The past 18 months have been particularly difficult for companies in the mortgage space. The big increase in interest rates has depressed mortgage origination activity, and originators like Rocket Companies (RKT 1.23%) are definitely feeling the pinch.
That said, recent activity by the Federal Reserve suggests the mortgage origination industry's dark storm clouds might be easing just a bit. What does this mean for companies like Rocket that are operating in this space?
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Rocket is a major mortgage originator with a portfolio of personal finance services
Rocket is a consumer finance company whose main business involves mortgage origination. This business segment, and especially its mobile app, accounted for the majority of its income as it tapped into the overheated refinancing business during 2020 and 2021.
To help diversify the company's income streams in recent years, Rocket also built out a portfolio of different personal finance and mortgage-related businesses. Other Rocket businesses include Rocket Money (formerly known as Truebill) which is a personal finance app that provides various services, including helping consumers manage (and cancel) various subscription services and providing tips on how to improve credit scores. Rocket Homes is a real estate search and agent referral network, while Amrock is a title insurance company.
While these ancillary companies help diversify Rocket's revenue streams, the mortgage company is the main driver.
Rising interest rates have depressed business
Like all mortgage originators, Rocket has struggled as the Federal Reserve raised interest rates starting in early 2022. As rates increased, the incentive for borrowers to refinance disappeared. Nobody is going to swap a 3% mortgage for a 6% one. Rising interest rates (combined with rapidly rising home prices) caused home affordability to fall, which pushed a lot of would-be first-time homebuyers out of the market. Rising interest rates also kept many would-be sellers in their homes as many were reluctant to sell their property (with the 3% mortgage rate) to buy a new home with a 6% mortgage.
Rocket's app is probably better suited for a refinance environment as well. Most mortgage companies have loan officers, who have a network of real estate agents, title attorneys, etc., and get referrals to potential borrowers. While technology has been able to replace some real estate functions, home buying is still largely a face-to-face business. Rocket relies on consumers to find them via the app. In a refinance-heavy environment, the business comes to them, and since Rocket doesn't pay loan officers' commissions, they have much higher margins than everyone else. That said, when the market becomes all about purchases, getting the business is harder.
Origination volume is expected to decline in the third quarter
In the second quarter of 2023, Rocket originated $22.3 billion, which was a 35% decline from the same quarter in 2022. This was an increase of 32% compared to the first quarter, but mortgage origination volume is highly seasonal, and the highest number of home sales take place in the spring and summer. Gain on sale margins (basically the profit margin before operating expenses) fell from 2.92% to 2.67%, which indicates that Rocket was pricing aggressively to get loans.
Despite the drop in volume compared to a year ago, Rocket cut expenses over the past year, so even with the lower volume, Rocket's earnings per share increased from $0.02 a share to $0.05. Rocket is guiding for revenue in the third quarter to come in between $850 million and $1 billion, which is a decline from the $1.2 billion they reported in the second quarter. Rocket said on the earnings conference call that the revenue decline was due primarily to macro issues in the housing market. Inventory levels are 25% of what they were in 2007, and existing home sales are highly depressed, as you can see in the chart below.
US Existing Home Sales data by YCharts.
The mortgage origination business is highly cyclical, and the industry has been in a trough for over a year, which is a long time in this business. If the Federal Reserve is done hiking rates, we should see mortgage rates level off and maybe even fall into late 2023 and 2024. This will do a lot to increase purchase transactions, and we might even see people who bought in the past two years have an incentive to refinance. Until that happens, it is hard to like the stocks for mortgage originators in general.
