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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.

November 18, 2024  | Updated | In this issue of The Institutional Risk Analyst , we ask a basic question. Will the US bond market wait for President-elect Donald Trump to take office in January and unveil his agenda? Or will the long end of the yield curve surge even higher as the likelihood of a US debt default increases?  BTW, President Joe Biden will let the Ukrainians take the gloves off before Christmas and strike targets deep inside Russia, a little parting gift for the incoming POTUS from the Party of War. With the Russian military disintegrating and 100,000 North Korean soldiers "reportedly" headed for Kursk, according to sources favoring escalation, how long will the US and other NATO countries stay out of the Ukraine War? In fact, the Russians have training agreements with the North Koreans in the Far East. And they receive ammunition. Everything else is a lie designed by the Party of War to justify the ever increasing escalation.   Our first quarterly conference call was held last week for subscribers to the Premium Service  of The IRA . We’ll be doing another call in Q1 2025.  Watch for a placeholder for the next discussion via email. In the space of 45 days, the credit markets have gone from certainty regarding falling interest rates to increasing fear of higher interest rates. “The economy is not sending any signals that we need to be in a hurry to lower rates,” Federal Reserve Chair Jerome Powell said during a speech in Dallas.   While Chairman Powell was inclined to be helpful to President Biden, he is inclined not to be helpful to Donald Trump and will now gladly drag his feet on further rate cuts. Given that Trump does not have much room to maneuver because of the rising budget deficit and LT interest rates, this sets the stage for a very public political confrontation with the Fed in the New Year. Those of us who traded the Trump Casino bonds years ago through several bankruptcies get the joke. In the tertiary phase of debt default, non-payment becomes inevitable. If all of this were not enough, the Fed has no idea about the state of liquidity in the markets as we approach the end of the year. Bill Nelson , Chief Economist at Bank Policy Institute , notes in his latest missive that "The Fed's guide for when to end QT may be unreliable." Specifically, the FOMC's calculus regarding the adequate level of reserves is subject to considerable uncertainty. The interaction between the Fed's investment portfolio, the Treasury General Account and Reverse RPs, and bank investment decisions, Nelson relates, can change the correlation between bank reserves and interest rates from positive to negative to neutral "instantaneously."  This means that Chairman Powell and the other members of the Fed's Board of Governors really have no idea whether there is sufficient liquidity in the system as the central bank slowly shrinks its balance sheet. Truth to tell, nothing has changed since December 2018, when Powell et al almost crashed the US financial system except 1) the increasingly political stance of the Federal Reserve as a new Republican administration takes office and 2) the prospective level of uncertainty coming from the Trump White House. For mortgage lenders and the equity markets, increased interest rate volatility is going to be the challenge going forward. For Fed Chairman Jerome Powell, the big question is when to push the red button and resign. Some progressives and market watchers were heartened when Chairman Powell pushed back on the idea that the President of the United States could fire him or other Fed governors. In purely technical, legal terms, this is correct. But as a practical political matter, no Fed chairman or governor can function without the support of the White House and the US Treasury. Richard J. Whalen (1935-2023) agreed to be an advisor to former Merrill Lynch CEO and Treasury Secretary Donald Regan in Reagan I, but he laid out several conditions that we recount in the Second Edition of "Inflated: Money, Debt and the American Dream," to be released by John Wiley in 2025: "Dick, I’ve been asked to become Secretary of the Treasury,” said Regan. Whalen replied: “I know, you’re on the list.” Regan said, “What should I do?” And Whalen said, “If you want it, take it, but for Christ’s sake stay away from Nancy Reagan and do not mess around with the Fed. Those are my terms if you want my help.” Sadly such civilized rules no longer apply in the confines of Washington in 2024. There is no institutional respect for the Fed in the politicized world of Washington, in large part because the US is headed for a financial crisis. The politicians in both parties are growing desperate for a way out like rats fleeing a sinking ship. Suffice to say, it's 1861 all over again and Donald Trump stands in the shoes of Abraham Lincoln as the head of a broke government. Fed Chairman are typically picked by the incumbent president and usually have served at the Treasury, on the Council of Economic Advisors or National Economic Council. Powell lacks this pedigree. President Jimmy Carter appointed Paul Volcker as chairman of the Board of Governors of the Federal Reserve System in 1979, just before losing the 1980 election to President Ronald Reagan .   Reagan was happy to have Volcker take the heat on inflation in the 1980s, but in the current scenario Donald Trump may not have much time to be nice.  Such is the fiscal fiasco created by President Joe Biden, Treasury Secretary Janet Yellen and Congress that the US markets could see a significant market correction before Trump takes office.  The US government is running a cumulative deficit of $1.9 trillion so far in FY2024 ($302 billion more than the same period in the prior fiscal year when adjusted for timing shifts*), according to the Bipartisan Policy Center . Spending is rising faster than revenue, largely due to higher interest rates. As our astute colleague Ralph Delguidice asked last week, does Trump even have an opportunity to roll out a new program before the proverbial debt comes due in the Treasury bond markets? Corporate debt spreads are relatively tight vs risk-free yields. Private companies are taking advantage of this fact in the new issue market.  But the reason corporate spreads are tightening is rising government debt yields and deteriorating sovereign credit default swaps spreads, not better corporate credit. That is bad. The floor of government credit default spreads is rising on a sea of unpayable public debt. There is a reason why the folks at FRED no longer publish US credit default swap rates. The charts below come from David Kotok of Cumberland Advisors c/o Bloomberg & CMA, and show the widening of five year CDS spreads for the United States since 2019.  David will be talking about the market for US CDS on the Money Show in Sarasota on December 7th . Suffice to say that the probability of default for the US has risen 4x since 2008. Source: Bloomberg/CMA Source: Bloomberg/CMA What these two charts illustrate is that the cost of insuring against a debt default by the United States is rising significantly. While the ebb and flow of the markets continues, the LT trend is headed toward an eventual default. Indeed, the US seems to be on track to see debt spreads for the US rise above corporate spreads for the largest and most liquid private companies for the first time since WWI. When President-elect Trump ponders his selection for Treasury Secretary, he ought to ask who will do a better job of managing a US debt default. Elon Musk has urged followers on X to support Howard Lutnick , former CEO of Cantor Fitzgerald . Lutnick is up against Scott Bessent , the founder of capital management firm Key Square , who reportedly wants the US dollar to remain the world’s reserve currency and use tariffs as a negotiating tactic. “My view FWIW is that Bessent is a business-as-usual choice, whereas @howardlutnick will actually enact change,” Musk posted on Saturday. “Business-as-usual is driving America bankrupt, so we need change one way or another.” But do either President Trump or Elon Musk understand how little time remains for political posturing? 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 13, 2024  | Premium Service  | With the victory of President Donald Trump  on November 5th, a number of our friends and neighbors who supported Vice President Kamala Harris have gone into seclusion. A period of morning has been declared among many people who placed the blue Harris-Waltz signs on their front lawns. Placing the signage on the lawn allowed them to think, for a while, that they were somehow superior to Trump supporters. After all, it was obvious, right? But it was not to be.  