Markman Capital Insight

Digital Banking Rebel Pioneers Leveraging Of Crypto For Home Loans

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Mortgage rates in the United States are rising quickly, yet a Miami startup is racing to securitize home loans with cryptocurrency. No down payment is required.

Milo, a Florida-based digital bank, is now using digital coins to secure hard assets. The larger plan is to pool crypto-backed home loans and offer them as bonds to asset managers and insurance companies.

The strategy is risky. Investors in financial stocks should beware.       

All of this should sound familiar. Pooling risky home loans, then selling them to unsuspecting assets managers was the recipe for the Great Recession of 2009. As long as housing prices continued to climb, homebuyers were able to refinance and everyone got paid, including bondholders. However, when housing prices imploded millions of low credit score borrowers defaulted. The rest is history.

Many economists see parallels.

Inflation is running at the highest rate in 40 years. Several years of cheap money policies at the Federal Reserve helped too many homebuyers chase too few new homes. Prices in many parts of the country have been rising at an unsustainable rate.  

At the Federal Open Market Committee meeting this week Fed governors are widely expected to raise short term rates by 50 basis points, and signal that more increases are in the offing. Although late, the change in policy at the Fed is sending a chilling message.

The Wall Street Journal reported that domestic mortgage rates are rising at the fastest pace in 35 years. At 5.5%, the average rate on a 30-year fixed mortgage is up 71% since January. Higher rates can increase a borrower’s monthly costs by hundreds of dollars. Ultimately those increases should lead to fewer buyers and lower home prices.

That’s why plans at Milo are fraught with warning signs. Bloomberg notes that Milo recently raised $17 million in Series A funding, and that the company has issued pre-approval letters on $340 million in new mortgages during the past month. Moreover, Josip Rupena, chief executive, claims that the company has a wait list of 8,000 home buyers in Texas, California and New York.

Those buyers will be able to secure mortgages without worrying about the down payment. Applicants will merely pledge their digital coins as collateral. This means they will also avoid taxes on capital gains, or the opportunity cost of rising crypto prices.

The product seems to be like a win-win, assuming real estate and crypto prices keep rising. Except there are signs both bets are unlikely to be winners in the near term. BitcoinBTC is off by 40% since it reached $66,000 in November 2021. And U.S. property prices now face headwinds from a change in Fed policy and rising mortgage rates.

Oddly, the major money center banks in 2022 have been stepping up exposure to crypto currencies.

Reuters noted in April that a slew of big banks began offering crypto to their most well-heeled clientele. Morgan StanleyMS (MS) is giving clients with at least $2 million, access to three new crypto funds. Wells FargoWFC (WFC), CitigroupC (C), Goldman Sachs (GS) and Bank of AmericaBAC (BAC) began offering dedicated crypto products last year.

Financial stocks are down sharply in 2022 despite rising rates. Traditionally financial firms have been helped by wider spreads between their lending rates and borrowing costs. This year banks have moved sharply lower. More downside seems to be cued up.

At $305.49 Goldman trades at 7.4x forward earnings and 1.8x sales. That is not extremely dear, yet it is also not historically cheap. The stock should trade substantially lower if rates continue to move higher and crypto remains under pressure.

My research suggests a decline to the December 2020 lows at $240 is possible if real estate and crypto prices continue to fade.

Aggressive investors should consider new short positions into strength.