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Where Will Rocket Be in 1 Year?

With the Fed cutting interest rates to zero, 2020 has been the year of the mortgage banker. Mortgage banking companies are experiencing their highest volume in nearly 20 years, and a slew of them have either gone public or made plans to do so, led by Rocket (NYSE: RKT), the company behind Quicken Loans.

The mortgage banking industry is certainly striking while the iron is hot. The big question is how long the boom will last. Where will Rocket be in a year from now?

Mortgage document

Image source: Getty Images.

The mortgage banker for a new generation

Rocket is the nation's largest mortgage originator. It's best known for its Rocket Mortgage app, which allows customers to apply for a loan, submit all the required documentation, and sign paperwork without having to show up in person. While this is a plus for a younger generation that prefers less human interaction to more, it is also a huge cost savings. The biggest cost for most retail mortgage banks is loan officer compensation. Loan officers find the borrower, go through different options, collect all the required documentation, and then guide the borrower through the closing process. They are usually paid anywhere from 0.6% of the loan balance to 1.5% of the loan balance. Rocket doesn't have that cost, and as a result it is much more profitable than the typical mortgage bank.

Mortgage banking is highly cyclical

Mortgage banking is a highly cyclical business. It is driven mainly by interest rate movements, but there is a demographic aspect to it as well. Interest rates drive the refinancing side of the business, while demographics drive the purchase side. As a result, these companies tend to trade with extremely low price-to-earnings ratios during boom times because the market knows that eventually the party will end. Investors accustomed to tech-company-type valuations won't find them in this sector; Rocket trades at a 2020 price-to-earnings ratio under 6. PennyMac Financial Services (NYSE: PFSI) trades at a 2020 P/E under 3.3.

The refinancing boom will last a while

The Mortgage Bankers Association recently updated its origination forecast for 2020 and 2021. The group now expects $3.2 trillion in mortgages for 2020 and $2.5 trillion for 2021. In August, financial services company Black Knight estimated that 32.4 million borrowers could save 0.75% on their current mortgage rate by refinancing. This is roughly 75% of the $16 trillion mortgage debt outstanding. Provided interest rates stay at current levels, the refinancing boom should go on for years. The Fed has forecast that the federal funds rate will stay in the current range of 0% to 0.25% through 2023, and will continue to buy mortgage-backed securities, which will probably keep a lid on rates.

Rocket's earnings estimates are probably too low

Rocket is expected to earn $3.42 per share this year; however, estimates for 2021 are less than half that number. Given the MBA's forecast for origination to drop by only 22%, is it realistic to expect Rocket's earnings to fall by over 50%? The MBA's forecasted drop in origination is based on the assumption that rates will rise in 2021. While that is certainly a possibility, the Fed is going to be working overtime to prevent it from happening. One of the oldest market maxims is "Don't fight the Fed." If the MBA forecast of rising rates doesn't pan out, 2021 will be another banner year for the mortgage origination business, and that 2021 Street estimate for Rocket will be going up as well.

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Brent Nyitray, CFA has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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