Let's Talk Loans - Vol. 87

Welcome back to a brief, spring break induced, let's talk loans. As I've done an exceptionally poor job of that work / life balance split - I'm going to skip the pleasantries this week and go right into the discussion.

Forgive me for missing last weeks edition. I was fortunate to attend the GAC (Governmental Affairs Conference) in Washington, DC. Quickly thereafter, a coast to coast trip to Los Angeles for a Raymond James hosted conference. Unfortunately, there just wasn't enough time in the day to put my thoughts down in the newsletter last week.

Let's tackle GAC first. Many of you took your concerns to your representatives as you stormed the hill. I was told by multiple clients that this year was special because all 50 states were in attendance and meetings were scheduled with political leaders. That's what happens in an election year! Overall attendance was strong, but this is a very different conference. Everything was so spread out, with meetings at the convention center, various restaurants, after parties, bars and late night dinners. There is no question you get all your steps in. Your concerns were noted and there was a clear theme. It's difficult times in the credit union industry with rising deposit costs, increasing delinquencies and narrowing margins. Preservation of capital and future income are in the forefront of your thoughts. Falling loan volumes are also on your mind. As reported by the CU Times and recent NCUA Q4 data - lending has slowed dramatically. Mortgages, consumer and commercial lending all down over 20%. The only lending category showing growth? HELOCs, which we've been writing about a lot in these columns.

This quote stuck with me:

"One in four credit unions reported a net loss for the fourth quarter"

Further :

"The net interest margin was 3.00% in the fourth quarter, down from 3.01% a year earlier and 3.02% in the third quarter."

Many of the discussions held in DC focused on improving earnings, battening down the hatches, focusing on credit and finding cost savings where possible. The need to be disciplined in managing the balance sheet was a key topic but there is hope that the economy will hold, rate reductions should occur later in the year, and we can work our way through this rough patch.

The flight from DC to LA was humbling. Travel time could have had me land in London had we flown east. Some five and a half hours of westerly travel later, I arrived at LAX. Here the discussion shifted more to our bank customers, who are in a similar situation to credit unions. Certainly there was a sigh of relief that we dodged another bank failure in NYCB. Just last year during this same LA conference did we watch the news wires as SVB collapsed. Here the discussion was optimistic that a struggling institution could raise $1bn in funds quickly and instead of having the FDIC step in, or Jamie Dimon, and continue to fight another day. There's something to be said some 12 months later that this is not just another failed bank, that it found a way to survive, that there is faith in the system. Could this be a sign of the industry turning a corner? Looking at the numbers, there is a stabilizing of margins. Have we found the bottom? Per S&P:

the median, taxable equivalent net interest margin of the banking industry dipped to 3.35%, down 2 basis points sequentially, after falling 3 bps in the third quarter and 5 bps in the second quarter, according to S&P

Rising cost of deposits also remained a strong talking point for the conference.

"The banking industry's aggregate cost of deposits rose to 2.31% in the fourth quarter, up 21 bps from a quarter earlier."

Regarding that hope that we could be witnessing the end of tightening margins - our calls with banks and discussions in LA feel as if you are seeing more liquidity and more options presently to take advantage of attractive loan rates. You're worried about heightened regulatory focus, concentration risks in certain troubled assets, but there are still good deals to be made. Banks seem to be proactively working to earn their way out of higher deposit costs by capitalizing on higher for longer rates in lending. We continue to see the fight between the lending arm of the institution vs the funding side of the conversation. Loan rates continue to slowly rise (particularly in CRE) as the realization of higher rates sinks in. This discipline is gradually being seen in the reported numbers.

"Still, further increases in deposit costs likely will not be as great and could allow net interest margins to soon find a bottom as loan yields continued to rise in the fourth quarter of 2023, climbing 16 bps from the prior period."

I have to tip my hat to the staff at Culina at the 四季酒店 in Beverly Hills. Each year we host a dinner to close out the conference on site. What was meant to be an outside dinner, in the city that never sees rain, we experienced a flash flood 30 minutes before the event. The tables were set only to see they sky open up with rain. Plates and utensils, glasses and napkins, all completely soaked. To see their team shift the whole dinner from an outside experience to an inside event in a matter of minutes was mind blowing. I'm pretty sure I even saw some of the chefs come out to place settings. It was a great meal and a good fellowship.

As a heads up, I'm excited to be joined again by Hamilton Fout from Fannie Mae next week as we talk all things housing and mortgages. Wednesday, March 20th, at 1pm central will be the event. Look to your fixed income sales rep for the invitation. We hope you can join.

Lastly, and quickly, an article that caught my eye in the WSJ yesterday . Is private credit taking over lending? Can depositories just not compete? Regulation, rising costs of funds, ever narrowing margins, technology, compliance, are they all starting to hamper traditional lenders? That's dramatic but we have seen private credit make a push into loans. One, they love a good discount. Make no mistake, they are on the hunt for a deal and are more opportunistic type buyers. Think more yield. However, our trading experience with them coming out of the great financial crisis was more for true distressed loans. Non performing assets. Back in 2008 there was plenty of distress in the system and a multitude of deep discount transactions to be found. However, we now see them pushing into fully performing assets. In Vol 76 of LTL I asked the question:

We had a conversation yesterday with a client on the gap in the spread between a willing seller (of loans) and an opportunistic buyer (of loans). After SVB, that spread was likely at its widest. The argument now, which side of the trade would need to narrow in their expectations? The seller would need to lower their price expectations or the buyer would need to raise their price? Could it be that the buyer will need to tighten in more than the seller to get a deal done?"

With each good bit of economic data out there, all of these private credit buyers can't find the distressed deal and do not want to return unused raised capital. Are they coming up in pricing (tightening yield) to put money to work? Are they filling a void in the market that depositories cannot afford to play in right now because of their liquidity constraints? I think the answer is yes and I believe you'll see more of this throughout 2024. It's interesting to me that they are working to push into more up in credit type trades. But make no mistake, if the world breaks, they will be thrilled to pick up the pieces.

Lastly, spring break in Florida with a teenage daughter. Prayers are welcome. Wish me luck.

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