Let's Talk Loans - Vol. 68

Welcome back to a special edition of Let's Talk Loans. We held our inaugural Whole Loan conference in Nashville on Wednesday and Thursday of this week. Clients joined us for conversations on the economic outlook, mortgages, commercial real estate, auto lending, the state of the balance sheet, M&A and investors outlook, and a deep focus on credit cards and consumer lending. A ton to unpack, but I hope it gives you a flavor of what was an incredible agenda.

The event was kicked off by none other than Cristian deRitis, deputy chief economist from Moody's Analytics. He really set the tone for what I thought was a very powerful, jam packed, first day. I have to give Moody's credit as they have been contrarian to the rest of the economist's out in the market today. Their view has been more "glass half full" for the last 12+ months, with a message being: strength for the consumer and a "slowcession" vs a recession. With inflation slowly falling, but maybe not fast enough for the Fed, higher for longer will persist throughout 2023 and well into 2024. The 10 year is forecasted by Moody's to essentially be 4% into '24 - down but only slightly as buoyed by a resilient, if slowing, economy.

For those naysayers who were looking for the glass half empty the question was asked "What could go wrong"? Where could the shock come that tips the economy downward? Where might we see some credit fracture? Unsurprisingly the Fed was the biggest concern. What happens if they overcorrect? (Which they have a good track record in doing so). Another hard shock to the banking sector could cause strategic sellers to become forced sellers of assets. I'll speak more about commercial real estate in a moment. China, Russia, the collapse of the consumer, a government shutdown could all be part of the tipping point. His few things to look for:

1. A consumer who pulls back too quickly. They are the driver of the economy.
2. If layoffs spike, jobs and wages fall - it can snowball quickly.
3. Watch corporate spreads. They remain historically average - NOT presently indicating any sign of serious corporate stress.

We then rolled into a star studded conversation about the residential market. My thanks to Hamilton Fout , Leonard Kiefer , Michael Fratantoni , and Steve Moss for a great round table discussion on the state of the state. The overall theme to the mortgage market was very positive. Yes, originations will be down but credit was in a very good spot.

1. Fannie Mae, Freddie Mac and the MBA all pointed to a period of slower mortgage growth. Somewhere in the $1.5trn - $1.7trn context. This will largely be driven by purchase money lending going forward.
2. Credit remains very strong. We talked at length to if this credit cycle turned negative the mortgage sector could be a positive compared to the GFC and other consumer assets.
3. The lack of supply in housing continues to be a boost for home values which have been a pleasant surprise to the market this year.
4. Spreads for mortgages are at historical wides. The absence of the Fed and the GSE's in the market is being felt. Further, concentration limits for banks are limiting some of the largest buyers appetitive which is what is behind the widening of spreads.

Next we moved over to commercial real estate which has easily been one of the more negatively spoken lending spaces in recent months. Frazer Gieselmann, Jamie Woodwell , Victor Calanog PhD CRE FRICS and James Armstrong led a deep conversation to a tough market. The conversation was surprisingly more positive than I might have expected. Yes, we focused heavily on the office sector and the known credit issues in that sector. However, "extend and pretend" seems to be the tone of the day. The FDIC, OCC and NCUA have jointed released guidance that depositories should give borrowers / guarantors grace in these difficult times. We are seeing a coming "debt wall" (below). We are witnessing growing maturity defaults, but the good new is cashflows are still coming in. Unfortunately, that cash flow is below today's current market cap rates. If higher for longer were to persist that could eventually become a problem.

All of the panel agreed to stop disseminating the misinformation that community banks own 75%+ of this total universe. The number is FAR below those headlines as illustrated by Jamie Woodwell's below graph. Once you factor in the top 25 banks, the number at the community level gets quite small.

Some other quick talking points from this discussion.

• Beware of valuations right now. Transaction volumes are down very sharply and it is difficult to peg values in the absence of information.
• Your first loss might be your best loss. Getting clear of some assets you know are going to be losers going forward can be spun into a positive story for investors and the market.
• Reported cap rates today are likely a lagging data point. While they might be directionally (up) correct, the severity of that increase likely hasn't made it into the data today.

