THIS WEEK'S 
REPORT:

The BAN Report: Inflation Cools / Atypical "Recession" / Mortgage Industry Shakeout / Bank M&A Cools / Gladwell Slams WFH / The $765MM MSR Portfolio

Inflation Cools

Yesterday’s CPI report showed that inflation, while still high, may be easing.   

Prices that consumers pay for a variety of goods and services rose 8.5% in July from a year ago, a slowing pace from the previous month due largely to a drop in gasoline prices.

On a monthly basis, the consumer price index was flat as energy prices broadly declined 4.6% and gasoline fell 7.7%, according to the Bureau of Labor Statistics. That offset a 1.1% monthly gain in food prices and a 0.5% increase in shelter costs.

Economists surveyed by Dow Jones were expecting headline CPI to increase 8.7% on an annual basis and 0.2% monthly.

Excluding volatile food and energy prices, so-called core CPI rose 5.9% annually and 0.3% monthly, compared with respective estimates of 6.1% and 0.5%.

Even with the lower-than-expected numbers, inflation pressures remained strong.

The jump in the food index put the 12-month increase to 10.9%, the fastest pace since May 1979. Butter is up 26.4% over the past year, eggs have surged 38% and coffee is up more than 20%.

Despite the monthly drop in the energy index, electricity prices rose 1.6% and were up 15.2% from a year ago. The energy index rose 32.9% from a year ago.

Used vehicle prices posted a 0.4% monthly decline, while apparel prices also fell, easing 0.1%, and transportation services were off 0.5% as airline fares fell 1.8% for the month and 7.8% from a year ago.

Gas prices, for example, have fallen for 58 consecutive days and are now below $4.

The national average cost of a gallon of regular gasoline now stands at $3.99, according to AAA, after 58 consecutive daily declines. That’s higher than it was a year ago but still well below a peak of nearly $5.02 in mid-June. Energy costs feed into broad measures of inflation, so the drop is also good news for policymakers who have struggled to contain the price increases and for President Biden, who has pledged to lower gas costs.

The national average includes a wide range of prices, from nearly $5 a gallon in Oregon and Nevada to about $3.50 in Texas and Oklahoma. But, broadly speaking, the drop reflects a number of factors: weaker demand, because high costs have kept some drivers off the roads; a sharp decline in global oil prices in recent months; and the fact that a handful of states have suspended taxes on gasoline.

However, the peak inflation narrative may be premature, and there is no evidence that the Fed is going to reverse course anytime soon.

The Cleveland Fed calculates a median consumer-price index and one that trims off the prices that moved the most. This is meant to try to get a sense of how broad-based price rises are—and both rose more than core prices last month. To add to the confusion, both were higher year-over-year in July than in June, even as the month-on-month rate fell back from the extreme reached earlier in the summer.

The Atlanta Fed’s index of “sticky” prices, those that are changed less often and are thought to provide a better guide to what businesses expect, fell. But it still rose at a worryingly high 5.4% annualized in July.

Finally, the New York Fed’s Underlying Inflation Gauge, which incorporates economic data as well as prices to try to get at the inflation trend, hardly dropped at all—putting it in a range of 4.7% to 5.9%.

The Fed will watch the data closely and react accordingly. But, so long as unemployment remains low, they will likely keep raising rates until inflation gets below at least 5%. 

  

Atypical “Recession”

If we are in a recession, then this would be the most unusual one yet. The author compared our current climate to a North Dakota oil town back a decade ago and there are some interesting similarities.

Economists and politicians have spent weeks arguing about whether the United States is in a recession. If it is, the recession is unlike any previous one. Employers added more than half a million jobs in July, and the unemployment rate is at a half-century low.

Typically, in recessions, the problem is that businesses don’t want to hire and consumers don’t want to spend. Right now, businesses want to hire, but can’t find the workers to fill open jobs. Consumers want to spend, but can’t find cars to buy or flights to book.

Recessions, in other words, are about too much supply and too little demand. What the U.S. economy is facing is the opposite. Just like North Dakota in 2010.

The underlying causes are different, of course. Williston was hit by a surge in demand as companies and workers flooded into what had been a small city in the Northern Plains. The United States was hit by a pandemic, which caused a shift in demand and disrupted supply chains around the world. And the comparison goes only so far: Williston’s population roughly doubled from 2010 to 2020. No one expects that to happen to the country as a whole.

Still, whether local or national, the most obvious consequence is the same: inflation. When demand outstrips supply — whether for steel-toe boots in an oil boomtown or for restaurant seats in the aftermath of a pandemic — prices rise. Mr. Flynn recalled going out to eat during the boom and discovering that hamburgers cost $20, a feeling of sticker shock familiar to practically any American these days.

There is also a subtler consequence: uncertainty. No one knows how long the boom will last, or what the economy will look like on the other side of it, which makes it hard for workers, businesses, and governments to adapt. In Williston, companies and governments were reluctant to invest in the apartment buildings, elementary schools, and sewage-treatment plants that the community suddenly needed — but might not need by the time they were complete.

Consumer confidence is at record lows, yet so is unemployment. The culprit is likely inflation, which has a way of making everyone feel less wealthy.