The pro-Harris crowd expected to win because they felt entitled  to win. Many of our friends in the Democratic Party would tell us that conservatives should not even be allowed to hold public office . The pro-Trump folks, however, did not need signs on the lawn. They already knew the outcome of the election as we noted in The IRA . We wanted to show compassion. This Friday, when we celebrate at Trump National , we will keep those disappointed Harris-Waltz folks in our prayers.  Moving from the absurd to the merely ridiculous, we note that the list of aspirational stocks and crypto tokens that are rising at double-digit annual rates is growing.  What does it say when ETFs based loosely upon a moveable fraud called bitcoin, a notional asset that is convertible into nothing at all, rises to near $100,000 fiat legal tender dollars?  It says inflation is still the problem. Fact is, Americans have grown entitled to capital appreciation, that is inflation , in all manner of assets and tokens. Thus the question: Could President elect Donald Trump be facing a maxi market correction before Inauguration Day? We note in the new edition of “Inflated: Money, Debt & the American Dream” to be released by Wiley Global in 2025 that President Trump and the Republicans face the same dire peril as did President Grover Cleveland 120 year ago: “President Grover Cleveland led the Democrats to an electoral triumph in the fall of 1892, winning control over both houses of the Congress and the White House for the first time in more than a third of a century. The conservative Cleveland took power just as the U.S. economy was collapsing. Foreign creditors and the country’s citizens were fleeing paper assets and demanding payment in gold. Even as the Democrats savored their victory in the five-month interregnum between the election and the inauguration of the new president in March 1893, the global financial markets began to unravel.” The financial crisis of 1893 was caused by inflation. Specifically, when the Treasury made purchases of silver, which were being paid for in then convertible greenbacks, Americans promptly exchanged paper for gold. In 1893, money was gold and greenbacks were debt convertible into gold. Today the paper dollar is convertible into nothing, but at least you can pay your rent or buy groceries. Crypto currencies are speculative tokens that must be converted back into fiat paper dollars to be useful.  Does President Trump understand the difference?  Below we review the constituents of our mortgage finance surveillance group to update our readers on the GSEs and other residential mortgage issuers. Remember, Fannie Mae and Freddie Mac are no different than issuers like PennyMac (PFSI) --  except that they also insure the mortgages and mortgage-backed securities (MBS). Our first live discussion for subscribers to the Premium Service  of The Institutional Risk Analyst  will occur on Friday, November 15, 2024 at 10:00 ET. Subscribers look for further details via email! Likewise the crowd of people who expect the GSEs, Fannie Mae and Freddie Mac, to be released from captivity is also growing, but not nearly enough to make it actually happen. In fact, the top-performing mortgage stock in the US over the past year is no longer one of the GSEs, but instead Blend Labs (BLND) , up 277% as of the close yesterday.  After BLND comes Freddie Mac, then Compass Inc (COMP)  followed by Fannie Mae. How could BLND and COMP possibly bypass the GSEs in terms of 1-year total returns? The short answer is that BLND and COMP each went public in 2021 at the end of quantitative easing and both stocks got crushed thereafter.  BLND and COMP both went out above $20 per share and both stocks fell into single digits. The low for COMP, a real estate brokerage firm, was $1.815 in November 2023. The low for BLND, an unprofitable mortgage firm, was $0.55 in May of 2023. As traders who follow the GSE penny stocks and preferred know, it is east to show triple digit equity returns when the stocks start near zero. The high for Freddie Mac was $74 on 12/21/2004 and basically went to zero after the government takeover in September 2009. The low for Freddie was $0.128 in March of 2011. Following the re-election of President Trump the stock surged from $1.2 to $2.60 at the close yesterday. Does this mean that Freddie Mac is ever going to be a public company ever again? Not likely.  As we’ve said before, when irrational exuberance takes GSEs stocks “to da moon,” take the money off the table. Let a greater fool speculate on an eventual release. One of the questions we have been asked about the Trump transition and mortgage finance is what must happen before the GSEs can be released. The short answer is that we need legislation to move the mortgage guarantee business from the GSEs to Ginnie Mae. The private GSEs cannot support $8 trillion in residential and multifamily MBS.   Ideally, new housing legislation would spin Ginnie Mae out from HUD as an independent agency so that it may be properly funded and staffed. The only trouble with this scenario is that once the GSEs shed the mortgage guarantee business, there is not much left. Without a sovereign rating and the revenue from the guarantee business, the GSEs are not very attractive as mortgage issuers. After Fannie Mae in our mortgage equity group, next on the list is Finance of America (FOA) , an unprofitable reverse mortgage lender that went public in 2020 over $100 per share and hit a low of $7 this past July. With a market cap measured in the millions of dollars and a spread of 150bp in credit default swaps (CDS), FOA is hardly an industry bellwether.  Yet the stock closed just shy of $20 yesterday. Again, if your stock is left for dead, it is easy to generate triple digit returns given the right nudge.  After FOA, the next member of the mortgage equity list is Zillow (Z) , a long-time public company that peaked at $200 per share in 2021 then basically lost 90% of its value but did not touch the all time low of $15 in 2016. Z jumped following the election of President Trump, but we cannot see how Washington is going to save real estate agents from the trial lawyers. Given the huge push by consumer groups to address the issue of home affordability, we think the NAR settlement from last year is set in stone. Sellers don’t mind paying 3% instead of 6% commission on a home sale. Bottom line, we think that the mortgage finance sector illustrates a larger problem for investors and also President-elect Trump, namely that the accumulated inflation added to the system during four years of President Joe Biden is still pushing up asset prices even as the economy shows signs of slowing. In our next comment, we'll be looking at some of the payments platforms in our fintech equity group to see what the world of consumer lending tells us about the state of the US economy. 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 11, 2024  | Happy Veterans Day. Memorial Day honors America's military men and women who lost their lives in service to their country. Veterans Day is the day we thank and honor ALL those who served honorably in the military – in wartime or peacetime. On Veterans Day, we are grateful to our great, great grandsire, Richard James Whalen , who walked from Poughkeepsie to Louisiana and back with the New York 159th Volunteers during the Civil War. Dick, as he was called, was a sharp shooter who also was known for wrestling black bears…  Last week saw a relatively rare event on Wall Street when R.W. Baird analysts led by David George  said JPMorgan (JPM)  was "best-in-class," but that it is "time to take profits" in the shares. That is, Baird put a "sell" rating on Jamie Dimon . JPM is up almost 50% so far this year and common shares are changing hands at roughly 14 times forward 2026 earnings. Below we take a hard look at the House of Morgan and some of the other names in the  WGA Bank Top 10 Index . Source: WGA LLC The surge in JPM following the election win by President Donald Trump was unusual and arguably begs to be sold, but the same can be said of a number of top banks, as shown in the chart below. The entire bank group moved higher with the election, but this change in valuation may not be permanent. Source: Google Finance (11/08/24) Will the change in government in Washington be sufficiently profound to impact bank stocks so dramatically? Probably not. The end of the Biden Administration will certainly usher in a more positive environment for all types of companies. After four years of progressive madness in Washington, banks are likely to see more reasonable behavior from federal regulators. Banks will also see higher credit expenses and flat to down net-interest margins because of bond market volatility. With the 10-year Treasury note at 4.3% yield Friday, the mark-to-market losses for US banks will again rise. As of Friday’s close, JPM was trading over 2x book and 5x revenue, so it may seem a safe bet that the stock is overvalued. Readers of The IRA should recognize that a lot of equity managers have piled into JPM and other large-cap names as part of the return of allocations to big banks since the end of Q2. Of note, JPM did not really trade off in the first half of the year. As a result, it will take a considerable stumble by JPM to convince managers to move out of the $670 billion market cap stock.  