top of page

THIS WEEK'S 
REPORT:

The BAN Report: Inflation Eases / Arbor's Challenges / Consumer Credit Update / Jim Simons / Webinar Next Week-5/18/24

 

Inflation Eases

Inflation eased in April, according to the CPI report this week.

 

Inflation eased slightly in April, providing at least a bit of relief for consumers while still holding above levels that would suggest a cut in interest rates is imminent.

 

The consumer price index, a broad measure of how much goods and services cost at the cash register, increased 0.3% from March, the Labor Department’s Bureau of Labor Statistics reported Wednesday. That was slightly below the Dow Jones estimate for 0.4%.

 

For the inflation report, price gains on the month were driven heavily by rises in both shelter and energy.

 

Shelter costs, which have been a particular trouble spot for Federal Reserve officials expecting inflation to come down this year, increased 0.4% for the month and were up 5.5% from a year ago. Both are levels uncomfortably high for a Fed trying to drive overall inflation back down to 2%.

 

The energy index rose 1.1% for a month and was up 2.6% on an annual basis. Food was flat and up 2.2%, respectively. Used and new vehicle prices, which had contributed to the early rise in inflation during the worst of the Covid pandemic, both declined, falling 1.4% and 0.4%, respectively.

 

Areas showing notable gains on the month included apparel (1.2%), transportation services (0.9%) and medical care services (0.4%). For transportation services, that took the annual increase up to 11.2%. Services excluding energy, a key point for policymakers, increased 0.4% on the month and were up 5.3% on the year.

 

The inflation increase was bad news for workers, who saw earnings fall 0.2% on the month when adjusted for inflation. On a 12-month basis, real earnings rose just 0.5%.

 

In the shelter components, both rent of primary residence and the important owners equivalent rent, or what homeowners think they can get to rent their properties, rose 0.4% on the month. They respectively increased 5.4% and 5.8% on a 12-month basis.

 

Rents are the biggest impediment to bringing inflation down, as they make up a large component of the CPI.

 

Rents are the biggest remaining obstacle for the US Federal Reserve in bringing inflation back down to its 2% target. That is, rents as measured in the consumer price index, a key yardstick for the Fed. But other measures meant to give more up-to-date data show rental inflation has moderated more quickly than the CPI indicates. Much of the divergence is driven by the methodological quirks of a CPI component known as owners’ equivalent rent, or OER. Because rents make up an outsize share of the CPI, higher-than-expected OER readings earlier this year have led Fed officials to suggest they will hold off longer than originally planned before reducing interest rates they hiked steeply in 2022 and 2023 to fight inflation. Fed Chair Jerome Powell on May 14 called housing inflation “a bit of a puzzle,” saying that lags between the different measures mean “we have to wait.” April CPI data published on May 15 showed a slight moderation both in rents and overall inflation.

 

Increased supply of apartments will help reduce pressure on apartment rents, although that creates challenges with multi-family loans.

Arbor’s Challenges

 

Arbor Realty Trust, a leading multifamily lender that specializes in bridge loans that were converted into CLOs, modified nearly $2 billion in loans in the first quarter.

 

The New York-based real estate investment trust modified almost $1.9 billion in loans in the first quarter to help borrowers facing “financial difficulties,” according to a quarterly report filed with the Securities and Exchange Commission.

 

Arbor modified 39 multifamily bridge loans by extending maturity dates and giving borrowers temporary rate relief. In exchange, some borrowers agreed to pay down principal, buy new rate caps and deposit more cash into reserves for renovations or interest rate jumps.

On about $1.1 billion in loans, borrowers put more cash into the deals — but only about 4 percent of what they owed.

 

On an earnings call last week, one analyst asked CFO Paul Elenio why Arbor did not require borrowers to contribute more.

 

“You have to be very pragmatic about how to improve your position on each loan,” he said. “And you have to keep in mind that we have a lot of good borrowers who are failing their assets substantially.”

 

Some of Arbor’s modifications required the borrower to bring any delinquent loans current.

