RKT - Rocket companies

[Spekulatius]

This is a recent IPO and an interesting business. I didn’t know that they have grown into the largest mortgage originator. They make their money on gains on mortgage sales , so earnings are going to be volatile. The last few quarters were fantastic, because refinance volume was high (Due to lower interest rates) but more important, margins were great too. I don’t own it, but I am tempted to buy some shares should it fall back around the IPO price ($18). They have been increasing their market share significantly  (almost 10x  to ~9% Market share for mortgages heir the last decade) and I see a chance that they expand into adjacent business lines.

https://www.sec.gov/Archives/edgar/data/1805284/000104746920004448/a2242208z424b4.htm

[wabuffo]

They make their money on gains on mortgage sales

 

G-o-S accounting has a long history for mischief by many company mgmt teams - particularly when it comes to loan/mortgage origination.

 

I didn’t know that they have grown into the largest mortgage originator.

 

yeah - it's easy to front-load the accounting profits and postpone the losses - which some mgmts have tried to hide by growing quickly (ie load more G-o-S "profits" at the top of the funnel from new lending than the older loans' historical "losses" coming out of the funnel at the bottom). 

 

I'm not knocking RKT - I know nothing about them - but G-o-S accounting is always a big red flag for me.

 

How are you getting comfortable with this name, Spek?

 

wabuffo

[CorpRaider]

Interesting time to sell a bunch of the company to the public.

[Spekulatius]

They make their money on gains on mortgage sales

 

G-o-S accounting has a long history for mischief by many company mgmt teams - particularly when it comes to loan/mortgage origination.

 

I didn’t know that they have grown into the largest mortgage originator.

 

yeah - it's easy to front-load the accounting profits and postpone the losses - which some mgmts have tried to hide by growing quickly (ie load more G-o-S "profits" at the top of the funnel from new lending than the older loans' historical "losses" coming out of the funnel at the bottom). 

 

I'm not knocking RKT - I know nothing about them - but G-o-S accounting is always a big red flag for me.

 

How are you getting comfortable with this name, Spek?

 

wabuffo

 

Well, they don’t keep the loans, they are mostly conformal loans and sold to FnF, so I don’t think there is too much potential for mischief there. As long as the paperwork is OK, they should be Ok, regardless of what happens to the loan. This is no different than any other mortgage broker.

 

The positives are that  RKT owns the customer relationship and they usually can get the refinancing done too because customer tend to stay with them (75% retention). That’s great news if they grow their servicing business. Then they probably can get into other lines. They claim to have a better software platform, but I don’t know if that’s true. I dealt with them when relocating a few years ago and decided not to do business with them because I could get better rates with a local credit union.

 

 

There are various knocks on RKT - the various classes of stock, leaving the founder in control No matter what, the fact that the founder cashed out $3B+ before the IPO (cash out refinance so to speak ) and the fact that mortgage initiations are very cyclical and the IPO is very well timed.

 

FWIW, a peer stock is PFSI and it has done quite well too and is worth watching, Imo.

[wabuffo]

Well, they don’t keep the loans, they are mostly conformal loans and sold to FnF, so I don’t think there is too much potential for mischief there. As long as the paperwork is OK, they should be Ok, regardless of what happens to the loan. This is no different than any other mortgage broker.

 

This type of business model is the same as the one New Century and Novastar followed - i.e., originate mortgages, sell them and/or securitize them and recognize gain-on-sale upon financing transaction that gets the loan off your books (but secretly retains losses if things go wrong).  Just because it involves conforming mortgages doesn't mean there can't be mischief and trouble.  This is basically a commodity business that is also heavily leveraged and employs shaky accounting.

 

There are two big risks - a) putbacks and b) warehouse lines getting pulled - both are usually fatal to a heavily-leveraged b/s (I am quoting here from their S-1):

 

RISK #1 - PUT BACKS:

We may be required to repurchase or substitute mortgage loans or MSRs that we have sold, or indemnify purchasers of our mortgage loans or MSRs.

