Mortgage banking is one of the most out-of-favor industries in the stock market at the moment. The business has always been highly cyclical, and the feasts of 2020 and 2021 are being followed by the famine of 2022, driven by the Fed's aggressive campaign to rein in high inflation. Mortgage rates rose dramatically this year, and mortgage origination volumes are a fraction of what they were a year ago.
That said, mortgage rates began to fall again over the past couple of months and if you believe the Mortgage Bankers Association, they will fall even further next year. Could things be turning around for the mortgage business and Rocket Companies (RKT -0.89%)?
Image source: Getty Images.
What goes up must come down -- and vice versa
Rocket went public at the perfect time -- late summer, 2020. The COVID-19 pandemic forced the Federal Reserve to cut its benchmark interest rate down to the floor in order to stimulate the economy. The Fed was also buying up large volumes of mortgage-backed securities in order to push down mortgage rates, which eventually fell to about 3%. Its "loose money" fiscal policy kicked off a wave of mortgage refinancing that saw origination volumes more than double on a year-over-year basis. You can see in the chart below how dramatically mortgage-origination volumes increased as mortgage interest rates were pushed down.
30-Year Mortgage Rate data by YCharts.
That said, no party can last forever, and volumes collapsed in the second half of 2022. According to Mortgage Bankers Association estimates, origination volume was $480 million in Q3, and in Q4, it's expected to come in at $398 billion. In the first quarter -- which is always seasonally slow -- the association expects volumes will fall further to $345 billion before returning toward normal levels in the periods that follow. If you believe the Mortgage Bankers Association forecasts, we can anticipate increases in volume beginning in Q2 2023.
Interest rates look to be heading lower
The Mortgage Bankers Association also forecasts that mortgage rates will continue declining. It expects the 30-year fixed-rate mortgage will slip to 5.2% by the end of 2023. This will do a few things.
First, it will make housing much more affordable than it was even a couple of months ago, which will hopefully encourage more transactions. Second, lower rates will encourage at least some refinancing activity. It probably won't make financial sense for most homeowners to refinance at those levels. However, doing a cash-out refinance to get access to funds to pay down high-interest-rate credit card debt can be a reasonable financial strategy for some borrowers. This is especially true at a time when many banks are eschewing offering home equity lines of credit.
Earnings appear to be at an inflection point
Rocket is expected to lose $0.09 per share this year and is forecast to earn about $0.02 per share next year. To put these numbers in perspective, Rocket earned $2.26 per share in 2021. Wall Street appears to think the worst is over for the mortgage banking sector.
So what can go right for Rocket at this point? First of all, the Fed is nearing the end of its interest-rate hikes for this cycle. The rapid increases in the federal funds rate this year have hammered investor sentiment, and have left many market participants hunkered down to wait out the storm. Second, mortgage rates compared to Treasury rates are exceptionally high. Differences this wide rarely last long, and historically, the gap between them has reverted to the mean. Finally, the U.S. has underbuilt homes relative to the amount of housing the market needs ever since the real estate bubble burst 16 years ago. Last year, unusually high prices for construction materials inhibited homebuilding. Now, however, lumber prices are back in the range of their historical norms.
Great company, but challenging environment
Is Rocket a buy here? Next year will be undoubtedly hard, but it won't be as bad as 2022. Rocket is one of the most shorted stocks on Wall Street right now, and those short sales represent future share-buying demand. The mortgage banking industry is likely going to struggle again for the first couple of months of 2023 -- but then the spring selling season will begin.
Rocket is also more than just a mortgage company. It has Rocket Homes, Rocket Auto, and several other ancillary businesses. Its app is second to none in brand recognition in its niche, and Rocket clearly envisions itself as more than just a mortgage company. As these other businesses grow, they will help offset any drag from the mortgage business.
So is Rocket a buy? If you're short, it probably is. If you are a long-term investor, Rocket is a great company in a challenging environment. The mortgage business is cyclical and while booms don't last forever, neither do busts. At this point, more can go right for Rocket than wrong.
