October 9, 2017 | Last week financials continued their relentless march toward the sky as investors chased the happy prospect of higher interest rates from the Federal Open Market Committee and maybe even tax cuts from Congress. In a world with too much debt and regulation, and too little economic growth as a result, driving financials (and all other asset classes) up to valuations not seen since the roaring 2000s is a fool’s errand, especially when you notice that credit spreads remain largely unaffected by the threat of “tightening” by the US central bank. As we noted last week, credit spreads are so constricted and lending volumes so weak that it is becoming increasingly difficult for larger banks and other intermediaries to earn a profit on old fashioned lending. Yet the members of the FOMC continue to think of current policy as a form of “stimulus.” The sad fact is that most Fed governors and staff economists don’t really know how to think about banks or the credit markets. Like their collaborators in the financial media, Fed officials largely think of benchmarks like Fed funds or the discount window, but it is credit spreads that really matter, both to bank earnings and economic growth. In fact, benchmarks like Fed Funds have very little impact on the credit markets compared with other factors. The folks at Fed Dashboard, for example, note: “The Federal Open Market Committee (FOMC) expects their interest rate decisions to change the economy because they expect the Effective Federal Funds (EFF) rate implemented at a trading desk at the New York Federal Reserve Bank to consistently cascade across credit classes from Treasury Bills to business and consumer borrowing.” But they warn that the Fed Funds rate “has not been consistently cascading through credit rates for decades, reducing the benefit to borrowers.” Of course, folks at the Fed do not seem to have much time for thinking about banking matters much less the functioning of the credit markets. One senior DC counsel told a group last week that Fed Chair Janet Yellen is “not terribly interested in bank supervision” and instead is focused on how monetary policy affects “working households.” The same observer says that the Board of Governors is likely “to be forced to do something about the Wells Fargo & Co (NYSE:WFC) board.” But apart from the intricacies of monetary policy, there is hope on the horizon for financials as President Trump changes the composition of the Federal Reserve Board and the leadership of other federal regulatory agencies. The Fed Board will remain at just four governors next month with the departure of Stanley Fisher and last week’s Senate confirmation of Randall Quarles as vice chair for bank supervision. Regardless of whether the Trump Administration makes any additional appointments to the Fed or other agencies, over the next year and more we look for a roll-back of regulations put in place since 2008. This is a primary reason why we believe that Chair Yellen is ultimately headed back to the private sector. Even before Quarles was approved, banking agencies were exercising their rather considerable discretion in a number of areas such as capital charges on commercial real estate and the Volcker Rule. The massive regulatory friction accumulated in the banking system and also in consumer facing nonbanks over the past eight years is being reduced. “The trend is clearly going the other way,” a veteran bank lobbyist opined last week. “Statutory provisions can largely be eviscerated by agency interpretation.” Indeed, despite the fact that the Trump Administration has not appointed many agency heads with responsibility for financial services, the fact is that the Treasury under Secretary Steven Mnuchin is driving the bus on reform and is making a lot of regulatory changes that are already in process. Deregulation is a far more important factor for financials than the illusory prospect of higher interest rates. Overall, the trend in terms of reduced regulatory burden on both banks and nonbanks is clearly positive and may contribute positively to earnings and economic growth next year. As we discussed last week, loan yields for the largest US banks are not that strong and volumes are modest, so with Q3 ’17 earnings we don’t look for many positive surprises on the asset side from the large banks as a group. Several names including Goldman Sachs (NYSE:GS) have warned on sales and trading revenues. We expect to see some weakness on the mortgage banking line due to weak volumes, frothy collateral pricing and small down marks on mortgage servicing rights (MSRs). The rebound of yields on the 10-year Treasury in September, however, may be helpful in this regard. While Chair Yellen may be able to justify rate increases to at least two of the other members of the FOMC, the continuance of QE in Europe and Japan promises to maintain downward pressure on market rates and credit spreads. There is simply not enough demand for credit from the real economy to satiate the need for assets from the financial sector. The world of large banks, institutional investors and insurers, for example, is basically Jurassic Park, where large carnivores compete for limited food in a shrinking marketplace. For example, sales of all types of asset securitizations by US banks are down 10% year-over year, an illustration of the drought of duration that exists in global markets and has been ongoing for years. Sales of securitizations (which is 90% residential mortgages) was once a multi-billion dollar per year proposition for US banks in terms of revenue, but now is just pennies. Table 1 below shows assets securitized and sold for all US banks through Q2 2017. Source: FDIC A big part of the reason for the decline in asset securitization volumes since 2008 is the Dodd-Frank law, but also is due to regulation and the resulting migration of US banks away from residential mortgage lending and also a decline in volumes. As in the case of Europe, public debt issuance in the US since 2008 has seen a big increase, mostly via borrowing by the US Treasury. Debt issuance by corporations, which have tended to borrow to fund stock repurchase programs, has also surged. But neither of these factors is actually bullish for economic growth or bank earnings. Zero rates and QE a la Yellen, Draghi and Abe is not about growth so much as it is about subsidizing debtors, especially governments and other public obligors who are beyond the point of recovery in terms of ability to repay debt. This financialization of the US economy is perhaps the single biggest driver behind the bull market in US equities and bonds, but has done little for income or employment growth. Chart 1 below show total US debt issuance in most asset classes. Source: SIFMA The regulatory pendulum in the US is clearly swinging towards ease and that is good for inflated expenses in most banks and consumer facing non-bank financials. Overall, though, the prospect is for bank earnings and revenue growth to stay “lower for longer,” even as the actions of global central banks drive up prices in many asset classes. Until global central banks end asset purchases and allow credit spreads to revert to something closer to the norm, it is going to be very hard for banks to generate any real earnings growth -- particularly if the Fed’s obsessive increases in short-term benchmark rates result in a flat Treasury yield curve. An end to QE also implies a significant increase in credit losses for US banks, an eventuality that will not be a problem given robust reserve and capital levels. But the wild card for global financials is whether the suppression of credit spreads by the Fed and other central banks has caused the formation of another hidden hot spot of risk that is currently hidden from investor scrutiny. And for our money, that hot spot of risk may well be in Europe, where many banks are lingering on the edge of insolvency and politicians are absolutely frozen in place. In that bad idea called the European Union, the tragicomedy known as banking lurches from one absurdity to the next as the community struggles with trillions of euros in bad debts. Last week, the European Central Bank (ECB) “launched a fresh push,” reports the Financial Times, to get European banks to take reserves on bad loans. The only problem is that the new regulation applies only to loans that go bad after the start of 2018, leaving a decade of accumulated bad debts untouched. Under current international accounting rules, EU banks can essentially ignore (and accrue interest) on bad loans. This makes published financials for EU banks completely useless for investors and credit rating agencies. More, just as “quantitative easing” in the US has not particularly helped either the resolution of bad loans or new lending, in the EU the opportunity created by ECB chief Mario Draghi’s efforts has been largely wasted. More public sector debt has been incurred and the banks – which admit to some €850 billion (6%) in non-performing loans – are essentially insolvent as a group. The FT’s Lex column notes with considerable understatement that EU banks “may be treading water” and that, when off-balance sheet exposures and derivatives are considered, EU banks are running at about 25:1 or more leverage. This compares favorably to large US banks such as GS, JPMorgan Chase (NYSE:JPM) and Citigroup (NYSE:C), but is far higher than all US banks as a group. It is some measure of the extremis in which Europe’s banks now operate that the former Italian premier, Matteo Renzi, almost immediately attacked Draghi’s actions as possibly causing a decline in lending to small and medium size enterprises in Italy if implemented. “Some European officials in the banking sector ignore that their duty is to AVOID credit crises, not CREATE them,” he Tweeted on Thursday, borrowing from the communication style of President Donald Trump. Later Renzi added: “If these rules pass, credit to small businesses will be impossible. We are making the same mistakes as 2013.” In Europe the “mistake” leading up to 2013 was when the ECB forced the tiny nation of Cyprus into a forced banking liquidation. Lacking a mechanism like the FDIC in the US to resolve insolvent banks, the Europeans instead destroyed the Cypriot banks and pushed all of Europe to the verge of a financial collapse. Since then, the EU and its members states have subsidized failing banks, most notably in Italy. And the ECB under Draghi has doubled down on QE and negative interest rates to keep the prospect of further financial contagion at bay. So as earnings season begins in earnest in the US this week, there are two big risks facing investors who hold exposure to US financials. First, there is still little in the way of revenue growth to support rising valuations. Remember, don’t fight the Fed (and ECB and Bank of Japan). Some of the better performers like Bank of the Ozarks (NASDAQ:OZRK) are up double digits this year, confirming our earlier warning about short positions in this national C&I lender. Even GS has managed to show some upside of late even though it may have some of the more disappointing results for this quarter. But at 1.9x book, OZRK and many other names are fully valued using any sort of Warren Buffett measure of future cash returns. Second, the continued incapacity of EU leaders to deal with the festering problems inside Europe’s banks creates a very dangerous situation for investors. The media and their enablers in the Sell Side chorus have been touting the prospects of Europe for many months, but the reality is very different indeed. Europe is drowning in debt and there are a number of large EU banks that are demonstrably insolvent. The use of derivatives and off-balance sheet financing to “double down” and save some of the bigger zombie banks is bound to end in tears. And such machinations increase the chances for a “surprise” event, which as we all know is the precursor to systemic contagion. With low levels of visible volatility in evidence, we can only note some very big contrarian options trades in the VIX of late that remind us of 1992 when George Soros broke the pound sterling. Have a great week. This Tuesday The Institutional Risk Analyst’s Chris Whalen will appear at American Enterprise Institute in Washington, D.C., to talk about “How has a decade of extreme monetary policy changed the banking system.” With Q3 earnings looming next week, a discussion of the Fed’s structural distortion of banks and banking seems most appropriate. Click here to see our presentation. The Institutional Risk Analyst (ISSN 2692-1812) is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

