May 26: Bank M&A; example of title/lender fraud; Basel update for LOs; wages & inflation; the Fed & mortgage rates

Ready to rush off and join the blockchain rush? Not so fast. The implementation of blockchain technology in the financial-services industry is meeting some resistance, with enthusiasm not equating to industrywide rollout. Like GSE reform, it will take many years and while blockchain’s potential for improving efficiency, security, and cost savings has been discussed, the commodity sector has concerns about loss of confidentiality, while other industry participants say formal regulation and oversight of the technology is needed.

Bank news

Rob, I heard a rumor that Wells Fargo pulled the plug on its rehab(203K) and reno(vation) loan programs. True?” You should ask your local Wells rep.

Bank M&A continues, and just in the last week or so it was announced that Berkshire Bank ($9.3B, MA) will acquire Commerce Bank ($2.2B, MA) for $209mm in stock or about 1.38x tangible book. And thanks to Brian M. who passed along this story about the move of its headquarters to Boston.

Down the coast in Virginia Union Bank & Trust ($8.7B) will acquire Xenith Bank ($3.2B) for about $701mm in stock. SmartBank ($1.0B, TN) will acquire Capstone Bank ($511mm, AL) for about $84.8mm in cash (20%) and stock (80%). In the state where the Green Bay Packers live Bank First National ($1.3B) will acquire First National Bank ($479mm) for about $76.3mm in cash (70%) and stock (30%) or about 1.06x tangible book.

Do banks protect themselves against fraud to a greater degree than non-depository lenders? Hopefully both categories are doing what they can! I received this note from Texas about a recent episode. The names have been changed to protect the innocent, and thank you very much to Linda D. for passing this along.

A title company asked the seller to provide them (and they did obtain) a voided check or deposit slip with the account they were to send the proceeds wire after funding (standard procedure).

The morning of funding, the listing agent receives an email from the ‘title company’ to confirm the seller’s name, email and phone number (which she gives to them). The title company receives a phone call from the ‘listing agent’ to let them know that the seller wants to change where the funds will be wired and they will receive an email and a phone call from the ‘seller’ to confirm and an email from the ‘listing agent.’

The title company receives the aforementioned email from the ‘seller’ asking them to change the account that they are to wire the proceeds to after funding and gives them the new account number and bank. Title company receives a phone call from the ‘seller’ to confirm the new account number the proceeds are to be wired and an email from the listing agent confirming the seller wants to make that change.

The loan funds. $100,000 is wired to the new bank account number from the title company to the ‘seller.’ The listing agent calls the title company to check on funding in the afternoon and title company just happens to mention that they sent it to the ‘new account number’ that had been given earlier that day. Because listing agent was a relative of the seller, she felt that was a little weird and called the seller to confirm. The title company immediately contacted the bank to pull back the funds. Monies were in limbo for several days as the bank sorted things out.”

The moral of the story, of course, is to have standard procedures and don’t deviate or make exceptions. Make the follow up phone calls and confirm. Don’t post the title company in MLS. Confirm, confirm and confirm. Be aware: fraudsters do not play fair.

Perhaps the average LO shrugs and says, “What’s the diff about this Basel stuff? Will it impact me?” Yes, it will, directly and indirectly, mostly be impacting the value of mortgages, and their servicing, for depository banks. If an LO specializes in originating a product that banks don’t want to own, there goes the demand for it, and then the price goes down and the rate is higher for the borrower. “The Basel Committee on Banking Supervision provides a forum for regular cooperation on banking supervisory matters. Its objective is to enhance understanding of key supervisory issues and improve the quality of banking supervision worldwide.” An argument has been made that one “improves the quality” by increasing the amount of regulation – it is a safety and soundness issue.

LOs should know that top banks are calling for a pause in the introduction of capital requirements by the Basel Committee on Banking Supervision, such as the Net Stable Funding Ratio and Fundamental Review of the Trading Book, allowing time for a review of their effects so far, before they are passed into legislation. Meanwhile, doubts have arisen on whether the Trump administration will observe the new rules, as its direction on economic policy remains undefined.

Servicing is a big part of it, and the value of that monthly cash flow impacts rate sheets. The punitive treatment of mortgage servicing rights (MSRs) under the Basel III risk-based capital standards threatens to undermine the value of this important asset, with adverse implications for the entire mortgage finance chain. Performance, capacity and service should be the primary drivers of who gets market share in servicing, not excessively high capital standards on one segment of the industry.

A paper by the MBA a while back listed the issues. “The new Basel III rule increases the risk-weighting of MSRs held by banks from 100 percent to 250 percent. It also decreases the cap on MSRs that a bank may hold on its balance sheet from a 50 percent common equity component of tier one capital to a more stringent 10 percent limit; MSR assets above the limit must be deducted from regulatory capital. In addition, MSRs, deferred tax assets and equity interests in unconsolidated financial entities are limited, in aggregate, to a 15 percent common equity component of tier one capital before they must be deducted from regulatory capital. The unnecessarily punitive treatment of MSRs makes them one of the costliest asset classes in the entire Basel III framework.”

