Why Rocket’s first quarter earnings failed to impress
Mortgage originators tend not to get a lot of respect from Wall Street analysts. Companies are avoided because they operate in highly cyclical business environments, which fluctuate with changes in interest rates and their direct effect on mortgage rates. Mortgage rates had fallen steadily throughout 2019 and 2020, but they started to rise again in January 2021.
Recently, Rocket companies (NYSE: RKT) reported record first quarter earnings, yet the stock sold strongly on the news. Why have investors criticized the company so harshly? Is it the recent rise in mortgage rate forecasts? Or was there something else in the report that worried investors?
Solid earnings in Q1 …
Rocket reported first quarter earnings per share of $ 1.07 in accordance with generally accepted accounting principles (GAAP). Revenue increased 236% year over year to $ 4.6 billion. Adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) increased from $ 922 million to $ 2.4 billion. Rocket’s adjusted net income jumped 170% to $ 1.8 billion.
… but a weak trend linked to the drop in volumes and margins
The reason investors were so negative on the report revolved around directions, particularly the margin on the sale. Take a look at the table below, which shows Rocket’s interest rate lock-in volume and selling profit margins since early 2020. Interest rate lock-in volume is used as an indicator of volume. production, while the Gain on Sale is the gross profit Rocket makes on each loan.
|End of term …||Lock volume||Profit margin on sale|
|March 31, 2020||$ 56 billion||3.25%|
|June 30, 2020||$ 92 billion||5.19%|
|September 30, 2020||$ 95 billion||4.52%|
|December 31, 2020||$ 96 billion||4.41%|
|March 31, 2021||$ 94 billion||3.74%|
|June 30, 2021 (indicative)||82 to 88 billion dollars||2.65% -2.95%|
For the quarter ending June 30, 2021, expected volume is expected to drop 18% to the midpoint of the estimates, and the gain on sale margin will decline even further. It’s a double whammy for gross margins, and that’s what drove the negative sentiment on the stock. This would translate into a 32% drop in gross margins based on lock volumes.
It’s important to keep in mind that 2020 has been the best year for mortgage originators since 2003, so any year-over-year comparisons for the rest of 2021 will be difficult.
There are also fears of a price war
Rocket is currently in a price war with his rival UWM Corp. (NYSE: UWMC), better known as United Wholesale. United Wholesale has told its brokers that they have to choose whether to do business with United Wholesale or Rocket. These two mortgage heavyweights were engaged in a price war before COVID-19 began, and the fear is that a new one will start as business becomes more competitive.
Not all mortgage activity will be affected by higher rates
The rapid rise in mortgage rates over the past four months has reduced the number of loans that will be eligible for refinancing activities. While this is certainly a reasonable fear, it ignores the effect of rising home values. Home prices have risen to double-digit percentages, due to a shortage of inventory and insatiable demand. The increase in home equity makes the cash refinancing business more attractive.
Home purchase loans are much less rate sensitive than traditional refinance loans. Between purchases and cash refinances, Rocket estimates that about 50% of its loans come from borrowers who are not rate sensitive. Finally, Rocket also has other businesses, such as auto loans and sales, closing services and real estate services, which will not be affected by rising interest rates.
Investors fight negative sentiment
Analysts expect Rocket to earn $ 2.29 per share in 2021, down 9% from the consensus estimate before the results were announced. That said, Rocket is trading at 7.7 times expected earnings per share for 2021. Rocket paid a special dividend of $ 1.11 per share in March. However, it does not currently pay a regular quarterly dividend.
Rocket has made impressive investments in technology and operations and, in the long run, it will remain the dominant player in its industry. Investors will, however, face negative sentiment from originators of short-term mortgages.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.