When they do change their view of JPM, however, look out below for all financials. JPM is now ranked #3 in the WGA Bank Top 10 Index and has been in this exclusive group all year. The stock has a beta just above 1, which is a function of the steady, almost 50% appreciation of JPM during 2024. Short-interest on JPM is < 1% of the float and still tiny compared with other large cap names. Yet there is a growing crowd of short sellers following the leading bank stock. Short-interest on JPM increased through the summer, culminating in a sharp selloff in August on recession fears. The median level of short interest for the S&P 500 is just 1.8% vs over 3.5% in 2008. The secular inflation of equity valuations over the paste decade has naturally tended to push down broad measures of short-selling. But that said, JPM is definitely attracting more attention from shorts who see a huge stock that may be due for a correction. So is JPM expensive? Compared with other stocks in our group, no. The bank has below-peer credit losses and the best operating metrics of the largest banks. Fact is, the banking industry has segmented into a handful of above-average performers and JPM is the largest leader of these winners. These stocks are visible in the WGA Bank Top 10 Index as shown below. Subscribers to the Premium Service have access to the constituents of the index and the weightings. WGA Bank Top 10 Index Source: WGA LLC American Express (AXP) is trading near 7x book value vs 4x a year ago. Another top performer, Ameriprise (AMP) , is over 8x book vs 7x a year ago. East West Bancorp (EWBC) is just below 2x book value vs 1.1x a year ago.  With a bit of an interruption in the first half, most of the better performers in the group are fully valued or more because a number of the other large-cap names are underperforming significantly. For example, t here is a reason that Warren Buffett has been selling Bank of America (BAC) for the portfolio of Berkshire Hathaway Inc. (BRK) . BAC ranks 46th in the WGA Bank Top 50 Index, an improvement from Q3 2024. Yet BAC is still dragging because of the bank's abysmal job of balance sheet management during and after the Fed's experiment in "quantitative easing" between 2020 and 2022. BAC's yield on earning assets vs net income was just 1.92% in Q3 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.

November 4, 2024  | The US bond market rallied for awhile on Friday morning, but the growing size of leveraged short positions in Treasury futures killed any sustained rebound. Brian Meehan of Bloomberg reports that short bets on Treasury yields have risen 50% in the past year to more than $1 trillion notional. These positions are so large that a sudden shift to net long could force the Fed to bail out the Treasury bond market again as in Q1 2020. Save the date! Our first live discussion for subscribers to the Premium Service of The Institutional Risk Analyst will occur on Friday, November 15, 2024 at 10:00 ET. Subscribers look for further details via email! Meanwhile, oblivious to the mounting risk in the bond market, global equity managers have piled back into financials with both feet. Like we said. Keep in mind that as the 10-year Treasury note rises in yield, banks become more and more insolvent, as shown in the table below. The average yield on large bank securities was just 3% in Q2 2024, according to the FFIEC. Fannie Mae 3s for delivery in November were trading ~ 86 cents on the dollar Friday. Source: FDIC/WGA LLC We rebalanced the WGA Bank Top Indices on Friday with the help of our friends at Thematic and the new group is reflected in the indices. Notice that JPMorgan (JPM)  is in the top of the group at number four behind Discover Financial (DFS) , Synchrony (SYF)  and  East West Bancorp (EWBC) . Also note that JPM and DFS, the latter of which is awaiting acquisition by CapitalOne Financial (COF) , are the only two names that have been in our top ten group all of 2024.   WGA Bank Top 10 Index Constituents Source: WGA LLC JPM's position in the index was unchanged vs Q3, but there was a lot of movement in the rest of the group. Wells Fargo (WFC) is back in the top quartile of the test group and Bank of America (BAC)  moved from the third quartile to the second, but Citigroup (C) , Truist Financial (TFC)  and Ally Financial (ALLY)  remain in the bottom quartile of our 105 bank test group.  Subscribers to the Premium Service  have access to the index constituents and the weightings for Q4 2024 . The chart below shows the entire test group by market cap, with the highest scoring banks starting on the left. Source: WGA LLC Even as hedge funds place huge bets on Treasury yields moving higher, the Fed may be finally considering sales of mortgage-backed securities. The Federal Reserve Board has been reducing the size of its Treasury holdings by $25 billion per month and up to $35 billion in MBS, but in fact the rate of prepayments on the mortgage paper is only a fraction of that amount. Prepayments on late vintage MBS surged in Q3 2024, but the sharp rebound in Treasury yields abruptly ended the September mortgage market rally.  “Speeds in the premium coupons jumped considerably last week, and have been elevated for the past four weeks,” notes Scott Buchta at Brean in a note about actual prepayments in September. “These pay-offs will primarily show up in the October prepayment report as there were a couple of collection days included in the Sept 28th-Oct 4th report…. The biggest w/w increases were in the 6.5% and higher coupons. In general, prepayment activity in the discount coupons remains very low (<=5 CPR) as turnover and cash-out refinancing activity remains muted.” “It is important to remember that these are the actual pay-offs (end of the process), vs refi applications which are at the beginning stages,” Buchta continues. “These [refi] indices are most likely near their peak, and we expect them to drop considerably as we move through November and into December as the refi indices have fallen 45% from their recent highs.” Why is this a problem for the Fed? Because the reduction of the system open market account (SOMA) at the Fed is moving asymmetrically, with relatively short duration Treasury paper running off in a very mechanical and predictable fashion. The low coupon MBS, however, is lingering as the few high coupon securities held by the Fed prepay, but the rest of the portfolio of low-coupon MBS is barely moving.  More, the effective duration of the SOMA MBS holdings is now larger than the Treasury securities owned by the Fed. Although the cap under the Fed’s “quantitative tightening” or QT is $35 billion in prepays of MBS from the SOMA each month, the actual prepayments are closer to $15 billion per month. The table below shows the relative increase in the MBS as a percentage of total SOMA securities. Keep in mind that, measured in dollars, the duration of the $2.2 trillion in nominal MBS owned by the Fed is closer to $6-7 trillion, depending on your prepayment assumptions. Source: FRED Last week, Bill Nelson at the Bank Policy Institute published an important piece about how the Fed manages (or fails to manage) reserves.  He noted, for example, that the model for liquidity used by the Board was designed decades ago (1968 in fact) by Bill Poole to measure liquidity intraday . The model was never intended to predict liquidity needs over time. Nelson: “There is a flaw at the heart of this conception of monetary policy implementation.  The Fed seems to think that when it oversupplies reserve balances, those extra balances just sit idly in each bank’s account at its Reserve Bank, ready to be redeployed easily in pursuit of higher yields.  The mistake has arisen because the Fed is drawing intuition from a decades-old model of reserve supply and the federal funds rate that was intended to describe the relationship over a day.  The mistake has caused the Fed to incorrectly judge that QE can fairly easily be reversed by QT and to misunderstand the relationship between its balance sheet and repo market resilience.” At the end of his piece, Nelson suggests that the Fed may be considering sales of MBS. Why? Because the portion of the SOMA portfolio that is in MBS is now rising as Treasury paper runs off. This is contrary to the public statements by Chairman Jerome Powell and other FOMC members that the Committee would like to return to owning primarily Treasury securities. In technical terms, moreover, it would be desirable to put away this huge block of duration with investors and invest the proceeds in higher coupon Treasury securities. A big reason for Powell to do the CMO trade is to narrow the Fed's negative net interest margin and eventually get it positive . Nelson notes that while the Fed is shrinking only by allowing securities to mature without replacement, it could also gradually sell securities. The Fed originally planned to sell securities to normalize its balance sheet as discussed in the June 2011 FOMC meeting. He concludes:  “It would be doubly useful if the Fed sold MBS as opposed to Treasuries.  