It seems that no matter what metric one looks into lately, a “pick your poison” situation unfolds. One in particular is reminiscent of the pre-2007/2008 crisis shenanigans that took place within the mortgage industry. I’ll get to that one later. How you choose to invest against the current clusterf**k depends on your risk appetite. Keep in mind the losses incurred by those who bet against the housing market leading up to and during the early phases of the great financial crisis, as the film “The Big Short” exquisitely portrays. And there lies the rub.

When investing prudently, you are ideally looking beyond the horizon to get right and sit tight vs. just a near-term gain. More often than not, opportunity presents itself well ahead of the trigger point, and the ability to participate without fear of volatility after the fact is gone. It is better to be three hours too soon than a minute too late.

Plunges in the stock market indices are easy to capitalize on by finding the most liquid ETF available, although finding less conventional investment vehicles with larger returns well ahead of the herd requires due diligence and time. One area where large institutions roam is the derivatives market. That’s not a recommendation, but just pointing out where potential trigger points could be hiding. The following data points are examples of where cycles are approaching tipping points, but timing is the key. You will not find the answer down the street at your local fortune teller. The best part about researching for the appropriate investment is that the symptoms of a trigger are usually hiding in plain sight, if you take the time to look. I won’t provide you with specific advice, but I can steer you along your way to finding that next big short (or long, for that matter).

Checking In on the Four Intersecting Cycles… “Generational (political/social), Price inflation/wage stagnation (economic), Credit/debt expansion/contraction (financial), Relative affordability of energy (resources)” – Charles Hugh Smith, OfTwoMinds, Mar. 14


US Consumers Tapped Out: Personal Savings Rate Plunges To 10 Year Low Amid Soaring Credit Card DebtZeroHedge, Dec. 2017

Retail sales decline for third straight month in February… “U.S. retail sales fell for a third straight month in February as households cut back on purchases of motor vehicles and other big-ticket items, pointing to a slowdown in economic growth in the first quarter… It was the first time since April 2012 that retail sales have declined for three straight month.” – CNBC, Mar. 14

Only 39% of Americans have enough savings to cover a $1,000 emergencyCNBC, Feb. 18

The State of the American Debt SlavesWolf Richter, Feb. 8

Auto Loan Interest Rates Soar to Eight-Year HighEdmunds, Mar. 5

Subprime Auto Defaults Are Soaring, and Private Equity Firms Have No Way OutBloomberg, Dec. 2017

Wanted: Debt or alive. What you need to know about financial markets today… “The real action, though, is in debt, where $14.1 billion was pulled from bond funds in the week through Feb. 14, according to data collected by EPFR Global. Most of it came from high-yield or ‘junk’ bonds, as investors grappled with the impact of rising inflation and interest rates on the riskiest corporate borrowing. With less money coming from central banks and yield-seeking ‘tourist’ investors, some of the most leveraged companies could have trouble refinancing their debt. That’s not an insignificant issue, with corporate debt as a percentage of gross domestic product running at an all-time high.” – LA Times, Feb. 16


Goldman, Atlanta Fed Slash Q1 GDP Forecasts Below 2.0%… “From its exuberant 5.4% expectation for Q1 GDP at the start of February, the Atlanta Fed’s guess has collapsed to just 1.9% as CPI and retail sales disappointments weigh on their outlook… Accordingly, we lowered our Q1 GDP tracking estimate by two tenths to +1.8%.” – ZeroHedge, Mar. 14

1976 – Jan 2018 Nominal House PricesCalculated Risk, Feb. 2018

A potential trigger point appears to be developing within the non-banking industry of mortgage securitization.  And there is likely more fire in those institutions than just mortgages when one sees the overall non-banking assets to GDP data is…

Let’s take a deep dive into one potential issue that’s reminiscent of pre-financial crisis shenanigans that would not be liquidity-friendly to the credit markets. Ringing any bells?  The following research paper is just shy of 70 pages, and you’ll have to read it yourself to truly grasp the issue. It may even open your eyes to other potential investment vehicles.  Here are a few paragraphs and charts as a teaser.

Liquidity crises in the mortgage marketBrookings Institute, Mar. 8:

“Much less understood, and largely absent from the standard narratives, is the role played by liquidity crises in the nonbank mortgage sector… These vulnerabilities in the mortgage market were also not the focus of regulatory attention in the aftermath of the crisis… liquidity vulnerabilities are still present in 2018, and arguably, the potential for liquidity issues associated with mortgage servicing is even greater than pre-financial crisis. These issues have become more pressing because the nonbank sector is a larger part of the market than it was pre-crisis, especially for loans securitized in pools with guarantees by Ginnie Mae. As noted in 2015 by the Honorable Ted Tozer, former President of Ginnie Mae…

‘Today almost two thirds of Ginnie Mae guaranteed securities are issued by independent mortgage banks. And independent mortgage bankers are using some of the most sophisticated financial engineering that this industry has ever seen. We are also seeing greater dependence on credit lines, securitization involving multiple players, and more frequent trading of servicing rights and all of these things have created a new and challenging environment for Ginnie Mae… In other words, the risk is a lot higher and business models of our issuers are a lot more complex. Add in sharply higher annual volumes, and these risks are amplified many times over… Also, we have depended on sheer luck. Luck that the economy does not fall into recession and increase mortgage delinquencies. Luck that our independent mortgage bankers remain able to access their lines of credit. And luck that nothing critical falls through the cracks.’