Mortgage Industry Shakeout

As refinance activity and the profits available for mortgage lenders during the last refi boom, the universe of mortgage lenders is likely to shrink. Santander, for example, exited mortgages early this year. The tend of mortgage lending and servicing shifting from banks to non-banks will likely accelerate.

More recently, the largest banks in home loans, JPMorgan Chase, and Wells Fargo, have cut mortgage staffing levels to adjust to the lower volumes. And smaller nonbank providers are reportedly scrambling to sell loan servicing rights or even considering merging or partnering with rivals.

“The sector was as good as it gets” last year, said Wennes, a three-decade banking veteran who served at firms including Union Bank, Wells Fargo and Countrywide.

“We looked at the returns through the cycle, saw where we were headed with higher interest rates, and made the decision to exit,” he said.

While banks used to dominate the American mortgage business, they have played a diminished role since the 2008 financial crisis in which home loans played a central role. Instead, nonbank players like Rocket Mortgage have soaked up market share, less encumbered by regulations that fall more heavily on large banks.

Out of the top ten mortgage providers by loan volume, only three are traditional banks: Wells Fargo, JPMorgan, and Bank of America.

The rest are newer players with names like United Wholesale Mortgage and Freedom Mortgage. Many of the firms took advantage of the pandemic boom to go public.Their shares are now deeply underwater, which could spark consolidation in the sector.  

Complicating matters, banks have to plow money into technology platforms to streamline the document-intensive application process to keep up with customer expectations.

And firms including JPMorgan have said that increasingly onerous capital rules will force it to purge mortgages from its balance sheet, making the business less attractive.

The dynamic could have some banks deciding to offer mortgages via partners, which is what Santander now does; it lists Rocket Mortgage on its website.

“Banks will ultimately need to ask themselves if they consider this a core product they are offering,” Wennes said.

On a call with one of the largest non-bank mortgage originators, the President noted that they can underwrite a mortgage for $5,000, while it costs JP Morgan Chase $12,000. It has become too expensive for many banks to offer mortgages to their clients. Additionally, we are seeing surprising interest in our $765MM MSR pool from mortgage originators that historically have not bought MSRs, but now wish to make up for slower organic growth in their servicing portfolios.

Bank M&A Cools

Bank M&A has slowed in 2022 due to a variety of factors, including depressed stock valuations and higher rates caused by higher inflation.

Only 35 banks decided to sell during the second quarter. That was down from 49 the prior quarter and well below the 66 transactions announced a year earlier, according to a Raymond James analysis.

"Bankers are pretty conservative, but a lot of banks are getting even more conservative now," said Michael Jamesson, a principal at the bank consulting firm Jamesson Associates. "They see a lot of uncertainty out there, and that makes it difficult to make big decisions."

Daniel Goerlich, banking, and capital markets deals leader at PwC, said that aside from prolific acquirers that are highly confident in their dealmaking abilities, more banks are leery about M&A this year.

"There is a general sense of caution about going into spending mode versus cost savings mode" with the specter of recession looming, he said. That noted, even while being more cautious, he said many banks remain interested in potential M&A to expand their geographic footprints, acquire talent, and gain new business lines.

CVB Financial Corp. in Ontario, California, is among them. The $16.8 billion-asset company's CEO, David Brager, said deal talks have "definitely slowed," but "conversations are still there."

He said on the company's earnings call that he remains interested in a deal but would approach one with a healthy level of skepticism.

"Any due diligence that we would do going forward" on a potential target, the possible impacts of an "economic slowdown and the credit quality would be an enormous part," Brager said. "It always is, but it might even be bigger now."

Bank M&A is cyclical and there’s been considerable consolidation in the past few years. Since the financial crisis, we have lost more than half of the banking charters and that trend is not reversing at any point. Some of our clients have asked us to review portfolios of potential acquirers, as they are concerned about increased NPAs due to higher rates.

Gladwell Slams WFH

Author Malcom Gladwell slammed remote work, believing it is harming society in a podcast this week. 

The bestselling author of “Blink” and “The Tipping Point” grew emotional and shed tears as he told the “Diary of a CEO” podcast hosted by Steven Bartlett that people need to come into the office in order to regain a “sense of belonging” and to feel part of something larger than themselves.

“It’s very hard to feel necessary when you’re physically disconnected,” the Canadian writer said.

“As we face the battle that all organizations are facing now in getting people back into the office, it’s really hard to explain this core psychological truth, which is we want you to have a feeling of belonging and to feel necessary.”

“And we want you to join our team,” Gladwell continued. “And if you’re not here it’s really hard to do that.”

“It’s not in your best interest to work at home,” he said. “I know it’s a hassle to come into the office, but if you’re just sitting in your pajamas in your bedroom, is that the work life you want to live?”

“Don’t you want to feel part of something?”

Gladwell added: “I’m really getting very frustrated with the inability of people in positions of leadership to explain this effectively to their employees.”

“If we don’t feel like we’re part of something important, what’s the point?” he said. “If it’s just a paycheck, then it’s like what have you reduced your life to?”

Well said and a provocative point. However, there will not be a major return to the office anytime soon, unless there is strong evidence that remote workers underperform. Perhaps, a recession and job cuts in which remote workers are disproportionately fired could scare workers straight.