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The Institutional Risk Analyst

© 2003-2024 | Whalen Global Advisors LLC  All Rights Reserved in All Media |  ISSN 2692-1812 

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Joe Biden Goes Subprime; Should Citi Buy NYCB/Flagstar?

May 20, 2024  | Over the weekend, as we worked on written comments for the proposal by Freddie Mac to buy closed-end second lien mortgages, it occurred to us that we’ve all missed the point on this latest example of progressive innovation. The operative term here is “subprime,” but the incentives are mostly political. And sad to say, any proposal that puts low-income families into the housing market at the top reminds us a lot of 2005. 

When the Wall Street Journal criticized the Biden Administration for floating the Freddie Mac subprime second proposal ("Return of the Housing Godzillas"), the word "subprime" appeared only once in a quotation from the 2008 crisis. But make no mistake that President Joe Biden wants to get the GSEs back into subprime lending, hopefully before September. Mortgage bankers should be outraged by Biden's surreptitious proposal to put consumers in harm's way.

Freddie Mac wants to take away some of the most profitable business in the conventional loan market from independent mortgage banks. Those lenders who think chasing closed end seconds is a good way to spend time are, in our view, headed for the mortgage dead pool. A pipeline of non-QM first lien jumbos with a sprinkling of seconds is a good mix. But the real victim of the Biden proposal to get the GSEs back into buying subprime mortgages is the consumer.  As we wrote:

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“Freddie Mac indicates that the primary goal of this proposed new product is ‘to provide borrowers a lower cost alternative to a cash-out refinance in higher interest rate environments.’ But is that really true? A cash-out refinance into a 15-year floating rate first lien may be a better trade for many low-income consumers today vs a second lien with a double-digit coupon. Subprime seconds have coupons in low to mid-teens depending on the credit and LTV. We believe that the illustrations used by Freddie Mac in this proposal are misleading. A loan officer acting in the best interest of a low-income consumer might recommend the 15-year refinance loan vs a second lien so as to eliminate the mortgage debt faster.” 

This week the Mortgage Bankers Association is meeting in New York for the annual secondary market conference. As the industry meets at the Marriott Marquis in Times Square, profitability is at decade lows and headcounts are falling, but very slowly.

Many in the industry think that they will be saved from headcount reductions and/or insolvency by an eventual reduction in short-term interest rates. A lower target for fed funds would certainly help production costs, but whether the long end of the curve follows is another matter.

As of month-end March 2024, the weighted average coupon (WAC) on outstanding Ginnie Mae MBS increased slightly from 3.56% in February 2024 to 3.59% as seen in Figure 29. In the chart below from Ginnie’s monthly capital markets book, loans originated since 2019 account for approximately 82% of Ginnie Mae MBS collateral outstanding.

A number of analysts are predicting a Fed rate cut in 2024, followed by a rally across the board in bonds. Yet issuers seem to be moving to the market now rather than gamble on what may or may not happen this year with the Fed. PennyMac Financial Services (PFSI) just announced a private offering of $650 million of senior notes due 2030. This follows several other senior unsecured debt deals by Mr. Cooper (COOP) and Freedom Mortgage.  

The good news for mortgage issuers is that delinquency remains relatively low and the industry has found a strong reception to new term debt issuance by larger lenders. The bad news is that the pool of banks willing to finance residential mortgage production and servicing is shrinking fast.

Last week, New York Community Bank (NYCB) announced the sale of its residential warehouse business to market leader JPMorgan (JPM). We expect that the Flagstar servicing business will eventually be sold as well, but losing the cash flow from the mortgage servicing business and the related escrow deposits would probably force the sale of the whole of NYCB. 

Unless Steven Mnuchin can waive his magic wand and get NYCB back to investment grade with Moody's, then we expect the Flagstar servicing business will be sold. Who could buy NYCB, deal with the bank’s credit problem and provide a stable home for the number five national residential mortgage subservicing platform? According to Inside Mortgage Finance, NYCB had almost $300 billion in UPB of servicing at the end of 2023.

What large bank would be willing to re-enter the market for servicing government loans and Ginnie Mae MBS? Simple answer is Citigroup (C).  While the bank has entered and exited from the residential mortgage business several times since the 1980s, the fact is that residential mortgage lending and servicing is one of the few sectors available for Citi that is actually big enough to move the needle. Citi is a subprime lender. They should be directly involved in government lending.

If Citigroup CEO Jane Fraser wants to add some upside potential to her improving stock, then we suggest first acquiring NYCB in its entirety and then go shopping in the world of nonbank issuers. The mortgage industry is ripe for a rollup strategy focused on acquiring mortgage servicing rights (MSRs) at the low end of cash flow bids. Why? Because there is a growing shortage of assets in the world of residential lending. 

A large bank like Citi will have a significant advantage over nonbanks attempting to roll up the sector. Citi could quickly assemble a servicing book that would enhance earnings and compete with COOP, PFSI and the other nonbank leaders. If Jane Fraser likes the idea, we have some specific suggestions. And needless to say, catching the falling knife of NYCB will make Jane Fraser very popular at HUD and Ginnie Mae. NYCB is currently the only remaining large bank servicer in government lending.

Why do we suggest that Citi go back to playing in residential mortgages? Because if you look around the markets, the days of nonbanks using leverage and gain-on-sale accounting to pretend profitability are over. Assets are being acquired for net cash flows, but no more.

Excess servicing transactions are proliferating and a number of conventional REITs may be headed for liquidation. We think that a significant amount of lending capacity will be leaving the sector. The only question is who will buy the assets of failing nonbank issuers on the cheap. We have a list. This is a great time for Citi and other banks to be buying mortgage assets at a discount.

In the next issue of The Institutional Risk Analyst, we’ll be updating readers on Merchants Bancorp (MBIN), one of the members of the WGA Bank Top 50 Index. Please note that we have created a new page for the exclusive use of subscribers to The IRA Premium Service showing the constituents of the WGA Bank Top 50 index.

The Institutional Risk Analyst (ISSN 2692-1812) is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.


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