 

Arbor’s loan book is substantially exposed to multifamily borrowers who used floating-rate bridge debt to buy thousands of units across the country while rates were low. After rates soared in 2022, these firms started suffering cash crunches and have struggled to make their new monthly mortgage payments.

 

At the end of March, Arbor had about $465 million in non-performing loans, meaning at least 60 days past due. That’s up about 70 percent from the end of 2023, according to financial filings.

 

If it weren’t for those modifications, Arbor would have reported $957 million in non-performing loans.

 

The firm is still reporting profits — $57.9 million in net income in the first quarter, down from $84 million in the fourth quarter of last year.

 

Many of Arbor’s loans have been packaged into collateralized loan obligations, or CLOs, securities that are sold off to investors.

 

Arbor has the right to buy out a troubled loan in a CLO pool and replace it with a performing one.

 

On the earnings call, Arbor CFO Paul Elenio said the firm has bought out $223 million in loans from its CLOs, adding the firm has worked out most of that balance.

 

Short-seller Viceroy Research has been attacking Arbor for months, attacking the firm as “the worst of the worst.”   It’s interesting to see their analysis of how DSCRs have fallen as rates have risen.

The above are six of their CLOs. As you can see, floating rate loans had adequate coverage before rates started to climb. This is a good illustration of how credit risk has moved from banks balance sheets to securitized lenders like Arbor over the past couple decades. Many of these borrowers could have gotten bank loans, but they wanted to maximize proceeds and took on the interest rate risk.

Let’s go back to 2022, for example when rates were low. Multi-family borrowers could get 70% or so from banks at 1.75% to 2% over SOFR. Arbor and other debt funds were giving proceeds as high as 85% at pricing about 75 basis points higher. Additionally, banks were a lot pickier with their multi-family borrowers and many of the debt-fund borrowers wouldn’t get loans from banks anyway.  

 

Consumer Credit Update

 

The New York Fed released its “Quarterly Report on Household Debt and Credit” this week. 

Aggregate household debt balances increased by $184 billion in the first quarter of 2024, a 1.1% rise from 2023Q4. Balances now stand at $17.69 trillion and have increased by $3.5 trillion since the end of 2019, just before the pandemic recession.

Aggregate delinquency rates increased in the first quarter of 2024. As of March, 3.2% of outstanding debt was in some stage of delinquency, up by 0.1 percentage point from the fourth quarter. Still, overall delinquency rates remain 1.5 percentage points lower than the fourth quarter of 2019.

 

Delinquency transition rates increased for all product types. Over the last year, approximately 8.9% of credit card balances and 7.9% of auto loan balances transitioned into delinquency. Early delinquency transition rates for mortgages increased by 0.3 percentage point yet remain low by historic standards.

 

About 121,000 consumers had a bankruptcy notation added to their credit reports in 2024Q1, more than in the previous quarter. Approximately 4.8% of consumers have a 3rd party collection account on their credit report.

 

It appears that the consumer is holding up well, but there are definitely some warning signs in both credit card debt and auto loans.  

Most credit card debt is floating, so it’s not surprising to see the delinquencies spike in this category. Serious delinquencies are now approaching GFC levels, as they are in auto loans. But, due to the high percentage of consumer loans that are fixed (estimated at 89%), the consumer is still in reasonably good shape. Note the improvement in student loan delinquency rates, although there’s certainly some noise there due to forgiveness.

 

Many banks were hoping that the US Supreme Court would tame the CFPB, but a ruling today meant the CFPB is here to stay.

 

The Supreme Court rejected a challenge on Thursday to the way the Consumer Financial Protection Bureau is funded, one that could have hobbled the bureau and advanced a central goal of the conservative legal movement: limiting the power of independent agencies.

 

The vote was 7 to 2, with Justice Clarence Thomas writing the majority opinion.

 

Had the bureau lost, the court’s ruling might have cast doubt on every regulation and enforcement action it had taken in its 13 years of existence, including ones concerning mortgages, credit cards, consumer loans and banking.

 

The central question in the case was whether the way Congress chose to fund the bureau had violated the appropriations clause of the Constitution, which says that “no money shall be drawn from the Treasury, but in consequence of appropriations made by law.”

