Since going public in August of 2020, Rocket Companies (RKT 3.40%), the largest mortgage originator in the country, has been a disaster, with its stock price down close to 66%. The company went public during an ultra-low interest rate environment and took full advantage of the refinancing boom as people rushed to lock in at low mortgage rates. But inflation surged, forcing the Federal Reserve to set aggressive expectations for raising its benchmark overnight lending rate, which has sent mortgage rates soaring at the fastest pace in 40 years, putting a swift end to the refinancing boom. Rocket's stock has not fared well and now trades at less than $9 per share. Is it time to buy the dip?
A bleak outlook for Rocket
Rocket is largely in the business of originating as many mortgages as possible and then selling the loans for a fee. It's a difficult business because there is lots of competition in the industry, and it can be difficult to stand apart outside of pricing.
Image source: Getty Images.
With the mortgage rate on a 30-year fixed loan now above 5%, refinancing is no longer attractive, which has been a huge drag on Rocket's earnings. Gain-on-sale revenue dropped from roughly $3.5 billion in the first quarter of 2021 to about $1.5 billion in the first quarter of this year. Rocket does have a large mortgage servicing portfolio that benefits from a rising interest rate environment, but the increase has not been enough to offset the decline in gain-on-sale revenue.
Data: Rocket Companies. Chart: Bram Berkowitz.
While it's not a straight line, gain-on-sale margins have been heading south. The outlook is also not improving in the near term. Closed loan volume of roughly $54 billion in Q1 2022 is down from $103.5 billion in Q1 2021 and is expected to come in between $35 billion and $40 billion in the current quarter ending June 30. Gain-on-sale margins are not done bottoming yet either. In Q1, they saw a benefit of 15 basis points (0.15%) due to some non-recurring items. Management is guiding for gain-on-sale margins to come in between 2.6% and 2.9% in Q2. It's hard for any lender to make money when their margins are below 3%, and it may be difficult for Rocket to maintain profitability in the near term.
Rocket's market share
Now, there is only so much Rocket can do given this huge increase in mortgage rates. But if you are thinking about the business long term, one way for Rocket to win is for them to take market share in the highly fragmented mortgage space. That way, when rates are up, Rocket is winning in the purchase mortgage market, and when they are down, Rocket is winning on refinancing.
Image source: Rocket Companies.
Rocket has done a good job of growing its market share, especially in recent years, getting up to nearly 9% of the market in 2021. Rocket's long-term goal is to reach more than 20% of the total mortgage market share. Management also said on its most recent earnings call that homebuying demand remains robust among millennials and first-time homebuyers, which the company thinks it can make good headway with. Capturing these customers now is big because when mortgage rates eventually go back down, Rocket will then have a very good inroad to helping these customers refinance.
But right now, unfortunately, the company is not showing any real signs of taking market share. As mentioned above, Rocket is guiding for $35 billion to $40 billion of closed loan volume in the current quarter. In April, the Mortgage Bankers Association said it expects total mortgage origination volume in 2022 to hit $2.58 trillion. That implies $645 billion per quarter. At the top end of Rocket's range for closed loan volume in Q2, that only implies a market share of 6.2%.
Should you buy the dip on Rocket?
Rocket still is the largest mortgage originator in the country and is working to diversify its product set to capture more borrowers and offer more than just mortgages. But the environment is still filled with uncertainty right now, and it's still a bit hard to tell what will happen with mortgage rates, although they have been declining more recently. With Rocket now trading close to 22 times forward earnings and not showing market share gains, I am going to remain on the sidelines for now.
