Why rocketing US mortgage lenders have gone too far, too fast

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America’s real estate market remains stuck in the mud. Existing home sales, which make up most of the US housing market, totalled just 4.09mn units in 2023, a 30-year low. Yet, median home prices hit a record high of $389,800.

Neither has stopped share prices of US mortgage lenders from regaining favour among investors. Rocket Company, owner of Quicken Loans, the country’s largest non-bank mortgage lender, is up 66 per cent since November. Rival UWM, the parent company of United Wholesale Mortgage, has gained 43 per cent.

Mortgage lending is a feast or famine business. The market takes the view that the interest cycle has peaked. The Federal Reserve is expected to cut rates, probably beginning in June. The average rate for a 30-year, fixed home mortgage was around 6.63 per cent last week, according to Freddie Mac. While that is more than double the level two years ago, it is down from 7.79 per cent in October.

Mortgage origination volume looks set to grow again in 2024 after falling to its lowest level in nearly 30 years, according to the Mortgage Bankers Association. Lenders should dole out over $2tn worth of mortgages in 2024. On current estimates, that looks to be up 22 per cent from last year but still well below 2021’s $4.4tn.

Therein lies the problem. Interest rates are unlikely to return to near zero levels soon. Many borrowers have already locked in ultra-low-rate mortgages. This means refinancing activity — which accounted for 58 per cent of the record mortgage originations in 2021 — will remain subdued.

As the dominant player in the direct-to-consumer mortgage space, Rocket can grab market shares as smaller players struggle or even go under. Consensus forecast expects Rocket to swing back to a net income of $613mn this year and $1.2bn in 2025. Yet these numbers may be too optimistic given that it will take time for Rocket to rebuild its margins. Its gain-on-sale margin — which measures how much is earned when mortgages are sold — came in at 2.6 per cent in the first nine months of 2023, compared with 4.5 per cent in 2020.

This makes Rocket’s valuation — an eye-popping 92 times forward earnings — hard to swallow. Its price to book value of nearly 3 times trumps that for mortgage-heavy Wall Street banks like JPMorgan, Bank of America and Wells Fargo. But Rocket doesn’t have appreciably higher return on equity. That suggests Rocket’s trajectory should soon plateau.