On May 5, the average interest rate on 30-year fixed-rate mortgages in the U.S. hit 5.27% -- a level last seen in 2009. Rising rates have impacted those searching for a home, as high home prices and high mortgage rates have drastically increased the cost of buying one.
One mortgage lender already feeling the effects of higher rates is Rocket Companies (RKT 5.67%). The company saw business boom in 2020 and 2021, when interest rates sank to historic lows and homeowners rushed to refinance. However, the business is vulnerable to these interest rate cycles, and rising mortgage rates have weighed on the business. With the stock down 50% from its 2020 IPO price, here's what the company can do going forward to become more resilient.
Mortgage rates are rising rapidly in 2022
In March 2020, when it became clear that COVID-19 was becoming a pandemic-level threat, stock markets tumbled as investors grappled with the shutdown of massive amounts of economic activity around the world. In response, in the U.S., the Federal Reserve launched massive fiscal stimulus programs, slashing borrowing costs for financial institutions to near-zero and engaging in quantitative easing by buying enormous amounts of debt.
This lowered interest rates across the board. In January 2021, the average 30-year fixed mortgage rate hit a record low of 2.65%.
However, now the Fed is fighting a different foe: inflation. The consumer price index was up by 8.3% year over year in April and has been rising at rates above 5% for a year now. In response, the Federal Reserve has committed to bringing down inflation by raising benchmark interest rates and gradually tightening the money supply.
So far this year, the Fed has raised its target interest rate range for the federal funds rate at two successive meetings. The range now sits at 0.75% to 1%. These rate hikes, and the expectation of more to come, have had a ripple effect, causing mortgage rates to blast off. As a result, fewer people are refinancing, and new home sales have slackened somewhat because of the higher cost burden those rates place on homebuyers.
How mortgage rates affect a business like Rocket Companies
In April, new home sales declined 16.6% month over month to their lowest level since April 2020. Existing home sales also fell in April, down 2.4% from March and 5.9% from last year. This takes a toll on companies like Rocket that rely heavily on mortgage originations.
After putting up $5 billion in net revenue in 2019, Rocket Companies' business surged. In 2020, its net revenue hit $15.6 billion, and in 2021, dialed back only moderately to $12.9 billion -- nearly 88% of which came from its mortgage origination business. In recent quarters, though, as mortgage rates moved higher, its revenue and net income have dropped.
Cyclical businesses can be risky investments
In the first quarter, Rocket Companies saw a record volume in new home purchase mortgages and cash-out refinancings. However, Rocket has historically relied heavily on non cash-out refinancings to drive its mortgage volume. These have slowed down drastically as mortgage rates rise, and the company closed on 48% fewer mortgages from last year, causing its net income to drop nearly 63%.
Rocket Companies is a highly cyclical company. When interest rates go lower, that business tends to do well as people refinance in droves. However, when rates move higher, it suffers. If inflation were to abate and mortgage rates were to fall, it could be a positive tailwind for the business.
The company could also boost results by diversifying its revenue sources. While it has expanded into areas such as auto loan refinancing and personal loans, these non-housing-related sources are too small, at 1.6% of total revenue, to help it weather a slowdown in its main business. Rocket Companies has work to do, and I'd like to see it grow these businesses more so that it can prosper during the down portions of these cycles.