SEARCH

February 10, 2025 | As the first month of the Trump Administration ends, the deconstruction of the administrative state is accelerating.  First rule: Personnel is policy. President Biden converted many of this political appointees to career positions, but the Trump Administration is moving to remove these employees. Last summer before the November election, we described how a key weapon President Trump and other conservatives are using is Schedule F, a new federal job category established in October 2020 by Executive Order 13957. It allows federal agencies to convert certain civil service positions to Schedule F. This makes them at-will appointments and removes rights to appeal in the event of termination.  President Trump initiated Schedule F in 2020 .  The executive order was rescinded by President Joe Biden in 2021, but Trump immediately reinstated the EO after the election.  Since then, Trump has idled or dismissed thousands of government workers. Thousands more have been given offers for early retirement . But suffice to say that the spoils system has returned to Washington and with it a certain level of operational chaos in the early days.   As with Trump I, the encore features a laser focus on loyalty by all Trump appointees and an unconstrained vision, to recall author Tom Sowell, when it comes to possible government action. Unlike Trump I, the new regime is prepared to take action in many more areas than court appointments with the support and blessing of the conservative establishment. And notice in particular how quiet and deliberate are the public workings of Trump II as it executes a classic conservative agenda and more. Remember when Cantor Fitzgerald CEO Howard Lutnick  told the New York Post  that all those who worked on the Heritage Foundation Project 2025 would be "toxic" under Trump II? Not. By no coincidence, Luknick found himself marginalized and even subject to opportunistic attack by Washington conservatives for shocking lapses like conflicts of interest . Now Lutnick may look forward to a rewarding tenure heading the Commerce Department.  Treasury Secretary Scott Bessent  has emerged as the adult in the room in Trump II, a steady and reasonable counterweight to the swirl of ideas and political rhetoric erupting from the White House.  Bessent has rightly said that short-term interest rates are the Fed’s problem, but LT interest rates are the Treasury’s problem. Show progress on the fiscal side in terms of reducing the deficit and LT interest rates will fall, but so far long rates have risen. Growing political noise is continuing to push reserve asset managers increasingly into gold, says Katie Martin at the FT . Despite the burgeoning fiscal deficit, global demand for short-duration risk free assets remains brisk and will reward any real progress made by the DOGE team under Elon Musk (h/t Eko) . There is huge potential upside for the Trump Administration in any reductions in scheduled Treasury debt issuance in terms of falling LT interest rates. Given the tightness in corporate debt and other markets, Secretary Bessent may be able to deliver some early wins for the Trump White House as federal cash outlays fall as a result of DOGE excavation inside the federal government. And falling LT rates directly impact political priorities such as home affordability. Upon Bessent’s confirmation by the Treasury, President Trump made him acting head of the Consumer Financial Protection Bureau and promptly ordered the entire agency to stand down. Whereas the CFPB tormented lenders with unnecessary fines and sanctions at the behest of Senator Elizabeth Warren (D-MA) , today the agency is essentially shut down. Look for legislation to change the CFPB into a traditional Washington agency or eliminate the CFPB entirely. Note: Hundreds of corporate lawyers face unemployment as a result. The policy agenda in Trump II is clearly informed by the conservative community in Washington, but the unconstrained view allows for literally any possible outcome. President Trump picked Jason De Sena Trennert , a respected Wall Street investment advisor, for a senior Treasury Department role overseeing financial market policy. Trennert is another adult in the room who will ultimately need to defend his agency, but meanwhile politics is the order of the day. “President Donald Trump has renewed calls to end a popular Wall Street tax break,” reports Kate Dorr at CNBC . “The ‘carried interest loophole’ refers to favorable tax treatment for certain compensation received by private equity, venture capital and hedge-fund managers.” Getting rid of the hideous carried interest tax exemption is good politics and Trump knows it. By pushing for an end to lower taxes for deserving private equity executives, Trump outflanks the Democrats politically and gains a big stick to use with Wall Street in other discussions. Do the big PE firms and Buy Side funds want to fight the White House on carried interest? Maybe. Do the Big Banks care? Not really.  They have more important things to consider. As Trump and his DOGE team struggle to cut federal spending by subjecting discretionary programs to a zero budget test much beloved by Elon Musk, folks in the financial sector are beginning to wonder if certain parts of the government apparatus will continue to function. Droves of government employees are leaving Ginnie Mae, for example, making some wonder if new issuance of mortgage backed securities will continue. HUD legal has told Ginnie Mae issuers, of note, not to present any new agreements for legal review.  As with Trump I, the world of banking and housing finance are not particular priorities for the White House, but that does not mean there is inaction. While  Bill Ackman  and other investors are still hoping to see the GSEs released from captivity, in fact the larger mortgage issuers are arguing privately to the White House that we should eliminate Fannie Mae and Freddie Mac entirely and move the guarantee function for all residential mortgages to Ginnie Mae.  The Trump Administration knows that releasing the GSEs from conservatorship is bound to be a political fight. Handing the entire residential mortgage industry to the banks and large nonbank issuers may be an easier lift, especially when done in the name of reducing risk to the taxpayer. In the grand scheme, the banks and independent mortgage banks (IMBs) that dominate housing finance have a lot more to gain by doing away with the GSEs. Of course, a deal with the banks and IMBs to kill the GSEs would include a way for agency MBS to remain risk free assets by paying an annual fee to Treasury. But as we’ve noted previously, when we unbundle the MBS insurance function from the two GSEs, the remaining business is limited and frankly not particularly attractive as an investment. From a conservative political perspective, eliminating the GSEs and putting all subsidized housing activity into the Federal Housing Administration makes a lot of sense. In the free-for-all of Washington today, we do not exclude any possibility that delivers fiscal savings and also brings positive political attention to President Trump and his administration.  As readers of The Institutional Risk Analyst ponder events in coming days and weeks, remember not to confuse political bluster with calculated change. The President needs explosive headlines, like Trump's idea to build resorts in Gaza, to maintain the roar of disapproval that is his political capital. He needs to fight. Fighting with countries is more fun that baiting pathetic Democrats. But President Trump does want to destroy much of the progressive political apparatus in Washington dating back to the New Deal. President Trump's actions are very considered and informed by the community of conservatives in Washington who have waited decades for this opportunity. If anything, the business community still does not appreciate the breadth and scope of the changes underway and in prospect in government under Trump II. We'll be describing the brave new world of Donald Trump in coming months. 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.

January 24, 2025  | In the strange world of Washington, speaking truth in public is a capital crime. Truth is often revealed accidentally. Sometimes truth emerges in a response to a question that somehow is asked, but the reply goes unnoticed. In other cases, cowed and confused media are held spellbound by Washington pharisees , never daring to ask an obvious yet impertinent question of some high official. Yet whether asked or ducked, the questions remain. Our favorite example of questions not asked is the relationship between the Big Media and the Federal Reserve Board. Despite the fact that some of the most senior members of the media in Washington “cover the Fed,” they never ask any meaningful questions about the most important aspect of monetary policy, namely the changes in the balance sheet of the central bank and related “open market operations.”  So completely vacuous has the media discourse with the Fed become that several fellow scribes have privately confessed befuddlement and frustration with their colleagues, people who seemingly cannot report on the obvious. For example, since the Fed is supposedly reducing its balance sheet, why has the Board basically maintained the level of reserves? And just where is the “floor” of total reserves in terms of dollar amount and the average rate?    If someone in the Big Media was actually prepared to ask such questions, the response might surprise the questioner and also the public at large, which is why we don’t ask the question. In order to cover the Fed and actually be allowed to ask questions during the FOMC press conference, you cannot ask Chairman Powell any embarrassing questions that he is not briefed on in advance.  And virtually every question the media asks Powell is couched in the happy talk of “monetary policy” so as not to roil the equity markets. In days past, members of the media who “covered the Fed” actually had to read the statistical releases prepared by the staff and thereby discern the direction of Fed policy. In the world of post-2008, however, the Board has become much more overt in trying to steer public "expectations" (and related media) with verbal direction that often times is at odds with the policy suggested by the data.  Under "quantitative tightening," the balance sheet is shrinking yet reserves are not falling. Does this suggest a divergence between guidance and data? You won't read any critical analysis of Fed policy in The Wall Street Journal . What sort of questions should the media ask the Fed? They might start by reviewing the questions published before each FOMC meeting by Bill Nelson at Bank Policy Institute . But even more important, stalwart reporters (h/t Alex Harris) might take a look at the questions that the US Treasury asks of primary dealers about the Fed’s balance sheet. These questions are sent to primary dealers for the quarterly refunding discussions . For example: Please provide your views regarding potential changes to the size and composition of the Federal Reserve’s SOMA portfolio.  When do you expect the Federal Reserve to cease redemptions of Treasury securities from the SOMA portfolio?  Do you expect the Federal Reserve to begin purchasing Treasury securities with proceeds from principal payments received on its MBS holdings? If so, when would such purchases begin? When do you expect the Federal Reserve to begin open market operations to grow the size of its balance sheet in order to maintain ample reserve balances?  What Treasury security tenors do you expect the Federal Reserve to purchase and why? What if any concerns do you have about money market functioning during such changes to the Federal Reserve balance sheet? That last question is a doozy.  And yet, for some reason, none of the anointed members of the financial media seem to be willing or even able to ask Fed Chairman Jerome Powell the most obvious questions about Fed monetary policy.  To make things easier, perhaps the Fed covering media could simply ask the questions posed by the Treasury to primary dealers?  This final query is especially of note: Please discuss how foreign demand for Treasury securities has evolved over the last year. What have been the recent drivers of demand for Treasury securities by foreign official sector and foreign private sector entities? How is demand likely to evolve over the next year? Please elaborate. The Treasury questionnaire for primary dealers certainly seems to merit attention. How do members of the media get a copy of the bank responses to these questions? Hmm?  Now that is a good question.  Meanwhile on Capitol Hill, the written responses by Treasury Secretary nominee Scott Bessent provide some insights on where single-family housing and the possible release of Fannie Mae and Freddie Mac stand in the priorities of the Trump Administration. Basically, Bessent seems to be distancing the Trump Administration from the idea of release from conservatorship “as is” and is leaving all options open. Sound like Trump I? Yeah. Ponder these questions and responses:  Question 69: If you decide to end the conservatorships of Fannie and Freddie, will you seek to do so through administrative action or through legislation by Congress? In your view, what conditions must be met before ending the conservatorships? Are there any congressional actions that must take place to end the conservatorships? Answer: If confirmed, I look forward to exploring all options available and being briefed by Treasury staff and all interested parties on the status of Fannie Mae and Freddie Mac, and if confirmed I will commit to acting in a manner that is thorough and thoughtful, and consistent with the law. If any legislative changes are warranted, I commit to working collaboratively with Congress in this process. Question 70: In your estimation, how long would it take to meet any required preconditions and complete the process of releasing Fannie and Freddie from conservatorship?  Answer: I look forward to being briefed by Treasury staff and all interested parties on the current status of Fannie Mae and Freddie Mac, and if confirmed, I will commit to carefully assessing and instituting a process if it is deemed appropriate. Question 71: Should the Trump Administration bar any individuals or entities who would financially profit from the end of Fannie and Freddie’s conservatorships from discussions and decision-making about potential release? Answer: If confirmed, I look forward to hearing from a wide and diverse range of interested parties in seeking the best path for Fannie Mae and Freddie Mac in compliance with applicable law as set by Congress. Question 79: During the 2008 crisis, the federal government bailed out Fannie and Freddie, vindicating widespread investor views that the GSEs were backed by an implied government guarantee despite their lack of an explicit government guarantee.  A. If the conservatorships are ended, would you support extending a full faith and credit guarantee to Fannie and Freddie, their securities, or their debt? In your view, would doing so require congressional action or could FHFA or the Treasury extend such a guarantee through administrative action? B. Should Fannie and Freddie be charged a fee for any government guarantee, whether explicit or implied? If so, how much should that fee be and how would such a fee affect mortgage costs?  Answer: It is my understanding that legislation from Congress would be required for an explicit, paid-for guarantee backed by the full faith and credit of the government. If confirmed, I look forward to being briefed on options regarding a government guarantee.  Question 82: If Fannie and Freddie were released from conservatorship, do you anticipate that credit ratings for their products would be downgraded? If so, how much do you estimate that their ratings would be downgraded by and how would that rating downgrade affect investors’ willingness to purchase their securities? How would these changes affect mortgage rates for homebuyers?  Answer: If confirmed, I look forward to working with all interested parties, including the Director of the FHFA to understand the potential implications of a release from conservatorship of the GSEs, including potential impacts on their credit ratings and the downstream effects.  