September 11, 2017 | Last week we heard optimistic noises coming from some of the top executives in the world of mortgage finance at the Americatalyst 2017 event. Falling interest rates have managed to get new applications for mortgage refinancing even with purchase loans for the first time in months, this as the 30-year mortgage has fallen back to pre-election levels. We're still calling for the 10-year Treasury to go to 2% yield or lower. The good news for Q3 ’17 earnings is that production volumes and spreads are improving for many lenders after a dreadful start of the year. Bad news is that falling yields on the 10-year Treasury implies a significant mark-down for mortgage servicing rights (MSRs). The movement of benchmark interest rates, coupled with significantly lower lending volumes and surging prices for collateral, could make Q3 ’17 a very interesting – and treacherous – earnings period for financials with exposure to MSRs and other aspects of residential housing finance. Away from the blissful consideration of the housing sector, tongues were set wagging late last week when Liz Hoffman at The Wall Street Journal reported that Goldman Sachs (NYSE:GS) commodities head Greg Agran will leave the firm. “Mr. Agran’s departure follows the worst slump in Goldman’s commodities unit since the firm went public in 1999. Bad bets on the prices of natural gas and oil contributed to a second quarter in which the unit barely made money,” The Wall Street Journal reported. The GS “Fixed Income, Currency and Commodities Client Execution” (FICC) arm has seen performance fall by double digits sequentially and year-over-year, causing investors to ask whether Wall Street’s preeminent trading shop has lost its edge. With investment banking and asset management essentially flat last quarter, GS’s net income dropped sequentially. Only a strong performance in equities prevented GS from seeing the Institutional Client Services income line break below $3 billion last quarter. Even though our contacts in the world of credit have been reporting better-than-expected results in the world of energy production, many Wall Street firms have been playing the long-side of energy (and bond yields), and with disastrous results. GS under Agran’s direction in particular was reportedly stung by taking principal exposures related to the Marcellus shale market in OH and PA. This fact is significant for several reasons. As we discussed last week with Paul Murphy, CEO of energy lending specialist Cadence Bancorp (NASDAQ:CADE), prices for natural gas are unlikely to see great upward volatility any time soon. Oil prices too remain under considerable downward pressure as domestic producers continue to develop new ways to cut production costs. “The Permian is still red hot with people paying high prices for acreage,” Murphy reports. “The Permian works at $49 per barrel all day every day.” While most commercial banks can make money primarily by lending, GS is forced to earn its profits by being smarter than other market execution platforms and thereby attracting institutional client trading volumes. Many buy side investors give their business to GS because they believe – rightly or not – that the boys of Broad Street have an edge when it comes to market intelligence. But the past few quarters of underperformance by FICC and the particular misstep with respect to the Marcellus trade suggest that GS may be losing its premier cachet when it comes to market acumen and related mindshare among institutional customers. Indeed, since the start of 2017, GS has significantly under-performed its peers and the S&P 500. With a price-to-book ratio over 1 and a beta of 1.4, GS is still quite fully valued – especially when you consider that the Street has negative revenue growth rates for the bank for the rest of the year. But magically the Street has GS showing a 4% positive revenue growth rate for 2018 and a 20% positive earnings growth rate to boot. Wall Street, after all, is about selling hope. Looking at the big picture for all US banks, commodities trading for customers has not be a strong contributor to total earnings since the implementation of the Volcker Rule in 2012. First comes investment banking fees, followed by credit products which contributed significantly to Q2 ’17 results. Income from commodities and other exposures has significantly trailed other components of non-interest income for all US banks. Notice how the big negative swings in credit contributed to losses in the 2008 and 2012 periods. Source: FDIC For universal banks such as GS, a lot of trading and other types of capital markets activity is conducted outside of the bank in the broker-dealer and is not captured by the FDIC data. For GS, total non-interest income of $14.9 billion at Q2 ‘17 is about 3x the bank’s $5.9 billion in net interest income, the reverse of the distribution seen in most large banks in Peer Group 1. Or to put it another way, the net interest income of most US banks averages 2x the non-interest income. With non-interest income at GS equal to 3.37% of total assets vs 1.3% for most large banks, the dependence of GS on transactional income is pretty much total. In many respects, GS is a hedge fund with FDIC insurance and access to the Fed's discount window. But not being able to overtly trade its own account represents a huge disadvantage compared with its larger peers. There are an awful lot of former GS bankers running around Washington, but the fact that Chief Executive Lloyd Blankfein and his colleagues actually allowed a bet on rising gas prices anywhere makes us wonder. Just about anybody and everybody The IRA speaks to regarding energy prices thinks that natural gas is a dead trade for years to come. The fact that GS chose to bet on whether a privately funded pipeline would be completed on a date certain illustrates the risks that universal banks must take to earn their keep. More, as Liz Hoffman reported in the Journal in August, the ill-fated Goldman trade with Marcellus apparently was to ride the price up as the transportation related discount for production from that region ended, but that sure looks like a principal trade to us. Why is GS even making wagers on Marcellus shale for its own account given the Volcker Rule? Good question. You can be pretty sure that nobody in the bank regulatory community will deign to ask that question so long as former Goldman President Gary Cohn remains employed at the White House. But then again, just about every major Wall Street bank has its own list of exceptions to the Volcker Rule. Look at the earlier chart and note the way that income from credit positions has languished until last quarter. Isn’t that remarkable? Could it be that the largest Wall Street banks are already starting to cheat with respect to Volcker Rule compliance by trading credit exposures for their own account on the assumption that this part of Dodd-Frank will eventually be repealed? The banking industry has made repeal of the Volcker Rule its number one priority in Washington, perhaps explaining the large number of GS alumni operating inside the Beltway since the election of Donald Trump. But to us, the real question with GS and the Volcker Rule is whether the smallest of the major universal banks can survive long-term without being able to aggressively trade its own account. With larger players such as JPMorgan (NYSE:JPM), Bank America (NYSE:BAC) and Wells Fargo (NYSE:WFC) able to use their balance sheets to win business, GS is the low man on the proverbial totem pole of big banks. Will the firm that survived the Great Crash of 1929, the Mexican peso crisis and the financial collapse of 2008 be the next name to follow in the unfortunate footsteps of Lehman Brothers and Bear, Stearns & Co? The Institutional Risk Analyst (ISSN 2692-1812) is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

September 18, 2017 | Some of the housing industry’s largest trade groups reportedly want housing finance agencies Fannie Mae and Freddie Mac to look at using new types of credit scores for assessing default risk on residential mortgages. These groups argue that existing scores are "unfair" to low income borrowers. Housing Wire reported last month that the groups sent a letter to Federal Housing Finance Agency Director Mel Watt, the Mortgage Bankers Association, National Association of Realtors, the National Association of Home Builders, and other groups pressing Watt on the issue. Watt, a former congressman from North Carolina and long-time member of the House Financial Services Committee, threw cold water on the idea that Fannie and Freddie would begin using alternative credit scoring models at any point in the next two years. “Watt said that making any changes to the government-sponsored enterprises’ credit scoring models before 2019 would be a “serious mistake,” reports HW. Ditto. FHFA chief Mel Watt is nobody’s fool and in particular understands the state of pay to play in Washington. The push for new credit scores is not really about competition or access to credit for low income households, but rather the corporate ambitions of the major consumer credit bureaus. “In 2006, VantageScore Solutions was introduced as a joint venture between three national credit bureaus – Experian plc, Equifax Inc. and TransUnion – aimed at providing an alternative solution to the widely used FICO score through the introduction of the VantageScore,” writes DBRS in a June 2017 report. “Recently, evidence points at VantageScore gaining traction in consumer lending and, by extension, in structured finance.” The three national credit bureaus or data “repositories” share a monopoly on individual credit reporting in the US. Yet as we’ve learned recently with Equifax (NYSE:EFX), the repositories take no responsibility for protecting consumer data or even telling consumers when they have been compromised. Nor do the repositories take any responsibility for the accuracy of data gathered or how it is used, as with identity theft and credit fraud. Because the GSEs require three credit reports for conventional and government mortgages, the repositories apparently decided to come together in an anti-competitive alliance to promote the new VantageScore as a way of displacing Fair Isaac Corp (NASDAQ:FICO), publisher of the FICO score traditionally used to assess consumer credit. By spending money on marketing and Washington lobbying activities, the three credit repositories have orchestrated a seeming groundswell of support for the VantageScore. But to us, the combination of the three data monopolies in the world of housing finance sure looks like anti-competitive behavior. Of course there are instances where an anti-competitive business combination constructed as an ancillary restraint will survive antitrust tests, but this situation with the three incumbent consumer credit repositories looks like an illegal attempt to stifle competition – namely FICO -- and create a vertical monopoly atop the existing horizontal data franchise shared by the three firms. In the rest of the world of consumer credit, there is competition between the three credit rating bureaus. By maintaining an accurate profile of a consumer’s credit, auto lenders, employers and other parties can quickly assess a subject’s basic credit standing with one report. Only because the GSEs require credit reports from all three agencies is a competitive market transformed into a murky, monopolistic alliance between the three incumbent credit data repositories. Some consumer advocates and Washington policy organs, including many that receive direct financial support from the owners of VantageScore, argue that the new score is more fair than the multiple versions of FICO scores, which are tuned for different industries and can vary by as much as 10% either way depending on the credit type. They also argue that the inclusion of limited rental payment data gives lower income borrowers a better chance of approval. Both private research and internal assessments reportedly conducted (but not published) by the GSEs, however, raise significant doubts as to the numbers of additional low income borrowers that might be approved using VantageScore vs FICO for mortgage lending. Some policy advocates have claimed that seven million new borrowers might be added to the mortgage rolls by wide adoption of VantageScore. “The credit score model used by the GSEs needs to be updated,” writes Laurie Goodman at Urban Institute. “The credit score model the GSEs essentially require mortgage originators to use for mortgage lending— FICO 4—is outdated, based on models estimated in the late 1990s. Both FICO and VantageScore have much more recent models, including FICO 9 and VantageScore 3. VantageScore is also rolling out VantageScore 4.0 this fall.” Goodman and other market participants note that the GSEs and the rating agencies are still using antiquated versions of the FICO model in their own models, versions that ignore advancements in new data and how events such as medical expenses are weighted in credit models. Credit professionals operating in the ABS market also wonder whether either the GSEs, the rating agencies or bond investors are ready to make a change, especially if it results in any expense to make the transition. Many policy advocates in Washington are innocently unaware of the magnitude of change that shifting to, say, FICO 9 would entail for the housing agencies, the credit rating firms and for major bond investors. In tactical terms, the GSEs are the source of the problem when it comes to antiquated