Most investors have very short memories and tend to enjoy positive money-making trends in current market environments. Worse still, today’s younger investors in growth and trader style don’t recall leveraged market downturns like 2008. One company that can create memories for young traders is Rocket companies (NYSE:RKT) stock.
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Rocket is a Detroit-based company that helps clients “achieve the American dream of homeownership and financial freedom.”
In addition to its core mortgage and refinance business, it has expanded into related industries such as personal loans and car sales. The primary business revenue comes from the origination, processing, underwriting and administration of GSE compliant mortgage loans, which are sold to the secondary market.
Mortgage applications are slowing down
Mortgage and refinance applications fell 1.8% recently, according to the seasonally adjusted index from the Mortgage Bankers Association. This was the lowest level since early 2020 before the Covid-19 pandemic hit the US economy.
Interestingly, both refinance and purchase requests decreased, even as mortgage rates fell.
Home refinances were down 2% week-over-week and down 8% year-over-year. Refinancing applications have fallen below 2020 amounts for the past four months, according to the MBA. Home purchase applications decreased 1% during the week and came in 14% compared to a year ago.
Joel Kan, MBA associate vice president for economic and industrial foresight, said:
“Rapid growth in house prices in much of the country, driven by insufficient housing supply, is weighing on the purchasing market and driving up average loan sizes.”
With home prices hitting all-time highs in nearly every market in the country, it’s hard to imagine huge growth in home loans in the future. And when interest rates finally go up, refinancing could drop to next to nothing.
Correlation of rates and delinquencies
Banks charge interest rates on loans to account for risk, in other words, defaults.
In theory, mortgage lenders charge a fee that will turn them into a decent amount of income distribution and protect against defaults. They can “borrow” from depositors from checking and savings accounts at almost zero and from the Federal Reserve at 0.25% and lend a 30-year mortgage at 3% and all is well in the world.
Recovery from defaults is included in those loan calculations, of course. But something always happens. In September 2009, US mortgages that were delinquent or delinquent increased to a staggering 14.4% of all mortgages.
But wait, don’t they sell all of their loans to third-party buyers like Fannie Mae and Freddie Mac? Yes, they do, but RKT generally retains administration rights, that is, handling loan payments and collections. But if a customer stops paying, RKT is often compromised:
“During any period that one of our clients is not making payments on a loan we serve, even in certain circumstances where a client prepares a loan, most of our service delivery agreements require us to advance our own funds to meet the principal and interest remittance requirements, payment of property taxes and insurance premiums, legal expenses and other protection advances “
Yes, the current average credit score is decent at 755 and the LTV is solid at 67%. NPL rates are low (0.72%). But like many forecasters they learned the hard way in 2007 and 2008. They claimed that real estate never falls, but things change. They always do it.
RKT stock valuation
The highly cyclical nature and highly competitive nature of mortgage banking make it nearly impossible to generate consistently high economic returns and steady growth. Like banks, most analysts use price-book value as a metric. RKT shares have been sold for more than 3 times their book value.
Low P / E makes no sense for companies like this due to 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 it is $ 1.15 to $ 2.10. However, 2022 could easily be zero or less if rates rise and competition becomes irrational.
However, Rocket has a good track record for profitability and growth, as well as an excellent management team. Whether those factors can overcome macroeconomic forces remains a question mark.
At this stage of the business cycle, Rocket is a risky stock.
Investors and traders often look for the next entry point in market dips. But the negatives versus RKT stocks outweigh the positives, so the next entry point for RKT should be below book value to create a margin of safety.
At the time of publication, Tom Kerr did not hold a position in any title mentioned in the article. The opinions expressed in this article are those of the author and are subject to the InvestorPlace.com Publishing Guidelines.
Tom Kerr has worked in the financial services industry for more than 25 years. He is currently Senior Portfolio Manager at Rocky Peak Capital Management. Prior to that, he was Director of Investments and Director of Research at SGL Investment Advisors, and held various positions in other investment-related organizations. Mr. Kerr has also contributed as a writer to TheStreet.com, RagingBull.com, and InvestorPlace.com. He is a CFA holder and earned a BBA in Finance from Texas Tech University.