Reading these questions from the Senate Finance Committee, the false narrative about releasing the GSEs from conservatorship "as is" seems to be unravelling. Is the blatant "pump & dump" operation in the securities of the GSEs that has been ongoing for months about to end? Notice that Fannie Mae seems to have peaked near-term and volumes are falling. Will you hear anything about the deliberate manipulation of GSE stocks in the Big Media? Not a chance. Source: Google Finance (01/23/25) 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 5, 2025  | First, we have updated the WGA Bank Top Indices for Q1 2025 . As you can see below, the WGA Bank Top 10 Index (WBSXW) has significantly outperformed the Invesco KBW Bank ETF (KBWB) over the past three years. If we look at the 104 banks in our index test group by score and market capitalization, the skew towards large-cap names is as extreme as it has been in more than a year. The highest score bank starts from the left with Discover Financial (DFS) followed by JPMorgan (JPM) just over $750 billion in market capitalization. Source: WGA LLC/Thematic As the first month of the term of President Donald Trump ends, Scott Bessent  has been confirmed as Treasury Secretary and Elon Musk  has been given read/write access to the national payments system. Researcher Nathan Tankus  broke the shocking story last week in a post for Rolling Stone ,  describing how Trump intends to gut the career staff at the Treasury and start selectively defaulting on Treasury payments. Remember, "Schedule F." More recently, WIRED  reports :  “The Bureau of the Fiscal Service is a sleepy part of the Treasury Department. It’s also where, sources say, a 25-year-old engineer tied to Elon Musk has admin privileges over the code that controls Social Security payments, tax returns, and more.” Of note, the union representing Treasury employees has sued Secretary Bessent over giving Musk and his employees access to the payments system. "The lawsuit, which was filed days after Treasury Secretary Scott Bessent agreed to a plan giving department officials allied with Musk access to the system," Politico reports , "landed amid growing pushback to the Tesla founder’s slash and burn efforts to cut hundreds of billions in federal spending." Even as President Trump toys with disrupting the Treasury’s ability to make timely payments, the dollar and gold are both surging to new highs. The global dependence upon dollars for payments and investments is allowing the dollar and gold to both increase. How is this possible? Because the era of dollar hegemony that suppressed both the price of gold and other currencies is about to end. Think of the start of Trump II as a macro inflection point, like the arrival of President Andrew Jackson in Washington circa March of 1829. As we note in the upcoming second edition of " Inflated: Money, Debt and the American Dream, " the eight year term of President Jackson left the US without a central bank and in fiscal chaos. Likewise, as we discuss in our latest conversation with Julia LaRoche , the Federal Reserve Board is playing a game of chicken with the White House over interest rates and market liquidity. Simon White  of Bloomberg sets the scene: “Traders and investment managers are positioning for higher inflation and weaker growth. The net long position in Treasuries is rising sharply, while positioning in short-term rates futures is becoming very net short. Dollar and gold longs are near highs, while the net long in stocks is falling, yet still has plenty of scope to drag prices lower.” What prices will be dragged lower? Bond and stock prices. Everything else will go higher thanks to inflation. Rising gold prices are an indication of growing unease at some of the policies taken or intended by the Trump Administration, but the strength of the dollar reflects latency on the part of global investors, who very literally have nowhere to run when it comes to fiscal instability in the US dollar system. The real threat of tariffs announced by Trump is not inflation, but rather a LT decline in the use of the dollar as the global reserve currency. As the Trump Administration steers the US towards fiscal chaos, LT interest rates are moving higher, putting further pressure on the Fed, banks and other leverage investors who have the misfortune of owning low-coupon assets. Fannie Mae 3s are trading at 84-18 this AM or 1.75% over the Treasury 10-year note. Bank of America (BAC)  owns $507 billion in MBS with an average yield of 2.5%, but the average yield for $3 trillion in MBS owned by the US banking industry is just 2.9% or figure a 15 point discount to par . Rising yields are likely to push mortgage rates higher and, eventually, home prices lower, perhaps with a weaker dollar, but this adjustment could take years to materialize. Remember, none of the traditional measures of fiscal and monetary policy make any sense in 2024. Economists worry about conventional notions, like the impact of tariffs on statistical measures of inflation, yet they miss the larger threat which is how President Trump intends to manage the fiscal posture of the US. Robert Busca  notes in a recent comment on Substack : “Changing relative prices via tariffs does not affect inflation unless the change in relative prices is dealt with in a strange way by the Monetary Authority. So that bends attention back to the Fed and how the Fed is going to respond to the Trump tariffs and to their impact on import prices which could turn out to be broad depending on the exact nature of the tariff or could turn out to be episodic across products.” Remember, one of the favorite business negotiating tactics of President Trump is to withhold payment. As it becomes apparent that taxes and spending are the primary focus of the Trump White House, shares in the GSEs – Fannie Mae  and Freddie Mac  – are retreating from the exuberant highs of mid-January. Freddie Mac peaked at $7.15 on January 15th, but has since dropped more than 30% below $5.  Source: Google Finance In the strange world of Washington, the GSEs will be released from conservatorship and the several hundred billion in common shares that will be owned by the Treasury will be sold to the public in order to finance more Trump tax cuts. A more likely scenario, however, is that the Treasury will exercise its option (which expires in 2028) and convert into common, leaving the US government the majority shareholder of the GSEs, indefinitely.  The GSEs will be released from conservatorship, but the Treasury will own 80% of the equity and face a significant loss on the trade. If, as we suspect, two years hence the Trump Administration’s fiscal hijinks have caused interest rates to rise and the dollar to fall, selling the shares of the GSEs will be a minor concern. In a world where US budget deficits are surging and the economy is contracting, global investors may be fleeing greenbacks into gold and foreign currencies. The long-only world of dollar-based ETFs and passive investing will be collapsing on itself. And President Trump will be doing a reprise of President Richard Nixon , imposing currency and price controls on a hyper-inflating US economy. During his confirmation hearing, Treasury Secretary Bessent said: "Congress presently has the ability and responsibility for addressing and managing the statutory debt limit. I look forward to working with you and your colleagues to ensure that we do everything possible to protect the U.S. economy and guard against default on our nation’s debt. Honoring the full faith and credit of our outstanding debt is a critical commitment." 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.

February 3, 2025  | Premium Service | Ameriprise Financial (AMP)  and PennyMac Financial Services (PFSI)  are two of the leaders in their respective industry segments and both delivered good results in Q4 2024, yet each has attributes that are making analysts and investors cautious about 2025. What do the earnings from these two high-flyers tell us about the economy and the investing environment? What are some of the common themes for these very different firms which depend so heavily on income from intangible assets?  Ameriprise Financial One of the clear headlines coming out of Q4 earnings from AMP is that guidance is softening, both in terms of the investment business and the balance sheet of the bank, where loan growth has been largely a function of mortgage lending.  Total assets under management were actually down 2% in 2024, in part due to competition from passive strategies and other market dynamics.  Yet GAAP net income was up strongly, as shown in the table below. Of interest, AMP CEO James Cracchiolo  thinks the advisor market is “a little pricey right now” and he does not see acquisitions in the future, preferring organic growth. “We expect more cash to be put to work and greater transactional activity as we move through 2025,” he told analysts.  But the more important question is whether AMP is a little pricey at almost 10x book value. While the parent holding company of AMP has roughly $190 billion in total assets, the bank unit is relatively small at $23.6 billion. The larger group includes two broker dealers, several insurance companies and hundreds of other vehicles and special purpose entities. Total earning assets of the holding company were only $71 billion at Q3 2024, according to the Y-9, while intangible and other assets were $110 billion, representing derivatives, customer relationships and other ethereal assets.  Source: FFIEC AMP had over $350 billion in assets under management in proprietary mutual funds and annuities at Q3 2024. Total Assets Under Management, Administration, and Advisement increased 10% in 2024 to $1.5 trillion at year-end. While some Sell Side analysts have underweight ratings on the stock, the reason is primarily valuation. At 10x book value and a forward P/E of at least 10x earnings is well above the group, but AMP has delivered equity returns that are also well-above peer.  The source of the earnings beat in Q4 2024 was corporate, however, while asset and wealth management was light at the end of last year. “While this was definitely a reported beat,” notes John Barnridge  Piper Sandler, “that the driver was primarily Corporate and taxes suggests a low quality beat as underlying earnings power is less than investors were expecting for 4Q24 and prospectively out of its largest business - Advice & Wealth Management (AWM) = ~2/3 of '24 pre-tax EPS ex-corporate).” To us, the real question with AMP is whether the crowd of equity managers that has caused this small asset gatherer to outperform the rest of the industry over the past five years is going to continue to push valuations higher. A sum of the parts analysis suggests that AMP is well-ahead of fundamental value vs retail asset managers, yet there are some institutional comps such as Apollo Global Management (APO)  and Ares Management (ARES)  that are even higher in terms of book value and/or earnings multiples. Source: CapIQ The fact that AMP has outperformed JPMorgan (JPM) over the past five years is interesting, but we see the slowing performance vs the industry leader over the past year as being more significant. AMP has been relatively stable in terms of market multiples, especially compared to ARES. That said, we’d be inclined to protect any LT gains in AMP with some sell stop orders on the theory that growing skepticism about future earnings growth may indeed be a sign that the best days in terms of appreciation are behind us. An equity market retreat would be a catalyst for a more substantial decline in AMP and other members of our asset gatherers group. Indeed, we think it is notable that AMP has underperformed the other members of the group other than SCHW over the past year. Notice that Goldman Sachs (GS) currently leads the group. Source: CapIQ (01/31/25) PennyMac Financial PFSI is one of the leaders in the mortgage industry and generally the first to report earnings and drop the Form 10 with the SEC. It is a long-proven axiom that the righteous report early in the 45-day period at the end of the quarter while the more devious hide in the back of the reporting period. PFSI is part of a binary paired with PennyMac Real Estate Trust (RMIT) , which reserves as a balance sheet for conventional loans, MBS and MSRs. PFSI serves as the issuer and external manager of the REIT, but retains the Ginnie Mae exposures directly.  We wrote recently (“ Residential Mortgage Finance 2025 ”) about how Rithm Capital (RITM)  should finally create a clear comp for PennyMac and Mr. Cooper (COOP)  by spinning off NewRez as an issuer and manager, leaving RITM as an externally managed, multi-asset REIT.  At present, RITM and the residential REIT, Two Harbors (TWO),  own seller/servicers as taxable appendages, a less than ideal corporate structure from a credit and capital markets perspective. REITs basically allow issuers to access retail investors looking for income, but are poor vehicles for accumulating capital. In 2024, PFSI was locked in a price war with United Wholesale Mortgage (UWM)  at the top of mortgage producers, Rocket Mortgage (RKT)  at number three and Freedom Mortgage at number four, according to Inside Mortgage Finance . A  number of other issuers showed double-digit gains in 2024, largely due to the surge in production in Q3 and into Q4, but the leaders in 2025 will be the firms willing to pay for the expensive purchase loans. As we go into 2025, production is slowing and profitability is uncertain because a few issuers led by Freedom are willing to pay premium prices for loans and servicing. Are the valuations for MSRs unreasonable? That depends upon your view of loan volumes and LT interested rates.  Source: Fannie Mae/Freddie Mac/Ginnie Mae/IVolatility Notice in the chart above showing new production in government loans how PFSI, RKT and Freedom were leaning into Ginnie Mae in Q3 and Q4, while other issuers were far less aggressive.  Like most issuers, PFSI is not making a lot on loans and more than 80% are expensive purchase loans, thus the servicing side gets far more attention from analysts. The chart below shows servicing results for PFSI. The table above shows servicing results from the Q4 2024 PFSI earnings presentation. First we see the servicing pre-tax of $168 million, followed by a non cash increase in the modeled value of the mortgage servicing rights (MSR) of $540 million and a loss on the hedge of $608 million. While PFSI is able to report a cash profit for GAAP purposes, PennyMac is down because of the “noisy” hedge results, to quote one noted analyst.  The total loss on the hedge for 2024 is bigger than net income. Note in Q3, when interest rates fell, PFSI took a loss on the MSR and a much smaller gain on the hedge. Freedom does not hedge the MSR at all.  During the Q4 2024 conference call, PFSI CEO David Spector said “the [GSE cash] window becomes less of an issue in periods of time of higher interest rates because sellers don't want to retain servicing because they don't hedge that servicing. And so, when rates were zero, there was a much better economic thesis to holding on the servicing when rates -- mortgage rates are 7%, and that's not so much the case.”  We suspect the folks at Freedom and other issuers might disagree with this observation on MSRs, but Spector may have been speaking generally about correspondents that sell loans and servicing to him. While larger firms like PFSI and others continue to retain and purchase MSRs, we push back on the idea that these assets are overvalued. Indeed, in a world where mortgage rates fluctuate between 6-7%, MSRs and firms that create them are arguably undervalued. Capitalization rates for retail properties start in the 6 times range and move up from there. Commercial office cap rates are in the 7s and 8s. Government MSRs with a 3% average coupon are trading in the 4.5x range, according to SitusAMC.  Looking at comparable assets across the real estate segment, residential MSRs look cheap. PFSI is up only half as much as JPM over the past year, but out performed the banks by 2x over the past five years. As and when the FOMC drops ST interest rates, the mortgage sector leaders are likely to outperform the banks and nonbank finance peers. If we eventually get a couple of quarter point rate cuts over the next 24 months, the hyper-efficient survivors in the world of residential mortgages will be positioned to deliver outsized equity returns. As you can see in the chart below, COOP currently leads the mortgage issuers group, followed by PFSI, RITM and TWO. We believe that the unified business model of COOP and PFSI are more attractive that the two REITS, RITM and TWO . As we've noted earlier, the REIT structure is less attractive to investors than the C-Corp configuration of COOP and PFSI. We think that both would benefit from spinning out the issuer as an independent seller/servicer, which would externally manage the REIT. COOP is up 700% over the past five years, PFSI a mere 200% and both RITM and TWO are actually down. The first chart below shows the past year's performance, while the second chart shows the past five years. Source: CapIQ (1/31/25) Source: CapIQ (1/31/25) 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.

