Mid July: Inflection Point Thinking
Cheap rally candidates, Why large banks rallied, The housing market, FFWM, "Great" Ajax
Good morning,
In this note:
Turn in rates inflection point: What are some written-off losers that can extend their rally?
How the largest banks outperformed by so much the first half of this year, where market structure drove returns ahead of fundamentals.
Some behind the scenes angles in the First Foundation (FFWM) recapitalization
Reeling REIT followup: among REITs carrying 7-10% bad loans, a look today at Great Ajax (AJX).
Put housing market doom forecasts to the side
Brief notes:
Trump was good for banks in 2018 and is again today. This note covered the benefits of a Trump victory in a February post. At the time, all anyone cared about was whether NYCB would fail but today “45” is back front of mind. The short version is a change in president should:
a) Support bank mergers. The FDIC has in recent years adjusted so that in order to acquire, many banks have had to commit heavily to lower-income lending, promise not to cut jobs, and had their mergers delayed by 6-9 months for unclear reasons. Some claim that in-state banks were not allowed to buy Texas-headquartered Independent Bank (IBTX) due to threatened delays over branch closures.
None of that occurred in the prior administration and we can likely expect a return to that normalcy.
Recall PNC is looking to acquire possibly hundreds of billions in assets. That could bring positive attention to the sector with this support.
b) Allow banks to compete better by pausing the endless calls for more capital. There is a tendency, with Yellen the most demonstrative, among democratic administrations to crimp bank growth and, whether intentional or not, push trillions of growth into unregulated lenders.
Wells Fargo has shown declining loans for 7 straight quarters. Ex First Republic, JP Morgan loans are barely above 2021 levels as these banks meet constantly higher stressed capital buffers.
In contrast, credit unions count air as Tier2 capital, Euro banks run with 50% less core equity, and Japanese banks are in their own world.
Private credit is now in the multiple trillions of dollars whereas before 2006 it was rarely mentioned. Blackstone is now worth $158 billion dollars, or 3x the market cap of US Bancorp.
Trump could give banks a shot again.
Conversions: Fidelity Homestead Bank of New Orleans (FBLA) is a coming conversion with 20% non-interest bearing deposits. It will enter the Russell 2000 and may come near 50% of tangible book.
Fidelity is a 100! Well, the efficiency ratio hovers around 100%, which is a drawback.
Still, at the offering multiple, the math with a properly run conversion trading at 50% of book is straightforward - shares double if they buy back shares to tangible book as their fiduciary obligation implies they do.
Do your own diligence, but this one is actually worth looking at, unlike so many other recent conversions.
On to the notes:
1) The market is pricing an acceleration of rate cuts. A look at what that means.
We have been through 2 fool’s gold rallies in banks since summer 2023 on the hope of rate cuts, but the consistency of rising unemployment and now shelter costs finally buckling suggest this time the likelihood is higher.
I tread very carefully writing anything related to macroeconomics, but in figuring out why some are forecasting so many rate cuts, one datapoint sticks out. When unemployment begins a material tick up, it keeps going, in almost every US economic cycle.
13 times since 1945 the unemployment rate has begun an uptrend and 12 times it has gotten away from policymakers.
Traditionally officials could use fiscal spending to cushion this ramp in unemployment but today Treasury runs crisis-level deficits as a matter of course so that is not reasonably available, making the Fed’s job more delicate.
In this context, it should not be a surprise that multiple Fed governors are discussing how to manage unemployment and markets are beginning to expect cuts.
So, what would you make of 8 consecutive 25bp cuts, as Citi calls for? The below plus the next 4 meetings after:
If you manage a portfolio, there is a clear possibility for a forgotten sector to see material support for the balance of this year, particularly if the Trump catalysts are added.
Where should investors look?
Dumpster search.
Dilution risk remains, as at FFWM and NYCB, but increasingly the market will give real-estate saddled lenders more benefit of the doubt.
One starting point for finding these call option companies is a Price / TBV screen:
Some of these companies are not salvageable, and many others are uninvestable. AFC Gamma is a pure play on cannabis lending, Great Ajax’ has a full page of related party transactions, Blue Foundry’s corporate governance, Ready Cap, North Dallas etc are all challenging.
Others however are in reasonable shape. I will profile FMBL in a later note. FLIC has an in-demand deposit franchise, and NASB just announced a repurchase that if acted upon would be a material catalyst.
Ironically on the opposite side of this screen at 100x tangible book is another beneficiary - United Wholesale Mortgage - UWMC.
Be careful with consumer lenders. 6-8 rate cuts is good for real estate but if that many cuts are necessary it will be because the unemployment trend is hurting consumers.
Below are the participants; be careful with many of these:
all table data from S&P