credit scores in the world of housing finance. By mandating universal usage of raw credit reports from all of the three repositories, on the one hand, and then dragging their feet on adoption of new credit scoring models – from either FICO or Vantage – the GSEs have created an intellectual and operational bottleneck in the US mortgage industry. But ultimately this Washington conversation is ignoring the most important constituency, namely global bond investors in the US and around the world. One of the dirty secrets of the pro-VantageScore, access-to-credit crowd in Washington is that not all consumers have enough of a credit history to get a FICO score. If you can fog a mirror, you can pretty much get a VantageScore. In fact, VantageScore 3.0 can generate a score for up to 35 million more people than conventional models, according to company claims. And the VantageScore model is about to get even more forgiving, according to The Washingtton Post. The basic credit models used by FICO and VantageScore are similar, but not comparable. An 800 FICO is not the same as an 800 VantageScore. The rental and utility payment data included in Vantage is limited and, to the earlier point on FICO, really does not tell you about the obligor’s ability to pay a 30-year mortgage and take care of the house. These differences between FICO and VantageScore make the credit rating agencies, lenders and servicers, and end investors in residential mortgage backed securities (RMBS) nervous about depending upon newer scores to judge default risk. Think about the folks at the Bank of Japan, for example, who are traditional and size buyers of GNMA securities. Goodman notes that the newer version of FICO and VantageScore are more closely aligned, but the fact remains that you cannot compare a FICO and VantageScore because of differences in the data and methodology. Yet the GSEs could do a great deal to help illuminate and clarify these issues. She writes: "In their 2017 Scorecard, the FHFA directed the GSEs to 'Conclude assessment of updated credit score models for underwriting, pricing, and investor disclosures, and, as appropriate, plan for implementation.' In addition, 'The Credit Score Competition Act of 2017,' HR 898 in the House and an expected companion bill in the Senate, would encourage the GSEs to consider alternative credit risk scoring models when making mortgage purchasing decisions. In particular, the GSEs would be required to establish and make public their procedures for validating and approving credit scoring models." Watt told an industry group last month that the FHFA is supposed to issue a request for information this fall addressing the impact of alternative credit scoring models on access to credit, costs and operational considerations. We agree with Goodman and others that it would be helpful to understand the rationale behind how the GSEs assess different consumer credit agency models for the purpose of default probability. But we also think that the GSEs moving from FICO to VantageScore is probably not practical either. There is not enough of a significant positive difference between the two models to make a change worth the time and money. We also think the idea of the lender selecting the credit score to be used in the underwriting process is a non-starter with investors – and prudential regulators. Real simple: the answer is no. More, there are some far bigger analytical issues that must be settled before the industry moves forward to new credit scores. Last week, Jack Kahan and Steve McCarthy of KBRA wrote an important research note on this issue of default risk estimates in residential RMBS: “Investors and originators alike tend to use the 2001-2003 mortgage origination vintages to establish underwriting standards and to benchmark base case default expectations on newly originated loans. Many industry participants have expressed the view that the market struck the perfect balance between credit availability and prudent underwriting during this period, pointing to pristine mortgage performance for those loans as evidence. Indeed, depending on the metric chosen, defaults for crisis vintage loans were 5.9x that of loans originated between 2001 and 2003. However, our research suggests that credit standards seem to explain only a fraction of this increase when judged through the lens of expected default rates. Based on the Urban Institute‘s HFPC Credit Availability Index, average GSE default risk due to borrower attributes was five percent between 2001 and 2003 and six percent between 2005 and 2007, a 20 percent increase.” More that just a request for information, we’d like to see a public, head-to-head comparison of the different scores supervised by the GSEs and their respective regulators, and with input from the credit community. The last word on this topic is not going to come from Mel Watt or anybody in Washington, but from the bond investors who hold $9 trillion in RMBS. Remember, if the GSEs were to mandate VantageScores, the entire analytical infrastructure of the credit, ratings and regulatory community would need to be revamped. And then the SEC would need to evaluate and validate the new models, especially given the new rules governing RMBS in Dodd-Frank. But of course this all implies that the three monopoly credit repositories would allow their “private” data on millions of consumers to be exposed to the public. Stay tuned. The Institutional Risk Analyst (ISSN 2692-1812) is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

September 25, 2017 | We start the week in downtown Manhattan with a presentation to the International Association of Credit Portfolio Managers in New York (click here to download slides). We’ll refer to some of the slides in the comments below. And we appreciate the feedback about last week’s comment about the role of Equifax and the other consumer credit agencies in the mortgage market. Of note to one reader’s question, lenders do not need a FICO score to submit a mortgage to the federal housing agencies for insurance, but the GSEs do require all three raw credit reports be pulled into a “Tri Merge” file as part of the underwriting process. And by no surprise, the consumer credit bureaus also have credit scores or their own. The competition between FICO and the three credit repositories is a glorious race to the bottom in terms of credit scores for mortgages. Suffice to say we’ll be coming back to the question of credit scores in the context of mortgage lending soon. Got a cheery missive from Jerry Flum at Credit Risk Monitor (OTC:CRMZ): “Debt is at its highest levels since 2007, and with interest rates near their all-time low, there’s reason to be concerned about the amount of risk growing in your public company customer and vendor portfolios.” They add: “Corporate debt is becoming excessive…” Of course, Jerry is preaching to the choir when it comes to our appreciation of America’s migration towards national insolvency. To review, there are three phases of indebtedness, this progression codified by our friend Bill Janeway in a November 17, 2008 issue of The Institutional Risk Analyst kindly republished by Barry Ritholtz. The first phase is solvency, then mere liquidity sustains the growing debt, and finally default results when both interest and principal must be borrowed or "rolled." Janeway noted regarding the creation of “the largest pile of leverage the world has ever seen” via the birth of financial economics: “The core of this grand project was to reconstruct financial economics as a branch of physics. If we could treat the agents, the atoms of the markets, people buying and selling, as if they were molecules, we could apply the same differential equations to finance that describe the behavior of molecules. What that entails is to take as the raw material, time series data, prices and returns, and look at them as the observables generated by processes which are stationary. By this I mean that the distribution of observables, the distribution of prices, is stable over time. So you can look at the statistical attributes like volatility and correlation amongst them, above all liquidity, as stable and mathematically describable.” Part of the reason that the US economy is growing more slowly now than in the Roaring 2000s is that the amount of leverage on private capital from banks has actually been reduced by the forces of the progressive oversight. The other day, we heard Mike Mayo, now of Wells Fargo Securities BTW, wax effusive on Citigroup (NYSE:C). The common stock of this zombie money center bank has moved up over 20% in the past year, trailed by JPMorgan Chase (NYSE:JPM) at +8% and Goldman Sachs (NYSE:GS) barely registering positive movement. But the thing to keep in mind about Citi and all of the big banks is that the ways of expanding actual profit margins are few. We are witnessing multiple expansion in the stock prices of financials, but no margin expansion to validate the higher equity market valuations. With a gross loan spread of 6.42% vs 4.40% for the large banks in Peer Group 1, Citi does have a higher return on assets but with a higher cost of funds, mostly in deposits raised from institutional investors. The notion that somehow larger banks are going to develop pricing power in the current loan market is kind of laughable. Loan margins have been under pressure for years, so even if the Federal Open Market Committee could make market rates go up, slack volumes in new C&I lending suggest that pricing dynamics could get even more competitive. The chart below from the St Louis Fed’s FRED system illustrates the slowing in new commercial lending. A big part of the issue here is that magical notion known as macro-prudential regulation. Even as the FOMC and other world central banks have been busily purchasing trillions of dollars worth of private securities to encourage investment, bank rules have effectively lowered loan-to-value or LTV ratios. Bank borrowers must have more skin in the game, which lowers the leverage on private capital throughout the US economy. Home builders, for example, must have more equity in deals compared to the 2000s. Today a homebuilder must have 50% equity in a deal for a 50 LTV loan instead of 30% capital in a 70 LTV loan. As George Gleason of Bank of the Ozarks (NASDAQ:OZRK) told us, he has less leverage on his book than he did decades ago. Prospective short sellers please take note. The result of regulation is less growth, but lower loan default rates and, at least partly, improved recovery rates for banks. But the other obvious effect is lower levels of economic activity. This is the pound of flesh extracted by supporters of the Dodd-Frank law in their crusade against Wall Street excess. Even as global bank regulators try to reduce leverage levels inside bank portfolios, the FOMC is engaged in a massive experiment in social engineering to encourage borrowing and investment by keeping rates artificially low. The Fed bought almost $2 trillion mortgage bonds to help the housing market, this even as prudential regulators discourage lending on construction and development loans. Indeed, C&D lending is perhaps one of the greatest opportunities today in financials. In Washington, one hand does not know what the other hand does. Fed Chair Janet Yellen expresses puzzlement about inflation, but clearly the lower levels of leverage on capital in the US banking system seemingly provide part of the explanation. A home builder can start three new homes at 70 LTV, but can support only two new housing starts at 50 LTV. Hmmm. Meanwhile back to Citi, we love to hear analysts talk about margin expansion at a bank with “stable funding” that is two-thirds foreign deposits, placing the bank in the top quintile of banks in terms of funding costs. The bank’s premium cost of funds is almost 2x the 43bp average for Peer Group 1. And did we mention that the bank’s return on earning assets is actually lower that its large bank peers? Even with the high-yielding returns on Citi’s subprime consumer book, the bank’s paltry overall yield on earning assets is a function of low returns on the bank’s business loans. With the large US banks as a group and Citi in particular, there ain’t no leverage pickup apparent in the latest financials. The all-important factor of loan demand is constrained by the idiocy of macroprudential regulation. This will not prevent Sell Side managers from bidding up Citi and other large caps, however, because quite simply there is nothing else to buy. Kudos to Pete Najarian for holding his ground against the bull stampede into financials. The Institutional Risk Analyst (ISSN 2692-1812) is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

