November 10, 2022 | Watching the collapse of the FTX crypto fraud pyramid, we are reminded that most financial stocks trade on tangible book value (TBV). When there is nothing tangible, well, then there is probably little value. Occasionally value hides in plain sight, waiting for the accountants to fashion a new rule and recognize same for GAAP purposes. The gain-on-sale income from mortgage servicing assets, for example, is a case in point. But in the instance of crypto fraud (or what our pal Nouriel Roubini wonderfully dubbed “shitcoins”), the value was only in the eye of the credulous in finance and the media. News reports suggest that FTX Chief Executive Sam Bankman-Fried misappropriated billions in investor funds, which he lent to his Alameda Research firm to the tune of about $10 billion. We have a couple of questions. First, when are state and federal prosecutors going to start prosecuting the crypto shills in finance, politics and media for fraud? Second, when will CNBC, Bloomberg and other financial media stop talking about and advertising for crypto schemes? At what point do the general counsels at media firms say enough and end the public promotion of crypto fraud? Consider two examples: Silvergate Capital (SI) and Signature Bank (SBNY). We warned our readers that these two crypto banks would soon come to a bad end. Back in February of this year, we profiled the former mortgage bank from Costa Mesa, CA (“Profile: Silvergate Capital Corp (SI)”). The fate of the remarkable but tiny SI is a matter of indifference to us compared with SBNY, a $118 billion asset regional bank with a proud legacy that stretches back decades to paramount private banker Edmond Safra and Republic National Bank. We wrote in July: “While many readers of The Institutional Risk Analyst have been watching crypto fiascos like Silvergate Financial (SI) and Signature Bank (SBNY), the prospect of financial problems for the 23rd largest bank holding company (BHC) and a large ABS issuer is cause for concern. But have any of the US bank regulators noticed?” A year ago this week, we warned our readers that the Fed’s “pivot” away from encouraging inflation would result in lower valuations for crypto tokens and stocks, especially the aspirational stocks that followed the crypto upsurge. Crypto has gone from a sort-of juiced up equity strategy to a distressed credit story in just hours. But now that the collective idiocy of crypto and, yes, blockchain too are hopefully falling by the wayside, let’s take a look at how financials are navigating the world of rising interest rates. Roaring Financials Over the past month, our bank surveillance group has rallied on hopes of moderating inflation, with Raymond James Financial (RJF) leading the group higher. The basic explanation for this rebound is twofold. First, the higher-beta stocks in technology and new media are getting hammered, forcing managers to seek shelter in less volatile names in order to preserve and protect that all-important assets under management (AUM). Second, the banks are seeing expansion of new interest margins even as the FOMC pushes ahead on interest rate hikes. We expect to continue to see improvement on the lending/NIM side of the equation, but the market side of the universal banks will continue to suffer weakness in absolute terms and in YOY comparisons. Loan growth will likely slow in 2023 as the economy slows, but notice that the Fed is now being criticized by both Democrats and Republicans. The table below shows our bank surveillance group as of the market close yesterday sorted by price-to-book value. The numbers are hardly distressed and are, in fact, quite normal. JPMorgan (JPM) at 1.5x reported book value is hardly cheap. Bank Surveillance Group Sources: Bloomberg, Yahoo Finance But with the huge swings in interest rates and asset valuations, the real question is what is true book value, net of mark-to-market adjustments c/o the FOMC and underwater loans and securities. Piper-Sandler writes: "GAAP Equity has been negatively impacted as rates have risen. Unrealized losses in AFS securities are included in AOCI (and therefore GAAP Equity), and as bond losses remain unusually large, the hit to equity is likewise bigger than anticipated for most financial institutions." While the fundamental view of financials may be neutral to slightly negative in the next year or so, don’t expect Buy Side managers to be shy about buying banks regardless of the outlook for earnings. So long as credit costs remain muted, the appetite for bank stocks should only grow as investors become convinced of an approaching pause in rate hikes by the FOMC. If credit expenses continue to rise, however, then the bull thesis around bank stocks may start to weaken appreciably. Not only are the equity market valuations of banks and nonbanks overstated coming out of QE, but credit costs remain far below average levels, suggesting that a mean reversion will occur recession or no, simply because of the reset in the floor for interest rates. We temper our generally positive view of lenders with the knowledge that there is no free lunch and that state TBV may fall just as it rose in 2020-2021. Next week we will be reporting on the discussion at the the 8th annual IMN MSR East conference in Lower Manhattan. What does or does not happen to the value of mortgage servicing rights (MSRs) in the next year will be top of the agenda. We have more questions than answers, sorry to say. Click this link to read our latest column in National Mortgage News. The Institutional Risk Analyst 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.