Moving over to a very thorough presentation by Amy Martin from Standard and Poor's. Amy did a great job of looking at the totality of the ABS market. First, performance. Prime losses have risen, or "normalized" back to pre-pandemic levels.

Credit quality in autos remains strong but there are some cracks to look at. Terms have lengthened as rates and car values have risen sharply during the pandemic. Further, Amy drew comparisons of the ABS market for credit union issuers vs their bank competitors.

Lastly on autos - a few of Amy's outlook comments are below.

Next we moved into the investment banking and balance sheet outlook for depositories. Starting with Nathan Stovall, who I have to confess I'm a complete fan boy. If you do not subscribe to his podcast "Street Talk" please do so. The title of his presentation was "Outlook for U.S. Banks As Rates Remain Higher For Longer" and it did not disappoint. There was a heavy focus on the rising cost of funds that all depository institutions are battling today. A shortage of cash, an increase in AOCI, and an increasing reliance on wholesale funding all point to tough times for banks in the months ahead.

Admittedly the M&A market is having one of its worst years in recent memory but there is reason for some optimism going into 2024. As more pressure is put on depositories this should lead to opportunities for those institutions better positioned to take advantage of what the market has given them. Interestingly, this was a message that Bill Sammon mentioned in our next presentation. Some closing thoughts shared by Nate.

Moving into that next conversation that Bill Sammon shared with us was a look from investors INTO depositories. Why might an investor today want to put more capital into an account in a market like this? The answer was they don't! They are on pause. Uncertainty from the Fed, uncertainty from credit, uncertainty on regulations, uncertainty for margins are all strong headwinds that depositories are facing today.

That said, while deal activity is at a low, action in the board room is at an all-time high. How can a CEO today position the bank to be prepared to go on offense when something shakes lose and looks cheap? Might selling underperforming assets today make sense? These are very timely discussions that boards are conducting privately today.

Next, we did a series of panels on consumer lending. We were joined by Rebecca Bacon, Christopher Connor, Eric Neglia and Brian Ford, CFA to focus on the recent boom in fintech lending. KBRA puts out a great report monthly as to the state of performance in the space. We were quick to point out that this research largely focuses on loans that make their way into ABS deals and are not necessarily representative to the whole loans that live on a bank or credit union balance sheet. Eric and Brian pointed to weakness in the lower end of credit and with younger borrowers. Lenders tightened their underwriting guidelines going into 2022 and that has helped more recent vintages. There were worries as to the impact of student lending turning back on that might continue to put stress on the consumer going forward.

Rebecca with Upgrade, Inc. mentioned their recent expansion into home improvement lending as well as indirect auto lending. A special thank you to our guest speaker Renaud Laplanche from Upgrade as he shared with us his entrepreneurial journey in founding the company. It was a rare treat to get to interview him and listen to his story. Chris from Funding Circle US highlighted the strong performance in small business lending that has been experienced due to conservative underwriting practices.

Lastly, the focus on credit cards by Craig Demoss and Mitchell Pangretic from Elan. Credit card growth has hit historic heights but delinquencies and charge offs are also on the rise. Often times we find that clients do not fully understand the portfolio and how to manage the risk of growth in potentially troubled times. The focus of the discussion was on how to safely and soundly grow the portfolio through a partnership program with some of the best in the business.

A hat tip to David Thompson from Raymond James to give our clients a change of pace presentation on the first day. As an University of Mississippi graduate, it was special indeed to be joined by Manning royalty as our keynote speaker. Cooper Manning shared with us his thoughts on the state of college football, his success as a TV personality and unique look into what it was to grow up in the Manning household. I think many of the attendees will agree that he gave a wonderful, candid conversation that captured all of us. My thanks to Cooper for agreeing to speak with us.

Be on the lookout next weekend for an audio version of this roundup. I was generously asked to join Nate Stovall on his podcast. This should be out and in the wild by mid next week. Have a great weekend!

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