Justice Thomas said the mechanism was constitutional.

 

“Under the appropriations clause,” he wrote, “an appropriation is simply a law that authorizes expenditures from a specified source of public money for designated purposes. The statute that provides the bureau’s funding meets these requirements. We therefore conclude that the bureau’s funding mechanism does not violate the appropriations clause.”

 

The case was brought by trade groups representing payday lenders.

 

Jim Simons

Jim Simons, arguably the greatest investor who ever lived, passed away last Friday.

Jim Simons, the prizewinning mathematician who abandoned a stellar academic career, then plunged into finance — a world he knew nothing about — and became one of the most successful Wall Street investors ever, died on Friday in his home in Manhattan. He was 86.

After publishing breakthrough studies in mathematics that would play a seminal role in quantum field theory, string theory and condensed matter physics, Mr. Simons decided to apply his genius to a more prosaic subject — making as much money as he could in as short a time as possible.

So at age 40 he opened a storefront office in a Long Island strip mall and set about proving that trading commodities, currencies, stocks and bonds could be nearly as predictable as calculus and partial differential equations. Spurning financial analysts and business school graduates, he hired like-minded mathematicians and scientists.

Mr. Simons equipped his colleagues with advanced computers to process torrents of data filtered through mathematical models, and turned the four investment funds in his new firm, Renaissance Technologies, into virtual money printing machines.

 

Medallion, the largest of these funds, earned more than $100 billion in trading profits in the 30 years following its inception in 1988. It generated an unheard-of 66 percent average annual return during that period.

That was a far better long-term performance than famed investors like Warren Buffett and George Soros achieved.

“No one in the investment world even comes close,” wrote Gregory Zuckerman, one of the few journalists to interview Mr. Simons and the author of his biography, “The Man Who Solved the Market.”

By 2020, Mr. Simons’s approach to the market — known as quantitative, or quant, investing — accounted for almost a third of Wall Street trading operations. Even traditional investment firms that relied on corporate research, instinct and personal contacts felt compelled to adopt some of Mr. Simons’ computer-driven methodology.

For much of its existence, Renaissance funds were the largest quant funds on Wall Street, and its style of investing spurred a sea change in the way hedge funds traded and made money for their wealthy investors and pension funds.

66% gross returns over a 30-year period are quite extraordinary, but he did keep his fund size under $10BB, and actively returned money back to his investors to keep the fund size smaller. Comparing him to Warren Buffett is difficult because Buffett managed a much larger pool of capital.

Nevertheless, Jim Simons was clearly the greatest quant trader of all time and he basically revolutionized trading. He did a Ted Talk a few years ago that showed how he used mathematics to crack Wall Street.

Webinar Next Week

With the 10-Year Treasury in the high 4’s and the Fed keeping rates elevated for longer, commercial real estate is experiencing stress, but the gloom and doom narrative from the financial press has not materialized. ‘Q1 Bank Earnings showed increased stress in CRE portfolios, but delinquencies are still low by any measure and the US economy continues to outperform. What happens next – is this the tip of the iceberg or can we thread the needle?

Four experts, each bringing a unique perspective and deep understanding of commercial real estate, will cover a variety of critical topics. This highly topical webinar will explore:

  1. Cracks in Credit from ‘Q1 Bank Earnings

  2. How lenders are underwriting new loans today

  3. Servicing and workout strategies for legacy credits

  4. Is Capitulation Coming on Rates?

  5. When Loans Go Bad: Recovery Rates on Resolved NPLs

  6. Recourse versus Non-Recourse Lending and Servicing

Please Join our webinar on Tuesday, May 21, 2024, at 01:00 PM EST with four dynamic loan workout experts featuring:

  1. Timothy Mazzetti, Vice Chairman-CRE, SitusAMC

  2. Charles Krawitz, Senior VP, Head of Commercial Lending, Alliant Credit Union

  3. Brad Salzer, President, Redstone Investments

  4. Jon Winick, CEO, Clark Street Capital

Registration Details:
Register Here
Tuesday, May 21, 2024, 1:00PM-2:00PM EDT

bottom of page