In this special edition of The Institutional Risk Analyst, we feature another fascinating conversation with John Dizard, a veteran financial journalist and columnist known for his in-depth analysis of global macro investing, commodities, and currency markets. He is best known for his 21-year tenure at the Financial Times. When we want to know what is happening in the world of energy, John is our first call. We first published his views on the approaching economic collapse due to the US-Israeli war against Iran in April and then again in July (see below). But nobody in Washington or on Wall Street wanted to hear it. John Dizard: Watch for Rationing of Oil, Gas & By-Products John Dizard: Energy Shortages Loom Despite Peace Deal With a midterm election less than two months away, the Trump White House is not remotely interested in talking about an impending surge in prices for energy, consumer products and particularly food, but that is precisely what John is now predicting. The Trump Administration is focused instead on important things like banning media from the White House or remodeling the Kennedy Center. John’s views are disturbing but also suggest some investment themes which we will address in our next quarterly discussion for subscribers to our Premium Service. The IRA: John, thanks for making the time. We spoke earlier with our contributor Mickey Maini, author of the Entropy Trap, and he predicted that if oil prices stay above $75 per barrel the Republicans lose the Senate in November. Current price for WTI is just below $100, for what it's worth. But there is barely any reporting in the US media about energy. Dizard: The triviality of what's being debated in the mainstream American media compared with the seriousness of what's going on in the rest of the world is astounding. I've never seen any greater divergence. So, you know, what can you say? The IRA: We can say that your prognostications on energy and the impact of the Iran war have been spot on since our first discussion in April. Our readers certainly appreciate your insights. Dizard: Thank you, Chris. Our little talk back in April about Group III base oils turned out rather interestingly. They're on allocation now by the major suppliers. There will probably be panic buying by some people, which will make the allocation a little worse. I don't think people ever quite realized what was going on with improving mileage for cars. Consumers thought that better mileage was for free. No, it was being bought at the cost of dependency on a type of oil that we weren't actually making in the U.S. The IRA: Before the conflict with Iran, more than 45% of U.S. imports of Group III base oil came from the Middle East, with the Persian Gulf supplying roughly 47% of total U.S. Group III demand/imports and 72% of European imports. The Independent Lubricant Manufacturers Association places the Persian Gulf's share close to 40% of total global Group III production capacity worldwide. This capacity is now gone. We are well and truly screwed. Dizard: The situation would be manageable if Washington were engaged, but they are not. Chevron (CVX) and Exxon (XOM), which are run by some moderately well-informed people, decided a couple of years ago they were going to make a little more Group III base oil in the states. That production will come on line in 2027, which will be a little late, and it won't be quite enough. The IRA: So when it is time to service your car or truck, there may not be any synthetic oil available? Dizard: Yes. And in the meantime, oil we might import from formerly friendly countries such as Canada may go to Europe. European refineries have just this past week been informed that they will not be getting 550,000 barrels a day from Saudi. The IRA: Yes, we saw that. They were canceling contracts all over the place. Dizard: The Saudis cannot ship the oil, you know, if it isn’t there. Oil is, as we've discussed, not a generic product you can simply buy to make up for your contract volumes by buying it elsewhere. The Europeans, I think, have a serious problem this winter on lubricants. They are also down to only 64% of their gas storage requirement which should have been filled by now. So the Europeans are short of gas and they're now short of oil, and they're also now concerned about this hybrid warfare with Russia. The IRA: Everyone assumes that Putin will make peace in Ukraine, but are the Europeans prepared for more of a war? The Europeans supply weapons to Ukraine and Russia is slowly destroying the country. Nobody's ever prepared for war. But the Europeans are going to have a big political problem this fall and winter if energy supplies run out. The pro-war parties in Germany lost big last week in Berlin and Mecklenburg-Western Pomerania. Dizard: Correct. We're going to be bidding against the Europeans for our synthetic oil which isn't all synthetic, but which is definitely high viscosity. We're going to be bidding against them because they're not going to be getting lubricants from the Middle East and their oil refineries are not going to be supplied with crude by Saudi. This is going to be educational. The Saudi news was, I think, the most dramatic news of the past week because the breakthrough of Ansar Allah, or the Houthis, as they're called, on the Red Sea. It puts them in the position to not only knock out any Saudi shipping, but if Mohammed bin Salman (MBS) or the Saudis more generally choose to counterattack, then the Houthis can destroy their refineries. And they've demonstrated their ability to do just that. Not only pipelines, but also refineries, which will take a lot longer to fix. And the Saudis do not know exactly what to do next. The IRA: So not only has the Trump Administration started a war in Iran that we cannot win, but we’ve also destabilized the Saudis, who have never been particularly adept at defending themselves. Dizard: The Egyptians were less than completely enthusiastic when the Saudis broke the idea of having Egyptian and/or Israeli joint military action against the Houthis because it means the Houthis would then go after all traffic in the Red Sea, not just the Saudis. They're currently allowing American and all other ships except Saudi vessels to go through. The IRA: Focusing on the Saudis is smart. If Ansar Allah close the Red Sea entirely, then they would force a coalition of nations to come after them. Dizard: Yes. Assuming that coalition is competent enough. The Egyptians do have some ability to do raids and even occupy an island. They might be able to do that. But that's also a war. The Houthis are very clever and determined fighters who are motivated by ideology rather than a paycheck, unlike the mercenaries that have been employed by the Saudis. The IRA: Ansar Allah