The MBA goes on to talk about the impact on banks, and therefore a great many borrowers. (Remember that Basel doesn’t apply to non-depository mortgage banks.) “In significant part due to the new Basel rules, banks of all sizes have sold MSR assets at a record pace, moving these assets to banks with smaller MSR exposures and to non-bank servicers. Many of these transfers were driven by Basel-related issues, not necessarily by the core competencies of the parties involved. As a result, many banks that are good at servicing and want to remain in the business have been forced to dramatically increase capital levels or shed the asset…The punitive capital treatment, on balance, reduces demand for MSRs, creating a less liquid market that could result in lower prices for mortgages sold in the secondary market, and higher rates for consumers.”

The goals of the Basel Committee are admirable – I want my bank to be safe and sound, have plenty of capital, and not take chances. But I also want my bank to be able to make money from servicing loans. What does a big bank think of it all, in terms of Basel? As an example, here’s Wells Fargo’s take on it.

Capital markets

Tax reform looks increasingly unlikely this year as Republican rhetoric shifts to simple tax cuts, says Sen. Ron Wyden, D-Ore. Both sides of the political aisle contain ample support for tax reform, he says, but the Republican majority has failed to reach consensus on legislation that would clear Congress and gain President Donald Trump’s signature.

Jobs and housing drive the market, and this morning we had weekly jobless claims. One of the biggest issues for the Fed is wage inflation (or the lack thereof). The last time unemployment was this low, we were experiencing 4% wage growth. We aren’t now and here are a few explanations with a few different theories. The first is that there has been a structural change in labor economics, and that the tradeoff between unemployment and inflation is over due to globalization, lack of union representation, etc.

The second explanation is that wage negotiation dynamics have been colored by the economy since 2008: employers are training people internally instead of hiring outside at a higher price, employees don’t feel comfortable asking for more, productivity is lousy, and the huge reservoir of the long-term unemployed means the market is not as tight as it may appear. The final one is a measurement problem: that the BLS numbers aren’t accurately reflecting the reality of the marketplace.

One example that springs to mind is the construction biz. Builders constantly complain that they can’t find skilled labor in areas where there is land, that they are offering signing bonuses, etc. But when one looks at the actual BLS numbers, construction wages are only growing 2.1%. We are seeing in the mortgage business with operations folks as well. So maybe we are starting to see pockets of wage growth, however it isn’t showing up quite yet in the rest of the economy or the numbers.

The Federal Reserve’s Open Market Committee has begun to raise short-term rates. They don’t set long-term rates, nor mortgage rates, but at this point they can influence them. How? Using the billions of agency MBS and Treasury securities on their books, aka balance sheet. Actively shrinking its balance sheet means selling these securities, which could mean driving down prices and driving rates higher. By buying and holding those securities the Fed has artificially depressed long-term rates. You’ll hear Fed Presidents speaking about this nearly every week.

The Federal Reserve’s bond buying has been the agency action with the greatest effect on financial conditions, according to research by Eric Swanson, a professor at the University of California at Irvine. “Forward guidance was more effective than large-scale asset purchases at moving short-term Treasury yields, while [bond buys] were more effective than forward guidance and the federal funds rate at moving longer-term Treasury yields, corporate bond yields, and interest rate uncertainty,” Swanson wrote.

And what’s happened since the election? The dollar, after shooting up in November by 5%, is now back to pre-election levels. The U.S. 10-year Treasury note yield, which pre-election, was close, give or take, to 2%, hit a high of 2.60% a few months ago and is back down to 2.25%. The stock market is at or near an all-time high. With politicians’ heads in other matters, this combination suggests no fiscal stimulus, weak economic growth, good corporate profits, and thus probably weak wage growth – not great news for housing.

In terms of the bond market, yesterday saw treasuries “better bid” with the curve mostly flatter – but not enough for borrowers to notice. Treasuries were confined to a 2.5 basis point range in the case of 10-year T-notes, which ended about .125 better in price than Wednesday night. Agency MBS prices were better by a smidge.

Ahead of the holiday the bond markets are closing early, and of course are closed Monday, but not without looking at some economic news first. We had the second estimate of Q1 GDP (revised to +1.2%, up from +.9%), core PCE Deflator (+2.1%), and April Durable Goods (-.7%). Coming up is the University of Michigan Sentiment Index for May; after that it will become very quiet. After the first volley of numbers the 10-year is yielding 2.23% and agency MBS prices are better by .125 versus last night.

The only cow in a small town in Texas stopped giving milk. The people did some research and found they could buy a super milk cow up in Terra Haute, Indiana, for $2,000.

They bought the cow from an Indiana dairy and the cow was wonderful. It produced lots of milk every day, and the people were pleased and very happy.

They decided to acquire a bull to mate with the cow and produce more cows like it. They would never have to worry about their milk supply again.

They bought a bull and put it in the pasture with their beloved cow.

Whenever the bull came close to the cow, however, the cow would move away. No matter what approach the bull tried, the cow would move away from the bull and he could not succeed in his quest.

The people were very upset and decided to ask the Vet, who was very wise, what to do.

They told the Vet what was happening. “Whenever the bull approaches our cow, she moves away. If he approaches from the back, she moves forward. When he approaches her from the front, she backs off. An approach from the side and she walks away to the other side.”

The Vet thinks about this for a minute and asked, “Did you buy this cow in Indiana?”

The people were dumbfounded, since they had never mentioned where they bought the cow. “You are truly a wise Vet,” they said. “How did you know we got the cow in Indiana?”

The Vet replied with a distant look in his eye, “My wife is from Indiana…”

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Rob Chrisman