One of the worst-performing sectors in this current slumping market has been the mortgage originators. Having feasted during 2020 and 2021, the economic environment has turned to famine as interest rates rise and choke off refinance activity.
Consumer lending giant Rocket Companies (RKT 3.15%) has not been immune to the difficult environment, so it has adapted to it by focusing on where the opportunities still lie.
Image source: Getty images.
The fastest increase in mortgage rates in over 30 years
Interest rates have moved up at a rapid clip since the emergence of outsized inflation has forced the Fed to lay out an aggressive path for monetary tightening. Jay Farner, CEO of Rocket, said that this increase has been "the largest in over 30 years."
You can see in the chart below, the path of mortgage rates over the past 30 years. While we are not at the highs we saw for most of the period, the increase in rates in such a short period of time has been exceptionally rapid.
30 Year Mortgage Rate data by YCharts
Mortgage refinances are drying up as rates rise
With interest rates rising so fast, one of the big pillars of mortgage origination -- the "rate and term" refinance -- has disappeared. Nobody is going to replace a 4% mortgage with a 6% one. This leaves home purchases and cash-out refinancings to pick up the slack. While they have increased to record levels 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 is guiding for another drop to a range of $35 billion to $40 billion. Margins on Rocket's production have been falling, which acts as a double whammy for revenue (fewer loans and less profit on them).
NYSE: RKT
Key Data Points
Rocket management believes the company's technology gives it a competitive advantage in that younger first-time home buyers tend to prefer using an app to originate and manage a loan. In the meantime, Rocket is cutting costs like every other mortgage originator to adapt 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 highly sensitive to mortgage rates, and they go up in value as interest rates rise. Some of Rocket's other ventures like Rocket Homes and Rocket Auto have the potential to drive loans and also diversify from the volatility of the mortgage origination business.
Is the stock bottoming? Depends on inflation
Rocket's stock price is down 46% year to date, but it did pay a special dividend of $1.01 per share in March. Is it cheap enough to buy? Rocket doesn't pay a quarterly dividend, so investors can't rely on steady income here. The company is expected to earn $0.98 per share this year, and Wall Street analysts are looking for $1.11 EPS in 2023. This gives Rocket a P/E multiple of 8.1. For highly cyclical stocks like mortgage originators, 8.1 times the earnings in a bad year isn't terrible. This is especially true for a market leader like Rocket.
That said, sentiment for the sector is awful. Everything is going to hinge on the Fed and whether these rate increases eventually work and take care of inflation. If inflation looks to be heading back down, the stock could be a buy.