January 27, 2025   | When President Donald Trump says that interest rates are too high, he may not fully understand just how right he is about the cost of credit. The “normalization” of interest rates has not only driven home purchase volumes to decade lows or more, but it has subjected trillions of dollars in commercial and residential assets created after 2008 and especially 2020 to a price reset. Large swaths of the financial landscape are under water in terms of loan-to-value (LTV), suggesting future credit losses ahead. We have written about the generally positive situation with bank credit, but the banks are only showing you part of the story. Underneath the carefully curated pictures of current bank credit and earnings lies a disturbing cash reality as more and more borrowers fall behind on payments and are given forbearance. The chart below shows almost $100 billion in bank revenue accrued but not received through Q3 2024. Source: FDIC That's right, US banks have reported $100 billion in revenue they have not received or about two quarters of earnings. Outside of the regulated confines of commercial banks, the picture is even less rosy. And the credit picture at the lower end of the spectrum in terms of default probability is eroding rapidly.  In fact, although the aggregate credit picture going into 2025 still appears fairly normal, we continue to collect data points that suggest the reported credit loss and delinquency numbers, and the cash actuals at ground level, have never been further apart.  Whether we are talking about the inflated valuations of private equity portfolio companies, revenue of banks accrued buy not collected, or the default rate on government insured loans, the picture of credit is growing darker. For example, the quest for government efficiency under the Trump Administration could have a significant impact on commercial real estate credit (CRE). New reports suggest that the Trump administration may sell 2/3 of federal office stock in Washington CRE daily reports , “which could reshape DC’s real estate market and leave landlords reeling.” That's one way to put it. Of the $500 billion in CRE loans maturing this year, 14% are considered underwater, meaning the outstanding debt exceeds the asset's current value, according to MSCI. Multifamily housing and office properties are said to be particularly at risk.  The chart below shows average prices for CRE nationally. One of the enduring legacies of COVID and the Fed’s massive open market purchases of securities is that many banks and other depositories are insolvent, just as the central bank itself is insolvent. Yet despite the very public and obvious fact of insolvency, the Fed pays the bills of the Consumer Financial Protection Bureau and also handsome dividends to member banks. “For the first nine months of 2024, the Federal Reserve Banks in the aggregate paid over $1.2 billion in dividends to their shareholders,” notes our friend Alex Pollock . “Yet at the same time, they together lost the gigantic sum of $63 billion.  On an annualized basis, they are paying dividends of $1.7 billion, for a dividend yield of about 4.5%, while losing about $80 billion, with negative retained earnings and capital.  How is that possible or ethical, you might wonder.” In the same way that we pretend that the Fed is positively capitalized, we are also pretending that literally hundreds of banks, thrifts and credit unions are solvent, even though published financial data suggests otherwise. If your bank has retained a lot of 2% MBS, CRE loans and other types of low coupon assets from the vast volumes forced by the FOMC during 2020-2023, then the bank or credit union is probably insolvent. Today coupons are higher, but new loan volumes have fallen off dramatically.  Even with the gradual runoff of mortgage portfolios, 56% of all residential loans are below 4% coupons and 70% are still below a 5% coupon. This metric tells us that any refinance wave is a long way off. Also, the volume of new MBS is going to be under downward pressure even if the Fed eventually drops short-term rates. Not only is the 10-year Treasury note a good surrogate for residential mortgage rates, but it also informs our view of mark-to-market problems inside banks and other depositories with the 10-year yield approaching 5%. Confirming the view seen so far in Q4 earnings, the data from Experian shows auto loan delinquency down slightly in Q4. Auto lease write-offs are at 14.0 bps, down from 15.4 bps last year.  And bank and private label credit cards are likewise muted in terms of delinquency through November.   However, total delinquency in residential mortgages is rising. The severe delinquency rate (share of balances 90+ days past due, in bankruptcy or foreclosure) is now 0.60%. This is up 13 bps from a year ago, when it stood at 0.47%, reports Experian. If we then start to factor in the degree of forbearance reflected in the official data, the picture becomes more serious.   Residential Loan Delinquency Source: MBA, FDIC The Biden Administration spent the past four years hiding financial problems from the federal budget deficit to increased morbidity among low-income borrowers. If we look at some of the Ginnie Mae issuers with the highest DQ2 and DQ3 ratios (for 60 and 90 days delinquent), there are a number of state-supported issuers with visible default rates in the mid-teens. These issuers are in default on the credit provision of the GNMA Guide and thus are also in default on bank warehouse lines as well. If, as we suspect, the incoming members of the Trump Administration take a tough line on credit costs and enforcement, some Ginnie Mae issuers with elevated levels of delinquency may lose access to bank funding. Whereas in 2021, when we saw high levels of delinquency and vast corporate cash flow due to refinance business, today we see slowly rising delinquency and falling loan volumes – a very dangerous combination.  The chart below from the Ginnie Mae global markets report shows LTVs for different loan categories. Source: Ginnie Mae Without new production volumes, residential mortgage issuers must rely upon corporate cash to make up any shortfalls in outbound payments to MBS holders at the end of the month. If the Trump Administration raises the FHA mortgage insurance premium (MIP) back to pre-2023 levels, new loan volumes will suffer as a result. An increase in the MIP in today’s market may even be counter productive in terms of reducing industry volumes.  Other changes that the Trump Administration is likely to make in pursuit of fiscal righteousness could actually tip over the proverbial apple cart in the world of residential lending. One proposal we have mentioned in previous issues of The Institutional Risk Analyst is the idea of limiting partial claims on delinquent loans guaranteed by the Federal Housing Administration. If this proposal is finalized by whoever is lucky enough to lead the FHA under President Trump, then the visible default rate on FHA loans and Ginnie Mae MBS will surge. Hundreds of thousands of loans currently hidden in an endless cycle of loan forbearance will suddenly become very visible. Just as many CRE loans are under water in terms of the value of the asset vs the existing debt, many residential loans are likewise at risk. At the end of November 2024, the average LTV ratio of loans in Ginnie Mae pools was an eye-watering 98.2% meaning that there is no equity in the $2.5 trillion in government insured loans. The average LTV for all residential loans was 85% -- if you give full credit to the private mortgage insurance in the conventional market. In a general housing market price reset, the boundary line between apparent stability and financial crisis has never been so thin as in 2025. May 2025! 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.