The Fed’s current normalization principles state  When QT started, 32 percent of its portfolio was MBS.  Now, 34 percent is MBS.  No one is refinancing the mortgages made at ultra-low rates that are bundled into the Fed’s MBS, so the securities are maturing very slowly. In a recent speech, Lorie Logan , President of the Dallas Fed, reminded the audience that the FOMC said in May 2022 that the FOMC might sell MBS and that they haven’t rescinded that possibility. Maybe it is not a coincidence that Roberto Perli, the recently hired head of the open markets desk at the New York Fed, is an expert on mortgage markets.” In June of 2022, we asked whether it wasn’t time for the Fed to engage the  Federal Housing Finance Agency (FHFA) under Director Sandra Thompson to fix the growing duration trap facing the Fed, the GSEs, many REITs and the banking industry (“ The Fed and Housing ”). Thompson, who has extensive experience at FDIC and Resolution Trust Corp dealing with bad assets and troubled depositories, understands why time is the most precious aspect of managing risk.  And time may be against us all when it comes to LT interest rates. Obviously with residential mortgage rates near 7% again, nobody in Washington or on Wall Street wants to see the Fed making outright sales of MBS into a retreating secondary market. But the Fed can use the power of wide spreads, which have boosted issuance of collateralized mortgage obligations (CMOs) and other structured securities, to shed low-coupon MBS on the books of the Fed and also banks and other financial institutions. The goal is to normalize net interest margin for the Fed and banks within say two years. We wrote in March of 2023: “The Fed, the prudential regulators, the FHFA and the GSEs need to sit down together and fashion a comprehensive program that will allow [the Fed], banks, REITs and the GSEs themselves to repackage low-coupon loans and MBS into CMOs and sell this paper into the market. The FHFA needs to re-open the doors of the GSEs to securities and seasoned loans older than six months. Once the selling process begins, prudential regulators will need to give banks forbearance in terms of the recognition of losses and the impact on capital. ”   Given the fact that LT interest rates may, in fact, continue to rise, we need to buy time so that banks are not forced into involuntary sales.  The good news is that by using the power of the GSEs as underwriters, we can restructure the cash flows from the existing MBS and create attractive “AAA” rated income producing securities and deep-discount zero coupon securities.  Banks and other investment grade investors can buy the relatively short-duration front tranches of these CMOs, while funds and insurers will find the longer-duration paper attractive.  The Fed ought to aggressively sell the short-duration tranches of deals created with SOMA MBS by the GSEs, but retain the volatile, longer duration (and higher return) principal only (P/O) tail pieces to reduce the impact on markets (and possibly generate a nice return for the Fed and taxpayers in the future). The FOMC should authorize the FRBNY to contract with the GSEs to issue CMOs starting with the lowest coupon paper, the 2s and 1.5s that the SOMA now holds. The same dynamic that has caused the duration of COVID-era MBS to quadruple or more since 2021 also affords the Fed an opportunity to get back some of the billions of tax dollars they have spent via QE. Unlike banks and other private financial institutions, the Fed has the ability to sequester long-duration, deep discount tranches of CMOs that can be problematic for private issuers. It’s time for the Fed to get smart on managing duration risk and help itself and the banks before circumstances create another money market crisis.  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.

October 30, 2024  | With the 10-year Treasury note now 75bp above recent lows after the Fed’s September rate cut, market participants are exhibiting confusion. The subliminal guidance from on high has suddenly stopped. No longer can equity traders discern the future direction of markets by reading the last FOMC press release. With Fannie Mae 6.5s for November at 102, mortgage rates will be above 7% by year end, at least if you are concerned about profitability. Into this intellectual vacuum, hordes of Buy Side economists and allied media are focusing their painfully conventional perspectives onto a key national issue. Will the election of Donald Trump cause higher interest rates in the US? Not necessarily. VP Kamala Harris is about business as usual, as illustrated by the fact that Treasury Secretary Janet Yellen failed to mention the budget deficit once during her remarks to the American Bankers Association yesterday . Donald Trump is a change agent, but you may not like the change. Most Americans really don't want to see the size of the federal government reduced because it implies lower living standards going forward. Our historical analog for President Trump is President Andrew Jackson (1829-1837). As we write in the upcoming Second Edition of “Inflated: Money, Debt & the American Dream” to be released by Wiley Global (WLY) in 2025: “Jackson was opposed by most of the nation’s newspapers, bankers, businessmen, and manufacturers, especially in the Northeast, but still won 56 percent of the popular vote in 1828. Comparisons between President Jackson and Donald Trump’s surprise victory over Hillary Clinton in the 2016 race and Kamala Harris in 2024 are not unreasonable. Thus began the Jacksonian Age.” If President Trump and his loyal boy wonder, Elon Musk , make progress cutting the federal deficit, then the likelihood is for interest rates to fall even as the dollar soars. The global bid for dollars and, more important, risk free Treasury collateral is so strong that a sudden reduction in new issuance by the Treasury will cause interest rates to fall sharply. The FOMC will become superfluous. Decades of deficits and related inflation will suddenly reverse and become deflationary. The chart below from SIFMA shows total securities issuance. The Treasury is the dark green line at the top of the chart and accounts for half of total issuance today . Source: SIFMA Remember, this market is used to absorbing $1.7 trillion (FY 2023) per year in new mostly short-term Treasury securities. What happens to demand for Treasury bills and also "AA+" Ginnie Mae MBS when we turn off the new issue spigot at Treasury?   The chart from FRED shows the assets of money market funds (blue line) and RRPs (red line). If Treasury reduces T-bill issuance, government-only mutual funds will need to change their investment criteria. Many executives of banks and money market funds will beg the FOMC to allow them to return to the subsidized world of reverse repurchase agreements (RRPs). But imagine if a future Treasury Secretary publicly tells the FOMC to keep RRPs inside of T-bill yields going forward. Just imagine. With economic data pointing to a robust economy, the bears are struggling to maintain their calls for immediate and deep rate cuts by the Powell FOMC. The US economy is not doing a "soft landing" but rather a "touch-and-go," a maneuver we've done more than once at La Guardia Airport in NYC. Since quality IPOs are now a very distant memory, starving equity traders have adopted an even more brazen and aggressive form of “pump and dump” strategy for extracting value from the clueless retail crowd. Source: SIFMA   Consider the case of two refugee stocks, Fannie Mae and Freddie Mae. These two captive GSEs have been pumped and dumped several times in the past year. The catalyst for this action? The distant prospect of a political decision by former President Donald Trump to release the GSEs from government conservatorship. As we've noted several times in The Institutional Risk Analyst , the GSEs were the two best performing mortgage stocks in the past year and more. Source: Google Finance We’ve explained ad nauseum  why neither of these finance companies will be released from government control in the near term, but that makes it all the easier for certain Wall Street firms and their consultants to pump up the stock. Brokers reveal fictional non-public meetings in Washington where the release of the GSEs is being discussed, right now. Firms distribute "white papers" and other email missives to retail investors, all with little or no disclosure. Think of the beauty of Fannie Mae and Freddie Mac from the perspective of some disreputable equity trader working for an equally prestigious securities firm. Since the prospective decision about releasing the GSEs is a question of politics and, thus, largely unknowable, you can tell your clients whatever crap story pops into your little head. You can tell lies and damn lies about the idea of releasing Fannie and Freddie, but the SEC and FINRA cannot and will not say a word.  