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Have We Got a Long Way to Run?

It is ten minutes after one in the afternoon on Sunday. I am at the store. Last week was an exciting one in the markets, with many S&P cos reporting earnings including all of the tech giants. Readers may recall I had a small speculative bet on silver, with option expirations on the 17th, which I wrote about here: http://rwhadvisoryllc.com/animal-spirits-or-spirit-animal/

Sadly, my calls expired just as the trade was coming into the money, but I did get shares put to me as the price crossed $19 and have enjoyed the gains on the way up. I maintain my long position in silver and continue to accumulate physical at the store. I don’t really have a price target at which I will sell. I view this, like gold and #bitcoin, as an easy trade for the foreseeable future and will probably only sell for reasons of necessity. If we see $48, I will probably take some profits and reallocate. Recall that I took only a very small position.

I should also follow up on this note I posted in between blog entries: http://rwhadvisoryllc.com/note-to-self-when-to-sell-dollars/ . Since then, the dollar has, in fact, dropped below 94.5. In fact, is reached about 92.64 before turning around to end the week at 93.46. I have dutifully reviewed my dollar long position and left it in place. I have not previously disclosed or discussed my dollar long position, so let me start with that.

I am fundamentally in the camp which says the dollar is going to go up, and will become very strong, i.e. the deflationary camp. I have found strong thinking on both sides of the inflation/deflation debate, and I squirm a little knowing how smart some of the people are saying that the dollar is crashing, but when I weigh these arguments on my own scales I have assayed that the dollar will experience a very strong rise before any final capitulation, should final capitulation occur. Also for the record, I think final capitulation will occur, just not now and not next. For insights into one of the strongest influencers on my long dollar thinking follow @jeffsnider_aip on Twitter and watch his Eurodollar university series on youtube: https://youtu.be/P0q7W9Hqk0M

But that isn’t the only reason I went long USD. I am thinking of it as a little bit of a paired trade with a bullish spread on CVX. I think we will be seeing some real volatility in oil over the next 12 to 36 months, ultimately with much higher overall prices. CVX, which was hammered after a negative earnings report last week, is a business I am familiar with and have traded or owned in the past. I expect the volatility in the dollar to show its reflection, both positively and negatively, in the overall stock performance of CVX. In the longer term I am expecting to shed my dollar long, and in the meanwhile look for gains and losses to partially off-set between these two trades. I don’t expect it to be a very direct kind of hedge. Just a little bit of a paired trade. I will be looking for USD to reach at least 104 before I think about selling.

Here are the details on my CVX spread:

I was able to spend some quality time with the earnings release by NRZ this week, but since I have already carried on quite a bit, I will post my thoughts separately. PennyMac will release earnings this coming week, currently scheduled for August 6th and I am looking forward to hearing what they have to say. Broadly, for this group of companies, my themes are:

  1. Transferring the bag, i.e. – shifting shares to public float, insider selling, loading up on debt, special bonuses and payouts to executives, etc.,
  2. The attendant pumping behaviors that go with (1), above, especially an emphasis on the current and next quarterly outcomes, which will all be very strong, a reluctance to recognize known or knowable costs and impairments in the current period and an unwillingness to acknowledge the potential severity of our current economic situation,
  3. The lack of self-awareness, avoidance or denial of the fact that huge profits are currently being privatized at the cost of taxpayers due to government manipulation of the markets and nationalization of mortgage banking risk, while privatizing profits, and
  4. The structural weakness and obsolescence of residential loan servicing and correspondent lending as activities at all.

I will look forward to digging in deeper on those themes this week. Meanwhile, stay informed with these two fantastic podcasts from this past week (I am not compensated in any way for posting these links):

Pomp Podcast #351: Roger Ver on Personal Freedom and the Early Days of Bitcoin

https://www.youtube.com/watch?v=P9oC_goIX8I&feature=youtu.be

Danielle DiMartino Booth with Jeffery Gundlach

https://www.youtube.com/watch?v=WQQA74TtWao

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https://lolli.com/ref/G3qkhczpGf

Final thought, and it is a difficult one: as of August 1 we had about 155,000 covid-19 related deaths in the United States. This has played out almost exactly as I had guessed when I wrote this: http://rwhadvisoryllc.com/another-blog-post-about-covid-19/ . Now we can see with hindsight that it has coalesced in the public consciousness only very slowly, and in the face of unimaginable denial. And arguably, sadly, this amount of death has not yet been sufficient to fully bring about that coalescence, as politicians, press, and common people all battle over every aspect of the disease and our response, leaving us without a uniform plan. Have we got a long way to run? Yes.

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Surrogate Market Forces for Loan Servicing

It is ten thirty at night on Sunday and I am at the store. I have mentioned before that Sunday is a day I like to spend reading, studying and learning. Most of my day was preoccupied by other demands, but I am finally able to settle in for some study, and especially with an eye on the markets and tomorrow’s open. To that end, I have been looking at TZROP. I have been through their public report, and done some other reading, but still in learning mode.

Another topic I have touched on tonight is my favorite: mortgage banking. Readers will know, I have a dim view of loan servicing, especially as an asset to invest in, but also primarily because it is wholly unsupportable from the perspective of both mortgagor and investor. The actual task of receiving, applying, and remitting mortgage payments into a bond structure is so stupid simple that no customer would ever pay the mortgage servicing fee, if they ever knew they were paying it, and had a choice. That means, yup, the only ones benefiting are the servicers.

