E320 | What Bank Balance Sheets Tell Us About the Future of Note Investing

Today’s chatter on the Paper Trail podcast is all about the latest Quarter 12025 Bank Call Report data and what it’s spilling about the mortgage note scene. They dive into why banks are feeling a bit skittish about the economy, hinting that lending is slowing down and defaults are creeping up like a surprise guest at a party! It turns out, over 70% of bank asset growth is from trading assets, not loans, which is like throwing a pizza party but only serving salad—everyone's gonna be disappointed! The crew breaks it down for investors, explaining how these shifts could mean more opportunities for note buyers as defaults rise and inventory comes into play. So, grab your headphones and let’s explore how to navigate these choppy waters without getting shipwrecked!

Get ready to dive into the wild world of mortgage note investing with the latest episode of the Paper Trail podcast! The host kicks things off with a bang, breaking down the Quarter 12025 Bank Call Report data that’s hotter than a summer sidewalk. He spills the beans on how banks are tightening their lending practices – and trust me, this is no small potatoes. With banks loading up on trading assets instead of actually lending, the episode paints a picture of an industry on the brink of change. It’s not all doom and gloom, but there’s definitely a shift happening, and savvy investors need to be paying attention.

As the host digs deeper, he highlights some key takeaways that’ll make any note investor perk up their ears. Slower lending typically means a higher risk of defaults, and with banks pulling back, there’s a chance we might see more distressed loans popping up. This could mean opportunities for those ready to pounce. The host doesn’t just throw out numbers; he weaves a narrative about cash-poor homeowners who, despite having equity, are struggling to keep their heads above water. This could lead to a wave of discounted sales that would impact property values across the board – so it’s crucial for investors to stay sharp!

To wrap things up, the podcast offers up some solid advice for navigating the choppy waters of the mortgage note market. The host emphasizes the importance of building a reliable team and staying flexible in investment strategies. With the signs of distress emerging, it’s all hands on deck for investors to prepare for what’s next. Whether you’re a newbie or a seasoned pro, this episode is packed with valuable insights served with a side of humor, making it a must-listen for anyone looking to stay ahead in the mortgage game. Tune in, take notes, and get ready to ride the waves of opportunity!

Episode Transcript

(00:44):
Welcome back to the PaperTrail podcast where we follow the
numbers, decode the headlinesand translate data into opportunity
for mortgage note investors.
Today we're diving into theQuarter 12025 Bank Call Report data
and what it tells us aboutwhere the industry might be headed,

(01:06):
especially for those of usbuying, managing or investing in
mortgage notes.
And people are probably askingwhat the heck is bank call report
data?
And most people don't knowthis, but the banks every quarter
must report their informationto the government and all this data

(01:27):
gets collected and a bunch ofpeople out there analyze all of this
data to figure out what howbanks are doing.
Are banks strong?
Is each you know what's goingon with all the different banks?
And today we'll talk moreabout the macro conditions, not a
specific bank.

(01:48):
And little spoiler alert.
Let me just tell you, banksare not bullish on the economy right
now.
Lending is slowing, defaultsin certain segments are starting
to creep up and many largebanks are loading up on trading assets,
not loans.
And that has some realimplications for people and note

(02:10):
investors in the space.
So let's unpack what all thismeans without all the fancy jargon
so you know where theproverbial puck is headed.
So let's first talk what thebanks are doing.
Let's talk about what they'renot doing.
Banks have really tightenedlending and top line number bank

(02:34):
assets jumped by about 436billion in quarter one.
That sounds like a really bignumber, 436 billion.
But here's a catch.
Over 70% of that growth camefrom banks trading assets and security
repurchase agreement.
You ever heard term repos?
That's what that is.

(02:55):
So actual loan growth was lessthan half a percent.
And even more telling in thiswas one to four family mortgage loan
balances actually shrank.
I'm not sure you know howoften that happens, but it's not
very often.
I believe consumer portfolioloans like auto and credit cards

(03:18):
were also down.
Most of the growth in thelending came from two categories,
non depository financialinstitutions and purchase and hold
security loans.
And that's really not theeconomy getting credit, It's Wall
street really just movingmoney around is really what all of

(03:38):
that means.
So think about it this way.
There's not a lot of inventoryor new loans coming into the space.
Just everything that's thereis still getting shifted.
Now let's be honest for usnote investors, most of us being
in a 15, 16, however manytrillion dollar industry, you're
just a speck in the universeand you'll be able to find loans.

