DETROIT — Quicken Loans is enjoying some of its most profitable months ever amid ultra-low mortgage rates and the fruits of its IPO this summer as part of Dan Gilbert’s Rocket Companies family of financial businesses.
Over in Dearborn, Mich., Ford Motor Co. has been burning through billions in cash during the global pandemic and economic slowdown.
Aside from its metro Detroit geography, the global automaker and nationwide mortgage lender have little in common. But one other thing they do share is below-investment grade credit ratings from the Wall Street rating agencies, also known as “junk” ratings.
Junk ratings don’t mean that a company is going broke. They do indicate perceived risk.
Quicken is rated “Ba1” — one notch below investment grade — by Moody’s Investors Service, which reaffirmed that rating in early September. Ford lost its investment-grade rating last year and in late March, Moody’s downgraded the company a step deeper into junk with a “Ba2” rating.
For Quicken Loans, the nation’s No. 1-ranked mortgage lender, the junk rating reflects uncertainties about the company’s ability to sustain its big profits after the boom in mortgage refinancings — the company’s traditional strength — comes to an end, as well as inherent risks in its business model that uses shorter-term financing that might potentially dry up in times of crisis, according to the rating agency’s report on the company.
In addition, Moody’s expressed concerns about company executives’ goal of growing Quicken to a 25% market share in the residential mortgage market by 2030, up from its current 8% to 9% market share.
Never before has a “nonbank” mortgage lender such as Quicken had a 25% market share. The closest was Countrywide Financial, which reportedly had a 17% market share in mid-2017 before its collapse in the subprime mortgage crisis.
To achieve that ambitious market share, Quicken might feel pressured to lower its lending standards and write riskier mortgages, according to the Moody’s report. And without commensurate increases in liquidity sources or capital, such a scenario would be a “credit negative.”
“While Quicken has a solid track record of managing record growth, the history of companies going in the residential mortgage market and grabbing for market share is not great,” Warren Kornfeld, senior vice president for Moody’s Investors Service, said in a phone interview.
Rocket Companies and Quicken did not respond to requests for comment for this article.
No one disputes that Quicken Loans has been making a lot of money. It had “exceptionally strong” profitability during the first half of the year with $3.2 billion in net income, according to Moody’s, and Rocket Companies as a whole reported nearly $3.5 billion in profit for just the second quarter.
Quicken, like many other mortgage lenders, has been doing strong business during the pandemic because the drop in interest rates led to a surge in homeowners looking to refinance their mortgages and lock in cheaper rates. Some lenders have struggled to hire enough staffers to keep up with the surging demand.
The Mortgage Bankers Association recently revised upward its full-year, industry-wide mortgage originations forecast to $3.1 trillion. That figure would make 2020 the second highest year ever after 2003.
Quicken, which uses call centers plus its Rocket Mortgage website and smartphone app to conduct business, has traditionally enjoyed big profits during refinancing booms. But booms don’t last forever, mortgage rates fluctuate, and the U.S. mortgage market is expected to eventually shift from predominantly refinances to predominantly home purchases.
“If everybody in the world refinances at under 3%, what are the chances rates are going to go to 2%? Probably not likely, they are more likely to go up,” said Guy Cecala, CEO and publisher of Inside Mortgage Finance.
In its national forecast, the Mortgage Bankers Association believes refinancings will be 56% of all mortgage originations this year, falling to 35% of all originations in 2021 and 22% in 2022. Total mortgage originations are forecast to fall by 30% next year and shrink another 13% the following year.
Quicken doesn’t publicly disclose what% of its business is refinancing activity compared with home purchases. However, industry insiders believe that refinancings have been the bulk of its business this year, and Moody’s says that Quicken’s “franchise in the purchase residential mortgage market is weaker and as a result much less profitable.”
“It’s not clear how balanced Quicken’s mortgage origination platform is,” Cecala said. “In a perfect world, you would like a mortgage lender who is doing as much home purchase as they are refi, you’d like to see multiple channels.”
“The obvious explanation is they don’t want to release that number because they are very heavily refi vs. home purchase,” he said.
Rocket Companies CEO Jay Farner told Wall Street analysts last month in an earnings call that the company has been increasing its home purchase mortgage business, too — “we expect the third quarter to be one of our best for purchase origination volume ever” — and that trying to classify its mortgages as either refinancings or purchases is an “old line thought process.”
“We think capacity, brand and client experience,” Farner said. “So, in a market where refinances are more prevalent, you may see more refinance volume from us. In a market where purchases are more prevalent, you may see more purchase volume for us … you need to kind of view it from the perspective (that) excellence in operations is really our focus, and then maximizing profitability with that excellence.”
Reaffirmed as ‘junk’
Quicken Loans received an updated credit review from Moody’s before announcing last month that it would refinance $1.25 billion in corporate bonds. The new bonds will carry interest rates of 3.6% and 3.8%; the old bonds’ rate was 5.75%.