It’s all about politics, after all. Fannie Mae peaked a little shy of $2 back in March 2024, then fell down to ~ $1.30 in June, but rebounded to a little over $1.60 by mid-October. Then the pump and dump crowd bailed, sending the penny stock into a swoon. One equity maven asked The IRA earlier this week: “Why is Fannie falling.” More sellers than buyers. Another mutual fund CEO asked if investing in the preferred stock of the GSEs is advisable. Only if you understand that it is just a speculative "flutter" and not an investment. And no matter how many times you may hear from this securities firm or that consultant that former FHFA Director Mark Calabria  is going to "take the GSEs out," it ain’t gonna happen without legislation from Congress and years of preparation. The odds of legislation on the GSEs and housing reform more generally are slightly worse than the prospects for crypto currencies to be declared legal tender by Congress this January. But remember, even the intelligent and righteous Mr. Calabria can come up with all kinds of fanciful statements and ideas about GSE release, but it does not matter. It’s all political. When it comes to Fannie Mae and Freddie Mac, members of FINRA can dress in clown suits, don the Mickey Mouse ears that the head of Enron once wore to investor meetings, and tell lies and lies. And it does not matter.  Meanwhile in the kingdom of fintech, the practitioners of pump and dump have been very busy indeed. Both SoFi Technologies (SOFI)  and PayPal Holdings (PYPL)  got the sudden dump treatment after reporting earnings.  The content of the earnings does not matter, but the steady runup in the stock prior to the earnings release tells the tale. At $11 billion in market cap, SOFI is a small stock, but PYPL at over $80 billion market cap was pushed around just the same, as shown in the chart below. Source: Bloomberg (10/29/2024) What these examples of excess liquidity illustrate is that there is a lot more demand – aka, inflation – than there are opportunities to earn that expected 2 & 20 return (or maybe just 1 & 10). A drop in the federal budget deficit will put sustained downward pressure on interest rates, so much so that President Trump may not even need to browbeat the Fed. Now imagine that. And a sustained drop in interest rates will make the deficit easier to finance, may improve the quality and breadth of the equity markets, and will also make the solvency issues of the US banking system fade into memory.  If LT interest rates continue to rise, on the other hand, then the US banking system is going to be in big trouble come Inauguration Day. With the 10-year Treasury note at 4.3% this AM, the US banking system is insolvent by a couple of trillion dollars, as shown in the table below from The IRA Bank Book for Q3 2024 . Source: FDIC/WGA LLC 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.

October 21, 2024  | The Russian propaganda machine is working full time to promote Moscow’s latest scheme for a new international payments system. Russia will present the proposal to fellow BRICS nations at the group’s summit this week in Kazan, Reuters  reported, citing a document distributed by Moscow to journalists ahead of the event.  The BRICS nations – Brazil, Russia, India, China and South Africa – admitted four new members at the start of 2024: Egypt, Ethiopia, Iran and the United Arab Emirates. Although the BRICS nations desire an alternative to the dollar, none of the members states have yet to design a workable plan. Indeed, the Russian proposal to the BRICS seems like a desperate move and essentially amounts to a system for facilitating barter between the participating nations. “The dollar’s stranglehold on global finance is fraying, and Russia’s proposal could be the nail in the coffin,” declares the Russian website www.rt.com . “And here’s the kicker: the U.S. and its allies, so adept at weaponizing the dollar, now find themselves cornered. Washington loves to peddle ‘freedom’, but when it comes to global finance, it’s all about coercion and ensuring the dollar’s imperial reign continues.” The event’s theme of anti-colonialism is appropriate given the venue. The Mongols ruled Russia for 240 years during the 13th to 15th centuries. Kazan was captured from the Tartars by forces loyal to Ivan the Terrible in 1552. The region was gradually Russianized and Muslim religious activity suppressed for centuries until the fall of the Soviet Union. Located 450 miles due east of Moscow, Kazan is a symbol of the ebb and flow of geopolitical power between East and West in Eurasia.  Like many cities in Russia, Kazan became a major manufacturing center for arms during WWII. Yet today Russia remains hobbled by economic and financial weakness that stems from the country’s authoritarian government.  Despite the war in Ukraine and the loud pretensions of Vladmir Putin , Russia is declining and China is again in the ascendancy, although neither nation is really growing in economic terms. Russia first organized a meeting of the BRIC nations in 2006 but has yet to produce any tangible results. Under Putin's erratic leadership, Russia has destroyed its economic ties to Europe and has resumed its place as a vassal state to Beijing. Today, China and the US are the move-movers of global economic affairs, although the status of the former is increasingly in doubt. Meanwhile, as we discuss in the upcoming Second Edition of "Inflated: Money, Debt & the American Dream," the use of the dollar is slowly declining. Many nations choose to hold the currencies of major trading partners other than the currencies of the US, China and EU. Rather than a replacement for the dollar, the global currency system seems to be displaying accelerating entropy. “Central to that is the proposal for a new payments system based on a network of commercial banks linked to each other through the BRICS central banks,” Reuters  reports. “The system would use blockchain technology to store and transfer digital tokens backed by national currencies. This, in turn, would then allow those currencies to be easily and securely exchanged, bypassing the need for dollar transactions.” Whenever you hear the magic words "blockchain" and "digital tokens," it's a good guess that whatever follows is nonsense. China has become the leading player within the BRICS in recent years, but troubles in the Middle Kingdom caused by that nation’s incompetent communist government have hobbled economic growth. There are more empty, unused dwellings in China built at the command of paramount leader Xi Jinping than there are total homes in the US. And in keeping with the spirit of the event, no western credit cards may be used in Kazan. No word yet on who is going to safekeep the national currency backing the unnamed digital tokens that will be used to settle transactions. The BRICS payments scheme lacks a functioning financial system as a foundation. The global payments system based upon the dollar is not merely a function of a large and liquid system for exchanging value in terms of trade, but an equally important system for financing trade and other types of economic activity. Replacing the dollar is not merely a matter of creating a new means of exchange but of replacing a global market for finance and investment built over half a century following WWII. More to the point, there is no leverage in the new BRICS payments scheme. Will member nations extend credit to other nations that are in deficit? Perhaps Russia, using its large gold reserves, will propose a new IMF-style lending arrangement to finance trade and current account deficits? Not likely. So far, none of the BRICS nations have shown a willingness to inflate their currencies sufficiently to serve as a viable alternative to the dollar as a global means of exchange.  The BRICS proposal to supplant the role of the dollar is inadequate. Less than a replacement for the dollar, the BRICS system seems to be a revival of the gold standard with a veneer of technology provided by blockchains, tokens other superficial techno trappings. Despite Putin’s pretensions about cooperation with the BRICS members, you can be sure that when the Russians sell you oil or arms, they will want to be paid in kind in tangible tradable assets such a commodities, gold or, yes, even dollars. 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.