 

We make representations and warranties to purchasers when we sell them a mortgage loan or a MSR, including in connection with our MBS securitizations. If a mortgage loan or MSR does not comply with the representations and warranties that we made with respect to it at the time of its sale, we could be required to repurchase the loan, replace it with a substitute loan and/or indemnify secondary market purchasers for losses.

 

RISK #2: WAREHOUSE LINES GETTING PULLED:

Our Rocket Mortgage business relies on our loan funding facilities to fund mortgage loans and otherwise operate our business. If one or more of such facilities are terminated, we may be unable to find replacement financing at commercially favorable terms, or at all, which could be detrimental to our business.

 

We fund substantially all of the mortgage loans we close through borrowings under our loan funding facilities and funds generated by our operations. Our borrowings are in turn generally repaid with the proceeds we receive from mortgage loan sales. We are currently, and may in the future continue to be, dependent upon a handful of lenders to provide the primary funding facilities for our loans. As of May 31, 2020, we had nine loan funding facilities which provide us with an aggregate maximum principal amount of $16.25 billion in loan origination availability, six of which allow drawings to fund loans at closing, and seven of which are with large global financial institutions. Included in those nine loan funding facilities are two loan funding facilities with GSEs. Additionally we are parties to an uncommitted agency MSR backed master repurchase agreement facility and a committed line of credit collateralized by GSE MSRs, each of which provides us access to up to $200.0 million of liquidity.

 

Again - I haven't looked closely at RKT.  They may be boy scouts.  But this is not a, what's the word? - oh yeah!  This is not what I would call an anti-fragile business model.  It works great until one day your lenders (who are also the ones buying your mortgage loan originations) see losses in the mortgages you sold them and then the business model completely collapses. 

 

Especially in this environment of Schrodinger loans during the virus (loans that are classified as being performing and in payment default/deferral at the same time!).  Tread carefully, my friend. (speaking from painful experience).

 

wabuffo

[Spekulatius]

Good points they securitized loans can still go back to haunt the Mortgage initiator. I do think it’s less likely now than it was back then, when liars loans were common. right now, that doesn’t seem to be the case at all.

 

As for warehouse lines, I think the Fed has basically providing a put for the Credit markets. It is clear they will grease whatever wheel will get stuck on the economy and I think keeping mortgage lending intact would be a high priority.

 

The other negatives (like the founder large cash distribution prior to the IPO etc) are bothersome and one for the reasons this IPO got of a rocky start.

[CorpRaider]

Well, they don’t keep the loans, they are mostly conformal loans and sold to FnF, so I don’t think there is too much potential for mischief there. As long as the paperwork is OK, they should be Ok, regardless of what happens to the loan. This is no different than any other mortgage broker.

 

This type of business model is the same as the one New Century and Novastar followed - i.e., originate mortgages, sell them and/or securitize them and recognize gain-on-sale upon financing transaction that gets the loan off your books (but secretly retains losses if things go wrong).  Just because it involves conforming mortgages doesn't mean there can't be mischief and trouble.  This is basically a commodity business that is also heavily leveraged and employs shaky accounting.

 

There are two big risks - a) putbacks and b) warehouse lines getting pulled - both are usually fatal to a heavily-leveraged b/s (I am quoting here from their S-1):

 

RISK #1 - PUT BACKS:

We may be required to repurchase or substitute mortgage loans or MSRs that we have sold, or indemnify purchasers of our mortgage loans or MSRs.

 

We make representations and warranties to purchasers when we sell them a mortgage loan or a MSR, including in connection with our MBS securitizations. If a mortgage loan or MSR does not comply with the representations and warranties that we made with respect to it at the time of its sale, we could be required to repurchase the loan, replace it with a substitute loan and/or indemnify secondary market purchasers for losses.

 

RISK #2: WAREHOUSE LINES GETTING PULLED:

Our Rocket Mortgage business relies on our loan funding facilities to fund mortgage loans and otherwise operate our business. If one or more of such facilities are terminated, we may be unable to find replacement financing at commercially favorable terms, or at all, which could be detrimental to our business.

