Let's Talk Loans - Vol 5

Vol. 5 of "Let's Talk Loans". Was a tough week with 3 days of travel and trying to keep up with the day job. The purpose of the newsletter is to talk about trends and themes in the loan market. If you're a depository (bank or credit union), REIT, insurance company, investor, originator, CEO, CFO, CCO, CLO or somehow in lending - I hope this gives some thoughtful insight to you. Please share with your peers and I welcome any feedback.

1) We just got back from the MBA's National Secondary in NYC at the Marriott Marquis. Historically, this is one of the largest mortgage conferences of the year. For 3 days, the 8th floor bar becomes the center of mortgage finance and speed dating happens with repeated 30 minute visits with clients. COVID changed that over the last two years but we were back and in person. Some thoughts and themes: ?

• First, it was great to see everyone IN PERSON again. No zoom, back to face to face discussions. There is no question the “theme” of the discussions are rates up, mortgage originations down, how will the market shift? I was worried it would be a doom and gloom vibe but it was more of a theme of curiosity on how we can find growth.
• We are moving to a more purchase money market and products need to evolve. Non QM, Non QM, Non QM - what's salable in the secondary market and has scale to originate in the primary market. How can I feed my loan officers?
• i. 40 Year Term, 10 Year IO Loans. Fixed rate, 10 year IO period followed by a 30 year amortizing period. My first thought here is this is not a depository product. I don't know many banks or credit unions, outside of modifications, that are looking for 40 year product. This likely finds a home in a CUSIP. But, affordability, higher home prices, rising rates and a need to get payments down could find some footing here.
• ii.???DSCR products. Rental properties. I was stunned to hear that originators would go as low as .75 DSCR on "residential" paper - underwritten to commercial guidelines. Calculated as gross income / proposed PITIA. The discussion was interesting for me. This is for the borrower of that beach house, who is renting it, but wants to catch the upside on property values. While the underwriter is purely looking at the rental income to qualify, an eye is also towards to borrowers ability to service the debt because they are visiting their home during portions of the year. Not sure this is a product many depositories will chase after and also likely finds it's way into a CUSIP.
• iii.???Asset depletion and bank statement paper. We have seen this paper for several years now. Many banks and credit unions simply call these "loans". More relationship lending to small business owners and gig economy workers that have difficult financials to understand. The discussion was fantastic that originators and buyers alike should EXPECT exceptions to underwriting guidelines with this paper. 20% or more, with common sense compensating factors being the justification. There is an art, not a science, to this type loan. Special note to lenders, document those exceptions in the loan file to help salability in the secondary market. I see this as a strong growth market.
• ?Second liens and HELOCs. Some positive discussions on that market coming back. And not in the 125% LTV context. We've seen a recent bump in originations and the more reasonable 80/10/10 type structure that we’ve seen trade. Per Transunion we have nearly 20 trillion in tappable home equity in the housing market. With rates up, borrowers locked in ultra low rate 30 year fixed coupons, borrowers could look here for home improvement. I could see this as a growth area.
• ?ARMs. Lots of chatter about dusting off the ARM lending manual. What’s the right index (SOFR)? What’s the right margin (300bps)? Caps and ceilings? 5 / 2 / 5? Floors? (margin)? Commentary from some securitizers were less positive on ARMs. Depositories in particular were more excited for this product. MBA reports that over 10% of current rate locks are ARMs which are some of the highest levels we have seen in a decade. I see this as a growth area - probably the largest. ?
• All things E mortgage. E notary. E note. E. E. E. How do we take all the manual processing out of making a loan? Streamline. Appraisals. Make it cheaper and faster to originate. Some discussions around how blockchain and fintech can aid in this space. We have a ways to go here still but the pandemic exposed several of the challenges faced by the manual nature of making a mortgage.
• NYC. Talks of it's eminent demise seem to be fading. However, we did witness a guy skate boarding down Park avenue in the middle of the afternoon. Pre COVID I think we would call that Darwinism. Today it seemed oddly normal. NYC didn’t feel empty but it was much less crowded. Actually would be a decent time to take the family and catch a show and not feel crammed together. LaGuardia airport has made some significant strides since I was last there 2+ years ago. The construction is much improved. Cab ride from LGA to Times Square right at about 30 mins. Strange. Speaking of cabs, far fewer of those operating anymore.

2) It was a big week for housing news. With rates up rapidly in Q1, can we glean any signs of weakness in the market? Supply chain still causing issues. Per Bloomberg, construction backlogs climbed to the highest since 1974. Builders are struggling to get materials and labor. That points to less supply and probably keeps home values supported for a time. Existing home sales dropped 2.4% MoM as we enter the spring / summer housing market. That again points to lower supply and bidding wars for homes. At some point though that reduced activity, rising rates, higher home values has to take a bite out of the consumer. For lenders, the MBA came out with their revised forecast for mortgage lending. Volumes should decrease, lead by a much lower share of refi (roughly cut in half - and still falling) and a 2.5 trillion dollar market in 2022.

3) Further cracks in the consumer. Continues to be focused on the bottom end of consumer credit. Income matters, per our previous chats with Moody's and KBRA, those borrowers down in the 75k incomes or below seem most at risk. I wrote about this last week as Q1 showed the first credit reserve BUILD by depositories in several quarters. Some see this as a sign of dark clouds forming. Up in credit consumer lending still appears to be strong. Mortgages in particular. Per the MBA: "In addition to improvement in the overall forbearance rate, the percentage of borrowers who were current on their mortgage payments increased to the highest level of 2022, despite potential headwinds such as high inflation and stock market volatility".

4) Hunting for loan growth for depositories. Per S&P, loan grown was fairly flat (+1.3%) across the board in Q1 but the devil is in the details. We often speak to the "have's" vs the "have not's". The below graph illustrates those challenges. Larger depositories are getting a bigger piece of the pie. Smaller depositories, who haven't invested in the tech to originate loans, are struggling some. This is where purchasing loans in the secondary market can boost ROA and ROE to offset some of the excess deposits and put good earning assets to work.

Next week is a repeat of this week. On the road again and visiting with our credit union clients. I'll do my best to give a summation of the theme there as well! Have a good week and hope you enjoy the content.

#banks #creditunions #mortgage #economy #housing #mortgages 4752266