October 17, 2024  | An astute reader of The Institutional Risk Analyst  asked a while back if Toronto-Dominion Bank (TD)  was not taking the place of Wells Fargo (WFC)  in the penalty box for big dumb banks. The short answer to that question is “Yes.” WFC is not even out of dodge yet, but TD has cut off several of the fingers of one hand in yakuza  style and is now headed for years of misery at the hands of US regulators, the Department of Justice and FinCEN.  Q: Is it time for TD to reassess its US strategy for going big in retail banking? Call us old fashioned value investors, but TD management deserve the torments of the damned for their business strategy in the US. They have risked a stable, low-beta banking and investment management business in Canada by pouring capital into a group of mediocre US retail banks over the past two decades. And they have sold their stakes in valuable investment advisory businesses. TD Bank reminds us of PepsiCo when it got into the retail restaurant business decades ago, beginning twenty years of intense value destruction. As long as PepsiCo invested in more Taco Bell restaurants, it looked great in terms of EPS growth. But ultimately the investments in retail restaurants were consuming capital and PepsiCo spun off the restaurant business in 1997 in an act of self preservation .   In fact, the TD retail bank in the US is destroying value with both hands (minus some fingers of course). And the real crime is that other banks in Canada are following TD’s bad example of buying underperforming US retail banks on the way to shareholder value hell. Click the link below to see a history of institutions acquired by TD going back in time to the successor of Penobscot Savings Bank in 1869. TD Bank US Holdings Acquisitions Because its undermanaged US retail bank was totally unprepared for a deliberate assault by organized crime organizations, TD must pay a total of $3.1 billion in penalties to resolve its latest management fiasco. This includes $1.9 billion to the Department of Justice in the single largest fine ever imposed under the Bank Secrecy Act . What was the sleepy appendage of an inoffensive Canadian bank doing with branches all over the eastern half of the US? Almost 200 branches in New Jersey alone? Getting targeted by professional criminals for a classic scam. You could write a great case study of TD about how not to manage KYC/AML risk.  In one example, TD reportedly was dupped by drug traffickers who purchased millions of dollars worth of gift cards via a branch in Southern New Jersey over a period of years. Are you shocked? All told, the bank “enabled three money laundering networks to collectively transfer more than $670 million through TD Bank between 2019 and 2023,” says the DOJ. We’ve long argued that Canadian banks as a group have utterly failed in their attempts to successfully acquire and grow retail banks in the US. There is not a single example going back fifty years where a Canadian bank made a profitable investment in a US retail bank. If we've missed one, please email: info@rcwhalen.com . Not only is the financial performance of TD’s US units below-average, but the operational risk created by the half trillion asset “retail” bank is off the scale and destroying any value to TD shareholders. TD and the other Canadian banks should stick with retail banking north of the border and global asset management.  The chart below shows the ROA of the US unit of TD vs JPMorgan, WFC and Peer Group 1. Source: FFIEC Regulators are actually compelling TD to create an entirely new unit to conduct triage and recovery for the US operation when it comes to the two acronyms from the infernal reaches of bank regulation: Know-your-customer (KYC) and anti-money laundering (AML). US authorities have imposed an asset cap on TD’s US operations, a sanction that may actually be a blessing in disguise. Rather than fighting to remove the asset cap imposed by US authorities, TD should instead take a hint from Wells Fargo and begin to downsize its US operations and shed most of the 1,200 branches and 10 million loss-leading US retail customers. Unlike WFC, which continues to report profits even after seven years in regulatory purgatory, we doubt that TD will ever generate consistent profits from the US bank unit. WFC, of note, has made a virtue of its own asset cap and dramatically downsized, exiting third-party correspondent mortgage. The chart below shows the efficiency ratio for TD Group US Holdings. Not only does the bank holding company have the highest operating costs of the group, but the variance in this metric is worrisome. Say what you want about the studied mediocrity of Bank of America (BAC) , but the results are consistent and reasonably stable. And of course JPM has the lowest cost of revenue in the industry in the low 50s. Source: FFIEC How much more capital will Canadian banks shovel into the furnace before institutional shareholders scream? TD recently sold part of its stake in Charles Schwab (SCHW) , a disastrous decision for TD shareholders who now face years of sanctions by US regulators without the benefit of the SCHW investment. The fact that TD actually sold some of its stake in SCHW to pay the US fines illustrates a certain lack of clarity on the part of CEO Bharat Masrani  and the TD Board of Directors when it comes to shareholder value. TD Bank US Holdings Source: FFIEC TD’s leaders have been talking for years about building a business in the US, but all that they seem to have done is create a vast about of reputation risk for the bank. The US unit now accounts for one quarter of TD revenue, but the operating results for the $540 billion asset TD Bank US Holdings are abysmal. We’ve said on X several times, TD ought to downsize or sell its entire US retail banking operation and throw the proceeds back into SCHW. Why?  First, doubling down on SCHW as an investment is going to be a better risk than buying also ran US retail banks. The list of dreadful crap that has been acquired by TD over the past 20 years is appalling. If we calculate the return on invested capital for TD equity only, the results are in low single-digits. If we also include the cost of the corporate debt, then the numbers get really small. TD could get better risk-adjusted returns on T-bills. How could the managers of TD ignore the published historical data for US banks showing negative risk-adjusted returns  in many years for half of the industry? Buy T-bills or Ginnie Mae pass throughs if you must, but why buy US retail banks at a premium to book value? TD Group US Holdings has $16 billion in goodwill and other intangibles out of $56 billion in total capital. Second, a significant stake in SCHW gives TD a possible option to buy the whole business, particularly if they stop wasting money on US retail banking. The retail banks that are worth buying are too expensive, but that does not mean we ought to buy crap. At present, SCHW is worth more than the larger TD Bank and has far more AUM. TD has less than $400 billion in AUM vs over $7 trillion in advisor assets for Charles Schwab. But SCHW’s total balance sheet assets are just shy of $500 billion vs $1.4 trillion for TD.   Source: Google Finance (10/16/24) TD is in for a long grind to get through the US regulatory sanctions. In the meantime, we think the Board of TD Bank needs to do some serious soul searching about the nature of shareholder value, especially adjusted for risk, based upon a US retail banking franchise. Given the huge focus on a retail consumer risk model, if TD were not being tormented for KYC/AML violations, it would be something else. Consumer risk in retail banking and mortgage lending is toxic. Investment management is lower risk and better returns. And SCHW is not the only large bank with a focus on investment advisory business in the US. 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.