January 21, 2025  | Premium Service | Over the past year and more, the sharp upward moves in the market value of the Fannie Mae and Freddie Mac, those high-flying penny stocks, have distracted some observers from the changes underway in the land of mortgage finance. With the nomination of Bill Pulte  to lead the Federal Housing Finance Agency, however, maybe the GSE trade is done. Below for readers of our Premium Service , we dig into the mortgage finance complex as a year of 7% plus residential mortgages looms ahead. The first, big picture question to ask is about the outlook for new production of 1-4 family loans and mortgage-backed securities (MBS). The answer is that average production in the industry was running below $1.5 trillion in 2023 and at $1.7 trillion in 2024. Estimates for production in 2025 were above $2 trillion based upon the assumption of interest rate cuts that are no longer anticipated. We expect the actual production in 2025 to be below $2 trillion.  S ource: Mortgage Bankers Association Profitability in the industry is likewise improving from the lows of 2023, but only just barely.  Not quite three quarters of all IMBs were profitable in the first 9 months of 2024 (h/t Joe Garrett), according to the Mortgage Bankers Association. But being barely profitable is a long way from financial stability and soundness. S ource: Mortgage Bankers Association The profitability of IMBs at the loan level us improving, but only just barely. The majority of the actual cash profit generated from lending is found in the mortgage servicing rights (MSRs), especially in the conventional loan market. The premium for selling the MSR with the loan is so attractive, and gain-on-sale profits are so hard to generate, that many sellers that might have preferred to retain servicing are simply compelled to sell to cover operating expenses.  Ginnie Mae volume growth continues to outpace both of the GSEs individually, accounting now for 40% of total MBS issuance. Many lenders lean towards the government market because the execution is far better than in conventionals. Volumes in Q4 were down low double digits, Inside Mortgage Finance Reports , with a 15% decline observed in December. The table below shows the TBA market for Ginnie Mae MBS as of the close on Friday. To-Be-Announced (TBA) | Ginnie Mae MBS Source: Bloomberg (01/18/25) Notice that the premium contract is a 6.5% for February delivery, one reason why 30-year fixed mortgage rates are rising above 7%.  Effective rates in the VA market, however, are far lower, driving refinance volumes.  As mortgage rates increase, lenders are leaning even more into the VA market to generate returns. “Securitization of VA loans was up 14.6% in the fourth quarter, and FHA volume rose 6.1%,” reports  IMF . “While the GSEs reported a 3.4% increase in conventional loans with no mortgage insurance, the quarterly volume of loans with private MI fell 1.3%.”  But the single biggest negative factor on volumes remains home prices, which continue to rise in most markets nationally, as shown in the chart below. One of the more notable aspects of the FOMC under Jerome Powell was the refusal to raise interest rates enough to force home prices down significantly. Because of concern about Treasury market liquidity, the FOMC did not even force system reserves down (h/t Bill Nelson ), even while engaging publicly in “quantitative rightening” by reducing the balance sheet. The residential housing market softness observed in 2023 lasted barely a year, followed by a resurgence of lending volumes and home prices in 2024. The boom in new loan production in Q3 2024 was not very long lived, however, and was visibly collapsing by the end of December. Despite weak production volumes, the larger issuers continued to bid aggressively for servicing assets in 2024.  The standard reason advanced for the aggressive behavior by players such as Freedom Mortgage and Rocket Mortgage (RKT) in the bulk MSR market is that superior recapture allows for higher valuations for MSRs. Rising interest rates is another reason often advanced for paying up for MSRs. But one key reason for higher MSR valuations is the growth in escrow balances for taxes and insurance, a systemic phenomenon that means much higher custodial balances and float earnings on MSRs. The chart below shows the fair value of bank owned MSRs with the average valuation around 160bp. Source: FDIC/WGA LLC The Mortgage Issuers The table below shows our enlarged real estate surveillance group, both public and private issuers. We have captured all of the public and private 144a deals available on the Bloomberg and from other sources to give readers some idea about what these firms pay for debt and equity capital. If there is no data, the field is left blank. Below we discuss selected issuers and REITs, and how we think they will fair in 2025.  The good news is that the larger Ginnie Mae issuers have taken advantage of a positive investor reception in the bond market to issue substantial amounts of term debt to finance servicing portfolios. As you read through this list, however, notice how many issuers with ~ $100 billion in servicing assets and marginal profitability are waiting to either sell the MSR or get bought out entirely. In 2025, consolidation is the name of the game in residential mortgage finance.  Mortgage Finance Source: Bloomberg (01/18/25), WGA LLC Annaly Capital Management (NLY)  is a REIT that has historically focused on agency MBS, but more recently has followed the herd into investing in conventional MSRs. The REIT is trading about book value, but is at a bit of a discount to some other REIT comps in terms of P/E ratio. The equity features a 13.5% dividend yield, which is the primary reason for investors to hold the shares. REITs are essentially passthrough vehicles that have difficulty accumulating capital, thus while we have owned NLY in the past, it is not part of our portfolio today. There are better ways to get exposure to MSRs. After NLY, we have Better Homes & Finance (BETR) , a mortgage platform that debuted in 2023 after a long and painful gestation period  that culminated in a SPAC merger. The stock had the bad fortune of coming out when the mortgage market was going through one of its most difficult periods in many years. The BETR stock did show signs of life in 2024 and even flirted with $30 per share in July, but closed last week below $10 per share.  After BETR on our list are two private placements for Bayview, the privately-held mortgage issuer that is paired with Lakeview Loan Servicing, the largest owned servicer in the mortgage industry. Bayview is active in the bulk MSR market and is one of the more sophisticated mortgage issuers. Bayview caters specifically to the insurance industry for the management of 1-4 family loans and MSRs. Bayview owns several insurers, giving the group access to the Federal Home Loan Banks for funding. Bayview just settled a 50-state inquiry regarding alleged deficient cybersecurity practices, but generally the firm has a very low profile. Bayview was recently involved in Everbank's acquisition of Sterling Bank of Michigan. Next on the list is  Cherry Hill Mortgage Investment Corporation (CHMI) , an agency REIT that has also begun to invest in conventional MSRs. Because REITs cannot become government issuers, they are forced to either focus on conventional assets only or purchase a seller/servicer, which is operated as a for profit appendage of the REIT, as discussed below. CHMI has a dividend yield of 20% and a P/E or just 3, both a reflection of the fact that the REIT trades at 0.75x book value.  Chimera Investment Corporation (CIM)  follows after CHMI and again we have a REIT that focuses on residential mortgage assets. CIM has only a 10% dividend yield, thus no surprise that the stock trades at a steep discount to book or 0.64x. During COVID, CIM surged up to nearly $50 per share, but at Friday’s close the stock was below $15 per share. The all-time high was $296 in 2008. Go figure.  After Chimera, next on the list is Finance of America Companies Inc. (FOA) , one of the smallest public issuers in our group. FOA is focused on originating and servicing reverse mortgages, and has been suffering from a lack of profitability. Of note, Onity Group (ONIT) acquired the reverse mortgage assets of Mortgage Assets Management (MAM) from Waterfall Asset Management in August 2024. FOA is now the only other independent reverse issuer and Reverse Mortgage Funding is owned by the US Treasury. FOA has rallied strongly over the past year, when the stock was trading well less than half of book value, and is near the 52-week high. Today FOA trades over 0.8x book, but faces the possibility of another year of high interest rates and low volumes. One of the largest lenders and servicers in the US is Freedom Mortgage , a private issuer located in New Jersey. Freedom had over $600 billion in owned servicing as of Q3 2024 and saw MBS issuance rise over 300% YOY as the firm leaned into the conventional and government markets. Although the equity of Freedom is private, it has issued significant amounts of term debt in the bond market and earned steadily declining credit spreads. The average yield on the “BB-” (Fitch) Freedom debt is below 8%. Like Lakeview Loan Servicing, Freedom typically does more government loans than conventionals, and is especially adept at recapturing loan prepayments in FHA and VA assets.  In the past several years, however, Freedom has been the bid to beat in the MSR market and has also increased lending activity overall based upon the belief that MSRs are still not fully valued in the markets. As we’ve noted in past missives, compared with commercial real estate, residential MSRs still trade at relatively low cap rates. Guild Holdings Company (GHLD)  is one of the best managed companies in the mortgage sector. Despite the ebb and slow of Fed interest rate policy, GHLD has managed to trade within a narrow range. The recent high was $17 in  early 2021 and the low was $7 in 2022. GHLD was near the highs in Q3 2024 when many thought that further rate cuts were coming from the Fed, but the stock closed at $12.74 on Friday or 0.68x book value. A top-20 issuer, GHLD did $14 billion in mostly purchase volume in 2024 (IMF), a 20% increase YOY, but lost money on a GAAP basis in the first nine months of 2024. The firm has $90 billion in unpaid principal balance (UPB) of servicing.  After GHLD comes loanDepot, Inc. (LDI) , a top-20 issuer which has been struggling to align expenses and falling revenue since 2021.  LDI had $114 billion in UPB of servicing at the end of Q3 2024. LDI saw volumes fall 10% in 2024 and 24% in conventionals last year. LDI ran up to 1.7x book in Q3 2024, but has since retreated to just above book value at Friday’s close.  The chart below comes from the Q3 2024 LDI earnings presentation. With just over $100 billion in MSR remaining, the obvious question is why doesn’t CEO Frank Martell simply sell the company? The answer is that at 1.2x book, there probably is not anybody other than retail investors willing to pay that price. LDI is a classic example of an issuer that has struggled to make expenses fit the greatly reduced level of volumes flowing through the firm. But the problems at LDI are deeper than mere indifference to a lack of profitability.  LDI looks a lot like other firms that exist to preserve industry employment rather than generate returns for investors. The $1.5 billion MSR at Q3 2024 is 3x the market cap of the company. The obvious trade is to sell the MSR, dividend most of the proceeds to shareholders, delist the issuer, and then sell or downsize the remaining business. When you notice that LDI has no term debt or preferred, the obvious answer seems to be that management is waiting for the phone to ring. Competitive issuers that want to survive the next year need to be buying MSRs and raising new funding aggressively. Mr. Cooper Group (COOP)  is one of the larger servicers in the US and also one of the few issuers in the industry that has been consistently profitable and has also built shareholder value. Since 2020, COOP has steadily built shareholder value by adding to book value through earnings, bulk purchases of MSRs and the acquisition of other businesses and valuable assets. The stock stood at 1.4x book as of Friday’s close.  COOP ranked fourth in owned servicing at the end of Q3 after JPMorgan (JPM) , Wells Fargo (WFC)  and Lakeview. Along with Freedom and PennyMac (PFSI) , COOP is likely to be one of the key consolidators in the mortgage sector. Notice that COOP has a substantial presence in the bond market and can easily access new capital to drive further acquisitions. The acquisition of Roosevelt Management Company gives COOP asset management capabilities and thereby additional scope for future growth. Another issuer that is looking for a new storyline is Onity Group Inc. (ONIT) , f/k/a Ocwen Financial. ONIT is a top twenty issuer but had just over $119 billion UPB of owned servicing at the end of Q3 2024. PHH Mortgage is one of the largest servicers in the country, with 1.3 million loans with a total UPB of $288.4 billion on behalf of more than 3,900 investors and 115 subservicing clients. The Liberty unit of ONIT is one of the nation's largest reverse mortgage lenders and, significantly, does only HECM loans.   The ONIT stock has been dead in the water for years. On Friday it was trading at 0.5x book value. Like LDI, the best thing for the ONIT shareholders would be the sale of the MSR and subservicing portfolio, and a wind up of the business. The servicing operation and Liberty may also have some value, but ultimately the owned servicing is the primary asset of ONIT.  PennyMac Financial Services (PFSI)  and its paired REIT, PennyMac Mortgage Trust (PMT) , are two of the more efficient and well-valued businesses in the mortgage sector. PMT is the lower yielding vehicle for holding conventional exposures while PFSI is the issuer and also holds the Ginnie Mae exposures. Since the end of 2021, PFSI has steadily climbed in terms of market value and closed Friday at 1.4x book value. PFSI had $650 billion in owned servicing at the end of Q3 2024, making the issuer one of the top players in the world of MSRs. The stock is near the all-time high and has been rising since 2020, due in large part to growing awareness by investors of the value of the large MSR portfolio. Like Freedom and COOP, PFSI has made extensive use of the debt capital markets to build a solid foundation for the firm’s liquidity and MSR funding.  We expect that PFSI will also be one of the winners in the coming consolidation of the industry. First, the firm is well-run and generates solid returns from both issuance of MBS and servicing. Second, PFSI has access to funding for bulk purchases of MSR or acquisitions, and also to build their own servicing platform. And third, by having the issuer/manager separate in PFSI from the conventional balance sheet at PMT, the firm has an advantage over Rithm Capital (RITM) , Two Harbors (TWO) and other ersatz REIT/issuer constructs.  Back in December, IMF speculated on whether the long-discussed spinoff of the NewRez lender might be in the cards for Rithm Capital Corp. (RITM) . At present, NewRez is the taxable appendage of the REIT known at RITM.  For some time now, shareholders have been agitating for a spinoff of NewRez as a way to unlock shareholder value. Specifically, the PFSI issuer model at PennyMac trades at a considerable premium to the REIT PMT. Based on price to book, RITM has not really moved in years. We think that moving forward with a spinoff would be good for RITM because the issuer could become the external manager of the REIT, which would include conventional, commercial and other exposures. Unlike PMT, RITM has a multi asset focus and can serve as a balance sheet for any mortgage related exposures that Mike Neirenberg and his team source. Post-spinoff, the RITM/NewRez binary could outperform PennyMac. The Ginnie Mae exposures and MSRs, however, must be housed inside PFSI and not the REIT. RITM acquired Shellpoint and then Caliber to solve a problem with Ginnie Mae. For the same reason that federal regulators will not allow a REIT to buy a bank, Ginnie Mae does not allow REITs to be issuers. The passthrough structure of the REIT does not allow the accumulation of capital needed to be a source of financial strength a depository or an issuer.   But if Nierenberg has the courage to go forward with the spin of the manager and the lender/issuer, we think that will unlock value for both RITM and NewRez. The accepted model in the industry is the issuer PFSI with the REIT PMT, a model that RITM ought to emulate. The broader, multi-asset mandate for RITM, however, could make it more attractive than the deliberately pedestrian conventional portfolio of PMT. We will talk about some of the other issuers in the world of Mortgage Finance in a future edition of The Institutional Risk Analyst.    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.