Nonbanks in the U.S. residential-mortgage marketThe post-crisis U.S. mortgage market has two very different pieces. One part of the market— the ‘traditional’ side — consists of highly regulated banks and other depository institutions that usually handle the three main mortgage functions — origination, funding, and servicing — themselves. They fund their mortgage originations with deposits or Federal Home Loan Bank advances, generally service their own loans, and either hold the loans in portfolio or securitize them in pools guaranteed by Ginnie Mae or the Government-Sponsored Enterprises (GSEs), Fannie Mae and Freddie Mac. The Second part of the mortgage market—nonbank mortgage originators and servicerswhich represented almost half of mortgage originations in 2016, up sharply from around 20% in 2007 (Figure 1). These nonbanks also represented close to half of all mortgage originations sold to the GSEs in 2016, as well as 75% of all originations sold to Ginnie Mae. The striking rise in the Ginnie Mae nonbank share appears to have continued in 2017; data from the Urban Institute pins the nonbank share of Ginnie originations at 80% in December 2017.

Share of all U.S. mortgages originated by nonbanks from 2001 to 2016. Source: Home Mortgage Disclosure Act (HMDA) data (Figure 1)

In addition to their outsized share of FHA and VA loans, nonbanks are more likely to originate mortgages to minority, lower-income, and lower credit-score borrowers. For example, in 2016, nonbanks originated 53% of all mortgages, but 64% of the mortgages originated to black and Hispanic borrowers and 58% of the mortgages to borrowers living in low- or moderate-income tracts. Nonbank mortgages are a smaller share of total mortgages outstanding than of new mortgage originations. However, as shown in Figure 2, in 2016 the dollar volume of mortgages in Ginnie Mae pools issued and serviced by nonbanks exceeded the corresponding volume for banks, and by the end of 2017 the nonbank share was close to 60%. As a result, nonbanks are now the main counterparties for Ginnie Mae. Inside Mortgage Finance estimates that the nonbank share of servicing was 38% for Fannie pools and 35% for Freddie pools at the end of 2017 (January 19, 2018).

Outstanding balance (in $blns) MBS guaranteed by Ginnie Mae and serviced by nonbanks vs banks. Source: Ginnie Mae (Figure 2)

Non-bank mortgage originations (in $ billions) from 2001 to 2016. Source: HMDA (Figure 6)

Due to the lower credit quality of loans being originated by nonbanks, a rise in defaults would likely hit nonbank lenders and servicers particularly hard, as happened in the years leading up to the financial crisis. Among other things, a rise in delinquency rates results in higher servicing costs… For loans serviced under a Ginnie Mae contract, the typical bank spends about 50 times as much servicing a loan in foreclosure as a performing loan.

Vulnerabilities of warehouse funding – There are three important vulnerabilities associated with the warehouse funding of nonbanks: 1) margin calls due to aging risk (i.e., the time it takes the nonbank to sell the loans to a mortgage investor and repurchase the collateral) and/or mark-to-market devaluations, 2) roll-over risk and 3) covenant violations leading to cancellation of the credit line.

Recently, pipeline aging risk led to the sudden closure in March 2016 of a large nondepository lender, W. J. Bradley Mortgage. The precipitating event in this closure was a ‘pipeline backup’ (the pipeline is the funding period between the disbursal of funds to mortgage borrowers and the securitization of the loans), reportedly due to new regulatory oversight of underwriting quality under the Consumer Finance Protection Bureau’s new TRID requirements. TRID violations arising from ‘small’ errors in the underwriting reports for each loan made it impossible for W. J. Bradley to sell the mortgages to a securitization vehicle within the period stipulated in their funding contracts. This covenant violation then precipitated the cancellation of all of its lines of credit. As described in section 4.2, this is very similar to the cancellation of billions of dollars of lines-of-credit to mortgage originators in the fourth quarter of 2006 and first two quarters of 2007 due to slowdowns in the securitization of mortgages in both the GSE and private-label markets. In both cases, these cancellations led to the immediate demise of the mortgage originators.

Typically, the master repurchase agreements for warehouse lines also allow the warehouse lender to mark to market the mortgage loans held as collateral on the line. If mortgage interest rates rise sharply while the mortgage is in the warehouse facility, for example, the mortgage will fall in value. If the market value of the loans times a pre-defined ‘advance rate’ is less than the repurchase obligations owed by the nonbank borrower, the warehouse lender is entitled to make a margin call. The margin call must usually be resolved within 24 hours, either by a cash payment or by delivering additional mortgage loans to bring the facility back into balance.”