October 10, 2024  | We are in Washington, DC, this week for mortgage industry meetings, but watching events in Florida has dominated many discussions. For the housing sector in Florida, Hurricane Milton simply adds to a situation where insurance rates are either soaring or coverage is unavailable at any price. Washington is engaged on the issue of flood insurance, but the larger need is to focus on providing basic property casualty coverage for homeowners.  "This is a monster mess in Florida," says David Kotok , Chief Investment officer of Cumberland Advisors in Sarasota. "I am getting constant calls from clients about losses in Florida. This is a multi, multi billion dollar loss event. I have never seen a loss event this big in Florida. The risk and potential losses to banks and other financial institutions is massive."   Jonathan Miller  of Miller Samuel made three key points about this latest storm event in a comment yesterday: 2024 Is Shaping Up To Be The Most Expensive Year For US Disaster Clean-Up The Frequency and Intensity Of Natural Disasters Is Ramping Up The Cost and Availability Of Insurance Will Have A Profound Impact on Housing Jon's last bullet is already a big problem for residential real estate in Florida and other flood-prone states. Many homes in Florida no longer have adequate home owners insurance much less federal flood insurance. Many homes in Florida not in "flood prone areas" had no floor insurance. The State of Florida, through the Citizens Property Insurance Corp ., is the largest insurance company in Florida. Styled as an "insurer of last resort," Citizens has an 18.5% market share and appears insolvent due to hundreds of thousands of policies in the area of the state most exposed to the latest storm. “The state-backed entity is now so large that it stands in the way of a healthy and effective insurance marketplace,” notes Jonathan Levin  of Bloomberg . “It issues policies at below the actuarially appropriate rates, thus curbing private insurers’ ability to properly price risk. It also introduces moral hazard by allowing homeowners to assume too much risk, potentially putting more people in harm’s way than there otherwise would be.” As the state-owned insurer Citizens has been taking up market share at below-market rates, private carriers are fleeing the state.  The Citizens situation is a major problem for Florida Governor Ron DeSantis , who like lawmakers in Washington pondering increased fiscal support for flood insurance is unwilling to cut-off homeowners in Florida from home insurance. Meanwhile, desperate subprime and even prime insurance carriers, seeing a wall of claims and litigation in Florida, have been denying claims, even where policies should cover storm-related damage.   “Homeowners insurance is labeled as one of the hidden costs for property owners, and their escalating prices could have an impact on the secondary and capital markets, in terms of loan salability and performance,” reports Brad Finkelstein of National Mortgage News . But what happens to the value of the home on Florida if the homeowner cannot get insurance at a reasonable price? We believe that Florida Governor DeSantis will be looking for a bailout from Washington to prevent the collapse of the state home insurance carrier. Loans in conventional and government insured mortgage securities must have home owners insurance. Back in May, Fannie Mae and Freddie Mac jointly created a blog post on explaining their home insurance requirements , which call for a replacement cost value policy, rather than the alternative, for actual cash value. The requirement for replacement cost protection covers the value of the securities that finance the mortgage, securities guaranteed by the GSEs. What is fascinating about “replacement cost” is that inflation in the cost of labor and materials over the past decade has greatly increased the replacement value of homes and commercial properties. In order for lenders to meet the replacement cost value criteria of Fannie Mae and Freddie Mac, or private investors, means getting insurance coverage that may no longer exist in the Florida market. As appraised values of homes have risen due to inflation, the willingness of insurers to cover replacement value has waned because of the elevated risk of storm damage.  Commercial insurance costs for Florida condominiums, for example, have been rising faster than inflation for a decade. Many attribute the rising scale of hurricane damage to global warming. But the more immediate and obvious explanation is the vast increase in population in coastal areas of the Southeastern US. When a hurricane hits Tampa or the Carolinas or coastal New York, the number of people and households effected is far greater than a century ago. The density of coastal communities and the rising cost of homes and replacing damaged structures is a huge issue for the housing industry.  And federal flood insurance, which is eagerly supported by home builders, encourages further home building in flood prone areas.    Meanwhile, even as the impact of climate change and the increased loss severity from storms on residential housing holds the public’s attention, the impact of changing use patterns and also weather events is causing perverse and dangerous changes in insurance coverage for commercial properties. Falling property values, for example, are causing insurers to reduce coverage on buildings based upon current market value vs replacement value. And the loans that finance these buildings are often found in commercial mortgage backed securities (CMBS).  “There is a non-climate reason for insurers to reduce commercial property coverage, especially for major-city office buildings,” opines Nom de Plumber . “As office properties continue to drop in value for non-climate reasons (amid higher interest rates and operating costs, plus post-Covid tenant vacancies and lower rents), insurers are considering material reductions in coverage amounts, potentially leaving the outstanding property loans insufficiently covered for casualty loss. That itself is an initial risk.”  Falling valuations for commercial properties based upon local conditions are only the start of a frightening feedback loop of deflation, NDP worries: “We could see as a compound risk, office properties may hence become extra-exposed to climate physical losses, adversely impacting the interest-only, premium-coupon, or subordinate CMBS bond tranches which contain them, especially in Single-Borrower/Single-Asset CMBS. Insurance coverage reduction has feedback loop to valuations,” he adds. “Hard to reverse the loop direction.”   Bottom line for investors and policy makers is that severe weather events and other factors such as declining utilization of commercial properties are creating big risks for public and private investors. The federal flood insurance scheme is already insolvent and must be bailed-out by Congress.  But the bigger issue is that risks to residential and commercial property owners in states like Florida may not be commercially viable as insurance. “Floridian homeowners with property insurance claims were over than nine times more likely to sue their insurance companies than elsewhere in the country,” wrote  John Dizard in Substack last year.  “Were Florida insurance companies nine times more tight-fisted and evil than other insurance companies in the U.S.?” He continues in a prescient article: “A fair number of homeowners will have extreme difficulty finding affordable property insurance. No home-owners insurance means no access to mortgage financing supported by the US government’s housing agencies. This is a real wake-up from the Florida Dream. Reasonable people might say this set of problems was not created by Governor DeSantis, but he happens to be Governor right now, this year and next year, when the reckoning is coming due.” 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.

