Let's Talk Loans - Vol. 84

Welcome back to another week of Let's Talk Loans. Going into the long President's Day weekend, the market did us few favors this week. If you enjoy conversations about banking, lending, the economy, fixed income markets, sales and credit you've come to the right spot. This weekly newsletter covers what's trading and trending as seen from the whole loan desk here at Raymond James . If you enjoy the content - please share it with a peer and subscribe!

Well. Yuck. Not the week for economic numbers that we all wanted. Inflation, despite many calls for it's early demise, appears alive and well. Both the CPI and the PPI this week showed better than expected increases. The first being CPI. There was real hope coming into Tuesday that this was going to be the print that gave Powell what he needed to turn on that March cut cycle. The expectation was a number that might be under 3% YoY and 0.2% MoM. Sadly, hope didn't break our way and the number turned out hot.

"CPI rose 0.3% from the prior month, ticking up from December, while climbing 3.1% on an annual basis, down slightly from December’s 3.4% rate. The core prices gauge -- which leaves out energy and food -- remained at a 3.9% growth rate from the prior year."

Then Thursday it was PPI that came in hot. You've got the blue bar (overall MoM), orange line (less food and energy) and red line (less food, energy, trade) all going in the wrong direction. Up. Remembering that this is one of Powell's preferred metrics of inflation, up is a four letter word.

"The so-called core PPI, which excludes volatile food and energy categories, climbed 0.5% from the prior month, and 2% from a year ago — both topping expectations."

"Treasuries extended their selloff following the PPI data. Two-year yields rose to the highest level since mid-December."

This took the punch bowl away on any hopes of a rate cut in the very near future. As I wrote two weeks ago after the jobs number came in - we are in a higher for longer market with likely only 2-3 cuts this year. Recent chatter from some previous Fed members even mentioned the dreaded word again. Hikes. I wrote earlier in the week in a post:

If you listen closely, even yesterday on CNBC, you'll hear a dreaded word. Hikes. It's back on the lips of talking heads. I doubt the next move is a hike, but the fear of the "twin peaks" of inflation from back in the 70s is something that Powell must be watching. CPI spooked us yesterday, I think it solidified 2-3 cuts for the year (and on the back half of '24) and I think 6-7 cuts died. WIRP seems to agree. Higher for longer, until something breaks.

I still believe directionally down is the right call but with each strong economic number, or higher inflationary print, we continue to push that cut further and further into the year. Moving on to something that is cracking (not breaking).

We are very active in the credit union market. Not exactly the headline credit unions want you to focus on. Those bankers that read this will roll their eyes and say they get to cheat because they don't have to pay taxes. I hear you, but you would be wrong to dismiss credit union's as anything but a vibrant competitor in the lending space. However, they are strongest in the consumer sector, less of a commercial competitor (though growing). This is a blessing since the focus these days is firmly on CRE as being the problem asset on the balance sheet. Though you can glean some early indications that "main street" is starting to soften in consumer credit. Credit unions do focus on the everyday American borrower or "member" as they call their customers. They are most active in consumer lending: auto lending, unsecured lending, credit card lending and mortgage lending. With the exception of mortgage, the other three sectors have weakened in the last two years.

"The net charge-off (NCO) ratio for credit unions was 0.77% in the fourth quarter of 2023, 16 basis points higher sequentially and representing the peak since the first quarter of 2012. The majority of the quarterly jump in NCOs was from used vehicles and unsecured credit cards. NCOs for used vehicles were up 36.1%. Unsecured credit card NCOs increased 30.5%."

Charge offs are the result of previous delinquencies. If the below quote is accurate, I would expect the NCO trends to continue.

"Credit unions reported a spike in loans that are delinquent for at least 60 days. The delinquent loan ratio was 0.83%, as of Dec. 31, 2023, up 11 basis points from the previous quarter and representing a tie for the highest ratio in the last nine years. Used vehicle loans comprised 27.2% of total delinquent loans and were responsible for 23.4% of the quarterly increase."

The other side of the coin here is higher rates for credit unions. They are also known for giving out higher deposits and lower than market rates on loans. That's a bit of a double edged sword right now as NIM is getting pinched. Coupled with rising provisions, due to rising charge offs, and they are struggling to manage profitability. It's no surprise to me that loan growth is cratering at credit unions as they wrestle with funding pressures and higher rates.

"Total loans and leases across the industry rose just 0.8% from Sept. 30, 2023, which was the most diminutive growth rate since the first quarter of 2021. Used vehicle loans declined 0.5%, ending a streak of 50 consecutive quarterly increases. Credit unions also cut their balances of new vehicle loans by 0.7%, discontinuing a 10-quarter upward trend. Areas of growth included junior-lien one- to four-family, member business and credit card."

Shifting away from credit unions specifically, but staying in the consumer credit space, a hat tip to Eric Neglia , Brian Ford, CFA and KBRA for their research on consumer and home improvement lending. This captures auto, home improvement, solar and consumer unsecured. Needless to say, this is a broad swath of collateral and credit. First, unsecured consumer, by its nature, its going to have a higher risk profile than the other three products. Second, originations in these sectors has grown mostly due to the pandemic. Names like Aqua Finance, Greensky and others have seen strong growth in loan originations as folks looked to float, drive, camp or fix up their existing properties. You can spot credit here also starting to bubble up slightly in delinquency but still showing good performance (exception of unsecured). Solar and home improvement has largely been prime or super prime borrowers.

"Securitized home improvement loans have generally performed in line with securitized solar loans from a net loss perspective, which makes sense given both loan types are predominantly made to prime borrowers and are additive to the borrower’s home value. Comparatively, home improvement loans have exhibited stronger credit performance versus securitized unsecured consumer loans, but weaker performance relative to securitized prime auto loans."

Back to commercial real estate. So many articles on the topic in the last two weeks since the NYCB story broke. Is this time different? I will say MAYBE. It certainly appears to be a heightened focus by the regulators. Should the regulators put the gun to head and force clients to liquidate properties that could be a "spark" that drives valuations. Commercial real estate is in such a fragile position. Similar to the residential mortgage market, many depositories carry a number of underwater coupon loans. Those legacy loans are underwater due to simple interest rate risk. However, two things differentiate the commercial loan market. The CRE space is often shorter, more adjustable in nature and many loans are starting to reach that step up or maturity window. With cap rates still being being very difficult to peg these days, credit tightening in, that step up in coupon presents a challenge. Further, while residential lending remains very sound in credit, the same cannot be said for CRE. Not only are you adding an interest rate risk component to the conversation but credit is on shaky ground. A bad combination for sellers today.

I also want to be clear that this is not an isolated item for banks big or small. This is most banks problem. Now the size of that problem could be smaller or larger per institution but this is fairly perverse throughout the industry. Again, much like the mortgage market, we were in a very low interest rate environment for the better part of a decade. The loan portfolio didn't just magically step up to current cap rates over night. Most portfolios from an interest rate standpoint remain deeply underwater. No different than the bond portfolio with its AOCI issues. While the credit component may be more of an industry focus (Office, Multi), more of a geographic focus (San Fran, Manhattan), more of a location focus (Dense urban vs suburban), or class focus (A vs B & C) - the credit issue is still there. It compounds the underlying problems.

Finally - we're hiring. If you're looking for a very dynamic, ever changing, close group / team atmosphere, fast paced, fixed income / investment banking / capital markets focus - we have an opportunity for you. Job description is below. FYI - don't send me your resume. It has to go through RJ corporate. If you don't apply through this portal, you won't be considered!

Have a great weekend. (M24-420573)