“The great wheel of circulation is altogether different from the goods which are circulated by means of it. The revenue of the society consists altogether in those goods, and not in the wheel which circulates them” Adam Smith, 1811 October 1, 2017 | This week in The Institutional Risk Analyst, we return to one of our favorite topics – namely credit spreads – as we consider the most recent statement from the Federal Open Market Committee. Fed Chair Janet Yellen made a presentation last week to the National Association of Business Economists illustrating that while she is puzzled by low inflation, Yellen is entirely clueless as to the workings of the financial markets. For some time now, we have been concerned that the FOMC’s overt manipulation of credit spreads has embedded future credit losses on the balance sheets of US banks. But now we are starting to see even greater signs of stress as the large Wall Street banks again return to derivatives in order to manufacture the appearance of profitability. The leader of this effort is none other than Citigroup (NYSE:C), which has surpassed JPMorganChase (NYSE:JPM) to become the largest derivatives shop in the world. Citi has embraced the most notorious product of the roaring 2000s, the synthetic collateralized debt obligation or “CDO” security, a product that fraudulently leverages the real world and literally caused the bank to fail a decade ago. “It’s an astonishing comeback for the roughly $70 billion market for synthetic CDOs, which rose to infamy during the crisis and then faded into obscurity after nearly destroying the financial system,” reports Bloomberg. “But perhaps the most surprising twist is Citigroup itself. Less than a decade ago, the bank was forced into a taxpayer bailout after suffering huge losses on similar types of securities tied to mortgages. Now, many in the industry say Citigroup is responsible for over half the deals that come to market, though precise numbers are hard to come by.” As we note in a new working paper appropriately entitled “Good Banks, Bad Banks,” large financial institutions are not particularly profitable. In times of tight credit spreads, the pressure on these banks to “cheat” when it comes to risk taking and disclosure becomes irresistible. The dilemma large banks face when credit spreads are very low is similar to retailers that cannot compete, for example, with the efficiency of Amazon (NASDAQ:AMZN). Low cost competitors compel other retailers to match prices, even if that forces them to lose money on each sale. Trying to “make up” the loss by increasing sale volume is the obvious path to retailer insolvency. In banking, high spreads eventually force borrowers to default and must be cured before the economy fails. Low spreads force banks to “match or lose customers” by cutting prices. When a “matching” bank’s costs are greater than the spread borrowers pay, the correct result is to shrink the number of deals done, eventually causing spreads to rise. But that’s disastrous for bank managers. As in retail, therefore, the initial reaction of bank managers is to make up for the “low yield” on each transaction by writing more deals. As long as government is willing to “insure” deposits of banks that speculate in this manner, it creates an obvious condition of “heads managers win” and “tails shareholders and taxpayers lose.” The most obvious use for a “synthetic CDO” is to generate a lot of fictional (“synthetic”) transactions that increase the bank’s “deal flow” without need to find actual customers that want “real” loans. Bad banks generate a capacity to make up for the low yield on each “real” transaction by creating “synthetic” transactions. Synthetic derivatives are an obvious source for permitting fraud that necessarily harms the perpetrating bank and, ultimately, the markets as a whole. “Bottom line,” notes our colleague Fred Feldkamp, “it is ‘impossible’ to convert ABS securities into a ‘risk free’ 20% return. As Goldman Sachs (NYSE:GS) proved in 1970 with bankrupt Penn Central's commercial paper, one cannot sell bad assets to customers that you want to keep.” Feldkamp observes that for a while now credit spreads have been too low for rational credit expansion. Banks are now forced to create and hide leverage off balance sheet (e. g. new "synthetic CDO" frauds and leveraged buyouts (LBOs) with outrageously high EBITDA ratios) in order to generate returns sufficient to pay employees when that is not available in the spreads associated with well-balanced bond sales. Again Feldkamp: “When I do my spread charts, I consider the upper and lower limits to define Adam Smith's concept of a ‘Complete Market.’ Above that range of spread, there is a cushion between equilibrium and a ‘crisis zone’ because experience tells me that the ‘drag’ of high spreads can be tolerated for a while as leaders ponder what to fix. Affected firms refinance when spreads fall.” He continues: “BELOW that equilibrium, however, I think there's only ‘irrational exuberance’ because (as Smith noted) ‘the Great Wheel of Circulation’ lacks the ‘grease’ of adequate net-interest margin (NIM) needed to keep it rolling and starts to wear out. The damage starts immediately and only the extent of the necessary ultimate repair is debatable. When banks die over dumb deals, we have no choice except to rescue depositors--thus it becomes ‘HEADS I WIN; TAILS TAXPAYERS LOSE’ at US-insured banks.” Feldkamp reminds us that had regulators stopped the losses generated by thrifts in the 1980s after Congress passed the ill-fated 1982 Garn-St Germain law, the cost might have been contained at a hundred billion. “By waiting seven years, however, we were just a few years away from creating a Weimar Republic collapse. Having enjoyed an eight year recovery today, the US markets are now FAR more leveraged and are therefore far more capable of a rapid descent into oblivion than 30 years ago.” We do not need to look back 30 years, however. Synthetic CDOs were a key source for the excessive and unreported “off balance sheet” leverage at Citigroup that exploded to create the Great Financial Crisis of 2008. Starting mid-September of 2007, the Fed successfully led markets back from a “mini-crisis” that began when Bear Stearns followed the path Goldman Sachs chose decades before when Penn Central went bankrupt. Bear abandoned support for two mortgage investment funds into which it had invested customers’ money. In mid-October, US Treasury Secretary Hank Paulson announced an intent to create a “Super SIV” (to be backed by the US government) that would “rescue” Citi from losses suffered in off balance sheet ”commercial paper conduits” that Citibank supported with standby liquidity facilities. Thankfully Hank’s ill-considered proposal never materialized. His announcement kicked off the Great Financial Crisis (that peaked thirteen months later). Within days, credit spreads for US corporate bonds leaped from “euphoric” lows to “crisis zone” highs. Credit markets required more than three years to regain spread levels observed before Paulson’s October 2007 announcement. To get a sense of just how tight lending spreads are for the major banks, the tables below shows the gross loan spread, and the percentage of loans and total assets, for each loan type at Citi and JPM. Source: FDIC/Total Bank Solutions The table above illustrates the great dependence of Citi on its credit card portfolio when it comes to yield, while more that half of its loan portfolio is generating less than 3% gross yields. Citi is clearly the weaker competitor compared to JPM. And as we noted last week, Citi’s dependence on offshore institutional funding sources gives it a cost of funds almost 2x JPM and other large banks. The moral of the story with Citi and other large banks is that there is no free lunch, but sadly no one on the FOMC seems to appreciate this subtlety. When the Fed pushes down interest rates and then manipulates credit spreads to achieve some illusory goal in terms of monetary policy, the result is a change in the behavior of investors and lenders that is profound. The fact that Citi, JPM and GS are now pushing back into the dangerous world of off-balance sheet (OBS) derivatives just illustrates the fact that the large banks cannot survive without cheating customers, creditors and shareholders. And just as retailers cannot compete with AMZN, Citi and GS certainly cannot compete against the monopoly power of the House of Morgan. In the case both of Citi and JPM, just half of the banks’ operating business comes from lending, while the remainder comes from risk bearing investments and trading. With some $50 trillion in off-balance sheet (OBS) derivatives, which is almost six standard deviations above the $1.8 trillion peer average for large banks, Citi and JPM are now the outliers on Wall Street in terms of derivatives exposure. A move of 30bp in the OBS derivatives book of either bank would wipe out their capital. Chart One below shows the OBS derivatives exposure of Citi, JPM, GS and the other major banks. Source: FDIC/Total Bank Solutions Notice that all three of the leading derivatives dealers have been increasing exposures since last year. Note too that the relatively small GS has a notional OBS derivatives book of more than $41 trillion, almost as large as that of Citi and JPM. More alarming, a move of just 7bp in the smaller bank’s OBS derivatives exposures would wipe out the capital of Goldman’s subsidiary bank. This gives GS an effective leverage ratio vs its notional OBS derivatives exposures of 8,800 to 1. And all three banks are clearly outliers compared to the rest of the large US banks, which generally eschew OBS derivatives as the tiny peer average suggests. So ask not whether President Donald Trump should reappoint Janet Yellen to another term as Fed Chair. Rather, ask yourself why Yellen wants to stick around Washington at all given the accumulation of risk inside the major US banks as a result of the FOMC’s manipulation of credit spreads. The combination of a lack of profitability and a huge derivatives book makes another financial collapse increasingly likely despite the apparent solidity of the US banking system. As with the S&Ls in the 1980s, Yellen and other regulators have an opportunity to throttle-back risk taking by Citi, JPM and GS now and avoid a calamity. But Buy Side investors would never tolerate such a move by regulators. As we note in "Good Banks, Bad Banks," larger institutions suffer from a fatal lack of profitability that ultimately dooms them to commit fraud and, eventually, suffer a catastrophic systemic risk event. As Fred Feldkamp never tires of reminding us: "The only thing worse than “excessive” leverage is 'excessive off balance sheet' leverage." The Institutional Risk Analyst (ISSN 2692-1812) is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

September 5, 2017 | In this issue of The Institutional Risk Analyst, we speak to Paul Murphy, Chairman, Chief Executive Officer and Director, Cadence Bancorporation (NYSE:CADE) and also Chairman of its main business unit, Cadence Bank, N.A. Paul formerly spent nearly 20 years at Amegy Bank of Texas, helping grow that institution from just double digit millions in assets and a single location to a bank with assets of $11 billion, offices across Texas and a growing book of business with a focus on energy. Amegy was sold to Zions Bancorp (NASDAQ:ZION) in 2005. Cadence was created five years later to invest in the US banking sector, starting in 2011 with the purchase of $1.6 billion asset Cadence Bank of Starkville, Mississippi. Today, Cadence is $10 billion in total assets and is rated “BBB” and “stable” by Kroll Bond Rating Agency. The IRA: So Paul, tell us your perspective on the hurricane and its aftermath for the City of Houston, which is an important part of your bank’s footprint. Murphy: Harvey has truly been an unprecedented weather event. Throughout the storm, our banking services remained fully functional and contingency capabilities were activated to ensure ongoing customer service was not impacted, despite local office closures. As challenging as it was, it served to validate the effectiveness of our contingency planning and preparedness protocols, which withstood this test well. The IRA: That is good news. What did you do early on in the storm’s aftermath? Murphy: Employee safety was our #1 concern. We are happy to report that all our team members are safe and secure, for which we are grateful. Sadly, a number of our staff and their families reported water damage to their homes, and many were subjected to mandatory evacuation orders in the Houston area and forced to seek shelter in alternate locations. The IRA: What is the situation in Houston today? Murphy: First responders did an incredible job supporting those impacted by the storm, as did thousands of volunteers. It’s often in trying times like these when we see the best in others. Managing the follow-up to this natural disaster will take a monumental and city-wide effort, and we are committed to helping our clients and communities rebuild and continue to prosper. The IRA: Apart from the tragedy of last week, how are you feeling about the world? We’ve been through the great oil credit bust that wasn’t in 2015, then the election of Donald Trump and related euphoria, and now the long, tormented disappointment? Murphy: We had a really good second quarter. Made $29 million, core deposits are up nicely, a whole 9 basis points of charge offs. Efficiency ratio at 53%. Return