July 29, 2024 | Premium Service  | Last week, Mr. Cooper Group (COOP)  acquired the mortgage servicing business of Flagstar Bank, N.A., the sole bank subsidiary of New York Community Bancorp (NYCB) . The transaction disposes of Flagstar’s residential mortgage servicing business, including mortgage servicing rights and the third-party origination platform, for approximately $1.4 billion. The transaction is expected to close during the fourth quarter of 2024.  As readers of The Institutional Risk Analyst  appreciate, this sale essentially unwinds the acquisition of Flagstar Bancorp by NYCB and represents a substantial destruction of shareholder value for common stockholders. The $1.4 billion in consideration paid to NYCB by COOP represents only a slight premium to the fair value of the mortgage servicing rights (MSRs) and the roughly $4 billion in related escrow deposits. These deposits will eventually leave the bank, which seems to be in a managed windup. But the transaction is a huge windfall for COOP. COOP Chairman and CEO Jay Bray  commented, “We have the operational capacity to onboard Flagstar’s customers with a smooth and positive experience, which will be our top priority. We also look forward to welcoming Flagstar team members to the Mr. Cooper family. We have long respected Flagstar as a mortgage servicer, and we feel very closely aligned with their cultural values.” COOP funded the acquisition with available cash and credit lines, providing the leading mortgage servicer with an accretive means of deploying capital and growing earnings. Of note, Mr. Cooper will subservice loans/HELOCs remaining on Flagstar's balance sheet since the bank no longer has the capacity to perform these functions. The addition of the Flagstar MSRs and servicing book is enormously accretive to COOP and will provide future income for the group as shown in the chart below.  COOP was already headed for another strong quarter in Q2 2024, but the NYCB acquisition positions the firm nicely for the rest of the year and an eventual rate cut by the FOMC. Indeed, a number of analysts and institutional investors had been reducing exposure to COOP after a long and very positive run for the stock. Mr. Cooper | Q2 2024 The same investors and analysts who have been reducing exposure to COOP equity may now need to reconsider that calculus. COOP continues to grow operating income faster than expenses, a trend that could accelerate as the leading non-bank lender absorbs the assets and people from Flagstar. Note in the chart below the striking disparity in equity returns between the two companies. For NYCB, this transaction is the latest chapter in an unfolding disaster. The new management team of NYCB characterizes the Flagstar servicing platform as a “non-core” business, but in fact the income and liquidity generated by the mortgage servicing activities was supporting the bank. Once these assets are gone by the end of 2024, we expect that the rest of the bank will be sold or recapitalized in short order.  NYCB lost $300 million in Q2 2024 and executed a 1:3 reverse stock split in a pointless effort to window dress the ongoing value destruction under the new management team. Net interest income was down 40% YOY and 11% sequentially, reflecting asset sales and loan charge-offs. The fact that the portfolio of 1-4 family residential loans is growing is nice to hear, but this is less than 10% of the loan book vs 60% for commercial credits. We suspect that NYCB will be forced to sell those performing residential loans for cash as losses on the multifamily portfolio grow. By shrinking the bank's revenues, NYCB is making itself less valuable and less stable, but the new team seems to be powerless to change the situation. The consideration paid by COOP to NYCB is a pittance compared with the future value of Flagstar’s mortgage operations, including MSRs and subservicing contracts totaling approximately $356 billion in unpaid principal balance (UPB) and over 1 million customers. Unlike many subservicers, Flagstar controlled the escrow deposits for most of the sub-servicing assets. Flagstar was one of the last bank issuers in the government loan market. Because NYCB does not currently have an investment grade rating, the Flagstar escrow deposits will likely move to another depository when the transaction closes. NYCB states that only $3.7 billion out of $9 billion in mortgage related deposits will be lost when the transaction closes, but as and when the 1-4s are eventually sold to raise cash, the rest of the mortgage-related deposits will likely disappear.  NYCB | Q2 2024 Notice that the NYCB team characterizes the escrow deposits from residential mortgages as "high-cost and volatile," neither of which statement is true. NYCB states that the residential mortgage servicing business was “non-core,” evidence of the fantasyland atmosphere which prevails under the new team. Consider the statement of Chairman, President, and Chief Executive Officer Joseph M. Otting :  "The Flagstar mortgage servicing platform is well-respected throughout the industry, which we believe is reflected in the premium we received. While the mortgage servicing business has made significant contributions to the Bank, we also recognize the inherent financial and operational risk in a volatile interest rate environment, along with increased regulatory oversight for such businesses.” "We are focused on transforming the Bank into a leading, relationship-focused regional bank,” says the former Comptroller of the Currency Otting, reflecting the evident confusion among the bank’s new management team. “Consistent with that strategy, we will continue to provide residential mortgage products to the Bank's retail and private wealth customers.” Joe Otting does not seem to understand the value of the Flagstar mortgage servicing business. Contrary to Otting’s statements about growing the bank, NYCB seems to be winding down. The bank is closing offices and shedding assets in an effective liquidation of the business. The fact that the Flagstar sale increased the bank’s capital slightly (70 bp) is irrelevant given the scale of the bank’s remaining asset quality problems. Meanwhile, the bank’s cost of funds has risen sharply in the wake of the Q1 2024 restatement. Here is the key passage from the Q2 2024 earnings statement: “For the six months ended June 30, 2024, the net interest margin was 2.13%, down 81 basis points compared to the six months ended June 30, 2023. The year-over-year decrease was primarily the result of the impact of higher interest rates and competition on our cost of funds. The average cost of funds rose 142 basis points to 4.36% driven by a 180 basis point increase in the average cost of borrowings and a 128 basis point increase in the average cost of deposits, along with an increase in average interest-bearing liabilities.  This was partially offset by higher asset yields, which increased 40 basis points to 5.50% along with an increase in average interest-earning assets.” Fortunately the bank has been rebranded as “Flagstar,” but the legacy NYCB commercial and multifamily credit exposures are now the dominant asset. The table below from the NYCB Q2 2024 earnings presentation gives readers a sense for just how small is the consideration from the sale of the Flagstar assets to COOP relative to the bank’s asset quality problems.  NYCB | Q2 2024 The stated non-accrual loans for NYCB at the end of Q2 2024 were almost $2 billion, a figure that we suspect understates the actual delinquency in the portfolio. Given that pain in the office CRE channel is only starting to surge and defaults in the multifamily sector are already mushrooming, we view NYCB’s credit outlook as problematic. NYCB | Q2 2024 A reasonable starting haircut for the bank’s CRE and multifamily exposures would be in the neighborhood of 20-25% of par value. Obviously this would leave the bank insolvent.  Or to put it another way, you could use the $1.4 billion proceeds from the sale of the Flagstar mortgage business -- two quarters from now upon close -- to clean out the bank's delinquent loans. But we suspect you'd be putting more loan loss provisions aside immediately We view the sale of the Flagstar business as a huge and unexpected positive for Mr. Cooper, but troubling evidence that NYCB is headed for a sale or failure. The national mortgage lending, correspondent and servicing business of Flagstar was the future of NYCB, not the retail branches that Otting et al. have retained and are now slowly eliminating. We view the attempts to right the sinking ship as commendable but largely futile. Long-time readers of The Institutional Risk Analyst will recall the Fall of 2008, when Wells Fargo & Company (WFC) acquired Wachovia Corporation in a government-assisted sale to prevent the bank's collapse. An all-stock deal with WFC worth $15.1 billion was announced in October 2008, overriding a bid by Citigroup (C) to acquire Wachovia Bank from the FDIC. The Citi deal would have forced the Wachovia parent bank holding company into bankruptcy, following the parent of Washington Mutual and Lehman Brothers in its entirety earlier that year. A third financial firm filing bankruptcy in Q4 2008 might have cratered the US credit markets. Wachovia shareholders approved the merger proposal on December 23, 2008, and WFC announced the merger's close on January 1, 2009. Upon close, WFC charged off the total equity of Wachovia, creating an accounting reserve that allowed WFC to clean up the Wachovia mess over time. In our view, one way or another, NYCB will either be acquired by a larger bank that can replicate the scale of the Wachovia merger transaction, or the FDIC will take over the bank and sell the net assets at 50 cents on the dollar. Indeed, the prospective discount on the NYCB legacy CRE and multifamily books may be too large a burden for a private investor. NYCB is an example of why we have suggested in previous comments that the scale of problems in the office and multifamily sectors may be too large for the private sector to fix alone. Remember, the FDIC is still sitting on the rent-stabilized assets of Signature Bank, deeply impaired assets that NYCB refused to buy and is no longer servicing for the bank insurance fund. Stay tuned as the situation around NYCB evolves through the rest of 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.