translates from Arabic as "Partisans of God" or "Supporters of God" (anṣāru llāh), where Ansar (أنصار) means "helpers" or "supporters". What do the Houthis want from the Saudis? Do they want the Saudis to make peace with the Iranians? Dizard: Well, it gets more complicated than that because it goes to tribal politics. Of course, the Ansar Allah have kinship relations with some Saudi tribes on the border And tribal politics in Saudi Arabia has been repressed for a long time. We'll see if that remains the case. The IRA: Do the Houthis want to overthrow the Saudis? We're seemingly winding the clock back 100 years, John. Dizard: Well, you know, that's certainly what the Houthis would like to do. And incidentally, while they look ragged when you see pictures of them, the Ansar Allah are actually very sophisticated people with a very old culture. They consider themselves the fount of culture and enlightenment on the Arabian Peninsula, not the Saudis. The IRA: They've probably been there and been organized in terms of towns and cities for quite a long time. The Horn is very different than the rest of Arabia. Dizard: That's for sure. The Ansar Allah have been there for a few thousand years longer, and they've been a civilized country for a few thousand years longer. They dispute parts of the border with Saudi Arabia. And the original peace there was negotiated for the Al Saud in 1934 by St. John Philby, Kim Philby's dad. The IRA: It’s a small world, John. Of course, Kim Philby was a high-ranking officer in British intelligence who secretly worked as a double agent for the Soviet Union. Dizard: Philby is another one of these strange characters that comes up. This is not something that can be fixed with some carrier strike by Secretary of War Pete Hegseth, who I think has had enough of actually trying to bomb the Houthis into submission. The IRA: Houthi light infantry armed with sophisticated anti-aircraft weapons are not great targets for complex aircraft. Dizard: No. And, you know, the Houthis turn out to be rather resilient people and smarter than they look. The Afghans looked primitive and ragged, too. So that was the interesting news of the week, and it's not fully absorbed here. The Houthi presence on the Red Sea does mean that yet more refining capacity has been knocked out. So product exports from the Saudi refinery at Jazan on the Red Sea, for example, are suspended. That's the real choke point in the world, is not just crude supply, but it's really product supply. And that's one more refinery that's crossed off the list. Did they actually destroy it? No, they didn't destroy it. They damaged it, but they have said no Saudi ships. The IRA: So Iran has flanked the Saudis and the western countries are not in the mood for an invasion of Yemen. What’s the endgame here, John? What do you think happens? Do the tribes rise up and get rid of MBS? The Iranians revile the Saudis for their corruption. Dizard: Well, the politics within the royal family are complex and MBS had been in a strong position especially with the urbanized, international people who have run the country, so there isn't really any visible opposition. The only problem is what's underneath that calm. The Saudi armed forces have not covered themselves with glory in recent years or even in the decades before. Saudi Arabia is not a country that can contest Iran militarily. The IRA: No, they can't. If the Houthis had the logistics, they could probably topple the Saudis tomorrow. What is the endgame for the United States? Dizard: As long as we're concentrating on keeping up the illusion that we've won, we're not going to fix what was broken. It's not a war you can win in the air or from the sea. No, no, it's complicated. The Iranians are hurting, yes, but they can hurt for a lot longer than we can hurt. And they showed that with the war with Iraq. These are people who, whatever their, you know, many... faults or vices and corruption and general unpleasantness, are battle-hardened fighters. They will hang on for a long time. The U.S. will have a hard time maintaining its blockade beyond six months for the obvious logistical and mechanical reasons. It'll be difficult. That will hurt the Iranians a lot, but it's not going to knock them out. The IRA: How does this situation impact capital investment in the industry. In other words, if I'm one of the majors or even a country and I'm worried about future production, where do I start building new refinery capacity? Dizard: Well, a good place to start would be to repair existing capacity and to bring it back into service. Finding skilled workers to build new capacity and the materials to do that is problematic. The California refineries that were taken offline, for example, have got to be reopened or nationalized or however that's done, because we're going to be short of capacity in the western US. There's a somewhat defective refinery in the Virgin Islands, which maybe could be brought online, but how quickly is the question. The IRA: So we need an end to hostilities? Dizard: Yes. And for the Russian refineries, which have been knocked out, repeated attacks have an increasing effect on how long it takes to restore refinery capacity. You can fix something, and then if it gets hit again, yet more damage will be done, which will be harder to repair. The Ukrainians have also gotten more sophisticated about which units and refineries they attack, so the fluid catalytic converters are the first thing they hit. Those take a while to fix and the Russians have responded to degradation by lowering the grades of gasoline and diesel they produce for sale. Russia is now on Euro 2, which is a grade of fuel you would buy 20 or 25 years ago. That type of fuel will do really bad things to modern engines. The Russians are facing significant problems. The IRA: So bottom line, the world has a deficit in refinery capacity for years to come? Dizard: I think that rather than building new refinery capacity, fixing old ones is a good place to start. There are several refineries that need to be repaired in the Gulf. At Bapco, the Bahraini refinery, heavy damage was done, so that needs to be repaired. Also, the Kuwaiti refineries, the ADNOC, the Abu Dhabi refinery, of course, even the Iranian refineries. The Iranians are not going to be happy if everyone else gets to fix their refineries, so the Iranians will get to fix theirs. The only way to even begin to get started is to have a truce. Not a peace for the ages, but some kind of working truce with the Iranians means dealing with them in a very different way we've been dealing with them. The IRA: Where does Washington start? Dizard: First, Iran has not been defeated. We have to admit that. We have to admit, oh, actually, they've done very well. And