Let's Talk Loans - Vol. 57

Welcome back. Seems we are in the throws of vacation season with a lot of out of office bounce backs. Perhaps you're sitting on a beach and I am certain you have been waiting for this newsletter to hit you. Hopefully with a drink in your hand. For those first time readers, we talk about all things loans in these columns. These are various hot topics as the trading desk here at Raymond James gives some market commentary on what we and our customers are discussing.

I really enjoyed the Barry Sternlicht bit this week on CNBC Squawkbox . Sure, he's a polarizing figure. Plain spoken, leans right but you can't deny he's in the middle of the CRE market right now. You can catch clips of the interview here , here and here . Big headline from the chat:

"The regional banks are not in good shape. They all have commercial real estate loans," says Barry Sternlicht. "Only by the grace of God do some of these regional banks continue to walk. Any group of hedge funds can take one of them down at any moment."

I've written a lot about this and I'm not as doom and gloom as that headline. However, the CRE market has not yet reset and there will be some pain here the longer rates hold higher. Blessedly, loans do not have to be marked to market. Barry speaks to that as we don't have great visibility into depositories CRE exposure. This "crisis" has been well documented though not yet fully realized. You have the refi debt wall coming. "Fire sales " in the San Francisco office and hotel sector starting. Lenders still making "relationship loans " at levels they couldn't clear in the secondary market today. CBRE pointing to a study that could wipe out all of tier 1 capital in a worst case scenario for 300 banks. The CMBS market still slightly frozen and Fitch saying "35% of pooled securitized commercial mortgages coming due between April and December 2023 won't be able to refinance based on current interest rates and the properties' incomes and values". One of the quotes that I think they missed in the below interview was "There's going to be a lot of opportunity for rescue capital". So far on this desk, we have received dozens of inquires such as:

• "I am interested in buying whole commercial first lien mortgages that are distressed. Does your group market these?"

These are buyers, bottom feeders, with lowball bids trying to pick someone off. Not serious buyers of size, with a compelling or creative bid that would entice a seller off the sidelines. The sell side of the trade is still materializing. I believe sellers right now would like to sell some of their troubled assets, are struggling to get a true handle on the value of the loan / asset and a measure of the potential loss but do not want their name in the spotlight. If they sell, will it make a headline and create a bigger problem for them? So far sellers are quiet, cautious, curious but resisting a rushed call to action. One could argue they should be more proactive in managing this risk based on the multitude of growing headlines but I'm seeing more "extend and pretend" at the moment. Presently, the sentiment seems to be that CEO's are aware of this but expect the Fed to bail them out with rate cuts. Market participants believe that there are cracks but not breaks in this market.

Perhaps if this crisis does truly crystalize into real, hard losses (something like a 2008 moment for resi) we can look back at this post and say I told you so. Simply scanning the headlines on Bloomberg's top page today...

Speaking of residential lending. Several big headlines of late. Some good, some bad. First, let's tackle the ugly . If you're in the mortgage business, this is not your year. Rates continue to climb and it's having a fairly savage impact on originations. Per S&P:

"Retail originations fell 64.9% and wholesale originations dropped 60.5% year over year, according to an S&P"

"Wells Fargo & Co. had the largest year-over-year decline in originations at 84.3% and Goldman Sachs Group Inc. had the second-largest decline at 79.1%. JPMorgan Chase & Co. had the third-largest year-over-year decline of 77.3%."

The secondary market for mortgages is not much better. While mortgage spreads have tightened in slightly of late, they are still historically wide. Longer duration paper remains well out of favor with many buyers.

Now over to the good news. Home values have held. At the onset of the onslaught on mortgage rates, many were concerned that home values would fall off a cliff. Leonard Kiefer cautioned that we might see a decline but not a cliff. The lack of inventory could be a potential buffer to steeply falling home values. So far, that theme has held true. Values have dropped from their peaks but it has been more gradual thus far.

"The median home sales price was $396,100 in May, down just 3.1% from a year earlier when 20% more homes were sold, according to National Association of Realtors data"

The issue at hand is new construction. We've talked about this on a few webinars but builders never recovered after the 2008 housing crisis. We just don't have enough inventory.

"In May, there were only 1.4 million homes for sale in the US, the lowest level since at least 2012"

When rates started to rise, builders went on pause thinking that the rabid demand for homes might slacken and prices could plummet. It hasn't. The recent spike in new construction I believe has renewed confidence that builders will still have the ability to sell new units once they come online. I did love the following quote:

"You can't buy what's not for sale"

Moving over to credit for a moment, TransUnion has released their May snapshot on consumer credit. Mortgages and cars continue to outperform cards and personal unsecured loans. Though it is interesting to me that 2022 vintage mortgages have now reverted back to their 2017-2018 vintage cohorts. If you recall, 2022 vintage mortgages would be when rates started to rise quickly and payments would be higher. Are those higher rates having an impact on a consumers ability to repay? Not quite as easy to see, but can we draw a similar conclusion for autos? Auto rates doubled in 2022 and those early delinquency numbers for 2022 vintage autos are now higher than their historical norm. I continue to believe that mortgages will outperform most other assets if we have a downturn.

Further picking on consumer credit, specifically auto. This headline grabbed my eye. With used car values having taken a hit in 2022, though rebounding recently, is there enough focus on LTVs? From the Bloomberg article :

"Used car loan-to-value ratios increased to 125 in the first three months of this year from 104 for the same period in 2021, according to the study released Tuesday by credit reporting firm TransUnion and market researcher J.D. Power. A ratio of 125 means that the borrower's loan is worth 125% of the vehicle's value"

"Given the possibility that accelerated depreciation will result in negative existing LTVs for longer periods, this will be especially important for lenders to monitor," Merchant said."

With delinquencies ticking up slightly, and LTVs being slightly out of line, might this be a precursor to higher losses?

Lastly, rates. Powell was on the hill this week. He gave little hope to those looking for the pivot. As such, rates have been on a tear. As of this writing, the 10 year treasury is at 3.75%, up from June 1st of 3.59%. The 2 year is worse, 4.77% as of this writing and up from June 1st at 4.49%. 2s and 10s are now 102bps apart again. It finally feels clients are starting to come to the realization we might be here for a bit. Question for you CEO's and CFO's out there. Your budget from January...has it changed by June?

Have a great weekend! M22-226910