Mark-to-Market on Bank America; Update on Credit Suisse & Guild Holdings

March 17, 2023 | Premium Service | In the first quarter of 2019, Credit Suisse (CS) was trading north of $17, but earlier this week was below $2 in choppy markets. The credit default swaps (CDS) were trading north of 3,300 basis points over swaps on Wednesday, implying a “D” bond equivalent rating for the bank. JPMorgan (JPM) wrote a note this week saying that CS is likely to be acquired by UBS AG (UBS).

Maximum Number of Basis Points

AAA: 1 bp

AA: 4 bp

A: 12 bp

BBB: 50 bp

BB: 300 bp

B: 1,100 bp

CCC: 2,800 bp

Default: 10,000 bp

Earlier this week, the Swiss National Bank provided emergency funding to CS, allowing the bank to initiate a pre-emptive tender offer for its debt. We have been a buyer of the stock below $2 and as discussed below, are inclined to add to the speculative position opportunistically.

Several readers have asked about various banks. We direct your attention to the most underutilized public resource on US banks, namely the National Information Center maintained by the Federal Reserve Board and the other members of the Federal Financial Institution Examination Council (FFIEC). NIC, as we affectionally refer to her, provides detailed performance reports on large bank holding companies down to $10 billion in assets.

One bank that comes up a lot in reader emails in Bank of America (BAC). The major question is how BAC compares to other banks such as JPMorgan (JPM). We published the most recent for JPM earlier (“Who Killed Silicon Valley Bank?; The IRA Bank Book Q1 2023.” We also thank our readers for comments and corrections on this analysis. Suffice to say that the presentation for GAAP filers and the regulatory data provided on NIC are very different. Below we show the mark-to market (M2M) for BAC.

Source: FFIEC/WGA LLC

Notice that BAC held $539 billion in MBS and another $270 billion in Treasury debt at the end of 2022. If we do the same analysis as JPM, BAC ends up worse in terms of negative M2M on capital because of the large MBS position. At 17% of total assets, BAC MBS position is in the 73rd percentile of Peer Group 1, vs the average for the 131 banks in the peer group of 12.5% of total assets. The good news is that as interest rates fall, the M2M deficit for banks also falls.

Update on Credit Suisse & Guild Mortgage

We first took a position in CS earlier in the year on the presumption that neither the US government not the Swiss National Bank would not allow the bank to fail. Our thesis turned out to be right, but the stock remains under intense selling pressure, in part because management has been unable to complete the restructuring of the US business.

The sale of the structured finance group to Apollo (APO) portfolio company Atlas Securitized Producsts has been a bit of a fiasco, in large part because the buyout firm was not willing to acquire the $20 billion in Ginnie Mae assets and servicing operation, Select Portfolio Servicing (SPS). Readers of The IRA will recall that last September, SPS entered into a definitive asset purchase agreement with Rushmore Loan Management Services LLC to acquire certain Rushmore assets. The deal was never completed, however, leading us to conclude that US regulators had informally said no to the transaction.

Since then, CS has conducted an auction process to sell SPS, including the non-agency servicing book and the Ginnie Mae assets, including warehouse loans and MSR financing commitments. We hear that roughly half a dozen Ginnie Mae seller/servicers made it to the final round of the auction, but no result has been announced. The slow process inside CS, combined with the deterioration in the credit performance of government-insured loans, has made the CS Ginnie Mae book near impossible to sell.

Residential Mortgage Loans

Source: MBA, FDIC

The government loan market is under intense pressure, both in terms of the perception and some tough realities. The collapse of Reverse Mortgage Funding (RMF) last year has already cost Ginnie Mae over $1 billion so far and more losses are in prospect. Buyout obligations are expected to increase over time to an average of $189 million a month over the next 24 months, reports Reverse Mortgage Daily.

The lenders to RMF included Leadenhall Capital Partners, CS, Nomura Securities (NMR), Barclays Bank (BCS) and Texas Capital Bank (TCBI). Leadenhall reportedly was wiped-out entirely when Ginnie Mae seized the MSR. A key lender in the space, TCBI, reportedly took a significant loss on warehouse financing of participations in the HECM loans. Because the mortgage note is contained in the first securitization of the reverse mortgage loan into a Ginnie Mae pool, TCBI did not possess the note and therefore lost the entire warehouse asset.

As a result of the loss, some observers thought that TCBI would step back from the MSR market, but in fact the opposite is reportedly the case. TCBI is said to be contacting Ginnie Mae issuers to support forward or HECM assets. TCBI is also expanding its capital markets capability to offer issuers TBA execution and warehouse financing.

More, there have reportedly been several completed MSR financings involving other large Ginnie Mae issuers in Q1 2023, including PennyMac Financial (PFSI), Freedom Mortgage and Mr. Cooper (COOP). These deals are reportedly being arranged by the former CS banking team now at Atlas. The transactions include a variety of banks in syndications of “promissory notes” rather than the bonds used in previous deals. As we’ve noted earlier, the securities market execution for MSR financing going back to 2017 now must be replicated with a bank loan.

