The mortgage business is a feast-and-famine affair. The COVID-19 pandemic pushed the Federal Reserve to lower rates, which triggered an enormous refinancing boom. This gave the mortgage industry two fabulous years, in 2020 and 2021. The reckoning came in 2022, when the Fed began an aggressive campaign of higher rates in an effort to curb rising inflation. This caused mortgage origination volume to collapse. Rocket (RKT 2.34%) was hurt by this decline and has been taking steps to reduce its reliance on mortgage banking. 

Picture of a couple getting a mortgage

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Push Button, Get Mortgage

Rocket is best known for its tag line: "Push Button, Get Mortgage." If you look at the different business models for mortgage banks, Rocket follows the retail model, which means it generally finds its own customers and assembles the mortgage loan itself. Another model is correspondent, whereby a lender buys completed loans from smaller originators. This is the model for Mr. Cooper (NASDAQ: COOP). Finally, there is the broker model, in which the originator partners with brokers, who find the loans. This is the model for UWM Corp (NYSE: UWMC)

The retail model has two subtypes: relationship driven and consumer direct. The former employs loan officers who network with real estate agents, title attorneys, etc. The latter basically involves reaching the borrower without a loan officer using technology or outbound calls. Rocket's business does include some brokers and correspondents, but the company is primarily a consumer direct lender. 

Consumer direct can struggle in a purchase environment

The consumer direct model has advantages and disadvantages. The biggest advantage is that the company doesn't have to pay commissions to loan officer, which can get expensive. The disadvantage is that it works best in a market when there's lots of refinancing; it struggles in a purchase market. Real estate agents tend to recommend lenders they have worked with in the past and who have a reputation for being able to get the loan done quickly and professionally. A consumer direct lender will have a hard time getting involved in the purchase business without direct contact with real estate agents. 

Rocket's reliance on consumer direct was evident in its 75% decline in origination volume, which fell to only $19 billion in the fourth quarter of 2022 from $75.9 billion in the fourth quarter of 2021. Not only did volume fall, the gain on sale revenue that Rocket earns on a loan fell, too. Rocket attributed this to higher-than-expected take-up of its Inflation Buster promotion product to drive purchase business. That was reflected in the share price, which has declined more than 40% in the past year.

Rocket has been diversifying its product offerings

Rocket has been building its other businesses to help drum up origination business and to diversify away some of the volatility of the mortgage banking model. Rocket bought Truebill and rebranded it as Rocket Money. Rocket Money is an app that includes subscription cancellations, credit score enhancement tools, and budgeting. Meanwhile, it launched Rocket Rewards in October, which provides rewards that can be applied to lower a borrower's closing costs. In other words, if Rocket is servicing a mortgage, it will reward a borrower for using Rocket's programs. When it is time to refinance the property, the rewards can lower the upfront costs. Rocket also owns Amrock, a property title insurer; Rocket Loans, which offers personal loans; and Rocket Homes, a home search and referral platform.

Rocket is forecasting first-quarter adjusted revenue of between $700 million to $850 million, up from $683 million in the fourth quarter. Adjusted revenue includes valuation changes on the mortgage-servicing portfolio net of hedges. The first quarter of the year is generally the slowest of the year, and that is exaggerated when purchase activity dominates. Volumes should pick up as we head into the spring selling season. Analysts expect Rocket to report a loss in 2023; however, the worst is probably over for the mortgage industry. If the U.S. hits a recession, rates should fall, and Rocket will use its consumer retention products to gather refinance loans, which will start the mortgage banking cycle all over again.