on assets is 1.19% and tangible capital is 12%, so we are feeling pretty good. These are pretty decent numbers. The IRA: You are a solid performer in the small regional category. We got to find you another bank to buy. We have a long list of non-bank mortgage firms that need to get married to a double-digit asset regional bank, of note. Create a whole bunch of Flagstar (NYSE:FBC) clones to bolster the profitability and stability of the mortgage sector, especially the FHA market. But we digress. Talk to us about the focus of Cadence since we first got to know you and there was a real focus on banking the energy business. Murphy: At the peak we were almost 19% energy exposure. Today we are closer to 11%. Going into the oil price downturn, we had about $1.1 billion in loans and about 100 energy clients banking with us. We had one disaster in the portfolio with a really tough set of facts. A couple of others got beat up pretty badly and were severely stressed, but just one out of a hundred was a huge disappointment. These were pretty good results, in part because more than half our exposures were in midstream companies where we’ve had zero charge-offs. We’re still in the business. The IRA: These are very good results and beg the question, why? You and the industry as a whole were preparing for the apocalypse in energy coming up to 2015, but the credit losses simply did not materialize as expected. Provisions were way, way too high vs the actual losses. What happened? Is this another impact of the secular rise in the value of financial assets? As with other asset classes, it suggests that credit events have no cost. Murphy: Equity markets have been wide-open for oil field services and E&P. Some of these deals that are getting done are priced against a 2018 EBITDA growth J curve that is just stunning. I don’t think it is going to happen. There is not so much of an expectation of an oil price increase but rather an assumption that there will be an increase in activity. We’ll see. The Permian is still red hot with people paying high prices for acreage. The Permian works at $49 per barrel all day every day. The IRA: So when we see these breathless articles about oil producers operating at a loss, in part because investors are funding the operations, is this accurate? What is the big picture from your perspective as a lender in the energy belt? Murphy: As with most things, you have to be careful with generalizations. The Energy business is still stressed given the prolonged low price environment. Costs have come down and producers are surviving but returns for investors have declined. In the right area, some operators are reporting 20% IRRs. Our portfolio is appropriately 55% Midstream, and that business is doing well. Natural gas prices are going to remain low for some time to come, but this is spurring an industrial renaissance along the Gulf Coast that is not widely understood. Cheap gas is a huge boost for industry and the economy. The IRA: We’re waiting for somebody to invent a teeny gas turbine that can go in a car and then maybe Elon Musk will have something with Tesla (NSADAQ:TSLA). In addition to energy, talk about the rest of your credit book. Cadence has a good amount of C&I loan exposure and also some residential. Talk about how you view the rest of the business. Have you participated in the great Texas real estate boom over the past few years? Murphy: We are heavy on commercial lending. Our residential portfolio is about $1.1 billion and we like the single family asset. Over the past couple of years, we’ve originated over $2.3 billion in residential loans and have charged off $220,000. We sell about half of our new residential originations, the longer-term fixed rate paper. We tend to keep the floating rate jumbos, the private banking paper. The IRA: And this sounds like well-underwritten production with a 50% risk weight presumably. Murphy: Correct. Its granular and diverse from a risk perspective. Great paper really. The IRA: Do you retain the servicing on the residential loans that are sold? Murphy: We do retain the servicing on some of the fixed rate paper. Over time I expect that we will retain servicing on more of our production. The IRA: Well, the large banks tend to overpay for loans and servicing, then have to play games with the average life to justify their earlier acts of optimism. But skyrocketing prices have choked off the move-up home purchase market thanks to the Federal Open Market Committee. Dan Perl at Citadel Servicing taught us years ago that the real average life of a mortgage is generally about four years, which is the decision cycle for most families. But maybe that is changing. How has Houston real estate come through the decline in oil prices? Murphy: Texas, in particular, is growing nicely. If you had asked me three years ago if we’d be adding new jobs every year, I would have said no way. But we have. But to the point about the duration of new production mortgage loans, if you account conservatively for the mortgage servicing rights created when the loan is sold, it is not a problem and can be a very nice business. You also have a choice as to how much of the MSR to capitalize. The IRA: Subjecting MSRs to fair value accounting has always struck us as a complete waste of time and money. Non-banks are so strained having to finance the purchase of the entire MSR, when all they really want is the 8 basis points servicing fee. Then they end up selling the excess strip for a concessionary price to a financial investor. What is your footprint in terms of residential production vs commercial lending? Murphy: We are throughout the service area on residential and our biggest originations team is in Houston, and Birmingham is where we have most of our loan production people. There are some soft spots in both residential and commercial credits in the energy corridor going up I-10. There was overbuilding in multifamily and they have some real problems. But in town, no. The mid-town, east side of Houston is booming. We have one client giving away maybe a little too much free rent to sign new tenants, but they are 93% leased. We hold the construction loan, but they will have no problem getting that project refinanced. The IRA: We would agree in the current environment. Loss given default (LGD) on bank owned multifamily loans has been negative going back several quarters, suggesting a very strong asset market. Residential LGDs are in the 50% range, the lowest in decades. How do you see the retail sector in particular? Your economic footprint is growing faster than most of the country. Is retail headed for a serious contraction? Murphy: Retail is the sector that worries me the most. This thing with Amazon (NASDAQ:AMZN) is a real problem. Everybody is talking about it. For us, we do not do unanchored retail loans. We must have WalMart (NYSE:WMT) or Kroger or somebody of that quality. And we have very low loan to value ratios. We have 40% and more equity in these deals, going back to your point about strong asset prices. But part of the reason for the great credit performance is the economy. Houston in 1975 had a million jobs. Today we have three million jobs. Over forty years we added 50,000 jobs per year on average. The IRA: What has been driving this remarkable growth in Texas? Murphy: The Port of Houston is a huge factor, the Texas Medical Center is growing, the pro-business environment, no state income taxes, attractive demographics and in bound migration all contribute. If Houston were a stand-alone country, we would be #25 in GDP. We have more jobs than 35 other states. It is a great place to live and do business. The IRA: Talk about the rest of your book. Murphy: We do commercial lending and real estate primarily within our footprint, though we will support national customers as well. Our restaurant team has a national focus. We’ve done great in that space. We have almost $900 million in exposure and have experienced almost zero credit events in that book. We sold one credit we did not like a while back at a discount, but that has been it. We have participated in a number of technology credits with Silicon Valley Bank (NYSE:SVB) and have our technology team in Austin. The IRA: Have you been involved with any of the new consumer lending platforms? Murphy: We are talking to a couple of players as an add-on to our production capacity. There were 400 of these on-line lenders at the peak, now there are 20 of them. We are interested in having that capability to originate loans. If they can meet our lending criteria, we’re interested. And we can help them finance and sell production that we don’t necessarily want to keep in portfolio. The IRA: Given how the FOMC has manipulated credit spreads, how much do you worry about the underlying credit risk that is currently masked by frothy asset values? Murphy: We worry about macro factors and everything else, but where I come back to is underwriting the specific credit risk. We don’t approach it with over-confidence, but we do depend on our lenders and credit people to manage the individual credits. There is more equity in deals today, in part because of regulatory guidance. But we have flexibility as well. We had some E&P credits that were real banged-up in 2015, but we came to the table, told them they had to recapitalize, then offered some ideas on how to get that done. But we worked with these credits and they all did in fact get it done. We looked through the cycle and had a more patient approach to helping what were truly viable businesses add equity and stay right side up. The IRA: Credit management is one of the main reasons that the $1-10 billion asset class banks in the US have the best financial performance. Thanks for your time Paul. #CADE #Houston #Birmingham #energy #MSR #PaulMurphy #hurricane

August 29, 2017 | Fed Chair Janet Yellen’s defense of the benefits of regulation last week in Jackson Hole probably killed her chances for reappointment, but the more pressing reason to see Yellen return to the private sector is visible in the US real estate market. Chair Yellen and her colleagues have created large bubbles in many assets classes from residential homes to commercial real estate to construction lending. As in the 2000s, this latest bout of asset price inflation will not end well for banks or investors. In this issue, The Institutional Risk Analyst looks at the most recent bank portfolio data from the Federal Deposit Insurance Corp for Q2 2017 to see what it says about asset prices and inflation. For some quarters now, the credit statistics for the $16 trillion asset banking system has been too good to be true, in some cases suggesting that credit events have no cost. The last time that this circumstances existed was the mid-2000s, when several large mortgage banks were reporting a negative cost – that is, a profit – from default events. The same real estate market dynamic that allows growing numbers of Americans to take cash out of their homes is depressing the cost of loan defaults to half century lows. Even faced with this rather striking situation, our faithful public servants on the Federal Open Market Committee can actually stand up in public and say that inflation is too low. The skews in the credit world are so large that some banks are actually earning a profit on recoveries after a loan balance is repaid in full. First let’s examine credit trends for 1-4 family mortgages, a $2.4 trillion asset class for US banks. Loss given default (LGD), a fancy way of expressing net charge-offs, shows the average loss for 1-4 family mortgages. At the end of Q2 2017, the LGD for this asset class was just 24%, the lowest loss rate net of recoveries since at least 1990. Last quarter, the volume of defaults on 1-4s fell below $1 billion or less than 1/10th of one percent of total loans. Source: FDIC The chart above suggests that residential assets prices are quite high, as reflected by the high recovery value -- 76% -- implied by the 24% LGD in Q2 '17. Since 1990 the average loss rate after a default for 1-4 family loans is 67%, thus it seems reasonable to ask when US home prices will adjust downward. How you feel about that depends upon whether you view the extraordinary home price inflation seen since 2012 as being permanent and thus immune to mean reversion. The situation in the world of construction lending is even more profound, with LGD’s well into negative territory for the first time since the 1990s. In Q2 ’17, LGD on those few construction loans that actually defaulted was negative 94%. Given that C&D loans tend to be mostly multifamily paper and have loan-to-value ratios around 50%, when you see a bank reporting such unusual profits on defaulted loans it suggests that the value of the real estate has basically doubled since the loan was made by the bank. Note that the downward move in LGD coincides with the end of quantitative easing by the FOMC. Source: FDIC Of note, home equity lines of credit are showing similar behavior to the 1st lien mortgages, which typically stand in front of HELOCs in the credit stack. LGD for HELOCs reached