August 22, 2024 | You could say that 2024 was a year when many searched in vain for a traditional recession, but found none. Newly minted finance stocks catering to mildly distressed consumers also postured for a recession last year, but failed in this strategy. In fact, 2023 is looking more and more like the year of modest aspiration for finance company stocks.
Some investors decided to return “to da moon” last year in a number of sectors that had little real chance of LT success. Many apparently successful stories were way off from the truly aspirational 2020-2022 COVID highs, when the FOMC “went big” with bank reserves. This made big percentage gains more attainable in 2023 but ultimately unsatisfying. In dollar terms, the moves in 2023 were tiny vs the post March rally in 2020-2021.
Take mortgage finance. The top performing stocks in 2023 were two battered penny stocks that used to be the lowest risk ticket in town, Fannie Mae and Freddie Mac. We wrote about the dim prospects for either escaping from government control earlier this year (“Will Donald Trump Release Fannie Mae & Freddie Mac?? Really?”). See our latest column in National Mortgage News for more thoughts on the agenda next year for mortgage finance.
Most recently, however, the two GSEs were overtaken by Blend Labs (BLND), a nouvelle mortgage tech company that is best known for consuming vast amounts of shareholder capital. BLND, in fact, is up 225% over the past year, perhaps buoyed by the prospect of a big surge in mortgage volumes in the event of a Fed rate cut? Not. BLND is still nowhere near its $15 IPO valuation. The free cash flow summary from the back pages of the Q2 2024 BLND earnings presentation is below. In fairness, losses are down from last year and there is a significant risk of profitability ahead.
BLND | Q2 2024
The key question to ask if you are long BLND or any issuer with exposure to residential mortgages is this: How big is the mortgage refinance opportunity in 2024 and beyond given multiple Fed rate cuts? Since purchase mortgage volumes are pretty steady, the real upside to any mortgage stock is from refinance volumes.
Even a 1% cut in the short-term rate for federal funds, however, may not move the needle much in terms of volumes, especially compared to the free cash flows earned from servicing. The chart below from Ginnie Mae illustrates how low loan prepayment rates have fallen from the extraordinary 2020 levels.
“At a 6.50% primary rate, conventional 6.5s and 7.0s are in the money, with 6.0s on the cusp due to the large number of borrowers with 6.875%-6.99% WACs,” notes Scott Buchta of Brean. “At a 6.00% FHA/VA rate, 6.5s and 7.0s are well in the money, with 6.0s also on the cusp (and in the money assuming a 5.75% driving rate). Again, this weeks drop in the average size of a conventional refi point to the cuspiness of these borrowers.”
“Cuspiness” may be a new term for some readers of The Institutional Risk Analyst. Translated into plain terms, well fewer than 10% of all mortgages are in the money for refinance after the rate rally earlier in this quarter. Even a full point reduction will mean little because of the heavily skewed distribution of mortgage coupons.
One very large player in mortgage finance, Wells Fargo & Co (WFC) is getting out of mortgages as fast as possible, both residential and commercial. WFC agreed to sell most of its commercial mortgage servicing business to Trimont LLC, ceding the title of biggest US commercial and multifamily mortgage servicer to the Atlanta-based firm. The news comes as the OCC has finally ended the consent order against WFC for creating fake customer accounts. The table below from the WFC 2023 Annual Report shows the residential and commercial servicing books.
WFC | 2023
Trimont will buy Wells Fargo’s non-agency third-party commercial mortgage servicing business, the companies said in separate statements. It is interesting to note that the deal announcement does not include terms. Estimates of the consideration from bankers in the CRE channel range from a large positive number to an equally large negative number. That is, unless we hear otherwise, WFC may need to pay the buyer to take the servicing asset and a loss may be in the cards.
The ostensive buyer of this considerable business is a non-bank servicer known as Trimont LLC, which in turn is owned by funds controlled by Värde Partners, a privately-owned alternative credit manager located in WI and named after a city in Jutland. Värde manages about $13 billion in AUM and has owned Trimont since 2015.
Funds controlled by Värde often make loans on property that are serviced by Trimont, such as the Alliance HP office tower in Ft Lauderdale. It is not clear whether Värde takes risk on any of the loans it manages for investors. There are no public financials available for Värde or Trimont, a point that may interest Treasury Secretary Janet Yellen and her colleagues on the Financial Stability Oversight Council or FSOC.
The deal is expected to close in early 2025, CNN reports, and will result in Trimont managing over $715 billion in US and international commercial real estate loans. Upon the close of the transaction, in fact, the private nonbank finance company will be the largest servicer of commercial mortgages in the US, just ahead of WFC, PNC Financial (PNC), KeyCorp (KEY) and CBRE Group, Inc. (CBRE). If Trimont wants to play in this league, an IPO may be in the cards sooner rather than later.
Of course, servicing commercial loans is very different from residential mortgages, most particularly since the servicer does not advance cash on defaulted loans. Yet the fact that WFC is selling this business as the tide of defaults is rising in CRE may raise a few eyebrows. Servicing is not a high-margin business and is usually paired with higher return activities as a loss leader to benefit large customers.
“Over the next three years, there’s about $2 trillion of debt coming due, and as those loans come due, the combined platform is positioned well to capture an increased amount of services and provide those services to clients,” Trimont CEO Jim Dunbar joyfully told Bloomberg.
Meanwhile in the wider world of nonbank finance, the leading stock in our surveillance group is Coinbase Global (COIN), up 161% over the past year. The largest US crypto exchange is profitable, but trades at half of the firm’s multi-year high back in 2021 with the COIN IPO. Despite the surge in the stock over the past year, COIN as an aspirational stock seems to be suffering from the ill-effects of profitability and familiarity.
After COIN, the nonbank group features Afirm Holdings (AFRM), which has been giving back gains made in 2023 through the first half of this year. Like COIN, the bloom is off the rose and lying on the garden path with this once high-flying fintech stock. The five-year high for AFRM of $176 per share is just a distant memory now with AFRM trading below $30 per share.
AFRM reported a GAAP loss of $160 million in the quarter ended March 2024 including $77 million for stock based compensation for company management and more millions for warrants to entice enterprise partners. The management team and commercial partners are taking the lion’s share of the value of AFRM it seems to us. It just goes to show that given adequate disclosure, anything is possible.
Neck and neck with AFRM in terms of 1 year returns is NU Holdings (NU), a provider of banking and payment services in Brazil, Mexico and other nations in South America. NU has been rising for the past year after a difficult beginning. NU came out in December 2021 and promptly got crushed, losing two-thirds of its value by the middle of 2022. The stock wallowed around $4 for more than a year but has since managed to build its way back up to around $14.
When you start from a very low base, wracking up big percentage gains is relatively easy. That said, NU has significant market penetration in Brazil and is expanding in Mexico and other large markets. The top level NU entity is domiciled in the Cayman Islands and is a foreign filer in the US, but operates banks and financial companies in a number of different markets. NU claims significant market share in Brazil and Mexico, where it is able to offer a broad range of banking and investment products.
We’ve been accumulating NU stock and see it as a LT play on growth in the region and also among the Latin community in the US. We also like the relatively new platform and the fact that the management team is coming from the world of nonbank finance and growing organically in each market depending upon the legal framework in those venues. Finally, NU appears to be profitable and well-capitalized, and adding new customers rapidly as they grow into new markets like Mexico.
In our next Premium Service edition of The Institutional Risk Analyst, we’ll be taking a look at the consumer lenders among the top 100 US banks to see if there is any sign of a recession in 2025.
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