Let's Talk Loans - Vol. 88

Welcome back to Let's Talk Loans! A college basketball frenzied edition. I'm sure your bracket has already been destroyed on the first night of games. Mine certainly has. My condolences to all the Kentucky fans out there - woof. This newsletter tackles talking points surround lending products: commercial real estate, residential real estate, and consumer lending (auto, unsecured, cards, solar, home improvement). Also, some of the challenges that banks, credit unions and lenders are facing when looking at the balance sheet. If you enjoy the content, please like, share it or subscribe to it!

This will be a mortgage heavy chat edition. A look at rates. From the WSJ:

"That is because mortgages, and mortgage-backed bonds, just aren't as in demand in financial markets as they were in the years before the Fed began to start to tighten in 2022. And they might not be for a while."

Let's dig into the "why" this article is being written because it is impacting a ton of lenders and you, the reader. I've written for a while that our desk, over our last 30 years, has been heavy residential mortgage. 2021 was an absolute monster of a year for trading volumes in mortgages as rates were held artificially low. The refi craze took lenders by storm, depositories desperately needed yield, they extended and went longer out on the curve and we saw two consecutive $4trn+ origination years in 2020 and 2021. In 2022, origination volumes took a hit as Chair Powell started to aggressively raise rates. It was a tale of two halves, the first was good and the second hurt. As such, mortgage trading volumes for 2023 were some of the worst this desk has seen in over a decade. Prepayment speeds plummeted due to 7% mortgages, balance sheets at depositories extended, were clogged up with legacy coupons and the Fed stopped buying. A terrible combination for mortgages.

Expanding further into the "why" rates have risen so much. The 10 year has been on the climb but so to have spreads widened. Giving full credit to Steven Childress from the RJ MBS desk.

"Three buyers of MBS from the GFC thru Covid: Banks, the Fed and others (MM, REITs, foreign, etc.). One buyer is not coming back: the Fed.? Banks will return, eventually, but nothing close to the buying activity we saw during Covid which led to tightest MBS spreads in history."

"On top of that, as the Fed lowers rates (maybe not this year) the curve will steepen and most likely form a bull front end, which leaves 10yr in upper 3% or above 4% for a while. Mortgage rates will be above 6% for a while (2024 for sure and probably for years forward).? Mortgage rates vs 10yrs is ~260bps today, down from above 300bps last year. I do not see it going to 150-180 range for many reasons and this will also help keep mortgage rates at the new normal."

Closing the rate discussion with a few final summarizing comments.

• You've lost your largest buyer (the Fed and Banks),
• Inflation has stayed stubbornly high which hasn't allowed the Fed to cut,
• Those higher rates, coupled with "loan locked" existing, legacy mortgages, have crimped existing housing sales and devastated originations.

However there is some surprising good news to this higher rate environment. Property values. Even I am amazed at just how strongly home values have held in a 7% mortgage market. We hosted a webinar this week with Hamilton Fout from FNMA and it lead to a great discussion with some insights as to how and why.

Hamilton's first chart shows just how much home prices rose as American's put considerable value into shelter during COVID with the help of an ultra low interest rate environment. We spoke to the LOW WATER MARK of North Dakota (25%), West Virginia (28%), Minnesota (29%) or Maryland (30%) being the bottom end of growth. Imagine your stock portfolio where the bad news is you're up only 30%! States like Montana (61%), Florida (61%) Idaho (58%), Tennessee (55%) and Arizona (55%) all saw massive property value appreciation from 2019-2022. We didn't have enough units (scarcity of supply), we had a ton of free cash dumped on us (increase in demand), with very attractive mortgage rates (attractive financing). All of the stars aligned and home values on a national level rose 40.8% during this time.

Then as rates rose and stimulus cash was spent many suspected that values would fall. What you'll note here from our discussion is that those states that saw enormous increases in values (ID, UT, MT) have seen a slowing of growth. Particularly in those areas where affordability and lack of supply are taking a bite. Those laggard states from 2019-2022 have now enjoyed a higher level of appreciation than the national average. West Virginia is one of the leaders now with 12%. Still, national home growth in 2023 was a positive 7.1%.

The focus of discussion then often shifts to renting vs owning. We spoke a little as to the number of units coming online with multifamily over the last year being more elevated than single family. That phenomenon has hurt cities like Austin, TX or Nashville, TN as an outsized number of multifamily units has helped with supply and softened home values. Still, one amazing talking point from the webinar is just how much pressure has built on the consumer in the form of payments. Pre-COVID (Q4 2019) the average monthly mortgage payment was $1,050 and the average renter was paying $1,298. Mortgage rates have gone from an average of 3.7% to 7.3% in Q4 2023. Mortgage payments have risen 113% to $2,242 a month compared to a $1,500 monthly rental (up only 16%). These numbers illustrate why affordability has added some risk to the mortgage market on 2023 originations.

So while this market of higher mortgage rates may be with us for a while, the Fed has renewed its call of 3 cuts this year.

"Powell conceded that inflation was stickier than anticipated over the past two months and cautioned that policymakers shouldn't be "dismissing data that we don't like."

"The stakes are high for Fed officials, who are trying to navigate two risks. One is that they ease too soon, allowing inflation to become entrenched at a level above their 2% target. The other is that they move too slowly and the economy crumples under the weight of higher rates."

I'm starting to struggle with the concept of 3 cuts and not just 2 (or less). There are 8 FOMC meetings over the course of 2024. Our first two have been pauses. Most agree that April will not be a cut with the market currently factoring in only a 16% probability for that meeting. The odds rise to 69% for the June meeting. That would put the first cut in July. You have only September, November and December's meetings left in the year. Does the economy feel weak enough for 2 out of those 3 meetings to get a cut? Not to mention in the middle of an election?

That's it for the week. I hope you enjoy some basketball and that your bracket holds! M24-451735