it has to be admitted by people in authority. So those people in authority can then negotiate with their Gulf counterparts, including the Saudis. That’s how this thing gets fixed. Now, doing this before the October 27 Israeli election is going to be difficult to impossible, and also before the U.S. midterms, which means that before the U.S. midterms, things are going to get really quite bad. The IRA: How bad does the shortage of refined product get? Dizard: With Diesel, we're close to seven bucks now. Does it get beyond that? Yeah. Is there a temptation for Washington to impose export controls for diesel? Yeah, but there are problems with that because you wind up also not being able to produce enough gasoline, because of the way refineries work. The IRA: Ah, if we cut diesel production we also cut production of gasoline? Life is not simple is it? President Trump has indicated that he supports export restrictions on diesel, but this sounds like a really bad idea. To restrict diesel exports, we must produce less gasoline. The US price of diesel is the cheapest in the world, but nobody in DC seems to understand that basic fact. The US has plenty of diesel except in the west where the progressives closed all of the refineries. But the rest of the world is short diesel and bidding up the price. Dizard: There's some simplistic ideas from, you know, politicians about how we just have to end diesel exports. Yeah, there are operational problems with doing that because we cannot store the diesel. Because you'd produce less diesel and less gas, prices will rise. Our pipeline network is not configured to support an export ban. Also, U.S. crude is not well adapted to diesel production. You need medium crude, at least, such as is produced in Canada, or heavy crude. Being able to produce a lot more Canadian oil would be good. The IRA: But we we’re in a trade war with Canada. Yeah, that was pretty bad timing by President trump wasn't it? Dizard: What's even better than medium crude is medium sour, crude that has a lot of sulfur in it, meaning that you extract that sulfur, but then you use that sulfur to produce fertilizer, which I'll get to in a second. The crisis in lube oil is here now. That shortage is here now. My advice to people, it's practical advice they might need, is if you have a modern car and you need a 0W-20 oil, don't put in a lower grade. You will wind up with problems with your engine. You can, with modern lube, drive further. So you can drive 10,000 miles or 12,000 rather than 4,000, but don't put in an inferior grade of oil. And it's going to be a problem. To the degree people can't get high viscosity oil, they'll have problems with their bearings, pumps, generally their engines. Just don't do it. The IRA: Oh yeah. You'll destroy the engine. Dizard: Right. And don't do it. So anyway, back to the sulfur thing right now, what's happened is the price of sulfur is kind of normalizing in a way around a thousand dollars a ton, which is up eight times from a year and a half ago. The problem is it can't go up further because the fertilizer companies who buy it to make sulfuric acid can’t go higher. About half of all sulfur produced in the world goes to sulfuric acid then most of that goes to producing phosphoric acid, which is then used to make phosphate fertilizers. So the problem is that with the price of sulfur having gone up as much as it has, farmers can't afford more fertilizer. The IRA: So they just won’t buy or apply fertilizer. That’s bad. Dizard: They can't afford those prices. So rather than raise prices, the fertilizer companies are simply cutting production, partly because farmers can't afford it and partly because there's not the physical availability of the sulfur to make it. This is going to result in food shortages. We had a good harvest for grains this year. There were favorable crops most of the world, including, by the way, Iran, which is why they're not going to starve to death. But that carryover will be limited. And crop yields are already declining in the US. And next year, they'll decline not only in the US, but around the world because farmers will not be applying as much from winter planting, spring planting on. There will be a food crisis starting next year. The IRA: We certainly don’t hear the White House preparing for a food crisis. Dizard: Food prices will have to go up a lot further for farmers to make a profit. Every dollar they have to pay for diesel is a dollar they can't pay for fertilizer. And the farmers, even at higher grain prices than they have now, can't cover their costs. They're losing money. You know, there is no transfer payment that's going to change that. So they're are hurting badly. Bankruptcies are up. Farm income is down. So there's going to have to be a major, major increase in food prices next year. We'll see how much of the Russian and Ukrainian crops actually manage to get to market because they can't ship out to the Black Sea because both sides, neither side will agree on it. The IRA: The Ukraine war was the start of food inflation. How bad does this get? Dizard: The Russians and Ukraine can't agree on a truce. The Ukrainians have to ship out by rail. They can't ship up the Danube River. The Russians have to ship out through Baltic ports, which don't have grain handling facilities. The food crisis is going to be the crisis of next year. I mean, it's bad when you can't drive as much as you feel like. It's much worse if you don't have the food. And it's already baked into the cake. There a were about 75 million tons of phosphate fertilizer used in the world last year. Next year, 30 million tons of that will not be there. Think about that and there's a multiplier on food production when you don't get a phosphate application or for that matter enough nitrogen fertilizer. The IRA: So it sounds like the world is going to force the US to make peace with Iran? Dizard: Something has to be done because the U.S. is not going to step up its prosecution of the war. It has to make some kind of truce agreement that will go beyond the memorandum of understanding. And the terms on which that truce is made are not going to be favorable. No, of course not. I mean, they're going to wind up effectively recognizing Iran has some kind of a gating function or some sort of partial control over the Strait of Hormuz because that's what they already have. The IRA: Well, Turkey has control over the Dardanelles. Dizard: Yeah, that was established by the Treaty of Sèvres and then another treaty in 1938. And, you know, Turkey is paid a transit fee for ships based upon the weight of the vessel calculated in gold francs. Transit of the Dardanelles under Turkish control came through the Montreux Convention of 1936. So, you know, this has happened