adverse market fee, and it was designed to allow them to provide for expected losses from borrowers negatively affected by COVID. These expected losses never materialized, and Fannie and Freddie's federal overseers decided to end the fee and take further steps to help homeowners take advantage of the low-interest rate environment to refinance their homes.

The capacity constraints of 2020 have largely been eliminated, and now we are seeing the mortgage bankers in a price war. Crosstown rivals Rocket and UWM Holdings have re-ignited their on-again-off-again war of attrition. This is driving down pricing for borrowers (which is good for refinance volumes). However, profits per loan are falling. On UWM Holdings' first-quarter earnings call, it forecasted that gain on sale margins would decrease 58% in the second quarter compared to the first quarter before stabilizing later on in the year.

There are still lots of refinance candidates out there

In early January, Black Knight forecasted there were still nearly 17 million refinance candidates, which works out to be nearly $5 trillion in potential volume for the industry. The Mortgage Bankers Association predicts refinance activity will fall by 33% this year to a total of $1.6 trillion. This forecast is based on an assumption that mortgage rates will increase to 3.7% this year. So far, rates are at 2.88%, according to Freddie Mac. The removal of the 0.5% charge will have the effect of lowering mortgage rates by one-eighth of a percentage point.

With rates heading south on COVID-19 fears and the removal of the adverse market fee, the MBA refinance volume forecast may turn out to be low. Rocket will almost certainly pick up additional refinance volume, which means the Street estimates for Rocket might be too low this year. 

Rocket is expected to see earnings drop by 50% this year to $2.06 per share. The company already earned $1.07 per share in the first quarter, and the Street is forecasting $0.49 for the second quarter. Between forecasts of the price war easing, the relaxation of government limits on lending, and reignited fears of a COVID-19-driven slowdown, the refinance boom may have some more gas in the tank. At Monday morning's prices, Rocket's stock is trading at 8.4 times expected 2021 earnings per share, which is about where mortgage bankers typically trade.

While mortgage bankers are financial stocks, they often trade like cyclicals, due to the fact that their earnings streams can be volatile. If the estimates are too low, Rocket should trade higher, especially as it works to diversify itself from pure mortgage lending. 

Brent Nyitray, CFA has no positions in the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Rocket Companies, Inc. Stock Quote
Rocket Companies, Inc.
RKT
$7.73 (-0.26%) $0.02
Fannie Mae Stock Quote
Fannie Mae
FNMA
$0.43 (0.16%) $0.00
Freddie Mac Stock Quote
Freddie Mac
FMCC
$0.43 (-1.14%) $0.00
UWM Holdings Corporation Stock Quote
UWM Holdings Corporation
UWMC
$4.24 (-0.70%) $0.03

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