January 13, 2025  | Fannie Mae 6% 30-year MBS for February delivery traded below par last week as the 10-year Treasury rose above 4.75% in yield. Rational residential lenders are now writing mid-7% loan coupons for sale into FNMA 6.5s. As the rate cut narrative has been once again downgraded, the markets sold off and financials continue to give ground. But rising interest rates is causing a lot more damage than simply pushing down prices for publicly traded securities.  One big reason for the selloff in financials is the fact that delinquency in commercial real estate exposures continues to rise even as banks reduce unused credit available to the sector.  Forbearance is now the order of the day, rendering bank financial statements more aspirational fiction that fact. Does this sound like 2010? Sure does. And, as yet, corporate debt spreads give no indication of trouble ahead. “The largest Non Owner CRE lenders are Wells Fargo ($64.52B), Bank of America ($36.67B) and JPMorgan Chase ($35.79B),” notes Bill Moreland  at BankRegData. “All three have elevated Non Owner NPL levels and all three are pivoting to historic loan modification levels (i.e. lowering payments so that borrowers can avoid delinquency).” Moreland notes that CRE delinquency is not nearly at peak levels for this cycle, suggesting that 2025 could see some significant losses to banks from commercial exposures. Just as published delinquency levels for consumer exposures are understating losses significantly, commercial exposures like real estate are likewise heavily manipulated by banks with the full knowledge of federal bank regulators. Commercial Real Estate | All Banks Source: FDIC/BankRegData “Frightening numbers, but perhaps the high is in?," Moreland muses. "Well, no. The gold chart on the right details the NOO CRE loan modifications where the payment has been lowered and the TDR has been left on accrual. They do this so that it avoids the NPL designation since NPLs are loans 90+ Days Due accruing Fee/Interest Income PLUS loans on Nonaccrual.”  After commercial real estate, one of the ugliest sectors in finance is private equity.  Portfolio companies that were supposed to be sold in public offerings are festering in portfolios years after the hoped for sale date. And loans against these private portfolio gems are now likewise increasingly suspect. Do investors understand that most PE companies are distressed on day one? They do now! When private markets had the wind of low interest rates behind them, private equity was easy. Buy the crap company, lever it up and do an IPO three years later. But in a higher-for-longer interest rate environment, PE is now toxic for institutional investors. If we assume that long-term rates will remain at current levels or even higher, what does this suggest for private equity returns? Or even better, private credit. “Lenders and regulators are beginning ask if NAV loans on private equity fund stakes have materially overstated LTVs, and hence understated default-loss risks,” notes our colleague Nom de Plumber . He continues: "After all, if a long-outstanding Private Equity Fund has been unable to IPO its increasingly stale portfolio companies, in hopes of repaying the highly leveraged loans which had financed their initial privatization buy-outs, then such portfolio companies are likely worth less than those loan balances (especially if below-expectation operating earnings, soft valuation multiples, and higher interest rates). In turn, that Private Equity Fund would have little or no residual value to repay any NAV loan.  If an NAV loan has a reported 25% LTV, but the “V” is iffy at best, it may effectively be uncollateralized." By no surprise, NDP reports that prudential regulators have begun to ask banks about their NAV loans to private equity fund Limited Partners----and any other financing transactions collateralized with private equity or private credit instruments. The larger phenomenon of forbearance has helped obscure PE related credits, but it is the lack of a market value that allows for malfeasance in reporting NAVs. Suffice to say that the estimates for loss provisioning against PE exposures at banks will be going up in Q4 and 2025.   Meanwhile, Bloomberg  reports that Blackstone’s (BX) former global head of GP stakes, Mustafa Siddiqui , has launched SQ Capital, which will invest in private equity secondaries with a focus on the middle market. BX sold their clients a load of crap in the form of private equity, but now a former BX partner will buy them back at a discount! So thoughtful! “Due to a dearth of initial public offerings and a gap in valuation expectations between buyers and sellers that has chilled some private equity deal activity,” Bloomberg  reports, “the secondaries market has been particularly appealing to investors seeking liquidity.” “SQ Capital estimates that a lull in exit volumes since 2021 has created a backlog of roughly 28,000 unsold companies, and around 40% of those have been in private equity ownership for at least four years. Private equity secondaries “is the most compelling area of the alternatives industry,” said Siddiqui, who likened the opportunity to the fat pitch he’s been waiting for. “It’s time to swing.” As firms like BX position new platforms to buy losers from their private equity clients, the flight away from PE and private credit is gaining momentum. But don't tell this to David Solomon and his colleagues at Goldman Sachs (GS) . Coming off its huge success in managing a portfolio of white label credit cards for Apple Computer (AAPL) , Goldman is creating a new business unit and elevating two executives in an effort to combat the growing competition from private credit funds. As we've noted to readers of the Premium Service, GS has the worst credit performance of the top-ten banks other than Citigroup (C). The abysmal GS credit performance against other investment banks is shown in the chart below. Source: FFIEC Part of the irony of the present predicament is that bond spreads are near record lows, suggesting that visible indicators of credit quality are at odds with the rancid fundamentals. Scott Carpenter of Bloomberg notes that spreads on collateralized loan obligations are at record lows, suggest that there may be a big adjustment in corporate loans and credit impending. Now that Wall Street firms have bid up corporate assets to absurd levels to feed retail credit strategies, the stage is set for a massive selloff of debt, loans and also issuer equity as markets adjust to a world where interest rates may not decline below current levels. Just as PE managers expected to be taken out of portfolio positions in a falling rate environment, buyers of distressed debt where also anticipating a tail wind from falling interest rates. But maybe not. As the credit losses from CRE and PE grow, the backlash against private equity investing is growing, even from established organizations within the financial community. "Statistically, there is an increased risk of failure with private equity ownership," note Alvin Ho and Janet Wong in a blog published by the CFA Institute ( " Private Equity: In Essence, Plunder? " ). "PE portfolio companies are about 10 times as likely to go bankrupt as non-PE-owned companies." And commercial bankruptcies are on the rise. According to data from Epiq, commercial Chapter 11 filings increased by 20% in 2024 compared to the previous year, with overall commercial filings rising by 17%. May 2025! 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.

January 6, 2025  | Premium Service  | As the New Year began, worries were being expressed about the uptick in consumer delinquency seen as 2024 ended. Is the US economy finally slipping into recession after several false alarms last year? Maybe. Will consumer loan default rates be higher in Q4 2024? Probably, but this is not yet a crisis or even a traditional credit downturn comparable to 2008. While loss rates in percentage terms are rising, the volume of loss affecting US banks remains very low, as we discuss below in our latest update on the largest US consumer lenders. Our suspicion is that the excess liquidity pumped into the US economy by the Federal Open Market Committee in 2020-2022 is finally dissipating, part of a recession of the monetary tide that caused crypto currencies to peak near $100k as measured by bitcoin.  Like all games of chance, trading in crypto currencies is a zero sum game that does not result in an increase in aggregate wealth. The buyer of bitcoin provides liquidity to the seller, but there is no increase in money in the system.  The value of crypto can go up or down, but there is no carry and no net economic benefit. But the Internal Revenue Service and other tax agencies around the world are certainly focused on the exchange of value represented by trading in crypto tokens. “The recent surge in Bitcoin prices has been a financial boon to its investors. Many have been cashing out with gains exceeding their wildest expectations,” notes Chris Amundson , President of Accounting Solutions in Chicago . Amundson publishes a must read comment on taxes and accounting each week that goes from individual to corporate perspectives. “Bitcoins were trading in the $97K range yesterday,” Amundson wrote last week. “If you had invested in this asset four short years ago, your capital gain would be around $80K per unit. In response to this windfall, the IRS has significantly increased its oversight on these transactions.” Amundson notes that new IRS initiatives include: 1) A question on both business and personal income taxes of whether or not the entity has sold any crypto assets inside the tax period, 2) -Broker / Dealers will be required to report all sales of digital assets to the IRS on newly created form 1099 - DA (Digital Assets) next year for the 2025 tax season, and 3) IRS and Justice Department Enforcement of the tax and criminal codes has increased substantially.” He concludes: “Taxpayers should note that if you use a crypto currency to purchase anything directly from an investment account, that this constitutes the sale of the asset. As such, Short or Long Term Capital Gains Taxes are due and payable that year.” And yes, if you work in the world of banking, FINRA or the SEC and touch crypto assets, you are flagged by compliance for enhanced monitoring. Thank you. The increased tax revenue collected by the IRS as a result of trading in crypto in 2024 does not represent true growth in economic terms, merely the allocation of losses to the seller (aka the greater fool). Warren Buffett noted that Bitcoin's price is rising only because Bitcoin holders are trading with each other – the private equity fund approach to investment. With each round, you hope that a greater fool will buy your asset for a higher price than you paid for it.  Of note, Gordon law writes  that the IRS has issued guidance on how to claim losses from worthless and abandoned cryptocurrency investments on your tax returns. According to  IRS Memo: 202302011 , if an individual’s cryptocurrency has decreased significantly in value, they may be able to deduct the loss under IRC Section 165. But only maybe, we’re told by informed auditors. The speculative gains on crypto are a blissful concern compared with the dire situation facing many low income consumers as Donald Trump returns to the presidency. There is even speculation that President Trump will attempt to start his second term with a $2,000 "stimulus" payment to struggling consumers, a modern version of the "bread and circuses" of ancient Rome. The Consumer Lenders In the final days of December, the Financial Times and other media published several reports about the fact that the Q3 2024 delinquency rate on credit cards was back up to 2010 levels, this after years of loss experience muted by the action of the FOMC. " Consumers are ‘tapped out’ after years of high inflation and as pandemic-era savings have evaporated," the FT reports. The chart below showing data from the FDIC going back 40 years is the series in question. Yes, net loss rates in percentage terms post default are back up to 2010 levels, but the dollar volume of net charge-offs remains very low. Also, we should all note the total outstanding receivables for bank credit cards have almost trebled since 2008. What is the problem? Source: FDIC While the net charge-off rate in percentage terms has crawled up to 2010 levels, in dollar terms the volume of loss is smaller vs the $1.1 trillion total asset credit card book.  Net-charge offs is another way to say loss per dollar of default . Net charge-offs in Q3 2024 were just $1.5 billion. Is delinquency on credit cards rising? Yes. Is it yet a significant negative for bank credit or earnings? Not yet. Could card delinquency rates move higher? Yes, but we’ve been waiting for that upward inflection in consumer credit for a year and more.  Source: FDIC When we look at some of the larger bank players in consumer credit, the picture that comes across is hardly alarming. Net loss rates across the industry have normalized since COVID, but the dollar volume of losses remains very low relative to the total portfolio. The chart below shows the net loss rates for the members of out consumer lenders group, including Ally Financial (ALLY), American Express (AXP ), Axos Financial (AX) , Barclays US LLC, Capital One Financial (COF) , SoFi Technologies (SOFI)  and Synchrony Financial (SYF) . Together they represent over $1 trillion in industry assets. Source: FFIEC Notice that Axos and SOFI are both below the loss rate for ALLY and Peer Group 1, a remarkable performance. The negative Hindenberg Research thesis on AX is still not validated. Even as the group has seen net loss rates on loans flatten out in the past several quarters, pricing on loan portfolios has also moderated after several years of increases. We are probably past peak levels for loans yields in the industry for this interest rate cycle, but the moderation in language coming out the last FOMC meeting probably indicates a slower downward trend in loan yields, as shown below.  Source: FFIEC SYF is the leader in the group in terms of the average gross loan spread near 18%, but the bank also has a net loss rate above 6% or around a “B” bond equivalent. Most banks have loan yields of 6%. After SYF we have the US unit of Barclays followed by CapitalOne. ALLY has the lowest spread of the group but thankfully is still above the average spread for Peer Group 1. Loan spreads have improved dramatically since 2022, but the yield on securities not so much, as shown in the chart below.  Source: FFIEC As you might expect, almost all of the lenders in the group are above the average securities yield for Peer Group 1, even though many larger lenders have securities yields well-below average. COF is slightly below the average along with ALLY, an enormous embarrassment but still better than Bank of America (BAC) . Axos is the best in the group in terms of yield on securities, followed by SOFI and American Express. What this means for the leaders is that the bank is focused on managing its portfolio and that the investment book is not a drag on earnings. Like operating efficiency, watching a bank's returns on its securities book is a good measure of whether management is paying attention.  After credit, perhaps the most important measure for any consumer lender is the cost of funds, which along with SG&A determines the bank’s net spread over its earning assets. Since Q4 of 2022, all banks have seen funding costs normalize after the extraordinary period of 2020-2021. For the past year or more, funding costs have been quite stable and spreads on corporate debt have rallied significantly, giving many issuers access to cheaper funding.  Source: FFIEC Barclays remains the outlier of the group in terms of funding costs, but all of the members of the consumer group remain well-above the average cost of funds of Peer Group 1 of around 2.5%. COF has the lowest funding costs in the group vs average assets, followed by SOFI and AX. Stable net loss rates and funding resulted in relatively stable net income, but the results for specific banks are remarkable. AXP is best in class in terms of asset returns, followed by SFY, which displays a large degree of variability in its results due to the high loss rate and variable funding costs. AX is dead center of the group and quite stable going back years, while the rest of the members of the group are at or below the industry average for asset returns. ALLY, as usual, is at the bottom of the distribution with SOFI next in terms of ROA.  Notice that SOFI peaked above 1% ROA in Q1 2024 but has sunk since then. Source: FFIEC When you see the poor asset returns generated by the US business of Barclays Bank (BCS) , it certainly begs the question as to the LT objective of BCS in the US consumer segment. American Airlines (AMR) has announced that Citigroup (C) will be the exclusive card partner for American's advantage program going forward, thus we have speculated that Barclays may make a move for the Apple (AAPL) card program currently operated at a loss by Goldman Sachs (GS) . Last October, the CFPB fined GS and AAPL almost $100 million for lapses in servicing. Nothing yet. AXP has high single digit growth estimates from the Street for Q4 2025 and 2025. The operative term her is consistent, with little variability in the operating metrics or analyst estimates. In all of the factors presented in this report, AXP moves less quarter to quarter than the other banks. At 3.4x book value, AXP is a full multiple above where it was a year ago and has been making new all-time highs all of 2024. But you can also argue that AXP is the most overvalued of the largest banks. 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.