 

We fund substantially all of the mortgage loans we close through borrowings under our loan funding facilities and funds generated by our operations. Our borrowings are in turn generally repaid with the proceeds we receive from mortgage loan sales. We are currently, and may in the future continue to be, dependent upon a handful of lenders to provide the primary funding facilities for our loans. As of May 31, 2020, we had nine loan funding facilities which provide us with an aggregate maximum principal amount of $16.25 billion in loan origination availability, six of which allow drawings to fund loans at closing, and seven of which are with large global financial institutions. Included in those nine loan funding facilities are two loan funding facilities with GSEs. Additionally we are parties to an uncommitted agency MSR backed master repurchase agreement facility and a committed line of credit collateralized by GSE MSRs, each of which provides us access to up to $200.0 million of liquidity.

 

Again - I haven't looked closely at RKT.  They may be boy scouts.  But this is not a, what's the word? - oh yeah!  This is not what I would call an anti-fragile business model.  It works great until one day your lenders (who are also the ones buying your mortgage loan originations) see losses in the mortgages you sold them and then the business model completely collapses. 

 

Especially in this environment of Schrodinger loans during the virus (loans that are classified as being performing and in payment default/deferral at the same time!).  Tread carefully, my friend. (speaking from painful experience).

 

wabuffo

yeah do not want.

[Philip Morris IV]

The positives are that  RKT owns the customer relationship and they usually can get the refinancing done too because customer tend to stay with them (75% retention). That’s great news if they grow their servicing business. Then they probably can get into other lines. They claim to have a better software platform, but I don’t know if that’s true. I dealt with them when relocating a few years ago and decided not to do business with them because I could get better rates with a local credit union.

 

So on the servicing side, RKT uses Black Knight's software, and even sold BKI the source code to their CRM.

https://www.prnewswire.com/news-releases/black-knight-and-quicken-loans-broaden-partnership-301003509.html

 

It appears they use proprietary tech for origination but hard to believe it's markedly better than BKI's or Ellie Mae (ICE).  Those two are rapidly adding software capabilities and clients, which only makes this space more competitive.

 

I happened to just refinance with RKT and while a good experience overall it wasn't a fully digital one.  Had to go to a Regus office to sign closing docs.  According to the agent they tried digital closing for a minute and had to backtrack.  Amrock also wanted to mail me checks, for me to then mail to my lender, and were somewhat bewildered by my request for a wire/electronic transfer directly to Wells Fargo.  So they have some kinks to iron out there.

 

BKI is interesting in its own right; a digital picks and shovels provider to any or all points on the mortgage life cycle.  ICE, RDFN and ZG have strong aspirations here and are not to be ignored either.  All fundamentally different investments, but an exciting space to play in right now.

[Spekulatius]

Circling back to this one because it is a interesting in a way. RKT stock is at a low since the IPO around $18. results have been song around $1/ share and quarter, but guidance for mortgages and specifically margins % for GoS were doen (from 4%+ at the peak to <3% next quarter ). It is clear they were over-earning and probably still are.

Beyond thwt, there are some interesting things:

1) They apparently internalize more title insurance with their own insurer AmRock

2) They have a car marketplace that is still small but gaining traction

3) more sign ups for Rocket Pro (for real estate agents) which keeps them on top of the mortgage  application process of their clients.

it seems that they are striving to streamline the mortgage process by internalizing more and more of the business process which is good from a margin perspective (Title insurance is very profitable) and catering the experience to homebuyers homebuyers. I think over time that makes them secular winners.

Initiating mortgage are a cyclical business but it’s a good business when done right. From my perspective (I have done more than half a dozen mortgages and refinances over the years) the banks have lost this market and Rocket and other mortgage brokers are runn8ng circles around them now.

 

https://ir.rocketcompanies.com/news-and-events/press-releases/press-release-details/2021/Rocket-Companies-Announces-First-Quarter-Results/default.aspx

I am also watching PFSI which has done well (until lately) and looks extremely cheap by many metrics (even more so than RKT).

(No position, I ended up buying FAF since I started this thread).