Mortgage Lenders Go Broke
As the markets fret over how soon a recession will happen, how deep it will be, and how soon thereafter there will be a recovery real world companies are going broke. This issue has to do with the housing market. Lending rates are up dramatically and the upcoming failures will be the worst since the 2007 Housing Crisis and Great Recession as mortgage lenders go broke.
Independent Lenders Will Bear the Brunt of the Pain
After the Financial Crisis big US banks reduced their presence in the US home mortgage market and the slack was taken up by independent lenders. That is where the layoffs will occur and those are the companies that will go out of business. The big issue is that non-banks are not as well capitalized as banks. This means they can profit more in good times and that they are more vulnerable when times are bad. By comparison back in 2004 a third of the top twenty refinancing lenders were independents and today two-thirds are. The bank share of refinancings went down from half to a third since 2016.
Applications for home loans have fallen in 2022. Although many companies will cut back and come through in one piece, those that have specialized in risky loans that do not qualify for government backing will be in trouble. One company that just filed for bankruptcy is First Guaranty whose majority ownership is by Pacific Investment Management Co., was holding loans which dropped substantially in value while they were financing those loans with a line of credit that has become more expensive.
We recently looked at if we are in a recession or not. The housing market tells us that we are knee deep in a recession even if employment is at an all time high and unemployment is at its lowest in decades. Home buyers are backing off from new purchases and anyone who wanted to refinance their home did it already. The cash flow of new mortgages and refinancing that companies like First Guaranty need to stay afloat have dried up. As a side note, the company laid off 471 of its 600 employees as it waits to pass through bankruptcy.
Bank Retreat from Mortgage Sector
US banks that were willing to provide risky loans to folks who were buying properties far beyond their means were largely responsible for the housing crisis. Regulations have helped reduce the risk of what happened fifteen years ago. But part of the risk has not gone away and has simply been transferred to independent lenders that are less regulated or not regulated at all compared to banks. Wells Fargo is the largest firm on Wall Street dealing mortgages and they have not only reduced that business but continue to do so. Banks fund their mortgage businesses with customer deposits while independent lenders fund their mortgages with short term credit. This dynamic has made banks more secure by far than independent lenders in the current environment of rate increases.
Value of a Loan Portfolio
An independent lender makes loans and holds a portfolio of loans as its asset. Ideally, every person who owes money will pay on time for the duration of their loans. But, in reality, people default, like many did during the Covid Crisis. That reduces the value of that portfolio and it reduces the cash flow from that portfolio of loans. And, in an ideal world for lenders, interest rates are going down so that older loans at higher interest rates increase in value. That is certainly not the case today as the Fed keeps raising rates to fight inflation. Independent lenders typically borrow on short term credit to finance their operations and today their costs have skyrocketed. This has caused a perfect storm in the home mortgage market. These are not companies whose stocks we can trade options on. But they are a significant part of the economy and the fallout from a collapse of home mortgage lenders can ricochet thought the economy and that is something to watch out for in trading options. As we have noted before, this not a good time to be trading options solo. Consider joining one of the trading squadrons at Top Gun Options were we potentially print money no matter how the economy or markets are doing.