July 30, 2024 | The folks at Politico published an article last week by former Federal Housing Finance Director Mark A. Calabria, Thomas Hoenig, Dennis Kelleher, & Aaron Klein ("Why Is the Government Encouraging a Taxpayer Bailout?") attacking the FSOC proposal for an industry-funded bailout facility for nonbanks. The link to the post on the CATO Institute web site is below:
At one level, the article is useful and very welcome as a public rebuttal of the handling of the Financial Stability Oversight Council (FSOC) under Treasury Secretary Janet Yellen. Unfortunately, the article actually validates some of the more questionable positions taken by the FSOC. At a higher level, however, the article is misinformed and illustrates the gap between two parallel worlds: housing policy and mortgage finance. They write:
"A powerful group of regulators known as the Financial Stability Oversight Council (FSOC) recently released a report focusing on the risks arising from the current regulatory structure for mortgage servicing. We applaud attention to these risks."
Really? What risks? The authors worry that the failure of a nonbank may somehow inconvenience consumers. But the public record and the private financial markets suggest that the authors are mistaken. Neither the FSOC nor the authors seem able to articulate precisely what financial risks are created by mortgage servicers other than a lot of pointless hand-wringing about consumers.
Independent mortgage banks tend to generate a lot of cash and healthy risk-adjusted returns. Profitable mortgage firms tend to take very good care of consumers, far better than banks. Indeed, signed copies our new biography of Stan Middleman, founder and CEO of Freedom Mortgage, are available for sale in The IRA Store. Get your signed copy while they last!
As we noted last week, large servicers such as PennyMac Financial (PFSI) and Mr. Cooper (COOP) are piling up profits and tangible equity returns that seem to refute every word ever written by the FSOC on the subject of non-banks. Compare PFSI and COOP to any large bank and tell us which you'd rather own.
Source: Google Finance
We agree with the authors that nonbank financial firms do not need a government backstop. Yet if you read the FSOC report, Yellen wants to tax the mortgage industry to foot the bill!! No thank you, Secretary Yellen, we already have a federal backstop: US Treasury. Yellen's proposal for a new backstop is merely a canard, a shameless attempt to help Treasury avoid another fiasco next time a Ginnie Mae issuer fails.
You see, the $7.5 trillion in conventional mortgages are owned by the GSEs, which are under government control. Uncle owns the risk. As we noted recently ("Will Donald Trump Release Fannie Mae & Freddie Mac?? Really?"), even were the GSEs to be released from conservatorship, the conventional MBS would continue to be guaranteed by the Treasury. This is why the GSEs will never be released, sabe?
The $2.5 trillion in government-insured mortgages in Ginnie Mae MBS are privately owned in theory, but government controlled in fact. In the event of default, the Ginnie Mae servicing asset is either sold to another servicer or taken over by the US Treasury. The choice is entirely binary.
Readers of The Institutional Risk Analyst recall that the abortive failure of Reverse Mortgage Investment Trust (RMIT) in November 2022 was entirely mishandled by the Biden Administration, resulting in billions in losses to the Treasury and a vexatious litigation with Texas Capital Bank (TCBI). We updated subscribers of our Premium Service back in April ("TCBI v Ginnie Mae Goes to Trial | Outlook for Commercial & Residential Mortgage Finance").
Janet Yellen does not want the media or members of Congress looking at her handiwork with Ginnie Mae. For those who missed it, RMIT was the largest government-insured reverse mortgage portfolio in the US. Post default, the business was unsalable and thus the government took it over. And there are more busted HECM portfolios headed for default.
The Yellen FSOC report was, in fact, a weak effort by Secretary Yellen to hide her department's mishandling of the RMIT default, but Calabria et al missed this little nuance. The Politico article also contains some erroneous information.
First, the authors err in saying that we must protect banks as the predominant originators and buyers of mortgage assets from risky nonbanks. In fact, brokers and independent mortgage banks (IMBs) have always originated most 1-4s, which banks used to buy. Bank share of owning 1-4s has been falling for decades and is now just 12%of total assets vs 25% in 2008.
Source: FDIC (RIS)
Today larger IMBs fund 80% of all residential loans in their own name, retain the servicing and sell the notes into the bond market. Banks originate loans in footprint and buy MBS from IMBs, but remain net sellers of 1-4s and residential MBS today, both for cash and credit risk transfer (CRT).
Yet even with the recent sales of MBS since the failure of Silicon Valley Bank in 2023, the US banking industry still has more than 100% of total capital invested in MBS. This a level of MBS as a percentage of total assets that is at least half again too large for safety & soundness. Why isn't Janet Yellen screaming about the MBS holdings of banks? Federal regulators should limit bank MBS holdings to no more than 50% of tangible capital.
Source: FDIC (RIS)
The financial markets and real equity returns tell the story of IMBs vs banks in terms of risk. Pick any bank you want and compare it to Mr. Cooper (COOP), PennyMac Financial Services (PFSI) and Guild Holdings (GHLD). Fact is that most banks have in many cases been dead money for years, while the better managed nonbanks have grown shareholder value.
The authors also err by suggesting that banks, which only ever focus on acquiring larger, high-FICO loans, somehow need to be protected in their dealings with IMBs. Banks provide warehouse finance and default line to IMBs on a fully secured basis, so it is not clear to us just what risk worries the authors. Aside from the failure of Silicon Valley Bank, the largest loss to a bank caused by residential mortgage exposures in recent years was TCBI's loss due to the default of RMIT.
Remember, banks are GSEs and reflect this fact in their often mediocre earnings and poor risk management results. IMBs don't retain loans and securities on balance sheet, and thus are far more liquid and profitable than regulated banks. In 2008, a third of the large regulated banks in the US by assets failed, while nonbanks were resolved in bankruptcy by the US Trustee without any inconvenience to consumers. So tell us again, Secretary Yellen, why you want to subject IMBs to federal regulation??
Where should Janet Yellen and the FSOC be looking for risk if not among residential mortgage servicers?? Start by looking at banks with MBS > 10% of total assets. Then have a look at Blackstone Mortgage Trust (NYSE:BXMT), a real estate finance company that originates senior loans collateralized by commercial properties in North America, Europe, and Australia. BXMT is trading at 0.8x book and is highly leveraged to a significantly impaired global asset class.
In our next comment, will update readers of the Premium Service on the latest in the world of nonbank finance (f/k/a the "fintech" sector).
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