Introduction
Rocket Companies is a financial services provider which has benefitted significantly from macro tailwinds given the Federal Reserve’s near zero interest rate regime. For the company to prosper, macroeconomic trends remain essential. Recently, the company has garnered much interest for mainly short term reasons: (1) the short squeeze at the beginning of March; (2) business transformation embracing digital platforms and e-commerce, with other companies such as UPST a classic example of the perception that fintech can bring revenues to the next level. However, the hard facts of the industry are that loan growth is not expanding organically, but rather, largely benefitting from refinancing due to low interest rates and related loan restructurings due to the pandemic. The US is not a high-growth economy, and growth rates in the matured mortgage space are likely to return to moderate trends. This article discusses broader industry issues surrounding RKT’s longer term scenario as industry competition intensifies. A relative valuation of RKT against peers is also considered.
Competition in fintech will heat up
Bullish investors are likely to highlight how RKT pioneered e-commerce in banking. This is an excellent crucible for counterarguments. Firstly, all financial institutions alongside industries outside financial services, are moving into the digitization of their businesses. Secondly, there are many other companies which provide online financial services, such as Z, RDFN, UPST and LC. Furthermore, e-commerce banking did well in 2020 due to the Black Swan event of the COVID-19 pandemic, benefitting simply because competition was taking a backseat. It remains to be seen how companies such as RKT will stand up to the very intense competition when traditional banks return in full force, along with replicable digital platforms.
Mortgage originations may have peaked
Chart 1 below indicates that mortgage originations appear to be peaking, and this is a function of ultralow interest rates amid the pandemic. Given the increasing concern over inflation, it is unlikely that interest rates will remain low. Rising inflation also means that long term US Treasury yields are rising, raising the cost of funds for lenders and borrowers. The chart below further indicates that the mortgage originations have been skewed towards the market with a high credit score (i.e. light blue bar), which is not the focus of RKT and e-commerce lenders (the SEC filing indicates that RKT’s average customer is represented by the dark grey bar in Chart 1). As such, while fintech is transforming how business is done, a hard fact is that there is no sign of above average growth in the markets for lower credit scores. Auto loans, another target market of RKT, is not growing spectacularly either, having flattened out since 2015. Debt balances as a whole has risen, increasing the market saturation rate, and this is discomforting considering that auto loan and credit card delinquencies have been on a rising trend (Chart 3). The situation, however, looks better on mortgages and that is probably a function of its priority during repayments and that mortgage originations increased mostly in the high credit score segment.
Chart 1: Mortgage originations appear to be peaking, and skewed towards high credit quality customers
Source: Federal Reserve Bank of New York
Chart 2: Growth rates on auto loans had been minimal for quite a while
Source: Federal Reserve Bank of New York
Chart 3: Improvement in delinquencies is largely in the mortgage segment, while credit cards and auto loans are deteriorating.
Source: Federal Reserve Bank of New York
Operating metrics are not great; quarterly revenue and earnings are declining
Loan growth at RKT was historically strong, with volume more than doubling between 2019 and 2020, while market share increased from 6.4% to 8.4%. However, as to be expected, delinquency has increased substantially from 1.01% in 2019 to 3.91% in 2020 as the economy deteriorated during the pandemic. The high margin on sale of loans to the secondary market may be hard to maintain going forward, especially if cost of funds increases due to rising rates. Mean reversion suggests potentially lower margins going forward. Meanwhile, client retention has been declining over time, from 95% in 2018 to 91% in 2020, indicative of rising competitive pressures.
Delinquency rates are inching up, even with massive loan growth
Source: SEC filing from Seeking Alpha
Of note, consensus estimate of revenue at RKT is expected to decline by -15% and -18% in 2021 and 2022. This appears connected with the abovementioned concerns over rising rates, flattening loans growth, declining margins, and rising competition. Revenue appears to have peaked in Jun-2020 and dropped in 2H2020. Operating income and margin had also declined in 2H2020, suggesting that the halcyon days are over.
Revenue and earnings appear to have peaked during the Jun-2020 quarter
Quarterly | Sep-19 | Dec-19 | Mar-20 | Jun-20 | Sep-20 | Dec-20 |
Revenue (M) | 1,654.80 | 1,972.60 | 1,406.30 | 5,089.00 | 4,703.50 | 4,781.90 |
Growth % qoq | 19% | -29% | 262% | -8% | 2% | |
Annual | 2020 | 2021(est) | 2022(est) | |||
Revenue (M) | 15,981 | 13,620 | 11,220 | |||
Growth % | -15% | -18% | ||||
Quarterly | Sep-19 | Dec-19 | Mar-20 | Jun-20 | Sep-20 | Dec-20 |
Op income (M) | 567.2 | 839.3 | 170.6 | 3,574.70 | 3,164.40 | 3,053.70 |
Op inc margin | 34.3% | 42.5% | 12.1% | 70.2% | 67.3% | 63.9% |
Source: Seeking Alpha, tabulation and calculations by author.
Valuation and high short interest could be redeeming features
Part of the interest surrounding RKT was due to the short squeeze in early March. At present, valuation remains adversely affected by significant short interest at 20%, compared to its peers where the short interest is typically less than 10%. Despite a tepid outlook towards the industry as a whole, RKT offers a better relative valuation play compared to peers. Among peers, it is one of the cheapest companies in terms of 6 months performance versus, P/S and P/B ratios, as shown in the table below. However, RKT’s stock price has historically lagged the performance of the S&P 500 as shown in the chart below, almost as if structural headwinds are against RKT's price momentum. RKT also has a longer track record and larger sales base unlike other companies in the below table.
6M Performance | Market cap (B) | TTM P/S | FWD P/S | TTM P/B | FWD P/B | 2021 sales (B) | 2022 sales (B) | |
NYSE:RKT | 4% | 44.8 | 0.2 | 0.2 | 5.4 | 6.4 | 13.60 | 11.22 |
23% | 7.0 | 7.5 | 5.2 | 11.8 | 11.1 | 1.35 | 1.72 | |
198% | 1.5 | 3.2 | 3.3 | 2.0 | 0.6 | 0.48 | 0.77 | |
536% | 9.6 | 9.2 | 19.2 | 31.1 | n.a. | 0.50 | 0.67 | |
Average | 190% | 15.7 | 5.0 | 6.9 | 12.6 | 6.0 | 4.0 | 3.6 |
As at 10-Apr-2021
Source: Seeking Alpha; tabulation by author.
RKT’s momentum has lagged the S&P 500 for quite a while
Source: Seeking Alpha
Conclusion
Low interest rates have spurred the rise in mortgage originations and refinancing, benefiting lenders such as RKT. Furthermore, greater activity in banking e-commerce and fintech revenues was caused by a boost in the use of online platforms during the pandemic. While historical revenue growth has been particularly strong, the regime of low interest rates which supported this growth will not continue indefinitely due to rising inflation. Furthermore, the industry’s competition is very intense, and online banking platforms across both new players and traditional banks are proliferating. The industry’s margins will remain compressed and commoditized, with limited options for product differentiation. The main redeeming feature of RKT is its cheap relative valuation versus peers although momentum has historically lagged the S&P 500.