a mere 31% in Q2 ’17, implying that banks are recovering almost 70% of the value of a loan when a borrower default occurs. The 25-year average LGD for HELOCs is 65%, illustrating that Chair Yellen and her colleagues on the FOMC have literally turned the world of real estate credit on its head. As the chart below suggests, the value of the collateral backing HELOCs has surged since 2012. Source: FDIC Next we move to the $780 billion in credit card loans held by US banks, an asset class that has seen recent growth after years of flat to down portfolio levels. The interesting thing about credit card loans is that they are totally unsecured. Thanks to the generosity of Chair Yellen and the other members of the FOMC, credit card loss rates have fallen dramatically since 2008. First let’s take a look at default and non-current rates, which are both turning up after the years of irrational easing by the FOMC. Source: FDIC Notice in the credit card chart that charge-off rates are above that for loans which are non-current, the opposite of this relationship for most other loan types held by US banks. This is due to the fact that, being unsecured, these credits tend to be charged-off before they have an opportunity to be classified as non-current. The next chart below shows LGDs for credit card loans, which at 83% is at the lowest levels since the mid-2000s. Source: FDIC The real question that the previous two charts raise is much on the minds of bank analysts, namely how much future default risk has been buried under the comforting blanket of low interest rates. The average rate of net-charge offs for credit cards is almost three quarters of a point above current levels, again begging the question as to when we shall revert to the mean. The answer to that question will have a significant impact on bank earnings and the ability of banks to return excess capital to shareholders. Finally, let’s take a look at the $1.9 trillion portfolio of commercial and industrial (C&I) loans, traditionally one of the most important indicators of future US economic growth. Defaults and non-current rates are both below the averages going back to the 1980s, while credit spreads are as compressed as ever over that same time period. The chart below shows net defaults and non-current rates for all bank-owned C&I loans. Notice that net charge-offs are below non-current loans, which may end up being worked out or restructured short of a formal default. Source: FDIC While the chart for net-charge offs for C&I loans looks relatively normal compared to the real estate related asset types, loss rates measured by LGD have been climbing since 2015. More important, new loan production rates (as well as sales) are falling so that the portfolio of bank owned C&I loans is no longer growing very much. This suggests that the US economy is slowing and demand for credit is therefore on the wane. The chart below shows LGD for all C&1 loans. Source: FDIC It’s important to note that the charge-offs and recoveries reported in each period by FDIC insured banks are disparate events. A recovery reported today might be related to a loan charged off three years ago. But the key element of price is reflected in the aggregate data reported by each bank, so that a rising recovery rate/falling LGD strongly suggests that prices in the underlying market are quite frothy. Just as in the 2000s and the 1990s, the Fed again has stoked an asset price bubble in real estate that may lead to significant losses for banks and bond investors should prices correct. Whoever gets the top job at the Fed, the FOMC must live with the balance sheet and market conditions served up by Chair Yellen and her predecessor, Ben Bernanke. While the Fed’s initial focus on narrowing credit spreads was correct, the FOMC should have stopped after QE1 ended in 2010. Instead, concerned that banks were not lending, the Fed continued to buy securities. The Fed has kept the pedal to the metal, repeating the errors of the 2000s by fueling a credit driven bubble in residential real estate. This time around, the bubble is more focused on affluent areas of the country, but the result is likely to be more tears. BTW, we’re rooting for Kevin Warsh as the dark horse candidate for the Fed job in the event that White House chief of staff Gary Cohn decides to stay put. But the biggest challenge facing Yellen's successor as Fed Chair is having the courage to admit that inflating asset bubbles does not create jobs or prosperity, just future financial crises. #inflation #janetyellen #FOMC #credit #KevinWarsh #bubble

August 22, 2017 | After several weeks on the road talking to mortgage professionals and business owners, below is an update on the world of housing finance. We hope to see all of the readers of The Institutional Risk Analyst in the mortgage business at the Americatalyst event in Austin, TX, next month. The big picture on housing reflected in the mainstream media is one of caution, as illustrated in The Wall Street Journal. Borodovsky & Ramkumar ask the obvious question: Are US homes overvalued? Short answer: Yes. Send your cards and letters to Janet Yellen c/o the Federal Open Market Committee in Washington. But the operating environment in the mortgage finance sector continues to be challenging to put it mildly. As we’ve discussed in several forums over the past few years, home valuations are one of the clearest indicators of inflation in the US economy. While members of the tenured world of economics somehow rationalize understating or ignoring the fact of double digit increases in home prices along the country’s affluent periphery, sure looks like asset price inflation to us. In fact, since WWII home prices in the US have gone up four times the official inflation rate. “Houses weren't always this expensive,” notes CNBC. “In 1940, the median home value in the U.S. was just $2,938. In 1980, it was $47,200, and by 2000, it had risen to $119,600. Even adjusted for inflation, the median home price in 1940 would only have been $30,600 in 2000 dollars, according to data from the U.S. Census.” Inflation, just to review, is defined as too many dollars chasing too few goods, in this case bona fide investment opportunities. A combination of slow household formation and low levels of new home construction are seen as the proximate cause of the housing price squeeze, but higher prices also limit the level of existing home sales. Many long-time residents of high priced markets like CA and NY cannot move without leaving the community entirely. So they get a home equity line or reverse mortgage, and shelter in place, thereby reducing the stock of available homes. Two key indicators that especially worry us in the world of credit is the falling cost of defaults and the widening gap between asset pricing and cash flow. Credit metrics for bank-owned single-family and multifamily loans are showing very low default rates. More, loss-given default (LGD) remains in negative territory for the latter, suggesting a steady supply of greater fools ready to buy busted multifamily property developments above par value. We can’t wait for the FDIC quarterly data for Q2 2017 to be released later today as we expect these credit metrics to skew even further. Single-family exposures are likewise showing very low default rates and LGDs at 30-year lows, again suggesting a significant asset price bubble in 1-4 family homes. The fact that many of these properties are well under water in terms of what the property could fetch as a rental also seasons our view that we are in the midst of a Fed-induced investment mania. For every seller in high priced states that finds current prices impossible to resist, there are several ready buyers. But the crowd of buyers is thinning. Charles Kindleberger wrote in his classic book, “Manias, Panics and Crashes,” in 1978: “Financial crises are associated with the peaks of business cycles. We are not interested in the business cycle as such, the rhythm of economic expansion and contraction, but only in the financial crisis that is the culmination of a period of expansion and leads to downturn.” One of the interesting facts about the mortgage sector in 2017 is that even though average prices have more than recovered from the 2008 financial crisis, much of the housing stock away from the desirable periphery has not really bounced. This is yet another reason why existing home sales at a bit over a million properties annually have gone sideways for months. The 600,000 or so new housing starts is half of the peak levels in 2005, but today’s level may actually be sustainable. We had the opportunity to hear from our friend Marina Walsh of the Mortgage Bankers Association at the Fay Servicing round table in Chicago last week. Mortgage applications have been running ahead of last year’s levels, yet overall volumes are declining because of the sharp drop in refinancing volumes. We disagree with the MBA about the direction of benchmarks such as the 10-year Treasury bond. They see 3.5% yields by next year, but we’re still liking the bull trade. But even a yield below 2% will not breath significant life into the refi market. Though prices in the residential home market remain positively frothy in coastal markets, profitability in the mortgage finance sector continues to drag. Large banks earned a whole 15 basis points on mortgage origination in the most recent MBA data, while non-banks and smaller depositories fared much better at around 60-70bps. But few players are really making money. During our conversations over the past several weeks, we confirmed that the whole residential housing finance industry is suffering through some of the worst economic performance since the peak levels of 2012. The silent crisis in non-bank finance we described last year continues and, indeed, has intensified as origination margins have been squeezed by the market's post-election gyrations. Looking at the MBA data, if you subtract the effects of mortgage servicing rights (MSR) from pre-tax income, most of the industry is operating at a significant loss. The big driver of the industry’s woes is regulation, both as a result of the creation of the Consumer Finance Protection Bureau and the actions of the states. Regulation has pushed the dollar cost of servicing a loan up four fold since 2008. From less that $100 per loan in 2008, today the full-loaded cost of servicing is now $250, according to the MBA. The cost of servicing performing loans is $163 vs over $2,000 for non-performing loans. Source: MBA As one colleague noted at the California Mortgage Banker’s technology conference in San Diego, “every loan is a different problem.” But nobody in the regulatory community seems to be concerned by the fact that the cost of servicing loans has quadrupled over the past eight years. The elephant in the room is compliance costs, which accounts for 20% of the budget for most mortgage lending operations. Technology Driving Down Costs To some degree, technology can be used to address rising costs. But when it comes to unique events spanning the range from legitimate consumer complaints to a phone call to follow-up on a past request or spurious inquiries, none of these tasks can be automated. The obsession with the wants and needs of the consumer has led the mortgage industry to some truly strange behaviors, like Nationstar (NYSE:NSM) deciding to rename itself "Mr. Cooper." Driven by the atmosphere of terror created by the CFPB, the trend in the mortgage industry is to automate the underwriting and servicing process, and make sure that all information used is documented and easily retrieved. The better-run mortgage companies in the US use common technology platforms to ensure a compliant process, but leave the compassion and empathy to humans. By using computers to embed the rules into a business process that is compliant, big steps are being made in terms of efficiency. Trouble is, this year many mortgage lenders are seeing income levels that are half of that four and five years ago. Cost cutting can only go so far to addressing the enormous expense inflation resulting from excessive regulation and revenue compression due to volatility in the bond market. Avoiding errors and therefore the possibility of a consumer complaint (and a regulatory response) is really the top priority in the mortgage industry today. As one CEO opined: “Sometimes the best customer experience is consistency in terms of answering questions and quickly as possible and communicating in a courteous and effective fashion.” All of this costs time and money, and then more money. Our key takeaway from a number of firms The IRA spoke with over the past three weeks is that response time for meeting the needs of consumers and regulators is another paramount concern. Being able to gather information, solve problems and then document the response to prove that the event was handled correctly is now required in the mortgage industry. But as one senior executive noted: “Sometimes people are easier to change than systems.” So in addition to the FOMC, banks and mortgage companies can also thank the CFPB and aspiring governors in the various states for inflating their operating costs for mortgage lending and servicing by an order of magnitude since the financial crisis. This is all done in the name helping consumers, you understand, but at the end of the day it is consumers who pay for the inflation of living costs like housing. Investors and consumers pay the cost of regulation. Over the past decade since the financial crisis, the chief accomplishment of Congress and regulators has been to raise the cost of buying or renting a home, while decreasing the profitability of firms engaged in any part of housing finance. We continue to wonder whether certain large legacy servicing platforms -- Walter Investment Management (NYSE:WAC) comes to mind -- will make it to year-end, but then we said that last year. Like the army of the dead in the popular HBO series “Game of Thrones,” the legacy portion of the mortgage servicing industry somehow continues to limp along despite hostile regulators and unforgiving markets. Profits are failing, equity returns are negative and there is no respite in sight. Even once CFPB chief Richard Cordray picks up his carpet bag and scuttles off to Ohio for a rumored gubernatorial run, business conditions are unlikely to improve in the world of mortgage finance. Winter is here. #mortgages #CFPB #Cordray #FOMC #housingfinance #rent #affordability