January 2, 2025  | Just before New Year’s eve, Bill Ackman of Pershing Square posted a long comment on X  encouraging investment in the common shares of the GSEs, Fannie Mae and Freddie Mac .  Below is Ackman’s comment in its entirety with our comments and questions in italics. Readers of The Institutional Risk Analyst  should review our earlier comments (“ Kamikaze GSE Release? Oh Yeah… ”) and ( “Liquidity Preference: SVB Financial Group, WaMu & Reemerging GSEs ”). We also recommend reading the latest notes from Moody's and other agencies on the credit implications of an end to conservatorship. Bill Ackman X 2:46 PM · Dec 30, 2024 I am often asked for stock recommendations, but generally don’t share individual names unless I believe the risk versus the reward is extraordinarily compelling. As we look toward 2025, one investment in our portfolio stands out for large asymmetric upside versus downside so I thought I would share it. We have owned Fannie Mae and Freddie Mac common stock for more than a decade. Today, they trade at or around our average cost. As such, they have not been great investments to date. Cute reference to "average cost," but total return to date would be of greater interest. We would be greatly surprised if Pershing Square and other fund investors have not reaped big returns on the ST gyrations in Fannie Mae and Freddie Mac, as shown below in a chart from Yahoo. The GSEs are among the two best performing financial stocks in 2023 and 2024 in percentage terms, but much of the latest return came after the November election of Donald Trump. These stocks are clearly attractive for ST trading opportunities, but are they a good LT investment? Do we even know how these business will operate upon release in 2026? What makes them particularly interesting today versus any other time in history is that there is a credible path for their removal from conservatorship in the relative short term, that is, in the next two years. Not sure how to define a “credible” path, especially since the largest party at interest is the US Treasury.  Also, the likelihood of a price "reset" in residential housing is growing. Until the Trump Administration lays out a specific proposal, it is hard to know whether there is a credible way to exit conservatorship without legislation. The Trump I team at the Federal Housing Finance Administration was never focused on release nor was the Treasury under Steven Mnuchin . His successor at Treasury, Janet Yellen , would not even discuss releasing the GSEs. During Trump’s first term, Secretary Mnuchin took steps toward this outcome, but he ran out of time. I expect that in the second @realDonaldTrump  administration, Trump and his team will get the job done. *** By popular demand, we have extended our holiday sale through January 7th, 2025. For 50% off The IRA Premium Service for life, use the coupon code "TheIRA2024" **** A successful emergence of Fannie and Freddie from conservatorship should generate more than $300 billion of additional profits to the Federal government (this is on top of the $301 billion of cash distributions already paid to the Treasury) while removing ~$8 trillion of liabilities from our government’s balance sheet. This statement is a little misleading. The unsecured debt and secured MBS are not counted as US liabilities. We don’t know how the Treasury will liquidate the original investment in the GSEs and, most notable, the growing tab for the liquidation preference since the GSEs started to retain capital. Every dollar of capital retained by the GSEs is a dollar owed to the Treasury, like buying equity with a credit card. The cash distributions were to rent the “AAA” rating, something that ends with release along with the funding support from Treasury. That support and the liquidation preference of Treasury is described in last year's 10-K from Fannie Mae : $119.8 billion has been paid to FNMA by Treasury under the funding commitment; $113.9 billion of funding commitment from Treasury remains. This amount would be reduced by any future payments by Treasury under the commitment. The senior preferred stock had an aggregate liquidation preference of $195.2 billion as of December 31, 2023. In the October 2024 Form 10-Q : The aggregate liquidation preference of the senior preferred stock increased to $208.0 billion as of September 30, 2024 from $203.5 billion as of June 30, 2024, due to the $4.5 billion increase in our net worth in the second quarter of 2024. The aggregate liquidation preference of the senior preferred stock will further increase to $212.0 billion as of December 31, 2024, due to the $4.0 billion increase in our net worth in the third quarter of 2024. The GSEs have built $168 billion of capital since Mnuchin ended the net worth sweeps in 2019. This is already a fortress-level of capital for guarantors of fixed-rate, first mortgages to creditworthy, middle class borrowers. References to a "fortress balance sheet" are usually an allusion to JPMorgan (JPM) , but it is useful to remember that JPM has the most double-leverage of any US bank. More important, no amount of private capital will get you to a "AAA" unsecured rating. The scenario we envision is that: (1) the GSEs are credited with the dividends and other distributions paid on the government senior preferred, which would have the effect of fully retiring the senior preferreds at their stated 10% coupon rate with an extra $25 billion profit (in excess of the preferreds’ stated yield) to the government. This extra profit could be justified as payment to the government for its standby commitment to the GSEs during conservatorship. Pershing Square seems to conflate the Treasury’s equity investment with the senior preferred stock dividends. These are two different things entirely. Treasury is owed full repayment on its equity investment and also has a claim against the GSEs shown in the liquidation preference since the 2019 amendment to the sweep agreement . Moneys paid in cash distributions on the preferred were to compensate the US as majority shareholder and guarantor. The private shareholders of the GSEs have no claim on these public funds. Treasury's position on getting repaid on cash advances is very clear from the experience with General Motors (GM) and Citigroup (C) and at odds with the Ackman description. (2) the GSEs’ capital ratio is set at 2.5% of guarantees outstanding, a level which would have enabled the GSEs to cover nearly seven times the their actual realized losses incurred during the Great Financial Crisis — a true fortress-level balance sheet. The private capital of the GSEs is not really adequate through an economic cycle. First, private capital does not really help. Only sovereign support can backstop an $8 trillion market. People who talk about private capital as being significant to the credit standing of the GSEs don’t get the joke. When Fannie Mae was created in 1938, there was no market in 30-year mortgages. Once US credit support is withdrawn from the GSEs with release, we think the conventional loan market will reprice significantly. A 2.5% capital ratio is the same required for mortgage insurers who by comparison guarantee the first ~20% of losses on often riskier mortgages with less creditworthy borrowers, compared with the GSEs’ guarantee which attaches at the senior-most <=80% of the property’s mortgaged value. Mortgage insurers therefore typically incur 100% losses on a default whereas by comparison GSE losses on a default are minimal. Comparing the GSEs to private mortgage insurers (PMIs) is not flattering to the GSEs nor a particularly good argument. Like health insurers, the PMI’s tend to avoid paying valid claims, creating risk for the GSEs and their correspondents.  For lenders, the biggest risk in the conventional market is GSE loan putback claims for delinquent loans, usually after a PMI has denied insurance. The GSEs also have enormous ongoing earnings power, particularly during challenging periods in the housing market where they tend to take significant additional market share. This enables them to quickly recapitalize after a period of housing market stress. True. This is the best argument for the credit standing of the GSEs, but that still won’t get them close to “AAA.”  Of note to retail investors, Ackman never mentions the possibility of a credit ratings downgrade for the GSEs upon release in his stock recommendation. The fact that Moody's, Fitch et al have already written about the conditions for a downgrade sure seems like a material fact. Assuming a Q4 2026 IPO, the two companies collectively would need only raise about $30 billion to meet the 2.5% capital standard, a highly achievable outcome. Freddie needs more than Fannie (which will need little if any capital) because it has grown its guarantee book more quickly than Fannie in recent years. The FHFA capital rule for the GSEs is excessive and will likely be reduced. When Moody’s rates the GSEs prior to release, the agency will make very clear that the market position and earnings power of the portfolio, and the support of the United States, are the main positive credit factors for the GSEs. The private capital level is a secondary concern. The $8 trillion in conventional residential and multifamily MBS relies upon the unsecured issuer rating of the GSEs. We estimate the value of each company at the time of their IPOs in 2026 at ~$34 per share. We assume their IPOs are priced at $31 per share reflecting a ~10% discount to their intrinsic values. We calculate a profit to the gov’t of ~$300 billion assuming full exercise of its warrants and a sell down of common stock in both companies over the five years following the IPOs. This number is a tad low. The cash advanced and commitments, plus the accrued liquidation preference, is over $350 billion now and will be closer to $500 billion by 2026. Ackman seems intent upon converting the money owed to the Treasury visible in the liquidation preference to the benefit of the private shareholders. This is a short-sighted move since it will generate a political firestorm inside the Treasury and in Washington. If President Trump, Bill Ackman and other institutional holders really want to see the GSEs released, then they must push for full payment of moneys owed to the Treasury. Otherwise, Ackman's positive statement regarding the GSEs should be viewed as just another ST trading opportunity. We believe the junior preferreds are also a good investment, but they do not offer nearly the same return because their upside is capped. Ditto. Trump likes big deals and this would be the biggest deal in history. I am confident he will get it done. There remains a high degree of uncertainty about the ultimate outcome so you should limit your exposure to what you can afford to lose if you choose to invest. And after making a public recommendation to buy the GSE common stock, Ackman tells readers to be careful. That shows a fine spirit. But as we have told readers of The IRA, the whole narrative about GSE release is a canard behind which the astute gain significant short-term trading gains. Whether the GSEs will ever be suitable LT investments for retail investors post-release is something that depends upon a number of decisions that have yet to be made. Our advice to readers is very simple: GSE release is a trade, not a LT investment. Happy New Year! 2:46 PM · Dec 30, 2024   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.

