Competition should weaken pricing even more as demand declines, but a lot more or a little more? Tough call. They are so eager enough to grow that UWMC and LDI both earned a meager $0.07 per share in Q2, and Zillow lost $18 million. New entrant Zillow ( Z): “ We continue to build a mortgage factory that serves both purchase and refinance transactions.” ( Zillow Q2 ’21 earnings conference call transcript) That's precisely when we gain market share.” ( loanDepot Q2 ’21 earnings conference call transcript) Top 10 player loanDepot ( LDI): “ We are continuing to increase purchase volume, aggressively recruit loan officers, launch new joint ventures and new product offerings. # 2 player United Wholesale Mortgage ( UWMC) : “I believe that we will become the number one overall mortgage company in America, whether it's next year, the year after, or the year after that.” ( United Wholesale Q2 ’21 earnings conference call transcript) How hard will Rocket’s competitors fight for the shrinking business volume? It could get ugly, if we believe the hype:
Banks are sitting on record amounts of cash, and investors are desperately seeking any investment with a yield.And the average loan-to-value ratio is 33%, the lowest since the 1980s.
Homeowners have over $23 trillion in equity in their homes at present, by far an all-time record.But what about cash-out driven refinancing, where homeowners refi in order to turn some of their equity into cash? A perfect cash-out storm is developing: As I said above, interest rate driven refinancing will decline sharply over the next few years. That’s a pretty weaselly answer, but you try to confidently address these issues: “ T he second quarter represented a transitional quarter…into an operating environment characterized by lower profit margins resulting from industry overcapacity and increased competitive pressure…” ( loanDepot Q2 earnings release) Where is the mortgage cycle headed for Rocket? Worse, but I’m not sure how much worse. Now a significant glut has grown, and pricing has neared historic lows. But lending capacity is relatively easy to add, and added it was. The capacity shortage caused a sharp rise in price like we saw with lumber, used cars, etc. The early-2020 refinancing explosion caught mortgage lenders by surprise. A wide yield spread indicates less competition, and vice versa. In the case of mortgage banking, an excellent proxy for pricing is the spread in yield between mortgage rates and 10-year Treasury bond rates. Supply in this case is the capacity and willingness of other companies to compete for those mortgage originations.Ī good way to estimate the level of supply is to measure pricing.
Why? Because demand is only half the story for businesses – supply is almost as important. National mortgage originations were actually 10% higher this Q2 than a year ago, but Rocket’s gross origination profits were lower by more than half. Source: Rocket Companies financial reports Profits of mortgage banks are even more cyclical than originations, as this chart of Rocket’s mortgage origination gross profit (“contribution margin”) shows: There is therefore a long way to fall a more normal level of $1 trillion or less. Refinancing remains near a cyclical high, with Q2 annualized originations of $2.8 trillion. The big swing item is mortgage refinancings, which of course are driven by interest rates. The chart shows that mortgage originations to facilitate home sales are pretty consistent, with the exception of the housing boom/bust of ’05 - ‘15. This chart shows how cyclical the mortgage origination business is: There should be no hurry – the odds are high that over the next year or more the news will get worse. I’d prefer to invest with more fear in the valuation, so I suggest waiting to see if Rocket can be bought below $15. How these stories play out is quite uncertain – even for an overconfident analyst like me! The current stock price seems to assume a moderately positive outcome. An industry paradigm shift as the home sale transaction shifts from being served by specialists like mortgage bankers, realtors and title insurers into one-stop-shop home sale generalists.A mortgage origination cycle as the current mortgage refinance boom inevitably wanes.Rocket Com panies ( NYSE: RKT) is in the early stages of two stories:
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