before. It's unfortunate that we can't have free transit. It's very, very much a problem for the people in the Gulf. And the Iranians have to consider their long term interests there as well. The U.S. is simply going to have to reverse its public position that it's won the war or the Trump Administration just has to change its position. The IRA: You’ve said that these supply shortages and price increases are already baked into the cake. Can you expound on how bad this gets? Dizard: You're talking about food prices and prices for other consumer goods going up significantly in the next 12 months and thereafter. They've already published the CPI increases for Social Security, for example, for next year. But that won't include the price increases that are going to hit between now and the end of the year, which are significant. So, I think that you'll get to the price levels that destroy economic activity in the east that you have in the west. So $7-8 diesel, perhaps higher after the midterms. Maybe $7 or $8 regular gas. The IRA: Could we see diesel at $10 per gallon in the East? It’s almost double digits in the West. Dizard: At $10 diesel, you start to get projects canceled, you know, shipments canceled, you start to get real demand destruction. The IRA: But that's not going to make people terribly happy. Well, they wanted to slow down the economy and fight inflation. This is how they'll do it. With these sorts of increases, the Fed may be cutting interest rates next year. Dizard: This will be a painful shock to Americans and it is a shock to the Europeans. They also are short of gas. And the Poles are going to DEFCON 2, let's say. They're preparing for war. The British, who have far from a hawkish Labor government, are preparing to recall the army's reserves to the colors. They're mobilizing their reserves because they think something will happen immediately. They don't know exactly what will happen, but they think that this war is widening. And they're concerned about a hybrid war that is happening now. What happens after that? Well, they don't want to be unprepared when it does happen. The IRA: Imagine if the shock from energy shortage causes a wider war in Europe, a war nobody can even remotely afford. Dizard: And the British take it seriously enough that they're already mobilizing reserves of people who haven't been in active service for at least months and probably years. So you have to remobilize them. And Germany and France have already started to prepare hospitals for mass casualty events. The IRA: You hear nothing about this in the American media. Dizard: What's amazed me is how poor is the response from the high end of the U.S. government. The command levels just have responded to this very badly. Why do you think the Chinese satellite images of US bases in Jordan can be seen in the rest of the world, but not in the US? That's not for security reasons. That's for PR reasons. The Trump Administration does not want US media to report how badly the US bases were hit. And by no coincidence, JPMorgan (JPM) suspended issuing its estimate of oil prices for next year. The IRA: Right on time. Thanks John. The Institutional Risk Analyst (ISSN 2692-1812) is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

September 21, 2026 | This past Friday, Federal Reserve Vice Chair for Supervision Michelle "Mickey" Bowman announced the initial findings of an independent review conducted by the Starling Advisory Group regarding the 2023 collapse of Silicon Valley Bank (SVB). Vice Chairman Bowman said in her remarks: “SVB failed as the result of a confluence of vulnerabilities including real but unrealized accounting losses on its securities portfolio that exceeded its capital, a run-prone deposit base that was 94 percent uninsured and concentrated in venture capital–backed technology companies, and a lack of operational readiness to borrow from the discount window when it was needed.” We have written extensively about SVB (“Who Killed Silicon Valley Bank?; The IRA Bank Book Q1 2023”). The key attribute was that the bank was an outlier among banks in terms of its assets, specifically securities. We wrote in March of 2023: “Why did Silicon Valley Bank, the 18th largest bank in the US fail last week? Because the bank’s management naively invested half the bank’s assets in “risk free” securities. The bank had 43% of total assets in mortgage-backed securities vs an average of 12% for the 132 largest banks in the US. Extension risk killed Silicon Valley Bank.” Source: FFIEC (Q1 2023) What is “extension risk?” It’s when an investor buys an asset or security with variable maturity or duration such as a mortgage-backed security (MBS). When SVB started increasing its position in MBS, the maturity of mortgage securities was measured in months. By the time that the Fed started to raise interest rates in March of 2022, the average life of the MBS was now measured in years and SVB was already completely underwater on its securities book. By June the bank was visibly insolvent, prompting hedge funds to short the stock, but it took a few more months for customers, regulators and the markets to figure this out. The chart below shows the gross yield on securities for the top seven depositories. Notice which bank is at the bottom. While SVB failed in March of 2023, larger depositories just sat on low coupon portfolios, killing net earnings for years to come. With interest rates rising, the unrealized losses on these loser portfolios is now growing. Note which large bank is at the bottom of the group. Source: FFIEC Vice Chairman Bowman is going to be making a number of changes to how the Fed supervises banks, but the key change that she needs to make is getting supervisory personnel to look at their own data. The first thing that the Fed should do when conducting a stress test, for example, is to look for outliers in the group. Hedge funds do this as a matter of course. SVB was an outlier in 2023 and had the largest position of MBS of any large bank by an order of magnitude, but nobody at the Fed or FDIC noticed. SVB represents a substantial failure by the US bank supervision community. After all, if the Fed and FDIC are not going to look at the standardized regulatory data from the banks, then why bother going to work at all? Variable duration securities have been at the root of many of the financial crises in the US over the past three quarters of a century. As we noted in our comments on the Basel III proposal, the Fed and other regulators cannot assume that bank managers understand the extension risk inherent in assets or securities with variable duration. Clearly the management of SVB was completely clueless. When interest rates rise, the effective maturity of an MBS or loan extends and