December 27, 2024 | A very happy New Year to all of the readers of The Institutional Risk Analyst .  As we close out 2024, the WGA Bank Top 25 is up [36%] and the Invesco KBW Bank ETF (KBWB) is right behind at [39%], but well-off the November highs. The broader WGA Bank Top 50 likewise shows the huge updraft that affected banks stocks in Q4 2024. Consumer lender Synchrony Financial (SYF)  leads the group with a 74% total return for the year and a 1.77 price/book ratio.  In our next Premium Service  issue, we update the subset of the WGA Bank Top Index that we lovingly refer to as “asset gatherers,” because of the primary focus on investment advisory business lines. Some of the best performing names in the top 100 banks followed by The IRA are asset gatherers, but some of these advisors take significant credit and market risk. Notice in the chart below that Charles Schwab (SCHW) continues to underperform the group, which is led by Stifel Financial (SF) , one of Wall Street's oldest investment banks. Source: Google Finance The broad market valuation of stocks in many sectors still reflects the strong rally in financials after the November victory of President Donald Trump. As the post-election euphoria wears off, however, the prospect of higher interest rates and bond market volatility, and rising federal debt costs, presents the Trump Administration and markets with some immediate challenges.  What are some of the risks facing investors and all Americans in 2025?  Politics The first risk is politics. The US Congress has lost the will to govern the country. As a result, it important to accept that President Trump does not control the fractious House of Representatives much less the Senate. Even though Republicans outnumber Democrats by a few seats in the lower chamber, the political map of the House is a mosaic. More than 30 conservative Republicans voted  against the latest spending stopgap legislation prior to Christmas , meaning that Trump will need Democratic support for many of his agenda items. If that sounds a lot like gridlock during Trump I, you’re right.  “Tonight, we once again found ourselves voting on a temporary spending bill just before Christmas—one that merely delays the inevitable until March,” noted five-term Congressman Alex Mooney (R-WV) , who is retiring this year. “I voted NO because we had ample time to pass individual, focused spending bills, yet chose not to. I cannot, in good conscience, continue supporting a cycle of failure that is damaging to the American people.” There are a growing number of conservative Republicans like Alex Mooney who would rather shut the government down than continue “the cycle of failure” that is the Congressional appropriations process. When Donald Trump shows up on January 20th and wants to cut taxes and increase federal spending, the reaction from conservative Republicans may surprise people and the markets. And there are an infinite number of other political risks, at home and abroad. Don’t assume that anything is a given or impossible in Washington in 2025. Apathy The second risk is investor apathy. The growing dysfunction in Washington does have real world consequences. Wall Street very much wants to pretend that everything is fine with the economy, that interest rates are falling and that the trees will grow to the sky. But in fact large portions of the investment world among the G-10 nations are at risk because of growing government debt and related inflation. Is that a global debt restructuring we see on the even horizon for many G-10 members? Public debt is now “crowding out” all else and generates outsized market volatility and equally destructive monetary policy innovations like QE. The gyrations of US monetary policy seen over the past five years do little to inspire confidence. As credit spreads on government debt continue to widen relative to private credits, what does this suggest for the future of money and debt in America and globally? Can private issuers, for example, have higher debt credit ratings than the sovereign or is it a ceiling? (We suspect the latter BTW.) Several readers have asked about a possible US debt default scenario. As we’ve noted in past missives the question is not about a sudden default by the US Treasury, but rather the hyperinflation that results when the Fed is forced to resume large scale purchases of government debt. If explicit debt monetization becomes part of the playbook, when is the US compelled to defend the monetary monopoly of the fiat dollar, imitating China by banning crypto currency? Fiat currencies, after all, are an authoritarian model that brook no competition, whether from crypto or gold. May 2025! When the US central bank buys government debt, the interest paid is returned to the Treasury (less the Fed’s operating losses), but Americans pay the cost of the debt via inflation. As the Fed buys more and more debt, reserves and bank deposits rise and asset classes like stocks and housing soar. The Washington drama around the debt ceiling misses the key point of inflation and the Fed’s balance sheet, but does provide the illusion of a political contest over spending. Source: FDIC Q: Isn’t it remarkable that not a single member of the media covering the Fed seems able to ask Chairman Powell about the central bank’s balance sheet?  The Fed has lost more than a quarter trillion in taxpayer dollars due to quantitative easing, yet we hear no questions about selling low-coupon debt to reduce the Fed’s interest rate mismatch. But the losses at the Fed’s secret hedge fund are the least of our worries in 2025 As the pricing for sovereign US risk continues to rise compared to corporate issuers, the entire topography of western finance going back a century to the Depression and WWII is threatened.  In the 1930s, government was at the apex of credit, but today the US Treasury is gradually seeing its standing decline in the global credit markets. What happens to banks and pension funds when Treasury debt really becomes junk? Will Chairman Powell at the Fed ding banks in future stress tests for owning overmuch long-dated Treasury paper?  Of note, the Bank Policy Institute, along with the American Bankers Association, the U.S. Chamber of Commerce, the Ohio Bankers League and the Ohio Chamber of Commerce announced before Christmas that they are filing litigation against the Federal Reserve, challenging the opaque aspects of the stress testing framework . This confirms our earlier view about the greater likelihood of private challenges to federal regulatory actions (“ USSC Kills Chevron | Zombie Banks Pass Stress Tests? ”).  Shrinkage The third risk faced by investors is shrinkage of returns due to inflation, which is both a financial and psychological problem. Shrinkage of the currency was how Americans described inflation a century ago and more. Yet in psychological terms, inflation has not been a serious problem for Americans for half a century and is still not yet top of mind. There is a tendency to ignore the obvious, even when inflation has become again a large factor in the analysis since 2020. Inflation in financial assets remains a big risk in the world of investing in 2025, but returns often shrink in an inflationary environment. The low double-digit gain on a private fund or credit strategy may seem attractive, but in fact is pretty pathetic when public market indices and even banks are galloping along at mid-double digits.  “Private Credit mutual funds allow retail investors to take more risk, get less liquidity, pay more fees, and earn less than with low-cost, liquid, transparent equity index funds,” notes our friend Nom de Plumber  in a pre-Christmas missive. “The manager in a recent Bloomberg article earned 37% over two years  in a private credit fund, while the S&P 500 earned over 60%. What is not to like? Thank you.” The propensity of Wall Street to offer progressively less investment return at a higher price is one of the hallmarks of American capitalism, but it also reflects the wasting effects of inflation on real value. When more fiat dollars chase a given set of opportunities, the price rises and returns fall. The vast sea of dollar liquidity has caused managers to pursue various alternatives from private equity to distressed credit to crypto currencies. All are evidence of persistent inflation. If you're making 15% net of fees on your retail credit fund, you're losing money baby. As the psychology of inflation becomes more widely shared, however, low return investment strategies will be abandoned in favor of short-term option strategies that promise to stay ahead of inflation. Like the 21% overnight rate i Russia. Markets and even nations will adjust their behavior to factor in inflation, creating a psychology of rising prices that persists and creates opportunities for radical action. Imagine if China, in desperation to escape from years of deflation, takes a really bad page from FDR in 1933, revalues the yuan and begins to pay $5,000 per ounce for gold.  This would be an effective devaluation of the dollar and a direct challenge to dollar supremacy. When your clients call you the next morning, what will be your advice? Credit The fourth and final risk factor facing investors and the US economy in 2025 is credit, a danger that has been largely obscured by the Fed’s policy of “going big” with reserves and asset prices. But big is not necessarily free of cost. As we noted in our last comment, in December the Fed finally dropped the rate paid on reverse repurchase agreements (RRPs) to the bottom of the range for fed funds.  When you see the Federal Reserve Board issuing ersatz T-bills in the form of RRPs, that is a pretty good indicator that the FOMC added too much liquidity to the economy earlier in the cycle and asset prices are likely to rise. Keep in mind that the Congress never gave the Fed the legal authority to take deposits from foreign commercial banks, GSEs and money market funds. Indeed, if President Trump wants to be rid of Jerome Powell he can simply impeach him for violations of the Federal Reserve Act going back to 2016. We got a list. Before Christmas, Bill Nelson of Bank Policy Institute asked: “As of December 11, the foreign reverse repo pool was $416 billion.  Why is fed borrowing over $400 billion from foreign official institutions?  Apart from central banks, who are these institutions?  The foreign reverse repo pool used to be much smaller, why did it grow in the mid-2010s and then again over the past 3 years?  What rate do you pay for the loans? Is a reduction in ON RRP rate meant in part to shrink the pool?”   When the Fed adds overmuch liquidity to the US financial system, there are a number of pernicious effects, mostly notably artificially higher asset prices and lower short-run credit costs. When the apparent cost of credit is muted by inflationary monetary policies, the financial system looks better in terms of the cost of default, even if the obligors are suffering from severe economic stress.  Instead of foreclosure and evictions, we see a growing flow of involuntary home sales, usually after one of more unsuccessful loan modifications. The net loss rates on $2.7 trillion prime bank owned 1-4 family mortgages are still negative while delinquency on FHA mortgages is in double digits. We estimate that delinquency rates on subprime 1-4s that typically go into Ginnie Mae securities are actually in the mid-teens if you adjust for the positive effect of soaring home prices on the cost of default. But the cost of reduced affordability of housing is also massive, leading to negative economic and also political results. Donald Trump won over Kamala Harris in 2024 in large part due to inflated housing costs. Source: MBA, FDIC In 2025, we expect to see loan delinquency rates for mortgage loans, auto financing and credit cards continue to rise, whether or not the Fed drops interest rates further. Loan forbearance and other progressive schemes are likely to end, meaning that the visible rate of delinquency will rise substantially. In 2025, for example, Ginnie Mae issuers will no longer be able to modify delinquent loans multiple times and recoup cash advanced via partial claims. Do you think anybody on the FOMC knows what a "partial claim" means? Eventually the economy will slow and the FOMC will deliver lower short-term interest rates sometime in 2025, which will boost home lending volumes. It will also boost home prices even further.  Short-term interest rates will boost production profits for lenders, but mortgage rates for home buyers may still be in the 7% range due to the federal deficit and widening credit spreads. As credit costs rise, President Trump may be releasing Fannie Mae and Freddie Mac from conservatorship around 2027. Downgrading the GSEs during a rising credit default cycle could impact the liquidity of behind $8 trillion in conventional loans severely. Before Christmas, Fitch Ratings wrote that an end to GSE conservatorship would have a direct negative impact on the GSEs, which it currently rates the same as the US government due to its “implicit” guarantee. “If taking the GSEs out of conservatorship would, in fact, result in meaningful downgrades, that could have knock-on effects for money managers,” Fitch warns. We’ve noted in the past that the GSE MBS aren’t rated, but most firms treat MBS with the same rating as the unsecured GSE issuer rating. “Significant downgrades could possibly cause concentration limit issues for some funds. Since money managers are currently the key marginal buyer of mortgages, disrupting their holdings could have a pronounced impact on mortgage rates,” Fitch concludes.  While the quality of the conventional loan portfolios of the GSEs are currently very solid, we worry that the large multifamily books will be a drag on profits for years to come. We also worry that the home price inflation caused by the FOMC during and after 2020 may disappear in a future correction.  That big uptick in home prices is great today and, in fact, makes the cost of credit in 1-4s seem negative. But what happens to lenders and investors when home prices do eventually correct?  “Using the rule of ‘the eights,’ history suggests that 2028 will be the year of the correction—at least until COVID-19 arrived on the scene,” Freedom Mortgage founder Stan Middleman  observes in “ Seeing Around Corners, ” his biography that was published by Forbes Books  earlier this year.  “Things change—sometimes without any warning. COVID-19 is the biggest single and most sudden change in my professional life. It brought huge changes in consumer preferences and behavior. As always, we must be very attentive to credit as always as we go forward. But strong home prices give us a lot of confidence that today’s home loans will be money good.” Get Your Copy Now! Of course, today's mark-to-market problem becomes tomorrow's credit expense. If home prices retrace in 2027 down to say 2021 levels, that will be bad but not necessarily an extinction level event such as 2008. But it needs to be said that the gross yield on securities held by the largest US banks was just 3.16% in Q3 2024 and the yield on MBS averaged just 2.89%. At yesterday's close, the 10-year Treasury note yielded 4.6% and Fannie Mae 2.5% MBS were trading at 81-04 for January delivery, according to Bloomberg , meaning that the US banking system will be insolvent by a couple of trillion dollars at year-end 2024. Like we said, don't ignore the obvious and have a very safe and prosperous New Year! Source: FFIEC   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.