(04:03):
But it still matters for note investors.
So what does this have to dofor those of us who are in this space?
When banks slow lending toconsumers and households, cracks
eventually show up in consumerdebt performance.
And here some of the takeawaysI think people should take away from

(04:26):
this episode.
Slower lending typically meanshigher default risk.
Later, less new lending cansignal some caution.
As credit tightens, distressedborrowers often can't refinance or
resolve delinquencies.
That means more defaults andmore non performing loans and more

(04:47):
inventory coming to the market.
Now recently most peoplethink, oh, in 2008 they were giving
out all these loans, so that'swhere the higher defaults came in.
But that's such an anomaly andI cannot tell you how many bigger
pockets, Facebook, Redditposts I see from people who are equity

(05:10):
rich and cash poor and theymight have 30, 40% equity in the
property, nobody will touchthem and they can't afford that property
anymore.
Now what happens in thoseinstances is they end up having to
sell and then they sell at a discount.
Then all of a sudden somebodyelse nearby has to sell at a discount.

(05:32):
And what does that do tooverall real estate comps?
Comps go down.
So it's going to impact.
You could be a great operatoron a rental property or any other
property or homeowner, but ifeveryone around you can't manage
your finances, it can impact you.
So just be aware of that.
Clearly banks are shiftingaway from some of this direct exposure,

(05:55):
these fast lending categoriesthat are, I'll call it like the rocket
mortgages who are nondepository, meaning they don't take,
they're not a bank, they'relarge companies.
I think UWM is another one.
Some of these securities andthey're doing this because it's easier
to move off their balance sheet.
For example, they get allthese loans and they turn around,

(06:16):
securitize them to Wallstreet, much easier.
Mortgage backed securities,you may hear.
But many of these underlyingassets are loans that are in disguise.
And as these, especially thecommercial side, you see these portfolios
mature, you're going to seerising delinquencies, amateur defaults,

(06:36):
which is opportunity for notebuyers who can work out extensions,
modifications to avoid eventaking some of these back by foreclosure.
Now what also has caused someof this, let's be honest, underwriting
quality kind of look shaky lately.

(06:58):
Some banks are reportedly evendoing note on note financing at 90
or 100% of LTV, basicallylending against other loans to offload
risk.
That's short term optics, notlong term stability.
I don't know any loans thatare doing that.
I'd love to find some loansthat are financing other loans but
that's again kicking the candown the road and could lead to more

(07:22):
distressed paper in the future.
Especially on some of thesejunior liens.
Now when people are doing thatwe start connecting the dots.
The actual note investingfirst lien mortgage balances shrank.

(07:44):
Let that sink in that for agrowing economy people are buying
refinancing.
With all the equity peoplehave between refinancing and buying,
balances actually shrank.
Think of how many mortgagesare like 3%, so how much?

(08:04):
Yes, a good percentage of thatis now principal versus interest.
But to me it's just mindblowing that you see that balance
shrink.
To me it's almost like seeingpopulation growth shrink.
It's hard to grasp.
Now junior liens and helocs ofcourse saw some small upticks and

(08:26):
that goes back to what I saidearlier where you've got the equity
rich cash poor people andthey're trying to survive.
I know an investor, not goingto name the name or the state who
has a pretty large portfolioof assets and they were looking for

(08:51):
some assistance financialbasically an equity partner step
in because they thought theywere cash negative x amount of dollars
every month.
When we looked at it they wereabout 5x negative cash equity in
cash flow per month and wherethey needed to be.

(09:11):
Now they had significantequity in their portfolio but now
it was about 40% equity.
But going to a lender is onlygoing to give you on a HELOC today.
If you can get up to 70% loanto value, you're doing great.
Most of them are at 50, 60%.

(09:32):
We passed on that opportunitybecause we didn't see an exit.
The portfolio was aninvestment portfolio so it was all
over the place for performance.
And knowing what we know, withdelinquencies rising in residential,
commercial, new constructionand other consumer segments, the

(09:54):
only exit was to sell.
And we didn't want to be partof having to kick in additional cash
to own a portion of portfolio,give them a loan to then take these
assets back.
Also again, some regional andsmaller banks are showing distress

(10:16):
that could lead to bankfailures or portfolio liquidations.
A few years ago, the companyPeer street as an example, was doing
a lot of lending.
They failed, went under andthat whole portfolio ended up getting
liquidated.
So don't be surprised if overthe next 6 12, 18 months we see more

(10:36):
defaulted loans.
I'm seeing it already, but aLot of what we're seeing is on the
investor side of things.
We're starting to see somecracks in people buying homes during
COVID but the rates are stillvery very low and the price points
aren't making sense right now.
But where we did see a gooduptick in defaults is also some of
those junior liens that peoplehad equity and maximize equity in

(10:59):
their property and now againare back to racking up credit card
debt and not able to pay.
As I mentioned, I keepreiterating this, it's going to probably
lead to more productavailable, also better pricing as
funds and banks look to exit.
There's more inventory, isthere less people buy this paper.

