One Big Thing
The Fed is now in a tricky spot when it comes to their massive mortgage bond buying program (emphasis mine):
All of this serves to squeeze mortgage-bond investors in higher-rate securities. Most of them bought the debt at a premium, and the constant reduction in lending rates leaves them vulnerable to prepayment risk as homeowners refinance and pay off their existing obligations at par. But it would be arguably even more painful if investors are herded into ultra-low coupon MBS, only to see rates rise. Known as “extension risk,” fund managers left holding 1.5% or 2% MBS could be saddled with huge losses if longer-term interest rates start to increase next year as the U.S. economy rebounds and inflation starts to pick up on the back of a Covid-19 vaccine.
It seems that the logical next step is for the Fed to step in and buy longer dated maturities more aggressively. I guess that we shall see. MSN Money
It should also come as no surprise that non-bank lenders like LoanDepot are taking themselves public in this environment. LoanDepot is, by all accounts, a well run company but ultimately, it makes money by originating a highly regulated commodity. Unlike banks, non-bank lenders typically do not have a diversified platform on which to rely when the mortgage market inevitably slows. It bears mention that the same non-bank lenders that are making a killing today were laying people off in 2018 when interest rates spiked and refinance activity slowed to a crawl.
An important thing to remember here is that everyone who refinances at a mortgage rate below 3% today represents a borrower who will not refinance in the future unless rates fall further and is less likely to sell their home and move if it would come with a substantially higher rate. At today’s interest rate levels, there is still meat on the bone but eventually everyone who is a refinance candidate will have done so. Then what?
Mortgages are commodities. The only reason that they are refinanced is if a borrower can lower their cost or extract equity and if rates rise, borrowers are far more likely to take out a second or a HELOC than refinance an inexpensive first mortgage. Don’t take my word for it though, its right on page 42 of the LoanDepot S-1 filing (emphasis mine):
Our earnings may decrease because of changes in prevailing interest rates.
We generate a sizeable portion of our revenues from loans we make to clients that are used to refinance existing home loans. Generally, the refinance market experiences significant fluctuations. As interest rates rise, refinancing volumes generally decrease as fewer consumers are incentivized to refinance their mortgages. This could adversely affect our revenues or require us to increase marketing expenditures in an attempt to maintain refinancing related origination volumes. Higher interest rates may also reduce demand for purchase home loans as home ownership becomes more expensive and could also reduce demand for our home equity and personal loans. Decreases in interest rates can also potentially adversely affect our business as the stream of servicing fees and correspondingly, the value of servicing rights, decreases as interest rates decrease.
……
The industries in which we operate are highly competitive, and are likely to become more competitive, and our inability to compete successfully or decreased margins resulting from increased competition could adversely affect our business, financial condition and results of operations.
We operate in highly competitive industries that could become even more competitive as a result of economic, legislative, regulatory and technological changes. With respect to our home loan, home equity loan and personal loan businesses, we face competition in such areas as loan product offerings, rates, fees and customer service. With respect to servicing, we face competition in areas such as fees, compliance capabilities and performance in reducing delinquencies.
Competition in originating loans comes from large commercial banks and savings institutions and other independent loan originators and servicers. Many of these institutions have significantly greater resources and access to capital than we do, which gives them the benefit of a lower cost of funds. Commercial banks and savings institutions may also have significantly greater access to potential customers given their deposit-taking and other banking functions. Also, some of these competitors are less reliant than we are on the sale of home loans into the secondary markets to maintain their liquidity and may be able to participate in government programs that we are unable to participate in because we are not a state or federally chartered depository institution, all of which may place us at a competitive disadvantage. The advantages of our largest competitors include, but are not limited to, their ability to hold new loan originations in an investment portfolio and their access to lower rate bank deposits as a source of liquidity.
Additionally, more restrictive loan underwriting standards have resulted in a more homogenous product offering, which has increased competition across the home loan industry for loan originations. Furthermore, our existing and potential competitors may decide to modify their business models to compete more directly with our loan origination and servicing models. Since the withdrawal of a number of large participants from these markets following the Financial Crisis, there have been relatively few large nonbank participants.
I totally get why a non-bank lender would go public in this environment where they are making record profits that will likely translate to more investor interest. That being said, it feels an awful lot like ringing the bell at the top and I’m not sure why anyone in their right mind would buy into such an offering.
What I’m Reading
Confidence Game: The National Association of Home Builders (NAHB) reported the housing market index (HMI) was at 90, up from 85 in October. Any reading over 50 is considered positive and this marks a new record high. Calculated Risk
Bold Prediction: Microsoft co-founder Bill Gates said Tuesday that he predicts over 50% of business travel and over 30% of days in the office will go away in the pandemic’s aftermath. If Gates is correct, this would have a devastating long-term impact on office and hospitality real estate, as well as the ecosystem of retail businesses that provide services to these types of properties. CNBC
Raging: By any measure, the latest COVID pandemic outbreak is bad and getting worse. The Bonddad Blog
Throwing in the Towel: About 300 companies that received as much as half a billion dollars in pandemic-related government loans have filed for bankruptcy, according to a Wall Street Journal analysis of government data and court filings. Wall Street Journal
In the Crosshairs: Amazon is making a big push into the pharmacy business with free 2-day prescription delivery for Prime members. This could spell trouble for the previously-resilient NNN lease pharmacy sector where credit tenants like Walgreens and CVS now find themselves squarely in Amazon’s disruptive gaze. Globe Street
Chart of the Day
Find yo self someone who looks at you the way that the Fed looks at mortgage-backed securities in 2020.
Source: Bloomberg
WTF
Nowhere to Hide: A 71-year old man was arrested for stealing a downed power pole, strapping it to the roof of his car and trying to take it to a recycling center to cash in because Florida. NBC Miami
Morning Wood: A “half dressed” Connecticut man who was spotted “humping trees” in a stranger’s backyard is behind bars on multiple charges. The Smoking Gun
Basis Points – A candid look at the economy, real estate, and other things sometimes related.
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