Moody’s decided to keep Quicken at a Ba1 rating, just below investment grade.
The rating agency saw the Rocket Companies’ IPO in August as a positive for Quicken because of the additional disclosure requirements and “market discipline” of being a public company. The offering, at a price of $18 a share, raised about $1.8 billion, down from the company’s initial goal of $3.3 billion or more.
Rocket lowered its offering price from what was $20 to $22 a share after inventors pushed back on the company’s valuation, saying it should be priced as a consumer or financial company and not a technology business, according to a Bloomberg report.
Rocket Companies traded just under $23 midday Monday.
In the Free Press interview, the Moody’s executive said that Quicken’s rating reflects the inherent nature of the company as a nonbank lender.
Nonbanks like Quicken do not take customer deposits and generally rely on shorter-term borrowing for the money they use to finance mortgages.
Quicken holds the mortgages that it makes for a couple weeks before selling them off to government-backed enterprises such as Fannie Mae and Freddie Mac, as well as to investors in the secondary market. The company then uses money it makes from the sales to pay back its short-term credit line funds.
“In the mortgage business, you are borrowing short-term money all the time to finance the mortgages that you haven’t sold off,” said Erik Gordon, a professor at the University of Michigan’s Ross School of Business.
According to Securities and Exchange Commission filings, about 93% of Quicken’s mortgages for the first half of 2020 were sold to government-backed enterprises, which insure the loans against homeowner default. Overall, Quicken’s average loan amount was $275,000, the average interest rate was 3.36% and its average borrower’s credit score was 751.
Kornfeld noted how some nonbank lenders failed during the 2007-08 mortgage crisis due to liquidity issues.
Nonbanks lack safety lines that traditional banks have, such as customer deposits, access to the Federal Reserve’s “discount window” for emergency borrowing and membership in the Federal Home Loan Bank System.
However, Kornfeld said many of the earlier nonbanks that failed wrote subprime and nonprime “Alt A” loans that went to private investors and weren’t backed by government enterprises.
That is much riskier business than what Quicken does.
“Government mortgages are, even in times of stress, far more liquid than non-agency mortgages or non-agency private label mortgage-backed securities,” he said.
Moody’s baseline credit rating for banks in general is A3, which is considered a low credit risk. For nonbank mortgage lenders, it is B1, or a relatively high credit risk.
Of the eight nonbank mortgage lenders that Moody’s rates, Quicken is the highest rated.
“This is a very strong franchise,” Kornfeld said. “This company, even though it’s a nonbank, its funding structure and liquidity and resources to cover their cash needs are solidly stronger than their rated nonbank peers.”
The Moody’s report faulted Quicken with a “credit negative” for making cash distributions to its parent company, Rock Holdings, in the months before this summer’s initial public offering because that transfer offset what had been Quicken’s rising capitalization. Rocket’s SEC filings say the distributions totaled $3.8 billion, of which $1.1 billion was for paying taxes.
“Nevertheless, given the company’s exceptionally strong profitability, we expect capitalization to improve,” the report said.
Quicken Loans and Rocket Companies did not respond to Free Press questions about the cash distribution.
What ‘junk’ means
Companies with ratings below investment grade typically must pay more to borrow money.
Finance professor Uday Rajan, also with U-M’s business school, said it is typically viewed with greater concern if companies lose an investment-grade rating and drop into junk territory. Companies that do this, like Ford, are known as “fallen angels.”
By contrast, Quicken’s rating started off in junk territory and has risen toward investment grade.
“Sometimes more important is whether it is improving or becoming worse over time,” Rajan said.
For Ford, its junk rating likely reflects concerns that the automaker has fallen behind competitors as well as impatience over when the automaker’s multiyear $11-billion restructuring plan can bring sustained profitability.
“There are concerns about Ford going forward, not whether it’s going to go broke,” Gordon said. “The rating would be much lower if people thought they were going to go broke.”
Cars loans vs mortgages
Cecala of Inside Mortgage Finance said it is traditionally hard for mortgage lenders to grow and then maintain a dominant market share for long periods of time.
“It’s not that easy to keep because most people don’t get a mortgage like they get a car,” he said. “BMW is a great brand, people will buy BMWs regardless of price, (but) people aren’t going to go to Quicken regardless of the price or the interest rate they’re getting on the mortgage — they’re always going to be shopping for the best deal.”
Cecala also said lenders haven’t always desired a market share as huge as the 25% that Quicken Loans is gunning for.
He noted how soon after Countrywide Financial collapsed and was bought by Bank of America during the 2007-08 mortgage market meltdown, Wells Fargo reemerged as the No. 1 lender with a market share around 20%. But rather than celebrate its dominance, the bank grew nervous.
“When Countrywide was in a tailspin and a lot of the nonbanks were going under, Wells Fargo’s market share shot up dramatically,” he said. “They publicly said they weren’t comfortable with that kind of market share, and that was an opportunity for them to actually raise prices and let the market share decline and let other lenders come in.”
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