One weird sign of trouble in the banking sector

It was only a few generations ago that most people spent their entire lives within a few miles of where they were born.

They grew up, lived, worked, and retired, all in the same place. And that was normal.

Travel and relocation didn’t really become commonplace until after World War II. But even then, the most common reason people moved was because of a job.

And it has remained that way for decades; people tend to choose where they live because it’s close to the place that they work.

But honestly that’s a completely outdated model, and I’ve been writing about this for years:

It’s the 21st century. Whether they realize it or not, countless people have the flexibility to live wherever they want (within reason) while still being able to do their jobs.

Few people ever thought about this… until Covid. And then suddenly tens of millions of people were forced to work from home.

I have no doubt a lot of people hated every minute of it. Some people are wired that way– they need a refuge… a daily escape, to be around other people in an environment outside of the home.

But others absolutely loved it. No more commute, no traffic, more time with the family.

One of my attorneys has an office in midtown Manhattan, but he lives in Connecticut. He told me that working from home saved him more than 2 hours a day.

He’s far from alone, and there are millions of people right now who are finally realizing the same thing.

If they can continue working from home, why bother even staying in the same city? Or the same state? Or even the same country?

Covid was the final spark of what will be a demographic megatrend: a great migration.

And most likely the migration vector will be from high cost, high tax places (like New York) to low cost, low tax places (Florida).

Why deal with the taxes, socialism, and obscene costs of Manhattan when you can spend half the price, pay no state income tax, and live on the beach in Clearwater, Florida? (Or pay almost no tax whatsoever and live on the beach here in Puerto Rico?)

And these same trends will hold worldwide. There will be people who leave London for the English countryside… or Iberian coastline.

And others who leave high-priced, highly-taxed Sydney so they can work remotely from Bali.

With this migration mega-trend in mind, my team and I have been sourcing residential real estate over the past few months, specifically looking at undervalued opportunities in low cost, low tax jurisdictions. both inside and outside the United States.

Within the US, Texas is one obvious candidate.

The state’s lockdown rules were far less Draconian than they were in other parts of the country. There’s no state income tax.

Living costs in Texas are much lower than in most of the US. And there are plenty of wide-open spaces.

It’s a strong choice for anyone looking to relocate while remaining in the US.

Someone from Silicon Valley, for example, could sell their house in California, buy a place outside of Austin, Texas (which is another prominent tech hub) for a fraction of the price, pocket the difference, and save another 30% of their paycheck between the tax savings and lower cost of living.

(And there are places overseas where the financial savings is far more extreme…)

So Texas is one of the places that I’ve been looking for undervalued properties.

It’s an interesting time to be in the market as well, because while the demographic trend is just starting, there’s a reasonable amount of distress in the housing market.

Plenty of people have lost their jobs, or lost their businesses… forcing them to liquidate some assets and sell their real estate for cheap.

This means that there are opportunities to buy cheap right now, while there’s plenty of long-term upside because of this migration trend.

So with all that in mind, my team and I found one such property in Texas that was in distress. It was a sprawling estate of nearly 20,000 square feet on more than 3 acres, located on the very picturesque Lake Travis about 40 minutes from Austin.

The appraised value was more than $12 million, and even in a difficult market it should be worth at least $6 million. But the property was being auctioned off, with the high bid just $3.25 million.

The auction closed yesterday; I’m very experienced in auctions and never overpay beyond what I think an asset is worth, so I was slightly outbid by another participant yesterday and did not win the auction. But I have no doubt there will be others like this in the future.

One interesting thing we found out, however, had to do with the banks.

My original plan (if I had won the auction) would have been to pay cash for the property. And then, eventually, refinance it with a local bank to pull my original funds out.

Most mortgages in the US tend to fall under ‘conforming’ loan rules that are set by federal housing agencies like Fannie Mae and Freddie Mac.

If you’ve not heard of those, Fannie Mae and Freddie Mac are technically private companies that are fully backed by the federal government.

Their mission is to buy mortgages from banks across the US, effectively helping to replenish the banks’ capital so they can make more loans.

Fannie Mae and Freddie Mac issue very strict guidelines to banks, stipulating exactly the terms under which they will buy a mortgage. And mortgages that fit those criteria are known as ‘conforming’.

For example, a conforming mortgage must be under a certain amount– and the federal housing agencies have a list of maximum loan values.

For most of the country, the maximum loan limit is $510,400 for a single family home, but for specific counties the limit may be higher. In Los Angeles, for example, the limit is $765,600.

And there are other requirements for a conforming loan, such as a borrower’s credit score, the ‘loan to value’ ratio, etc.

The point is that banks are able to sell their conforming loans to these government(ish) agencies, making the transaction nearly risk free for the banks.

This didn’t used to be the case. Long ago, banks would sit on their mortgages for the full 30 years and make their money on the interest payments.

These days, banks are just useless middlemen. They write a loan and almost immediately flip it to the government. And instead of making their money on the interest payments, they charge all sorts of origination fees, funding fees, ‘points’, etc.

Mortgages that don’t meet the ‘conforming loan’ standards– like jumbo loans– can’t be as easily flipped… and that means the bank actually has to be willing to hold the loan on its books and collect interest.

And this terrifies banks. God forbid they actually have to do real bank business!

That’s what I found so interesting. I had one of my associates call several banks in the area to inquire about their lending terms.

Some of them were local banks, some were national banks (like our old favorite Wells Fargo) with local branches in the area.

Literally every single bank told us, “Yeah, we’re just not doing jumbo loans…”

This is pretty incredible. Since jumbo loans are not conforming (i.e. they can’t be flipped, risk-free, to the government), the jumbo mortgage market represents a more honest indicator of lending conditions.

So the fact that these banks are simply NOT making jumbo loans is very interesting. It suggests:

(a) Banks are NOT optimistic about economic conditions, and they don’t want to take on new risks right now; and

(b) Banks are NOT optimistic about their own conditions. Most banks are sitting on a mountain of loan losses right now because millions of people have skipped loan payments due to Covid. So they’re not willing to take on any new risk because their balance sheets are already in dismal shape.

According to the Wall Street Journal, for example,Americans have skipped payments on more than 100 million loans since Covid struck. That’s debilitating for banks.

And this jumbo issue we came across over the past few days is just another sign of trouble lurking beneath the surface.

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