The good news is that despite the turmoil caused by the failure of RMF, MSRs were being financed in Q1 2023 – at least until the failure of SIVB and Signature Bank (SBNY), which has participated in many MSR deals. The bad news is that many issuers are now worried that the market turmoil may cause some banks to back away from the MSR market. One of the leading warehouse lenders, however, tells The IRA that he is not concerned about the market turmoil and their pipeline of Ginnie Mae MSR financings is full.

Meanwhile, in a related development last week, PennyMac Financial (PFSI) dropped an 8-K confirming that APO portfolio company Atlas and several new vehicles are stepping into the shoes of the crippled Swiss lender with respect to PFSI's Ginnie Mae MSRs. The 8-K states in part:

"On March 16, 2023, PennyMac Financial Services, Inc. (the "Company"), through its direct, wholly-owned subsidiary, Private National Mortgage Acceptance Company, LLC (“PNMAC”) and two of its indirect, wholly-owned subsidiaries, PNMAC GMSR ISSUER TRUST (“Issuer Trust”) and PennyMac Loan Services, LLC (“PLS”), consented to assignments of all of the credit facilities provided to the Company by Credit Suisse First Boston Mortgage Capital LLC, as administrative agent (“CSFB”) and Credit Suisse AG, Cayman Islands Branch, as a buyer or purchaser (“CSCIB”), and Alpine Securitization LTD, as a buyer or purchaser (“Alpine”). All of the credit facilities are assigned to Atlas Securitized Products, L.P. (“Atlas SP”), Atlas Securitized Products Investments 3, L.P., Atlas Securitized Products Funding 2, L.P., and Nexera Holding LLC (each an “Assignee Buyer”).

Only time will tell what happens with the process of refinancing MSR bonds as they come due. Falling loan volumes are going to make commercial banks hungry for quality C&I assets once the dust settles from SIVB. If interest rates now fall as a result of efforts by the Fed to stem the deposit run on smaller banks, this will assist lending in terms of higher productions volumes. But the heavily skewed distribution of loan coupons in the market due to QE means that lenders will not see significant refinance volumes until mortgage rates are in the 5s or lower.

Guild Mortgage

In the past couple of years, we have sung the praises of Guild Mortgage (GHLD), a purchase mortgage lender with one of the few legitimate retail channels in the industry along with Caliber, now part of Rithm Capital (RITM) and Freedom Mortgage. Since GHLD focuses on higher cost purchase mortgage loans, the nonbank lender is obsessively focused on managing expenses. The result is that GHLD is consistently profitable and is among the most efficient operators in the mortgage business.

As a result of the discipline shown by CEO Mary Ann McGary and GHLD’s veteran and very stable operating team, the firm reported solid profits in 2022 as much of the rest of the industry was thrown into disarray. Like our longtime friend Stan Middleman at Freedom Mortgage, what we see in GHLD is an old-fashioned appreciation of the operating realities of the mortgage business. Residential mortgages are 100% correlated to interest rates and employment. So long as the Federal Open Market Committee is compelled to pursue the conflicted dual mandate of full employment and price stability, the mortgage industry will be a roller-coaster.

Guild Mortgage

Despite this challenge, GHLD has managed to cut the ends off the risk curve and delivery steady, middle of the fairway results that are the envy of the industry. In 2022, over 80% of GHLD’s production was purchase mortgages. Adjusted EBITDA totaled $103.5 million compared to $366.2 million in 2021, one of the better comparable periods in the industry. GHLDs in house servicing portfolio increased 11% to $78.9 billion from 2021, with retained servicing rights on 89% of loans sold.

The purchase component the GHLD servicing book means that the loans tend to payoff slower than the industry average. More, delinquency is below industry averages and GHLD manages to recapture one-third of the refinance transactions on its servicing book, a best-in-class metric. (Note: When you see a residential mortgage issuer reporting recapture rates in the 70s, they are not doing the math right.)

In Q4 2022, GHLD reported a small loss, but compared to some of the larger players in the business their results were stellar. We believe that we are at an inflection point of sorts, where stronger players like GHLD and Mr. Cooper (COOP) are going to continue taking market share. GHLD acquired Inlanta Mortgage in December 2022 and just acquired Cherry Creek Mortgage, a privately held Colorado-based lender with 68 physical branches in 45 states.

Guild Mortgage

Portfolio

We recently added Western Alliance (WAL) and GHLD to our portfolio, which is shown below.

L: CS, CVX, NVDA, WMB, JPM.PRK, BAC.PRA, USB.PRM, WFC.PRZ, WFC.PRQ, CPRN, WPL.CF, NOVC, LDI, WAL, GHLD

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