The Covid-19 pandemic has forced changes on servicers which bring their (lack of) utility into focus. These are basic changes of work-from-home, and customer self-service which 1) should have been made ten years ago, but for the problem that it 2) undermines the idea that the utility provided supports the amount paid by borrowers. As servicers move their teams to work from home, they will enjoy reductions in overhead costs at their facilities. Their decentralized workforce will demonstrate that the tasks of loan servicing can be largely crowdsourced, when human intelligence is required. Servicers are accelerating the already purposeful programs migrating customers to perform much of the work of servicing themselves, using self-service options online.

So, when will the servicing fee come down? When will we start to see some price wars with servicers trying to attract borrowers to their platforms with discounts and incentive? When will we see agents paying premiums and incentives to mortgagors in exchange for rights to transaction information about tax and insurance payments, or other personal information? When will borrowers be able to choose? My answer is: we will see things like this before your current MSR’s expected duration is up.

The drum beat I am pounding is that servicing is an anachronistic institution. One which we are doing out of habit, because the people paying don’t really know they are paying it, and because there is no real incentive for the servicing industry to innovate, except on cost of regulatory compliance. Because of this, it is structurally weak, and ready for a fall. For those who knock it over, there will be opportunity.

In other news, I will again recommend Peter McCormack’s four part docu-series about our current Treasury Secretary, Kip Mnuchin, which you can find on YouTube here:

https://youtu.be/CEDGVatau5A

Final thought:

Our hearts beating on

Gentle shores and crashing cliffs

Ocean’s timeless way

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Residential Mortgage Loan Servicing Deep Thoughts #2

If homeowners could choose to service their loan for themselves for free, or pay the .25% servicing fee to have one of our big bank or non-bank servicers do it for them, how many would still pay the fee? How about once the homeowners learn that servicing their own loan requires no extra work from them?

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PennyMac Earnings For Breakfast

It is still May 6th, and I am still at the store. It is now about twenty minutes before seven in the evening. I want to write a few words about PennyMac and earnings tomorrow. Obviously, with my history with PennyMac and its management, my views on the company are plagued by biases. Those biases suggest the company operates at a constant deficit in human and intellectual capital which will impede even a successful strategy. And my assessment of the company’s strategy is basically this: PennyMac is not a company built to last. It is a company built on the oldest models for the purpose of exploiting the institutionalized business of mortgage banking. It exists to profit to the very fullest extent possible before the inevitable collapse of the current, anachronistic (and I would add anti-competitive, socialized risk) model of the industry. I don’t judge that as a wrong-headed thing to do. In fact, it cannot be argued against, if one looks at the financial performance of the company so far. I am saying the company is purpose-built, and that purpose is not to lead an industry into the future, but to seek the available excess rents while they exist. While one can chalk up my views of management to the bitterness of a failed work assignment, I think this strategy assessment stands up to scrutiny. If one considers the start of the company, where its money came from, what other business interests that same money had and has in and around the same industry ecosystem, who the leadership team is and what their backgrounds are, I think there is a good argument to say I am right. Time permitting, I will expound more on these questions of origin and interests.

PennyMac’s planned obsolescence is not its only weakness at this point in time and this point in the economic cycle. Or perhaps even because of its mission, it is concentrated in businesses I think are especially vulnerable to sudden disruption, by intervention or by market forces. Specifically, I am talking about correspondent lending and residential mortgage loan servicing. I view these as obviously fragile businesses that are capital intensive and valueless. Again, I will certainly be expounding on these subjects in more detail in the future. Add to these the latest developments in credit risk securities esoterica, financed with leverage, of course, and gorged on by PennyMac and I just could not be more bearish.

Still, is it enough to have conviction for a trade? No. I just don’t have enough insight to say what the trade will be for tomorrow’s earnings. I am on the sidelines, eager for a look at whatever the public docs say and don’t say. Even if I thought I had insight into financial under performance, in this climate of Fed intervention, I’m not sure it would matter. Everyone is getting a bailout if they are big enough to have lobbyists. And PennyMac minds its Washington connections.

If I could share one tradable insight, it would be this: During the first quarter founding partners of the company, acting in coordination with it, took actions as disclosed in published 8-Ks, to dis-invest about 35% of the company’s equity, transferring it to public float. People will argue that these sorts of actions get planned well in advance, and many features of the economic landscape could not have been known by the investors and management at the time the decisions were being made. My point would be that it doesn’t matter. The founders had an exit planned when they went in, and they are beginning to exit. They may be very happy/lucky that they transferred their ownership and its attendant risks to the public just as the markets were about to collapse (and arguably, just as the old model of the mortgage industry is about to disappear). Maybe it is just good fortune. But keep in mind, many sophisticated investors have been aware of the potential impacts of the coronavirus since December, or possibly November of last year. This is doubly true for investors who are well connected politically or who have global financial interests. Even putting all of the pandemic to one side, as though it never had happened, the macro-climate was already in serious distress. Fed interventions have pre-dated the coronavirus by many months. I can easily imagine that the founding investors saw the sun setting on the business model and started to execute their planned exit well before the virus. It was just time.

I don’t know how bad tomorrow’s results will be, or maybe even they will be good. But the rats are leaving the ship. It won’t be staying afloat for long.

Parting gift: another #bitcoin meme that made me laugh over and over… https://twitter.com/i/status/1258070598225408001