the valuation falls dramatically because it is now priced further out the Treasury yield curve. The value of an MSR, on the other hand, goes up. We wrote: “The bank regulatory agencies need to develop an entirely new approach to managing the risk from not only [mortgage servicing assets] MSAs, but the entire family of loans, securities and intangibles such as MSAs that have variable duration. Most of the major crisis in the financial markets over the last 50 years have involved risk exposures with variable duration. The failure of Kidder Peabody, Long-Term Capital Management and Silicon Valley Bank all involved episodes where management did not recognize the explosive duration risk embedded in portfolios.” Earnings Setup: Top Seven Depositories Below we provide some thoughts on Q3 2026 earnings for the top seven US depositories and some thoughts on trading the group for the balance of 2026. As we noted several weeks ago in The IRA Bank Book for Q3 2026, reported credit costs are down and the largest area of growth on bank balance sheets is in "all other loans," which is dominated by securities lending. Notice in the chart below that, unlike last year, the portion of all other loans that includes stock margin and securities lending is growing faster than loans to non-depository financial institutions (NDFIs). Source: FDIC/WGA LLC Many of the top banks provided updates to guidance at the recent conference sponsored by Barclays Bank (BCS). But the fact is that the entire banking sector is laboring under a cloud of uncertainty about inflation, interest rates and the Iran war that all come thanks to Donald Trump. More than two-thirds of the 101 bank stocks in the WGA Bank Top 50 test group are down. Of note, subscription rates for the Premium Service are going up on October 1, 2026. Bank of America (BAC) CEO Brian Moynihan made his usual excuses for the bank’s poor performance, but talked at length about how U.S. economy proved more durable than expected. When bankers don't want to talk about their financial performance, they talk about the economy and consumers. As you go through the charts of the top seven depositories below, BAC is often the worst performer in the group. We don't make up these numbers. Bank of America disclosed at the Barclays conference that its third-quarter trading revenue is somehow is expected to remain flat compared to the prior year — news that sparked a broad-based sell-off across major bank stocks last week. Most US banks will see Wall Street earnings declining in Q3 but Main Street banking revenue up on volume and higher rates. The chart below shows ROEA for the top seven depositories using data from the FFIEC. Source: FFIEC

September 16, 2026 | This past weekend The Institutional Risk Analyst updated our watch list for precious metals, The WGA Precious Metals Top 25. All of the constituents of the Precious Metals Top 25 are available to subscribers to the IRA Premium Service. Please note that our subscription rate for the Premium Service is increasing in October. Our latest conversation with Ivan Bayoukhi on Wall Street Bullion follows below. We received a number of comments on our discussion with David Kotok last week (“David Kotok: China, the Dollar and Bretton Woods 2.0”), but one of the most interesting observations came from Bahamas-based gold fund manager Henry Smyth, who we interviewed last May (“Interview: Henry Smyth on the Return of Gold as Global Reserve Asset”): “By looking at gold revaluation as a purely US exercise to reduce debt or support social security you ignore completely the unintended consequences of such a move. The same error occurs in positioning the gold dynamic as Bretton Woods 2.0. Bretton Woods 1.0 was victorious Washington shoving it's vision of a postwar order the throat of everyone in attendance. Full stop. In that order, gold was eliminated from the global monetary system, allowing the unfettered credit expansion the denouement of which we now see before us today. What we see now is an organic self organizing order in which gold returns as the gravitational center of global value. The new payments system is a result of this tectonic transformation, not its origin. In this emerging system there is no fiat and no jurisdictional nor organizational center. Just gold.” One of the ironies of the collapse of the dollar-centric Bretton Woods schema is that gold now offers the independence from central bank control that many sought in Bitcoin and other crypto tokens. Remember that the Bank of England was the world’s first central bank. It was created to extend government control over money and to finance a war. Central banks lack any positive features save as vehicles for redistributing wealth via currency debasement. Before Labor Day, Morgan Stanley (MS) said gold hit its fourth-quarter target sooner than anticipated and sees the metal climbing above $5,000 an ounce next year, though it cautioned the path is unlikely to be smooth. “Gold has reached our Q4 forecast of $4,450/oz faster than expected,” analyst Amy Gower wrote, adding that “we see a path to >$5,000/oz in 2027 but with scope for volatility too.” Meanwhile, we remain bullish on both silver and gold, in large part because available supplies of both metals are ebbing. Total demand for silver is projected at roughly 1,112.6 million ounces, while available supply sits near 1,066.4 million ounces, leaving a shortfall of about 46.3 million ounces. “The silver market is in the sixth consecutive year of structural deficit,” notes Renegade Resources. “Since 2021, the world has consumed 762 million ounces more silver than it has produced. That number is roughly one full year of global mine supply, drawn down from above ground stocks across London vaults, COMEX warehouses, ETP trusts, and industrial user inventories.” In a potentially important development for silver in the US, Bunker Hill Mining Corp. (BHLL), and Silver47 Exploration Corp. (AGA) announced a definitive arrangement pursuant to which Bunker Hill has agreed to acquire all of the issued and outstanding common shares of Silver47 by way of a plan of arrangement. The combined company will seek a name change to “Bunker Hill Silver Corp.” and remain listed on the Toronto Stock Exchange. As we discussed with our friend Ivan, we remain bullish on precious metals and feel like the inflation outlook is only going to worsen as the year heads to a close. Diesel fuel is almost $10 per gallon on the west coast of the US. President Donald Trump has blamed the Ukraine’s attacks on Russian energy assets for the shortage of diesel, but in fact the destruction caused by the Trump/Israeli war with Iran is the major cause of rising prices globally. Most of the global central banks are preparing to fight the inflation from the Iran war with higher interest rates, truly an exercise in futility. “The Fed seems on course to hike rates by a quarter point on Wednesday with a vote that could be 10-2 with possible dissents from Governors Bowman and Waller (but these dissents are far from certain),” notes John Ryding at Brean. But is the FOMC even relevant to inflation with the US Treasury running a $2 trillion fiscal deficit? “Interest rate futures have priced in an 88% probability of a rate hike after seeing the PPI and CPI data for August. It was not that the data were hot (contrary to claims in the media that the inflation data for August were hot) but there are no signs of progress towards 2% especially given the way Chair Warsh described the July inflation data,” Ryding continues. FinTech and AI Stocks Decelerate

