Rocket profited on servicing, but lost its lead in originations

Rocket Companies lost its lead in production for the first time ever in the third quarter while hitting its gain on sale margin targets, and reporting guidance for the current period below analysts’ expectations.

Rocket’s servicing gains drove net income of $96 million on a GAAP basis in the third quarter, versus $60 million in the second quarter and well below the massive $1.39 billion profit one year ago.

But on an adjusted basis, a measure which takes out changes in the fair value of mortgage servicing rights among other items, the Detroit-based company lost $166 million in the third quarter, compared with a loss of $67 million in the second quarter and profits of $1.14 billion one year prior.

“The adjusted net loss was largely due to still elevated operating expenses and low gain-on-sale margins, as origination volumes continue to plummet as a result of the steep increase in interest rates,” said Warren Kornfeld, a senior vice president at Moody’s Investors Service, in a statement. “However, Rocket continues to be conservative with respect to capital management during this very severe operating environment for non-bank residential mortgage companies.”

Inclusive of the fair value change, Rocket’s servicing business generated income of $514.5 million in the third quarter, compared with $345.1 million three months prior and a $7 million loss for the same period in 2021.

Rocket originated $25.6 billion during the most recent period, compared with $34.5 billion in the previous quarter and $88 billion one year prior. The company, which for some time has been the nation’s leading originator, ended the quarter in the No. 2 position as its volume fell. Its chief competitor, United Wholesale Mortgage, reported third quarter volume of $33.5 billion.

The gain on sale of 269 basis points was above the midpoint of Rocket’s prior guidance of between 250 basis points and 280 basis points. This is compared with 292 basis points for the second quarter and 305 basis points one year prior. It was also ahead of Keefe, Bruyette & Woods’ expectations of 263 basis points.

Its fourth quarter guidance was as follows: adjusted revenue, between $600 million and $750 million; closed loan volume, between $17 billion and $22 billion; and gain on sale between 230 basis points and 260 basis points. In comparison, UWM’s guidance was for between $19 billion and $26 billion of fourth quarter originations.

Rocket’s guidance “came in much weaker than us/consensus on virtually every metric,” said KBW analyst Bose George in a report.(Analysts had not yet released their take on UWM’s guidance at deadline. ) 

“With mortgage rates hovering above 7% and industry capacity still elevated, we think that the operating environment could remain challenging well into 2023,” George added.

George now expects Rocket to report an operating loss of 15 cents per share, versus the prior KBW prediction of a 3 cent loss and the street estimate of a 1 cent profit.

Current mortgage industry economics are not sustainable, said Brian Brown, who takes over as the company’s chief financial officer on Nov. 15, during Rocket’s earnings call.

Yet Rocket’s own pricing promotions, including Inflation Buster, will contribute to a quarter-to-quarter decline in margins, although they are still “incrementally profitable,” Brown said.

During the third quarter, Rocket cut expenses by more than $100 million, which was within its guidance of between $50 million and $150 million. In the fourth quarter, it looks for a further reduction of between $50 million and $100 million.

“Over the past 12 months, we have taken significant action to reduce our overall cost structure,” Brown said. “In fact, if we look at the third quarter of this year, compared to the third quarter of last year, on an annualized basis, we have reduced our expenses by more than $2 billion or approximately one-third of our total costs.”

Meanwhile, the Rocket Rewards program is one way for the company to manage its customer acquisition costs, by mining the ecosystem of other products it offers, said CEO Jay Farner.

“We cannot be thinking about when interest rates may come down,” Farner said. “We’ve got to be thinking about how we increase our conversion rates, engage our client base, drive the lifetime value of loans, and that puts us in a position to win.”

Farner also used the opportunity to once again get on his soapbox about the competitive situation in the broker channel. He did not mention United Wholesale Mortgage by name, but UWM is well known to be the driver of much of the competition.

Approximately half of the top 10 wholesalers have exited in the past year, he claimed. “They’ve either been pushed out by something called ‘the ultimatum,’ or they’ve decided to no longer participate in wholesale,” Farner said. “Wholesale on its own is a very challenging business right now, because…without the sale of that MSR, every loan you’re originating is losing you cash.”

Thus brokers are losing choice, and now have just one or two wholesalers they can rely on.

“So that means that they’re not as price competitive, which will bode well for our retail system as they continue to lose choice,” Farner noted.

But it’s also become easier to sign up new broker partners. “If you’re fighting to save your business, and you’re in a situation where your choices continue to get eliminated, then you’re looking for a new partner, someone who probably is more open to a free market system,” Farner continued. The lack of profitability, along with lower volumes, will take brokers out of the market next year. “They’re struggling because of a lack of choice that’s been now kind of forced upon them,” he said.