Let's Talk Loans - Vol. 86

Welcome back to another edition of Let's Talk Loans. 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 tied to lending - I hope this gives some thoughtful insight to you. Please share with your peers and I welcome any feedback!

As tired as I am writing about this, it's news, it's in the moment, and it brings with it the risk of contagion. Considering everything that has been written in with NYCB at the turn of the year where they had a golden opportunity to take the hit, wipe the slate clean, come out of this fresh and work to rebuild confidence - we wake up this morning to the following series of headlines.

Commercial real estate can bring you down in today's market. It's toxic, it's widely held, it's opaque, it's non-uniform and it is in the spotlight. Why is this important to you? It can cost you your job. It's this quote from the Financial Times :

"New York Community Bancorp has replaced its chief executive and identified “material weaknesses” in internal controls that guide how loans are reviewed, amid worries about the US regional lender’s exposure to the commercial property market."

To make a disclosure in this market that you have a weakness in how you're reviewing commercial real estate obviously will be received poorly. I'll use that statement as an advertisement for our services here on the loan desk at Raymond James. We can analyze your portfolio to highlight credit risk, repayment risk, LTV risk, maturity risk and show pricing for the portfolio. Further, we can facilitate conversations with underwriters and specialists to discuss potential work out solutions and if necessary, liquidation options. With this latest news on NYCB, you can be certain that the annual review on your CRE book is going to more intense. You'll want to be able to say you've had an independent 3rd party review of your portfolio. We're here to help.

Shifting over to more interest rate chatter. While I do not personally subscribe to this line of thought of the below headline , I have been a loud proponent of "higher for longer." I was never in the 6-7 cut camp and previous editions of this newsletter have articulated repeatedly my case for this. I have written many times that in 2024 one should expect cuts to come later in the year and be more in the 2-3 context as data continues to roll out. Now at the start of March, we are seeing inflation moderate or even tick up, GDP expectations are back on the rise, employment remains resilient - all pointing to cuts further down the road. The market immediately shifted downward the moment Powell even hinted he was done. I suspect many clients breathed a sigh of relief at those comments. But what if the cuts do not come? Are you prepared for that even if it is only a 20% likelihood?

"Apollo Management Chief Economist Torsten Slok said that a re-accelerating US economy, coupled with a rise in underlying inflation, will prevent the Federal Reserve from cutting interest rates in 2024."

Moving over to the auto market. Melinda Zabritski and Michael Brisson are two of the consumer analysts I follow most closely. I quote them fairly regularly in these newsletters. I had the good fortune to chat with Michael as he struggled to understand why depositories were not raising auto rates high enough. I love his graph below as it does a great job of illustrating our conversation. The simple version is why has the benchmark (5-year treasury) risen nearly 400bps when the auto rates have only risen 200bps? If a lender were attempting to maintain a margin commensurate to their borrowing costs, shouldn't rates rise with the underlying benchmark? For most of our depositories the answer is no. They often fund on deposits, not borrowings to lock in a spread. Of late, that cash has been spent, deposits are flat, cost of deposits are rising, and lenders are now looking to borrowings. Their cost of funds are no longer 75bps, but instead it's 475bps, and they have to jack up rates to slow down volumes. So there has been a lag in watching these rates work through the pipeline but I believe most readers would agree that funding has been tight for much of 2023. Further, you have to look at the compensation side of the equation. Most lending units are not paid based on profitability but volumes. You know what makes a lot of loans? Lower rates.

Moving over to Melinda's work. You see for new and used the steady loss of market share in 2023 by depositories. Again, this is illustrated by a lack of cash and rising deposit costs. The first graph below is for the used market sector. Used car lending is much more concentrated in bank and credit unions. The new car market is more with the domestics and the captives. Think Ford, Honda, Toyota, etc. Two years ago, credit unions made headlines that they had taken over the dominant position of market share in 2022 at 31.68%. Mid 2021 / early 2022 was peak deposit inflow from free stimulus cash. They had a cheap level of deposits, and they used it to make a lot of thin margin loans. Then rates rose, deposits flowed out and they are forced to slow down lending. In 2024 I'll make the prediction that you'll continue to see banks and credit unions struggle with market share due to funding pressures.

It's VERY pronounced in the new car market. You see credit unions jump from 13.92% in 2021 up to 20.92% in 2022 and then plummet back to earth with 12.10% of market share. Generally speaking, new car loans make up less than 1/3rd of the depository portfolio. A cheap cost of funds in the form of free deposits spiked lending and now that window is gone which has reduced lending. Banks are historically more disciplined in match funding their lending volumes. You can see their market share drop from 29.88% to today's 20.42%. That ties more closely to when rates started to rise. With those higher rates, and increased competition for market share f'rom credit unions, they saw volumes stop. I'll remind you of last years Ally earnings report on Oct 19th, 2022.

Jeffrey J. Brown – Ally Bank CEO One other observation I would make. You've heard other CEOs make comments about pulling back from segments of the auto finance market. I think you need to look closely as to what is really happening. Prime lending continues to be a very solid space. Super prime lending has seen very aggressive pricing from the credit unions. It makes sense that some banks don't want to chase that.

Lastly, a few thoughts on SF Vegas this year . Each year I search for the “theme” of the conference. It appears this will be a record or near to record attendance. KBRA indicates there were 8,800 registered attendees. As we all know, maybe a ? of attendees actually register proper – it is more about the meetings around the conference. It certainly felt full and vibrant this year. The theme that I felt was how can the mortgage market unlock all of this trapped equity in mortgage / housing land. HELOCs, home improvement loans, unsecured lending – something to help compliment the terrible mortgage origination lending environment. Perhaps misery loves company but it was refreshing to hear from customers that our experience in a steep decline in mortgage trading was felt across various other desks and clients. As we have seen a large uptick in HELOC, closed seconds, and home improvement lending, most conversations surrounded how can we do more of this and at scale. The scale part was the struggle for Wall Street. They struggled to find scale on NON QM lending in the mid / late 2010’s. So too do they now find trouble in scaling up home improvement and second lien originations. I had the usual few conversations surrounding NPL, scratch and dent and distressed trades. Some conversations surrounding autos. It was great to connect with over 20 customers in various speed dating meetings, a panel solar leases and two lovely dinners.

Just to keep things interesting, there was Las Vegas marathon to navigate. The Vegas strip looked like Times Square on New Years Eve. That was fun.

Conference season continues and posts next week will be a little lighter. Several members from my team will be descending upon GAC in Washington, DC . If you're there, we'd love to see you!

Have a great week! (M24-431786)