March 2, 2026 | Whalen Global Advisors (“WGA”)  has released the The IRA Bank Book Q1 2026 , a quarterly review of the US banking industry that focuses on operating and credit trends. The more than 30-page report is available to Premium Service subscribers and reviews the results for the industry in 2025 and sets expectations for the year ahead. Source: FDIC/WGA LLC The year 2025 was extraordinary period for many reasons, including low credit loss rates and soaring asset values. QE teaches us that high asset prices suppress the cost of credit, until asset values fall. UBS believes defaults in private credit could reach 15% , 3x the peak delinquency rates for bank loans in 2008. The report details the rising exposure of US banks to non-depository financial institutions, including credit managers and private equity sponsors. The report includes a proprietary estimate for the continent credit exposure of US banks to NDFIs, as shown in the chart below. Source: FDIC/WGA LLC In the 1920s, many observers believed that asset values had reached a ‘permanently high plateau. Sectors like private equity and credit, and AI, all promise higher credit costs ahead. When credit costs rise, earnings decline and stocks follow. The sharp declines in bank stocks in January and February illustrate this tendency. The fastest growing bank asset category remains loans to non-depository financial institutions (NDFIs), up 7% in Q4 vs Q3 and up 35% YOY to $1.4 trillion at year-end 2025. With growing signs of credit stress among nonbank lenders, banks will eventually pull back from NDFIs. The latest default involving UK mortgage issuer Market Financial Solutions threatens a £930 million shortfall in collateral backing loans to Apollo (APO) , TPG Inc. (TPG) , other NDFIs. The IRA Bank Book Q1 2026 is available for purchase in The IRA online store  and to subscribers to The IRA Premium Service . Subscribers may login and download the full report below.

The latest edition of “The Wrap” features our view of the key events in Washington and on Wall Street over the past week. Don’t forget to watch “The Wrap” on The Julia LaRoche Show  every Saturday on YouTube to catch our discussion of what’s hot and what’s not in the world of finance and investing.  AI Market Rout Accelerates February 27, 2026 | The noise from the unwind of AI is adding to the contagion across the equity markets, which is also hurting bank, credit and BDC stocks. The FDIC just released the bank industry data for Q4 and we'll be publishing The IRA Bank Book industry quarterly on Monday. A viewer asked Julia if banks were required to back their gold holdings with cash under Basel III, but the answer is no. Under Basel III, physically allocated gold is classified as a Tier 1 asset with a 0% risk weight, placing it on par with cash and high-quality government bonds. This allows banks to hold physical gold without needing to set aside additional capital for risk under Basel III. Credit costs were down for banks in Q4 and the only noise in credit is commercial property (CRE) and, of course, private equity and credit.  The world of private credit is unraveling pretty much as we predicted some months ago. Institutional investors can and do abide by limits on redemptions for private equity and credit, at least for a while. Retail investors cannot and do not, and will run when there are clear signs of distress and illiquidity. Remember the deposit run at Silicon Valley Bank. Liquidity seems to be the issue with Blue Owl (OWL)  and some other fund sponsors. The fact that OWL and its companion BDC, Blue Owl Capital Corporation (OBDC) , are public stocks only adds to the potential for a liquidity run. Selling private credit to retail investors created the circumstances for forced liquidation. Our finance company portfolio is below sorted by the 200-day moving average. Finance Company Surveillance Group Source: Yahoo Finance (02/26/26) Despite the strong results for banks and other financials, the markets are giving back all of the gains of '25 and more. Almost every name in our nonbank finance group is down double digits. Note that legacy payments giant Fiserv (FISV)  is near the bottom of the list along with OWL, Coinbase (COIN) , Robinhood Markets (HOOD)  and Upstart (UPST) .  Of note, we've learned this week that some of the larger private credit sponsors such as Apollo (APO) are funding themselves via the Federal Home Loan Banks. APO insurance subsidiary Athene, for example, is a member of the Federal Home Loan Bank of Des Moines and, through membership, has issued funding agreements to the FHLB in exchange for cash advances. APO, KKR & Co (KKR) , Brookfield (BN) and Blackstone (BX) have acquired insurers. OWL also has a relationship with an insurer as do many other private credit sponsors and managers. You'll be hearing more about private credit shops and the FHLBs in future issues of The IRA . The selloff in technology stocks and related names continued this week, even after Nvidia (NVDA)  reported upbeat earnings. The leading chipmaker gave a first-quarter outlook that easily beat the average analyst estimate and delivered a 73% surge in fourth-quarter revenue, but no matter. As we predicted last year, the bloom now seems to be off the rose for any stock related to AI. FS KKR Capital Corp. (FSK)  announced financial results for the fourth quarter and full year ended December 31, 2025, reporting results that fell short of Wall Street expectations and included a dividend cut.  FSK reported a $114 million ($0.41 per share) loss for the quarter and a ~30% cut from the previous $0.70 common stock dividend.  United Wholesale, Rocket Report United Wholesale Mortgage (UWMC)  reported solid volumes for Q4, but then spooked the market by not taking questions from investors after releasing earnings. The change in routine by UWMC CEO Matt Ishbia , who normally loves to take questions from analysts, caught investors off guard and the stock fell sharply.  The market-volume leading company guided to slightly lower Q/Q revenue in Q1 on the heels of its material acquisition announcement of Two Harbors (TWO) . Big question: Will TWO shareholders approve the deal with UWMC, especially with the acquirer's shares falling? As of Q1 2026, TWO book value per share is ~ $11.13.  Based on exchange rate and current trading price, investors will get around $9.00 per share in UWMC stock. What a deal.  By comparison, on of our favorite portfolio holdings, Annaly Capital Management (NLY) , reported strong fourth-quarter 2025 results on January 28, 2026, exceeding analyst expectations for both earnings and revenue.  Like many stocks, NLY sold off after earnings were released, but is still trading at a 10% premium to book value vs a 20% premium at the end of 2025.  And finally, Rocket Companies (RKT) beat Street estimates for revenue and net income , ending a transformational year that included the purchase of Redfin and Mr. Cooper. The stock jumped on the positive news after the close yesterday and confirms RKT as the clear leader of the residential mortgage sector. "Rocket proved itself this quarter as a category of one," said Varun Krishna , CEO and Director of Rocket Companies. "This is the power of an integrated homeownership ecosystem - massive top of funnel, scaled origination-servicing recapture, expansive distribution for industry professionals and a technologically advanced foundation for infinite capacity - built for the AI era. We exceeded guidance in a quarter that closed out a transformational year. I'm so proud of how the Rocket, Mr. Cooper, and Redfin teams executed together." "Bottom Line: The stock is our favorite way to position for an acceleration in overall housing activity, backed by the thematic catalyst of leveraging proprietary technology..." writes Eric Hagen if BTIG . "We're especially bullish around management's guidance for the $500 million of guided synergies from the COOP merger to get realized 6-12 months ahead of schedule, which is mostly the result of effectively pruning the servicing portfolio now that it's fully integrated onto a single tech platform. The stock has pulled back 20% from the 52-week high in mid-January, though we attribute much of the correction to negative read-throughs from other lenders..." Mortgage Rates Fall Our latest column in National Mortgage News  on Federal Reserve Board Vice Chairman Miki Bowman's Basel III proposal to reduce capital requirements for bank investments in mortgage loans and servicing assets is below. https://www.nationalmortgagenews.com/opinion/basel-proposal-helps-banks-but-changes-little We appreciate the feedback we received from our colleagues in the industry. Our background note on the history of Basel III is here (" Miki Bowman Pushes Back on Basel III & Residential Mortgages "). The good news about housing finance, of course, is that the average for 30-year fixed rate mortgages dipped below 6% this week, although more aggressive lenders have been below 6% for some time. Remember, lenders set mortgage rates on loans, markets set the yield on bonds and mortgage-backed securities.  We expect short-term interest rates to move lower over the course of 2026, but mortgage rates are priced off of the 10-year Treasury and may be a good bit more volatile.  We are arranging a new 30-year mortgage for a home purchase in FL and we do not intend the price the loan until late April. Silver Market Continues to Tighten Last but not least, we note again that supply problems in the silver market are threatening the market position of both the COMEX and the London Base Metals Exchange (LBME). The tightness of the physical market for silver and the rapidly eroding confidence in the pricing of the two main western exchanges suggests that a seismic shift is underway in the global market for silver. "India's markets regulator on Thursday directed mutual funds to use domestic stock exchange spot prices to value their physical gold and silver holdings from April 1, 2026," Reuters reports . "The Securities and Exchange Board of India (SEBI) said mutual funds may now use polled spot prices from recognized stock exchanges that settle physically delivered gold and silver derivatives contracts, ensuring that valuations reflect domestic market conditions." The Institutional Risk Analyst (ISSN 2692-1812) is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

February 23, 2026  | The equity of many banks traded off in January following Q4 2025 earnings. The earnings were not bad by any means, but some investors seemingly decided to take profits after a remarkable run in banks stocks going back to last October.  Citigroup (C) remains the best performer of the top five depositories, but there seems to be more risk than reward in large banks presently. The prospect of additional interest rate cuts were the main catalyst for the secular move higher in financials in Q4, but as we like to remind readers, relative spreads are the driver for bank profits, not interest rates. Well-managed banks should make money regardless of interest rates, but a flat yield curve with relatively small differences in rates between the long and short tenors can hurt profits. Banks fund off short-term rates and lend or invest off the longer term. Twos to Tens Back in 2023, the key Treasury market benchmark of the 10-year note minus the 2-year note was negative, shown in the chart above from Fred. This reflected the tight policy of the Federal Open Market Committee. Whereas 2s to 10s were 1.5% back in 2021 during the last part of quantitative easing, today the spread is just over half a point, reflecting a less attractive interest rates environment for banks, REITs and other financial institutions that profit from leverage.