December 4, 2024 | When is the US stock market going to correct? That is the question we hear increasingly from readers of The Institutional Risk Analyst . Many of the major indices are up mid-double digits so far this year. Notice that the large-cap financials have led the way, as we have predicted in our Premium Service , and the WGA Bank Top Indices confirm this trend. Does anybody think that large cap US banks deserve to be up 40% YTD? Source: Google Finance President elect Donald Trump has not even taken the oath of office, but a number of stocks and crypto tokens have soared since his win in November. PSQ Holdings, Inc. (PSQH), “America's leading commerce and payments ecosystem valuing life, family, and liberty,” announced Donald Trump Jr. and Willie Langston joined its board of directors, causing the stock to surge a little. PSQH is still down almost 50% from the 2023 IPO, but no matter. How's that for a chart? Source: Google Finance One of the more amusing aspects of the post-election process is the idea that President Trump and his family will be helpful to the crypto sector. In fact, Trump will be helpful to his crypto token. Remember, its all about the Donald. Meanwhile, Alex Mashinsky , co-founder of crypto lender Celsius Network, pled guilty yesterday in New York to two counts of fraud for artificially manipulating the value of his token. As we get further and further from the manic years of 2020 and 2021, the volatility of many stocks have fallen significantly in dollar terms, but the percentage gains from the persistent episodes of euphoria are impressive. In financials, for example, the Trump Trade has caused the undead to not just walk, but run. We view the multiple all time highs for major stock indices this year as a sign than a significant blowoff is coming in global equities, a correction ultimately driven by the ebb and flow of inflation. Witness penny stocks like Freddie Mac and Fannie Mae up more than 100% in the past 30 days. Remember, it’s a trade, not a destination. As we noted in our previous post (" Kamikaze GSE Release? "), the odds of actual release of the GSE by the Trump Administration are less than 1 in 5. As Moody's Analytics chief economist Mark Zandi told an audience in New York City last night, GSE release is a solution looking for a problem since nobody in the mortgage sector supports the idea. Our best guess is that GSE release will push up conventional mortgage spreads by 50bp meaning a 7.5% mortgage coupon given TBAs this morning. And that is before we deal with an impending downgrade of the US, as discussed below. Once it becomes clear that the White House does not have the time or political capital to push through a GSE release from conservatorship, we suspect that windfall gains will evaporate. Don’t be that greater fool. Freddie Mac peaked at $3.50 on 11/26/24 and has since given back a $1 per share. Source: Google Finance Another remarkable story is SOFI Technology (SOFI) , a languid fintech/bank name that has underperformed the market for several years, but began to rise in August and then exploded on October 1st. SOFI more than doubled since that time. SOFI was up 44% in the past month and 112% over the last 90 days. What happened? The SOFI financials in Q3 2024 were OK, but the Street apparently liked the growth in customers. SOFI is a small consumer lender that still needs to grow significantly to fit into its bloated overhead costs, which are more than 2x Peer Group 1. SOFI also continues to see large volatility in its financials. Lacking a tangible catalyst, we would not be surprised to see SOFI give back recent gains. In the world of fintech, the top performer in our surveillance list is Lemonade (LMND) , a provider of insurance products through various channels in the United States, Europe, and the United Kingdom. Good news: LMND is losing less money than in previous years, but it is still losing money. Equity managers simply love it. The stock is up 180% YTD and particularly in the past month. It began to move in mid-October below $20 and took off at the start of October. The stock peaked at $53.85 on November 25th and has given ground since then and closed at $45 yesterday. Another member of the Trump Trade group is Robinhood Markets (HOOD) , a high-flying broker dealer that went public in 2021 at the end of QE, ran up to $85 in August 2021, then collapsed below $7 in June of 2022. The business model remains retail brokerage + crypto, which should tell most investors all they need to know. In August of this year, HOOD began to climb the stairway to heaven and reached $38 at the end of November. Source: Google Finance HOOD is up more than 200% YTD. Given that the US economy is growing 3-4% per year with a $2 trillion budget deficit, some economists would say that the economy is performing "better than expected." Our view is that the behavior of financial markets suggests that inflation remains a serious problem, but equity managers are loading up on market risk to an astounding degree. One event on the horizon that has not yet gotten nearly enough attention from the thundering herd is that Moody's Investors is now the only major rating agency that still has the US at a "AAA" rating. When the US sovereign rating is eventually downgraded, everything that depends upon the US rating, including federal agencies, large banks, Ginnie Mae and the GSEs will also be downgraded. The US is trading around 30bp in 5-year credit default swaps (CDS), a spread that suggests a "A/BBB" rating for the US using the classic S&P ratings breakpoints. As we've noted in The Institutional Risk Analyst many times, the average US consumer is around a "B/CCC" credit, which is why credit card rates are well above 20%. Sabe? AAA: 1 bp AA: 4 bp A: 12 bp BBB: 50 bp BB: 300 bp B: 1,100 bp CCC: 2,800 bp Default: 10,000 bp How will equity managers react to a credit downgrade of the US by Moody's to "AA+" in the near future? We suspect that they will huddle during the commercial break, become comfortable, and then buy more US equities. We can all look forward to the day when many large corporate credits will be trading inside  the credit spread for the US. But what happens to the Trump Trade and the broader equity markets if the FOMC passes on a December rate cut? Federal Reserve Bank of St. Louis President  Alberto Musalem  said it may be time for policymakers to slow the pace of interest-rate cuts amid higher than desired inflation and declining concerns over the labor market, Bloomberg reports. Musalem says that it will likely be appropriate to keep lowering rates over time, but said the risks of cutting rates too quickly are greater than those of easing too little.   “It seems important to maintain policy optionality, and the time may be approaching to consider slowing the pace of interest rate reductions, or pausing, to carefully assess the current economic environment, incoming information and evolving outlook,” Musalem said in remarks prepared for the Bloomberg & Global Interdependence Center Symposium in New York. 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.

November 26, 2024 | Updated for FOMC | Yesterday we turned in the final draft of "Inflated: Money, Debt and the American Dream" to our editors at John Wiley & Sons (WLY) . We edited 20,000 words from the original book and added a new chapter to deal with the Ben Bernanke , Janet Yellen & Jerome Powell FOMCs from 2010 through the election of President Donald Trump . We also added some great great new material from Jim Rickards , Judy Shelton and many others. What did plunging back into the financial history of the United States for the past year tell us? Nothing has changed. Americans are part Calvinist prudes, part libertine punters who would rather speculate on the next thing than be concerned about the actual details of today. Think of the advocates of crypto tokens as the descendants of the silverites of the 19th Century. Like silver coinage, crypto currencies represent an ideal index of mounting inflation and financial stress within the 175 year-old fiat dollar system, but offer no means of escape. Like private equity, as we discuss below, crypto currencies are merely a convenient receptacle for excess fiat liquidity. One thing that has not changed in the second edition of “Inflated” is the invocation from Frederick Hayek : “I do not think it is an exaggeration to say that it is wholly impossible for a central bank subject to political control, or even exposed to serious political pressure, to regulate the quantity of money in a way conducive to a smoothly functioning market order. A good money, like good law, must operate without regard to the effect that decisions of the issuer will have on known groups or individuals. A benevolent dictator might conceivably disregard these effects; no democratic government dependent on a number of special interests can possibly do so.” Among of the most asked questions from our readers concerns the direction of interest rates and particularly long-term yields. We think a rapid retreat on short-term yields is pretty much a given, as and when an adequate economic pretext arrives, but longer yields are likely to rise due to the federal budget deficit.  The prospect of a liquidity-driven capitulation from the Fed is growing even as the federal debt mounts and LT yields rise. Note, for example, that the FOMC has reduced the rate on reverse repurchase agreements (RRPs) 5bp to the "floor" or bottom of the policy range. This is not a "technical" amendment folks and reflects the growing bias of the Committee towards ease. Watch what they do, not what they say. And remember, Congress did not give the Fed authority to pay interest on deposits of money funds and GSEs (h/t Bill Nelson ). Fed chairmen like Arthur Burns and Paul Volcker once lectured Congress about budget deficits, but not in the age of “big” liquidity and de facto fiscal policy by the FOMC. Buying trillions of dollars in securities and losing hundreds of billions in taxpayer funds is a fiscal operation, whether or not the Fed or Congress care to recognize it. Will President Trump hold Jerome Powell responsible for the results of the Fed's hedge fund? The Fed will continue to lose money on its portfolio for years to come as trillions of dollars in mortgage-backed securities purchased by the Fed Board under Chairs Yellen and Powell linger. Since the 10-year Treasury is the indicator of solvency for US banks and also the reference for residential mortgages, the fact of a 4.3% yield is not welcome news. The Mortgage Bankers Association has just pushed down loan production estimates 10% for 2025 to just $2.1 trillion. That figure may yet fall lower if LT Treasury yields rise further. There was a funny article in Bloomberg  at the end of September lauding the US banking sector for dodging the bullet on unrealized losses, but this was before the 10-year Treasury backed up 75bp in yield through October.  If as we suspect the Fed eventually drops short-term interest rates, the long end of the Treasury yield curve may rise, exacerbating the trillions of dollars of losses hidden inside many US banks, and also private equity and credit funds. Speaking of unrealized losses, Robin Wigglesworth wrote a great piece in the FT earlier, detailing the mounting trainwreck in the world of private equity. PE managers are actually resorting to outright fraud in order to conceal the extent of the losses and, most important, continue paying themselves management fees.  When you don't need to report results publicly, it is easy to defraud credulous investors who must window dress their badly considered decision to invest in private vehicles. Wigglesworth notes that “the growing use of “payment-in-kind” loans — where interest payments are rolled into the principal rather than paid to lenders — is a sign that all is not well in private creditland.” No indeed. Truth to tell, many of the investors in the world of private investing are just as insolvent as the large banks. “Quietude on ostensible defaults does not constitute good cashflow returns for private credit lenders,” opines Nom de Plumber  from his Manhattan risk vantage point. “Payment-in-kind interest and principal may forestall defaults and loss severities, but do not return liquid capital.”    Bloomberg’s   David Wighton notes that “returns from venture capital have shriveled since the bubble burst at the start of 2022. UK venture capital funds lost 25% of their value last year, according to figures for members of the British Private Equity and Venture Capital Association.” The trouble with private equity, of course, is that it is private. Without a public market price to validate the claims of managers, investors have no way to test the supposed valuations or returns reported by the long list of conflicted professionals involved. Given that President Trump has vowed to tax the “profits” within the endowments of some of the largest US universities, for example, the pretense surrounding PE returns may soon end as endowments fess up on concealed portfolio losses.  At the end of October, the State of Florida announced its intention to sell up to $4 billion in private credit loans. Nom de Plumber  notes that it will be interesting to see if and how this open-market sale of illiquid private credit assets occurs. “For once, Florida may be staying ahead of a storm,” he advises with tongue in cheek. Of note, Elizabeth McCaul , a member of the ECB’s supervisory board, said that some firms involved in private credit “have grown to such a scale and have reached such a level of interconnectedness that they now exhibit systemic characteristics.”  Could President Trump be faced with calls for bailouts of PE funds in the New Year? The size of private credit shops makes “their stability integral to the health of the broader financial system,” McCaul declared, although without naming any specific firms. It is important to remember that banks fund much of the world of private credit via "secured" commercial loans to managers. These loans often feature double-digit coupons, one reason why yields on bank loans have risen -- at least in theory. But will relatively new bank loans to private credit firms turn to ashes? Whether we are talking about banks or private equity, the prospect of higher LT interest rates means that financial stress in the global dollar system is rising. Even though the yield on bank loan portfolios has jumped several hundred basis points since 2022, average yields on securities have barely moved, as shown in the chart below for the banks in the WGA Bank Top 100 Index. Source: FFIEC The average yield on $2.9 trillion in MBS held by US banks was just 2.8% in Q3 2024. Fannie Mae 2.5% MBS are trading at 83 cents on the dollar, suggesting a market-to-market loss of more than $500 billion for this category of bank assets alone. The Treasury 2.875% bonds of 2043 are trading at ~ 78-13 this morning. There are many large banks in our surveillance group with yields below this level, as we noted in our profile of Bank of Hawaii (BOH) last week. Indeed some of the largest US banks in our surveillance group have loan and securities yields significantly below the Peer Group 1 average. If yields on the 10-year Treasury note move above 4.5%, the alarm bells will start ringing in Washington. If yields touch 5%, then the entire US banking industry will be in distress and the Federal Reserve Board will have already resumed QE with a focus on longer-dated maturities. And all of this may happen before Donald Trump has even taken the oath of office in January 2025. Treasury Secretary-designate Scott Bessent earlier announced a "3-3-3" plan inspired by the late Japanese Prime Minister Shinzo Abe , which most resembles a policy proposal from President Joe Biden . Abe adopted a "three arrows" plan that featured aggressive monetary policy along with fiscal stimulus and structural reforms aimed at lifting Japan's economy from stagnation and persistent deflation. "U.S. Treasury was able to save the country during the Civil War by expanding the deficit… They saved the economic well-being of the country during the Great Depression by spending. And then we were able to save the world during World War II. So we have to get this down, or we have no room for maneuver," Bessent said in a speech. Of note, the Abe "three arrows" plan of two decades ago was a dismal failure and led to the Bank of Japan engaging in more yield curve control (aka "financial repression"). Our bet is that the Bessent "3-3-3" plan likewise will be a failure and that the Fed will be forced to restart QE sooner rather than later to rescue commercial banks, funds and of course the US government from overmuch debt. Now you know why we have avoided bank common stock since 2022. Happy Thanksgiving to all! In our next comment, we will don the Raging Bull hat and provide a detailed check list of what needs to happen before the GSEs, Fannie Mae and Freddie Mac, are released from conservatorship. Suffice to say if the well-regarded Treasury nominee gets started on release immediately after confirmation by the Senate, Bessent still may not have enough time to get the job done in a little less than four years. And this assumes that the US financial markets somehow avoid a real-world mark-to-market in the meantime. First Half 2025   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.