In this issue of The Institutional Risk Analyst, we feature a contribution from Mickey M. Maini, the founder of Solstice Laboratory, an independent research lab in Dubai. Maini is the author of The Entropy Trap. His publication, The Solstice Letter, tracks the three gates, dated and kept on the record, free at solsticelaboratory.substack.com. The archive lives at solsticelabs.com. September 14, 2026 | On Friday August 28, 2026, a Federal Reserve chairman who promised nothing moved the two year Treasury more than any Jackson Hole speech has moved it this century. Eleven basis points, and September hike odds from one in three to better than even by the close. The consensus filed it under one word, hawkish, and moved on. Here is the better filing. America has a written plan for its debt. The plan needs three permissions it does not control: the Fed’s, the courts’, and time’s. Friday’s Jackson Hole speech was the first permission answering in public, and the answer split. That is the story. The rest of this piece shows you the document you are living inside, and where it stands. The plan Readers of this publication can recite the debt arithmetic in their sleep, forty trillion gross, roughly ten trillion of it rolling inside the next twelve months, an interest bill compounding at rates everyone in Washington calls temporary. So skip the diagnosis. The interesting document is the treatment plan, and it is public. In November 2024 a strategist named Stephen Miran published a paper on restructuring the global trading system. Four moves. Charge the world for access to the American market, with tariffs as the invoice. Price the security umbrella into the same negotiation. Meanwhile, make sure the debt has buyers. Then, when conditions allow, refinance into very long paper at gentler rates, the century bond mortgage. The author went on to chair the Council of Economic Advisers and then to a seat on the Federal Reserve Board. The current chairman occupies the seat the author vacated in May. Whatever one thinks of the paper, it has been close to the machinery, and since February the receipts have landed in its order. Where the plan stands Move one, the invoice, went out and is being litigated. That is permission two, still with the courts. If the tariff powers fall, the plan loses its down payment. Move two, the buyers, is the part running at full speed, and it is the part this readership prices every day without naming it. The debt is being rolled at the short end, where captive money lives, through 444 auctions last fiscal year. Money market funds hold $7.9 trillion, parked for exactly one reason: the front end pays. Run the arithmetic nobody runs out loud: $7.9 trillion at today’s front end rates is roughly three hundred billion dollars a year paid to short term creditors simply to stay. Call it the payroll of the parked. Stablecoins add the new deputy: 300 billion of tokens that must, by statute, be backed by Treasury bills or their close cousins, which is why Tether’s Treasury book is now larger than Germany’s and why the issuers collect about twelve billion a year of float for holding it. The Treasury Secretary told the Senate that two trillion of them by 2028 was reasonable, adding "I could see it greatly exceeding that," and has since said the issuers will be factored into how the government manages its debt. A captive buyer, built from phones, conscripted by statute. The same fortnight as Friday’s Jackson Hole speech, the Treasury doubled the maximum size of its long end buybacks. Dealers are getting capital relief to warehouse more paper. Analysts already pencil the Fed itself back into the bill market through reserve management purchases. Notice, then, what high short rates do in this architecture. They are not fighting the refinancing. They are its payroll. A chairman who sounds like Paul Volcker is not an obstacle to this plan. For now, he is its paymaster. Move three, the mortgage, waits on the permissions. Which brings us to Friday in Jackson Hole. Friday, the first permission Read the Jackson Hole speech as a permission slip and it becomes legible. The chairman reaffirmed two percent as fixed, said financial conditions are not currently restrictive, and left a September hike live. The market believed him at the short end. He also elevated artificial intelligence to the Fed’s central research question, called it potentially a new factor of production, and gave it a task force. The wager that growth pays the mortgage now has an office inside the building. And the word debt appeared exactly once in the prepared text, at the top, when he thanked his hosts for the weekend. Forty trillion outside the door. One mention, as a courtesy. That is the split: the premise got a task force, the vehicle got a warning, and the destination went unnamed. The third permission is time, and time is the one draining. Look at Friday’s close on August 28th, because it is the tell of the year. A hawkish speech moved the two year eleven basis points and the thirty year just two basis points. The long bond finished at 5.21 percent, near its highest in two decades, after the most inflation fighting speech in years. When the short end obeys and the long end shrugs, that is not policy talking. That is premium, charging by the day. And the plan carries a twist it did not price: the investment boom that is supposed to pay the mortgage is, for now, bidding against the Treasury in its own bond market, hundreds of billions of buildout raised from the same institutional pool that must absorb the wall. The exit ramp charges a toll on the road that leads to it. What the instruments read A word on where our own gauges sit, in banded terms, because the Laboratory publishes readings rather than opinions. The gauge we keep on policy transmission, we call it PEDI, for policy effectiveness decay, measures how much relief each central bank move buys and how long the relief lasts. It reads at the line: the highest