August 14, 2017 | In this issue of The Institutional Risk Analyst, we speak to George Gleason, II, Chairman and CEO of Bank of the Ozarks (NASDAQ:OZRK). Since acquiring a controlling stake in the bank in 1979, Gleason has built the $20 billion total assets institution into a regional powerhouse with over 250 offices in 9 states and a national commercial lending business. As we noted in our discussion with John Kanas of BankUnited, short-sellers have lost a lot of money betting against Gleason and his team at OZRK. The IRA: George, you have been running OZRK for almost four decades in some of the fastest growing areas of the US. Looking back over that period, how have things changed for the bank and the regions that you serve? Gleason: At the risk of sounding like Charles Dickens, I would say that everything has changed, and nothing has changed at all. In my 38-year career, the pendulum has swung from Paul Volker pushing the fed funds target rate over 20% to Ben Bernanke pushing it to almost zero. The seemingly inexorable trend of suburbanization has given way to a massive trend of re-urbanization. Technology has evolved rapidly with a rate of acceleration that seemingly increases every day. The changes are almost unlimited, but at the outset of my first day on the job 38 years ago, I articulated to our staff the principles of pursuing excellence in everything we do, always striving to be the best we can be, improving every day, working hard and adhering to the highest standards of ethics, integrity and fair dealing. Those values and principles have not changed. Whatever success we have had is attributable to our dual abilities to rapidly evolve with the constantly changing macro environment, while relentlessly holding true to the core principles and values that define our bank. The IRA: OZRK is known for being aggressive when it comes to commercial real estate lending, but also for excellence when it comes to managing credit. Of the bank’s $15 billion or so in total loans, $12 billion is in real estate. Looking back over the past three decades, OZRK has reported loan losses that are significantly below its peers. How have you been able to manage the bank so impressively including through the financial crisis? Gleason: The word “aggressive” is often used to describe our real estate business, and I don’t think that is accurate. I view us as “very active” in the real estate space, but very conservative. Real Estate Specialties Group (RESG), our large real estate group, does business across the nation with many of the best sponsors on many of the best properties on extremely conservative terms. At June 30, 2017, assuming every loan in the group was fully advanced, our weighted average loan-to-cost would be about 49% and our weighted average loan-to-value would be about 42%. We are extremely conservative, approving a mid to low single digit percentage of the loans we see. Because of our expertise in CRE and the value we bring to our clients, we see a huge volume of business and that allows us to be very selective. The IRA: Looking at some of the bank’s credit and performance metrics, you have above-average asset returns and margins, excellent operating efficiency, and a default rate that is a half a standard deviation below your asset peers. Your loan book also has a very short duration, less than three years and again well-below peer. Finally, your level of unused credit lines is above peer. How did you come to formulate this remarkable business model? Gleason: We are fortunate to have been among the best performers in the industry year after year for many years. The explanation for that performance is not simple. It is not just the CEO or the head of this unit or that unit or a few great strategies. It is a result of hundreds of skilled and highly motivated people working hard, as a team, in a constant pursuit of doing a better job today than yesterday – always striving to get better. It also has a lot to do with our mission to be the best bank in the eyes of four competing constituencies with very different goals – our customers, shareholders, employees and regulators. Simultaneously making all four of those competing interests view our bank as the “best bank” is like putting a twin fitted sheet on a king bed. They have very different interests, but solving that complex equation of reconciling those competing interests is exactly the goal we vigorously pursue every day! The IRA: Last year seemed to be a peak in terms of bank lending, both for C&I and CRE exposures. How do you see your local markets and also the national CRE market where OZRK is one of the most prominent players? Gleason: We feel good about the current environment. After the Great Recession, there were a few years where new CRE supply did not keep pace with demand growth, and that was followed by a few years where a robust level of construction occurred due to the pent-up demand. Today in most markets, submarkets and micro-markets, supply and demand is pretty much in balance for most product types. There are of course exceptions both ways, but most markets are exhibiting reasonably healthy conditions. New construction in certain markets and product types continues to be justified by population growth, household formation, job growth, changing demographics and other such trends. You just have to do your supply/demand homework on each project and make sure that the demand is going to be there to justify the new supply. Working with intelligent and discerning sponsors helps in that regard, as it means two of us are very critically and thoughtfully looking at the supply/demand metrics. The IRA: Given the bank’s consistent financial performance, you trade at a premium valuation of almost 2x book value and have 80% institutional ownership. Yet there is a certain constituency on Wall Street that seems bound and determined to short OZRK’s stock. Do you think that these pessimistic souls actually understand the bank’s business or are they simply looking at the real estate exposure? Gleason: No, I don’t think they understand our business. My guess is that they screened for banks with a high growth rate and high levels of CRE. Their dual assumptions are probably that CRE is bad and all CRE is more or less the same. That is silly. First, we see great CRE opportunities and we see bad CRE opportunities every day. Our track record over several decades suggests we are good at knowing which is which. Second, at 49% LTC and 42% LTV our RESG CRE exposure has a massively different risk profile than some other banks’ CRE portfolios at 75% or 80% LTV. The IRA: The US economy has been through five extraordinary years of Fed monetary policy where our central bank has deliberately manipulated credit spreads. How concerned are you about the impact of the Fed’s action distorting asset prices in sectors such as commercial real estate? Gleason: It has been a fascinating time to be either a commercial banker or a central banker! You probably recall that even before the official arbiters announced that the Great Recession was in fact a recession; people were all abuzz about what shape the recovery would be. Would it be “U” shaped, or “V” shaped or whatever? When asked that question back then, I always gave this answer: “The U.S. economy has fallen from a ten story window and is battered and bruised on the sidewalk. The recovery will be the economy crawling down the sidewalk, battered and bloodied, for years to come.” As we expected, it has been a long, slow and erratic path back from the bottom. Understanding that we operate in a very complex global economic and geopolitical environment with a constantly changing array of risks, our bank has become more conservative over the last ten years than ever before. For example, the leverage in our CRE portfolio is about 25 points lower on average than it was a decade ago. That doesn’t mean we have a negative view of the future, it simply means that we want to be prepared no matter what the future holds. Maybe thinking like that, I can keep my job another 38 years! The IRA: OZRK is in the process of shedding its parent holding company to save costs and boost returns. Can you talk about what drove this decision and how the change will impact the bank going forward? Gleason: For many years we did nothing in our holding company that we could not do in the bank. Early this year, I asked myself the question, “Why do we have a holding company?” When I couldn’t answer that question, I started asking others. We began to realize that we were incurring a lot of accounting, administrative and regulatory costs and work for a holding company we weren’t using. I analogized it to paying taxes, insurance and maintenance on a beach house you never visit. We got rid of it. We don’t believe it limits or changes our business strategy at all for many years to come. The IRA: Finally, talk a little about your plans for the bank going forward. You have done a series of acquisitions over the past two decades. What should your investors and customers expect to see in the future? Gleason: Last week some of our directors and a few of our top officers joined me to ring the NASDAQ opening bell to celebrate our 20th anniversary of going public. That sort of thing is not really my cup of tea, but the people at NASDAQ were wonderful and it was a great experience. I told our directors the night before that as we were ringing the bell, I was going to be thinking 1% about the last 20 years and 99% about the next 20 years. And that’s exactly what I was thinking. Our focus is clearly on the future. The IRA: No surprise there, but will we see more acquisitions? Gleason: We expect great organic growth, and some very accretive acquisitions. We are confident that the world in which we operate will continue to rapidly change, and we believe that our unchanging principles and our great people will achieve some remarkable things. I firmly believe that our best years lie ahead! The IRA: Thanks George. The Institutional Risk Analyst (ISSN 2692-1812) is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. 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