RKT Stock: Rocket Mortgage Is at a Risky Phase in the Cycle

Most investors have very short memories and tend to enjoy the positive money-making trends in current market environments. Even worse, today’s younger growth and trader style investors have no memories of leveraged market crashes like 2008. One company that may create memories for young traders is Rocket Companies (NYSE:RKT) stock.

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Rocket is a Detroit-based company helping its clients “achieve the American dream of home ownership and financial freedom”

In addition to its basic mortgage and refi business, it has expanded into related industries, such as personal lending  and auto sales. Primary business revenues come from originating, processing, underwriting and servicing predominantly GSE-conforming mortgage loans, which are sold to the secondary market.

Mortgage Applications Are Slowing

Mortgage and refi applications went down 1.8% recently, according to the Mortgage Bankers Association’s seasonally adjusted index. This was the lowest level since early 2020 before the Covid-19 pandemic affected the U.S. economy.

Interestingly, both refinance and purchase applications declined, even as mortgage rates went down.

Home refinancings declined 2% on a week-to-week basis and decline 8% on a year-over-year basis. Refinance applications faded lower than 2020 amounts for the past four months, according to the MBA. Home purchase applications declined 1% for the week and came in 14% when compared to a year ago.

Joel Kan, MBA’s associate vice president of economic and industry forecasting, said:

“Swift home-price growth across much of the country, driven by insufficient housing supply, is weighing on the purchase market and is pushing average loan amounts higher.”

With real estate prices at all-time highs at almost every market in country, it’s hard to imagine much mortgage loan growth going forward. And when interest rates eventually rise, refinancing could drop to almost nothing.

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Correlation of Rates and Default

Banks charge interest rates on loans to account for risk, in other word defaults.

In theory, mortgage lenders charge a rate that will make them a decent amount of income spread and protect against defaults. They can “borrow” from checking and savings depositors at close to zero and from the Federal Reserve at 0.25% and lend a 30-year mortgage at 3% and all is good in the world.

Recovery from defaults is included in those lending calculations, of course. But something always happens. In September 2009, mortgages in the U.S. that were delinquent or  in default rose to an astounding 14.4% of all mortgages.

But wait, don’t they sell all their loans to third-party purchasers like Fannie Mae and Freddie Mac? Yes they do, but RKT usually retains the servicing rights, meaning handling loan payments and collections. But if a customer stops paying, RKT is often on the hook:

“During any period in which one of our clients is not making payments on a loan we service, including in certain circumstances where a client prepays a loan, we are required under most of our servicing agreements to advance our own funds to meet contractual principal and interest remittance requirements, pay property taxes and insurance premiums, legal expenses and other protective advances”

Yes the currently average credit score is decent at 755 and LTV is solid at 67%. Delinquency rates are low at 0.72%. But as many prognosticators learned the hard way in 2007 and 2008. They stated real estate never goes down, but things change. They always do.

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Valuation of RKT Stock

The very cyclical nature and highly competitive nature of mortgage banking makes it almost impossible to deliver consistently high economic returns and steady growth. Like banks, most analysts use price-to-book value as a metric. RKT stock has been selling for more than 3 times book value.

Low P/Es are meaningless for companies like this because of the severe volatility of earnings based on the factors mentioned above. Look at the spread on Yahoo Finance for earnings estimates. The range for this year is $1.79 to $2.65 and for 2022 its $1.15 to $2.10. However 2022 could easily be zero or less if rates increase and competition become irrational.

However, Rocket does have a good history of profitability and growth as well an excellent management team. Whether those factors can outweigh macroeconomic forces is still a question mark.

At this stage in the economic cycle, Rocket is a risky stock.

Investors and traders often look for the next entry point on market dips. But the negatives against RKT stock outweigh the positive, so the next entry point for RKT should be below book value to create a margin of safety.

On the date of publication, Tom Kerr did not hold a position in any security mentioned in the article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.

Tom Kerr has worked in the financial services industry for over 25 years. Currently he is a Senior Portfolio Manager at Rocky Peak Capital Management. Prior to that he was Chief Investment Officer and Director of Research of SGL Investment Advisors, and has served in a number of positions at other investment related organizations. Mr. Kerr has also been a contributing writer to TheStreet.comRagingBull.com and InvestorPlace.com. He’s a CFA charterholder and obtained a B.B.A in Finance from Texas Tech University.

View more information: https://investorplace.com/2021/07/rkt-stock-rocket-mortgage-at-risky-phase-in-the-cycle/

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