Let's Talk Loans - Vol 7

On to Vol. 7 of Let's Talk Loans. Thank you for reading and subscribing. The goal and focus of this newsletter being to chat about what's trading and trending in the whole loan market.

A short summary on the month of May and what we saw transact. While it was our 2nd highest trading volume ever for the month of May, trading volumes dropped considerably compared to the last 5 months. Fascinating to see we nearly traded more PAR balance on HELOCs this month than 1-4 family residential mortgages. That was largely due to the slow down in 30 year deals as a result of significant pricing discounts and extending durations. This continues the theme and shift to shorter duration assets that we started to feel a few months back. ARMs starting to make a comeback, SOFR seems to be the index. Legacy 30 year fixed coupon (3.0%) pools are still very much clogging up the secondary market. Deep discounts for prime paper for this 2021 vintage is common but the bid for the loan has certainly softened this month. HELOCs, ARMs, Autos, and Fintech / consumer unsecured are very much in vogue but admittedly we have seen spreads across all trading assets hit wider levels.

1) Speaking of fintech, I clearly struck a chord this week with a posting from the WSJ on consumer paper and the buy now pay later craze. I do greatly appreciate the banter this generated.

This quote in particular lead to many of the naysayers to pile on. "While consumer-loan defaults and delinquencies remain low across the board, there are signs surging inflation and the end of pandemic-era stimulus programs are causing more subprime borrowers to fall behind on their debts." Prior to the pandemic, many fintech lenders had never been tested by a true recessionary economy. You have two schools of thought here. On one side of the coin, the algorithm was going to get it right and big data was going to have it's day. The other side lays in wait, ready to pounce and say "I told you so", this space is nothing but weak credit. Back in 2020, many of those lying in wait feel as if they had their moment stolen from them when the Fed and Congress threw $5 trillion dollars at the consumer. They might argue this masked true consumer weakness and delayed the inevitable. The other side feels vindicated that the algo got it right and have pressed on making more loans and expanding into new markets.

Presently, the truth has a little bit of something for everyone. Fintech lending has really helped those institutions dependent on the branch at a time when lockdowns prevented consumers from leaving their homes. These partnerships have flourished, giving access to credit for consumers in a very unique time. We've seen several mergers between banks and fintechs as the push for technological efficiency in banking approaches a crescendo. Candidly, many depositories have long needed to step up their tech spending for loan originations, bolster these new avenues to attract borrowers and invest in their own online platforms. Digital, online lending isn't what it was back in 2005 and it appears the internet might be something that's here to stay (sarcasm included).

Performance has also largely been strong. Yes, some of that is due to an overload of stimulus. Our friends at KBRA track the ongoing performance of these loans throughout their life cycle as found in ABS deals. From KBRA's April report on fintech lending I quote "Credit performance across the marketplace consumer loan sector showed mixed results during the March collection period (April reporting period), with Tier 1 showing stability and Tier 2 continuing to normalize toward higher prepandemic levels." Further: "We continue to expect credit performance to weaken in both indices, but more meaningfully in Tier 2, throughout 2022, as inflationary pressures weigh on consumer balance sheets." That's very consistent with much of consumer lending right now. Those lower income borrowers, most impacted by rising inflation and fading stimulus will be hit the hardest. Delinquencies and charge offs will likely grow for that bottom tier of credit but top tier credit remains solid today. Much of what we see trade in this space has a 660 FICO floor and a blended prime credit score in the mid 700's. I'll post more on this in coming volumes.

2) The Federal Reserve has started it's pivot regarding it's balance sheet. As of June 1st, the Fed is no longer reinvesting runoff into new purchases and letting the portfolio contract. While it has not yet outright announced the selling of assets, that would be the next phase (should we get to it) of qualitative tightening.

This specifically will affect mortgages but likely many other sectors of lending going forward. The Fed has bought over 30% of the MBS issuance in recent years and significantly influenced rates. As that lead order continues to diminish, so too will mortgage rates likely be impacted.

"Q: But what about mortgage securities? The Fed has said that over the long run, it wants to own primarily Treasury securities. Selling mortgage assets would more quickly shift the composition of its asset holdings toward Treasurys"

3) CECL.

"At the time of initial CECL adoption in 2020, more than?92% of institutions in the U.S. banking industry?qualified to wait until 2023 for CECL implementation"

It's hard to overstate that quote. Not much has changed since 2020 and few have opted for early adoption of the new regulation. The overwhelming majority of depositories are about to go live on one of the largest changes to loan loss accounting in a generation. The fortunate news for most is that the pandemic likely has already swelled their reserves ahead of this new FASB. That should dampen the pain of CECL day 1. Still, S&P predicts this will be a headwind to earnings and an increase in reserves by roughly 15%. Our real world examples thus far have largely demonstrated slightly higher figures (though very much in the ballpark) but each portfolio composition is different.

If you continue to struggle with the data gathering, your CECL solution or a "reasonable and supportable" forecast / assumptions, please give us a call. We can help.

4) Mortgages and housing values. Despite the Case Shiller index putting up a blistering 20.6% March YoY growth in home values (the highest rates since 1987), there are signs the housing market could finally be cooling.

I argue that rates might finally be taking a bite out of affordability and slowing down the breakneck rise in property values. 1 out of 5 homes the last week of May reduced their offering price, showing some weakness in continued rising home prices. Rates bounced off their 5.50% 30 year fixed rate highs. Lastly, and most importantly, home builders are starting to catch up with the lack of inventory. We still have a way to go but we posted the highest number of housing starts since 2006. This could indicate we are approaching a corner in this market. Time will tell.

5) Lastly and specific to mortgages. It is one of the most trying times in the better part of a decade to be a mortgage lender. A rapidly shifting market away from refi's and super low 30 year fixed rates. New products with renewed demand for HELOCs and ARMs. Non QM loans more focused on purchase money business. Lenders and loan officers alike are scrambling to adjust to this different world. We bring together some of the biggest names in this field with a very timely discussion on the state of the mortgage market this Thursday, June 9th, at 1pm central. Fannie Mae will kick us off with an economic and mortgage forecast. We will then dive into a workshop and roundtable discussion with Redwood, Flagstar, Deephaven and PenFed to talk about what's working in all corners of the mortgage market right now. Space is limited, please register early, for what I think will be our best discussion yet on lending.

#housing #mortgage #mortgages #banks #creditunions #fintech #lending #credit 4772612