(11:23):
And I recently mentioned onanother podcast this increased foreclosure
activity probably going tolead to more investors taking properties
back.
So be careful, be prepared.
That might occur.
So how do you prepare as anote investor?
Great question.

(11:44):
Let's be real, there is ashift coming and I'm not saying 2008
all over again, but we've seenthese signs flashing yellow for at
least a year.
So what do I recommend?
They mentioned in a priorpodcast build your take back team.
Now if you're seeing moreforeclosure activity, you need boots

(12:09):
on the ground.
Realtors, preservationcompanies, contractors, property
managers, the attorneys.
Start getting them lined upnow because not only do you need
them for the deals, they mayactually lead you to some deals.
They may know somebody who'sin trouble.
You might be able to buy that loan.

(12:32):
Second, choose your target andchoose it wisely.
I know some who are targetingsecond liens, some in helocs, some
who are targeting non owneroccupied single family, some doing
commercial.
Now the seconds and commercialof course are the first segments
to show the cracks and alsothe most discounted notes you can

(12:55):
buy.
But they're not for everybody.
So pick your target.
I also recommend that you staycautious with reperforming loans.
With some of this consumerweakness data, even reperformers
could slide again be extrathorough doing some of that property
level in person due diligence.
What I thought was reallyinteresting was it was actually comical

(13:17):
I should say and I did notcall this person out.
Which I really wanted to wasI'm in a very large group with a
lot of people who are passiveinvestors and this person made a
comment that they pulled outof every non performing note fund
they invest in and went to aperforming note fund specifically

(13:38):
theirs or one they'reaffiliated with, work for whatever.
And I just if it was not themost, what's that term where you're
self promoting post I've everseen in this group which you're not
supposed to self promote, Iwas like of course it's from this
person which this person onlysees rainbows and unicorns about

(14:00):
their philosophy and their assets.
But to me I look at the exact opposite.
Non performing note funds arebuying assets already non performing
and at a discount performingloans you're paying a heavy premium
for, especially reperforming.
And if they go non performingyou will lose.
You know you're going to losemoney on that deal or you're not

(14:22):
going to make enough to payyour investors back point blank.
Tell you that right now.
I know some debt funds thatonly focus on performing and I can
share with you their financials.
They are ugly because of theirdefault rates.
So if someone tells you thatin a downward economy at performing

(14:43):
loans, again non performing orhigher risk, of course they are.
But if you have two people arevery good at managing each asset
class, I wouldn't say get outof one and go to the other because
the other one could also havesome significant and serious issues.

(15:05):
Also, when you're on thelookout, be careful of the tapes
you're looking at.
Some of them can also havereally hairy assets.
Some of them, for example, atape we saw had a lot of bad paper
with lawsuits.
Others again people trying toget rid of exposure in regards to
super low interest rates.
Make sure you target everyexit strategy and don't just say

(15:27):
oh this looks great on aforeclosure, but if they were able
to reperform or filebankruptcy, it crushes you.
Be careful of that.
And as always as I wrap upepisodes, if this feels overwhelming,
consider investing in a fundworking with experienced operators
because they invest passivelyin a mortgage note fund like us at

(15:49):
70 as we actively adjust ourstrategies based on data like this
and data that you don't haveto spend a Sunday like I am scouring
through to see where we'reheaded and start planning accordingly.
So my final thoughts in thisepisode as we wrap it up.

(16:09):
Clearly big banks are startingto pull back from some of that traditional
lending.
They're more leaning harderinto trading and off balance sheet
strategies.
We're starting to see earlysigns of distress, especially emerging
in the non banks commercialjunior liens which those are always

(16:33):
a first to see and then itmakes its way into that single family.
We're also seeing an investorloans but again it creates opportunity
for those who are smart,prepared note investors.
And at 70 we are watching this closely.

(16:55):
We do look at our strategiesboth manage risk and manage that
upside down.
As we wrap up this episode,thanks for tuning in to the Paper
Trail podcast where we followthe numbers and keep you ahead of
the curve.
For more information on noteinvesting in general you can check

(17:18):
us out at 7e investments.comalso we will be hosting the paper
trail conference sept 18th to20th in Chandler, Arizona.
Can grab [e-mail] I
highly recommend you takeadvantage of our current introductory
pricing on those as this eventdoes have limited ticket quantities

(17:42):
and we anticipate that it willsell out.
And also if you feel like yougot value from this episode, we'd
appreciate if you could followrate or share this video.
Leave us a Google review andcheck us out again@7e investments.com
where we provide insights,tools, education and real opportunities.

(18:06):
Until next time, stay alert,stay flexible in your investment
strategies and keep followingthat paper trail.
Thank you.