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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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Debt Deflation in CRE? PFSI, COOP & RKT

May 6, 2024  | Premium Service | We completed the rebalancing of the WGA Bank Indices last week, including adding Zions Bancorp (ZION) and dropping two outliers, Hawaiian Electric (HE) and First American Financial (FAF), the giant title insurance underwriter and grandfathered thrift holding company. There are a lot of folks in the mortgage industry who don’t know that First American is a 125 year old savings bank.

The WGA Bank Top 10 Index is shown below, including the new weighting, methodology and test score changes. The top ten group in particular shows the power of the score-weighted methodology. Big h/t to our friends at Thematic in Menlo Park.

WGA Bank Top 10 Index (WBXSW)

The big takeaway from Q1 2024 earnings is that credit pain in commercial exposures is rising fast, but we see no special concern coming from the Fed, Treasury or other regulators. Bloomberg reports that "Distress in CRE CLO Loans Jumps Back Up to Record." Yeah. And the stated, accrual accounting CRE loss numbers are way, way behind the cash reality.

A reader named Burke sent us this little missive he penned for his banking team earlier in the week:

"Pound-for-pound the failure of Philly’s Republic First should have been bigger news (like Rocky Balboa on the top of the museum steps). In this day and age of $1T forgiveness on a range of debts and deficit spending—a mere $667mm fairway 'divot' taken by the FDIC (ultimately you and me) on a Saturday morning when Campus Protests and Spring Golf weather distract us, was a perfect 'nothing to see, move along' moment for the FDIC. Yet, minus $667mm on a $4B loan and securities pool— in supposedly a good economy on some random local bank, should wake up some boards and accountants. But no one seems to want to connect the dots. I was on CNBC in ’23 before and during the Silicon Valley/First Republic/Signature dam breaking 'surprise', trying to hint at this upside-down MtM risk and boards needing to wake up. Banks carry about 8% common. If the run-of-the-mill Republic First interest rate mark on the loans is 13.3% that is not just wiping out one bank’s 8%, it is as though an invisible bank got wiped out too—that invisible bank is the FDIC."

Ditto. The degree of blithe presumption in the financial markets as the bad debt accumulates is astounding. Below we do a “lighting round” a la CNBC's Jim Cramer through earnings in the mortgage finance ghetto. Note that the volatility in key asset values like mortgage servicing rights (MSRs) is a function of the uncertainty swirling around the direction of interest rates at the US central bank.

How is the cacophony of confusion now pouring from Chairman Powell and other FOMC members in public commentary helpful to confidence or the Fed’s standing as an institution? The media circus surrounding the FOMC is ridiculous and unseemly, and increases market volatility and hedge losses for financial institutions. One member of the FOMC ought to be deputized each month to carry the message that represents the majority view. The rest of the members of the Committee should be quiet.

Speaking of economists, we had a lovely conversation with Jan Hatzius of Goldman Sachs (GS), Gennaro Zezza of the Levy Institute & University of Cassino, Italy, and Harriet Torry of the Wall Street Journal at the Levy Institute event last week. Notably, GS Chief Economist Hatzius was calling for a Fed rate cut two months hence in July.

We think the proximity to the November election makes a rate cut before December pretty unlikely. And all of the participants in the Levy event should reconsider their assumption that the market for Treasury and agency debt is continuous and always functioning. Again, Menand & Younger (2023) note:

"American public finance has long been closely intertwined with the American monetary framework and that deep and liquid Treasury markets are, in large part, a legal phenomenon. Treasury market liquidity, in other words, did not arise organically as a product primarily of private ordering. Instead, it was actively constructed by government officials. The high degree of convertibility between Treasury securities and cash—the market’s “liquidity”—depends upon entities that can create new, money-like claims to buy Treasuries."

We clearly surprised the crowd when we said that there is a “debt deflation” underway in commercial real estate in the US and invoked Irving Fisher. But even with the wheels falling off the economic cart in cities such as New York and Los Angeles, commercial developers are still scrambling to buy these suspect assets.  And in yet another post-COVID change datapoint, Sam Ash, the century-old music retailer founded in Brooklyn, announced the closure of its 42 retail locations because of competition from online sellers. 

Whether we speak of legacy content, cars or many other products, the great aggregation of demand and fulfillment is continuing apace, with Alphabet (GOOG) unit Google and Amazon (AMZN) leading the way. The surveillance and monetization of all online activity is about processing capacity and money, just as in payments or program trading. Big is better. And even some very big players, like Microsoft (MSFT), are marginalized in the fight for eyeballs. Does MSFT really need to surreptitiously change the default browser setting in millions of Windows 11 installs with each software update? Really?

Some readers were a bit taken aback when our bro Michael Whalen predicted in our last issue (“Then Old Media Became Redunzl”) that all of the existing media conglomerates would eventually be pushed out of content entirely by the great eyeball aggregators led by GOOG. But Michael may be correct. He works in the trenches of modern music and has a bad habit of being right when it comes to money and the world of content. And Michael has a new album out with Mark Isham et al: "Watercolor Sky"

Hedge the MSR?

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