Banks Contemplate Higher Short term Rates;Kroll Rolls out non-QM Pool Risk Measures

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I know there's a show on TV entitled It's Always Sunny in Philadelphia. While I realize that's never the case, if it was, I assume there wouldn't be a need to "seasonally adjust" anything, let alone the housing market. Wells Fargo Economics Group write, "Without a doubt, this year's harsh winter weather is behind much of the slowdown, with cold and snowy conditions keeping buyers away and limiting the work for building crews. Now that spring has arrived we should begin to see conditions return to normal. Unfortunately, today's housing market is anything but normal. Underlying demand remains exceptionally weak, as traditional buyers are still deferring home purchases." Does anyone remember if Punxsutawney Phil saw his shadow or not? Glass half-full.

Bank and mortgage company mergers and acquisitions continue - there are geographic benefits, and the cost of compliance is just too expensive for many institutions. On Friday we had our first bank closure in quite some time: Allendale County Bank, Fairfax, South Carolina, was closed, and the FDIC entered into a purchase and assumption agreement with Palmetto State Bank, Hampton, South Carolina, to assume all of the deposits of Allendale County Bank.

Another trend that is winding down in the banking industry is the long period of Fed Funds at or near 0%. Whether this happens in 2015 or 2016, keep in mind that it is in the Federal Reserve's best interest to not stifle any economic growth. But we've had 0% short-term rates since 2009 and some bankers and lenders can hardly remember doing business in any other environment. Many bankers are just starting to see commercial loan growth edge higher as the economy recovers. On the deposit side of the equation (remember that loans are assets and deposits are liabilities for banks!), most sit in core such as DDAs, interest checking, savings, MMDAs, or short term CDs. That is more because interest rates on all deposit products are so low, customers don't really seem to care much, and favor safety over anything else.

So what if the Fed starts to move the Fed Funds target rate higher next year, or maybe 2016 depending on employment and economic growth, by 1-3%? The idea that depositors will happily remain in core deposits is less certain and banks are looking for ways to prepare. Should banks should seek to lock in their deposit base and protect their margins by marketing long term CDs to existing customers? Probably not - Pacific Coast Bankers Bank believes that "there are a host of problems with this solution and even the premise upon which it is based. Core deposits are typically relationship-based, so they already have a long duration. Unlike core deposit customers, CD customers are typically the most rate-sensitive. As such, these deposits almost always will be of a shorter duration. Further, if a bank thinks a CD penalty will keep a CD customer in place in the face of a 300bp rise in deposit rates, the math doesn't work."

In an environment where every basis point counts, depository banks enjoy a marked advantage over independent mortgage banks that have a 3 or 4% warehouse line: the bank's cost of funds is much closer to 0%. Banks will have to work diligently on their proper management of deposits in an increasing rate environment. And independent mortgage banks will have to continue negotiating advantageous terms on their warehouse lines. Either way, most are not predicting any kind of short term rate increase for another year or two.

Do lenders "target" certain minorities, or is it "seeing opportunities"? Given fair lending laws, CRA bonuses, and geographic restrictions, that is a touchy question, especially for banks. But when a lender receives a "special exemption" from the CFPB regarding lending to minority groups, or they publicly come out and say they're going to do it, well, that's another issue. In several states (California, Arizona, New Mexico, Texas, and Florida to name five) the Latino population, whether new immigrants or 2^nd generation, definitely is having an impact on the housing numbers.

Banks across the nation are using the advantages of having deposits, and thus being able to offer portfolio products, to help their originators offer various products. These products often include non-QM loans. But are these loans riskier than QM loans? And what is risk? Kroll Bond Rating Agency, which cranked things up after the other rating agencies miss-rated billions of dollars of MBS, released its methodology for assessing non-Qualified Mortgage (non-QM) risk in U.S. residential mortgage-backed securities (RMBS). The report, Assessing Non-QM Risk in U.S. RMBS, provides insight into KBRA's proposed analytic approach for rating RMBS backed by non-QM loans. The methodology relies on KBRA's fundamental analysis of mortgage risk, augmented by stressed assumptions regarding a borrower's propensity to engage in litigation against an originator, and potential losses resulting from a successful borrower claim. Arguably securities made up of non-QM loans (not at all to be confused with subprime loans) will have a different risk profile - especially from a liability perspective - than QM securities. Heck, why not securities blended with the two? Regardless, there is little historical data demonstrating how this risk factor might affect mortgage performance. Certain assumptions made by KBRA have been derived from limited data on litigation-related mortgage loss. The report, Assessing Non-QM Risk in U.S. RMBS, can be found at www.kbra.com.  

"Markup": The process by which congressional committees and subcommittees debate, amend, and rewrite proposed legislation." I mention this because on the policy front, the D.C. financial policy complex has been almost exclusively focused on the Johnson-Crapo GSE reform proposal which will be marked-up on April 29 (probably incorporating aspects of the Maxine Waters & PATH Act proposals). Given that Congress has less than 50 working days left until the election, counting recesses and campaigning, but their staffs have more working days, the work resolving the unstable conservatorship situation with Fannie & Freddie will likely fall in the "behind the scenes" category. Is any plan that will take, according to experts, five or more years really worth it? David Fiderer points out a major deficiency in the proposal: "The key to successful lending and investing is risk diversification, and the key to stable markets is the broad distribution of risk among institutional investors. The Johnson-Crapo system, which relies so heavily on deeply subordinated debt, obviates those goals." 

Obviously the agencies are not too adverse to taking their functions, changing their names, and moving on with life. After all, the Freddie & Fannie systems have worked pretty well for several decades, in both the primary and secondary markets. Will a new system in which private companies could package mortgages into federally insured packages be better? As it stands now, Johnson-Crapo would require successors to F&F to maintain a 10% capital cushion, which, as the WSJ points out, is more than double what the companies would have needed to withstand the credit crisis from which we are emerging. And what about managing a five year transition - are we going to ask the staffs of F&F to stick around? Will the taxpayer foot the bill for the retention bonuses that might be required? Tomorrow the Senate Banking Committee starts considering amendments to the legislation - who knows what might be tacked on just to garner votes? And even if differences are ironed out, a full Senate vote & approval is not guaranteed, and even after that, there is less certainty that the House of Representatives will vote to approve it. And let's not forget the November election... the make-up of the House and Senate may change... and then what? 

We're here at the last few business days of April, and I am hearing mixed things about how the month is turning out for lenders. For many, March was a great improvement over Jan & Feb, and April is coming in close to March for production. My bet is that we continue to see M&A and channel changes (leaving wholesale, or adding correspondent, for example) well into the summer. 

We have quite a bit of economic news this week. Today & tomorrow are some second tier numbers: Pending Home Sales, the S&P/CS 20 city index numbers with their two-month lags, and Consumer Confidence. Wednesday is the ADP Employment Change number, Employment Cost Index, GDP, and the Chicago Purchasing Manager's Survey. Wednesday the 30^th also has the FOMC's interest rate decision - expect no change. May Day - Thursday - is Initial Jobless Claims, Personal Income and Consumption, a series of PCE (Personal Consumption Expenditure - a measure of price changes in consumer goods and services) numbers, a few ISM (Institute of Supply Management) numbers, and Construction Spending. And if all that isn't enough, Friday is the Big Kahuna: changes in Nonfarm Payrolls, the unemployment rate, hourly earnings, and so on. For numbers, we're still stuck in a range: on Friday our buddy the 10-yr T-note closed with a yield of 2.67% and this morning we're at 2.68% with agency MBS prices worse a tad.

 

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