Now for a brief intermission from Brookings.

Roughly 75% of warehouse funding lines of credit are tied to LIBOR rates, and the majority are tied to a 3-month LIBOR rate. Time spread is dependent upon how long it takes to securitize a “tranch.” As the overall health of a housing market deteriorates, the length of time to securitize will increase and the corresponding market interest rate will rise.

So what’s up with LIBOR lately?

Libor Rates Surging: What Does It Mean?… “3-month Libor rates have surged over 2%, the highest since 2008… Libor rates reached cycle highs across all durations… The Libor-OIS spread, a key indicator of short-term liquidity and credit risk is soaring… With an economy overloaded with debts, most of which are linked to Libor, it is not surprising that a rise in Libor rates and short-term interest rates precedes the end of each economic cycle. Libor rates and short-term interest rates rise, causing debt-service payments to increase at the end of a business cycle. Debt service payments end up growing faster than income and defaults occur, triggering the end of the business cycle…

The spread between the two rates is considered to be a measure of the health of the banking system. It is an important measure of risk and liquidity in the money market, considered by many, including former US Federal Reserve chairman Alan Greenspan, to be a strong indicator for the relative stress in the money markets. A higher spread (high Libor) is typically interpreted as an indication of a decreased willingness to lend by major banks, while a lower spread indicates higher liquidity in the market. As such, the spread can be viewed as an indication of banks’ perception of the creditworthiness of other financial institutions and the general availability of funds for lending purposes.” – SeekingAlpha, Mar. 13

Back to Brookings…

“…During normal times, when a nonbank violates a covenant, the warehouse lender will generally waive the covenant or renegotiate the agreement. During times of stress, however, the incentive of the warehouse lender is to pull the line and seize and sell the underlying collateral as quickly as possible, as warehouse lenders are allowed to do under the repo eligibility provisions afforded them under BAPCPA 2005. Amplifying these dynamics is the fact that large nonbanks typically have warehouse lines of credit with multiple warehouse lenders, and the lending contracts tend to have cross-default clauses such that a default on one line triggers an automatic default on the nonbank’s other credit obligations. If these lenders sense that the failure of the nonbank is imminent, each has the incentive to minimize its losses by canceling the line and seizing its collateral before its competitors. This race to seize assets can further erode the viability of the nonbank as an ongoing entity, and if the warehouse lender sells the mortgages after it seizes them, those sales can weigh on mortgage valuations.

The rapidity with which covenants can bind is exemplified by the final month of operation of New Century Financial Corporation, which was the largest nonbank mortgage lender in 2006.

On March 2, 2007, NCFC announced that it was unable to file its annual report on Form 10-K for the year ended December 31, 2006 by March 1, 2007, without unreasonable effort and expense. . . The announcements caused a variety of issues with the repurchase counterparties to the Debtors Master Repurchase Agreements, including margin calls, restricting and ultimately terminating funding for loans originated by the Debtors. . . This exacerbated the Debtor’s liquidity situation and, by March 5, 2007, the Debtors were able to fund only a portion of their loan originations. The Debtors’ inability to originate loans and the exercise of remedies by the Repurchase counterparties left the Debtors in a severe liquidity crisis. On April 2, 2007, the Debtors (other than Access Lending) filed chapter 11 bankruptcy cases…’

Warehouse funding during the financial crisis – In 2006, the top 40 mortgage originators accounted for about 97% of the $2.98 trillion total mortgage originations in the U.S., and 28 of those institutions, representing 59% of total mortgage origination, used at least one warehouse line of credit to fund their originations. Many of these nonbanks and some depository mortgage originators also had off-balance sheet entities called Structured Investment Vehicles (SIV) (aka Derivatives)…. The two largest nonbanks in 2006 were New Century Financial Corporation and American Home Mortgage Corporation… sources of warehouse credit began to dry up rapidly in the run-up to the financial crisis as the slowdown in the securitization markets made it difficult for the nonbanks to move loan originations off the warehouse lines and the premiums paid for subprime warehoused loans evaporated… The collapse of the short-term funding structure of nonbanks and some depositories such as Countrywide led to rapid losses in liquidity and lending activity

Banks assign an internally generated credit rating to each of their credit facilities. Looking at all credit facilities extended to nonbanks, only about 5% of the facilities were rated AA or A by the bank lender, with an additional 28% rated triple-B. Of the remaining two-thirds with high-yield ratings, the majority have double-B ratings, but about 15% of all warehouse lines are rated single-B or lower by their warehouse lenders.”

Add some icing to the cake with this headline that just crossed my screen…

Sound Familiar? Home Flipping In The US Hits 11-Year HighZerohedge, Mar. 14


Rocket Mortgages…

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