in the life of the series, with 1977 and 78 the nearest rhyme in the record. We published that reading the Monday before the speech, with a map of three doors, and named a hike as the fastest path through the line. Friday August 28th priced that door before the week was out. The note is dated and public. A second reading has stood since early summer: the system is carrying live triggers while the price of insuring against them sits near the cheapest of the cycle. Friday widened that gap. Every letter carries its calls in a dated record box with a named falsifier, and the grades print in later issues, misses included. The credit reading For the credit reader the near tape matters more than the map. A hike is now close to a lock, priced near ninety percent after Friday’s inflation print, with a second priced by year end. It lands on an economy where the AI buildout is already collecting its first jobs: information industries shed 23,000 last month even as restaurants and local government carried the headline gain. The two year now sits about a full point above the funds rate, a gap last seen in 2022, and the curve has flattened as the front end does the moving. Tightening into a labor market held up by waiters and school payrolls has a short and unhappy history, and credit usually finds out first. Two clocks Strip it to the mechanism and the whole question is two clocks. The machine clock: how fast artificial intelligence turns into measured productivity and tax receipts. The money clock: the wall’s due dates, the auction calendar, the interest bill compounding. The plan works if the machine clock beats the money clock. On Friday the chairman tightened the money clock with one hand and made the machine clock his institution’s biggest open question with the other. Both clocks now tick inside the same building. I will state the falsifier plainly, because a view without one is a mood. If the Fed turns friendly, the courts bless the invoice, and the long end rallies through a quarter of well bid auctions, then the plan got its permissions, the crossing is on, and I will say so in print. Until the gates answer, watch them and not the noise: his September language, the long auctions, the ruling calendar, and the thirty year, the thermometer nobody can jawbone. Either way, both branches charge the same assets. If the plan works, the crossing is paid for slowly, by savers, and short bills at these rates are the fair wage for waiting. If it stumbles, the collateral underneath the system gets repriced upward, the old fashioned way. The discipline is the same on both branches: own real things before you need them, collect the front end wage while it is offered, and own nothing that needs the Fed to save it. 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.

"When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.” Citigroup CEO Chuck Prince (2007) January 21, 2019 | Earnings have turned out to be a snoozer rather than the recession step down some gloomy souls predicted. Even if the economy is slowing, does it matter for earnings, which keep rising ever higher as net revenues stagnate? Our big takeaway from last week was the remarkable consistency in the big banks missing estimates for trading revenue, even as the Street saw higher volumes across many desks. And no surprise that securities underwriting revenue evaporated with the closure of the high-yield market in Q4 and a tedious equity pipeline. Markets seem to be moving sideways, albeit with lots of hyperventilation from the analyst community. But that does not mean there is no news. First, kudos to George Gleason at Bank OZK for turning in strong Q4 numbers. OZK remains under suspicion, though, due to its role as a benchmark for commercial real estate lending. Likewise regards to the bankers at Goldman Sachs (GS), who supplanted the traders for the first time in a decade in the only measure that matters, namely gross revenue. Of note, OZK outperformed GS last week, with the common of these two very different banks up 21% and 14% respectively -- this after OZK spiked 12% in a matter of hours after earnings were released. And, Lord be praised, both names are now trading just above book value. A year ago, OZK traded at 1.8x book value. Them were the days. Meanwhile in the automotive sector, Elon Musk and his Tesla Motors (TSLA) science project are grappling with the reality of being the most flashy, high cost member of a commodity industry. The latest TSLA announcement of layoffs took the stock down a notch and suggests evidence of liquidity stress to us, but the forgiving narrative in the financial media is that the heroic Musk wants to make money selling his mid-side Tesla 3 sedan. Never mind that consumers don’t want sedans or that the midsize slot in the global auto industry is basically a break-even proposition. Of note, TSLA is trying to squeeze every last penny out of the proverbial lithium nugget by raising the cost of ownership for Model 3 in ways beside an increase in the sticker price. For example, Tesla is officially ending any type of free Supercharging program, a surprise increase in the cost of the affordable Tesla 3. The drastic increase of Supercharging prices around the world is the latest shock for loyal TSLA owners and prospects, but also reveals the financial stress operating inside this still tiny manufacturer of electric cars. As we note in “Ford Men: From Inspiration to Enterprise” the global auto industry is a break even prospect nominally and consumes capital in terms of risk adjusted results. The advertised $35k price tag for a Model 3 is too low to be profitable in the current market. Compare the Tesla 3 with an Audi A-4 starting around $37k or an S-4 starting at $50k. Frankly the highly differentiated Tesla brand ought to be focused on a hybrid SUV that is higher in price than the premium manufacturers. Yet Musk has decided to follow the example of Henry Ford and compete on a lower price in a market that is largely consolidated and financially integrated. Good news for TSLA shareholders, of course, is that the stock is basically unchanged over the past year at about 3x sales, but what a wild ride it has been. To our astonishment, TSLA has a beta of 0.6, meaning far less volatile than the broad markets. But the credit spreads tell the tale. The TSLA 5.3s of 08/25 closed Friday at $87.75 at a weak “B” credit spread with a yield to worst of 7.71% (+500bp over 5 year Treasury debt). Compare to General Motors (GM) 5.1s of 5/25 at +260bp to the Treasury curve and Ford Motor Credit (F) 5.96s of 01/22 at +282bp to the curve. Source: US Treasury Meanwhile in mortgage land, the misery continues. Even though the spread between the benchmark 10-year Treasury note and the 30-year fixed rate mortgage has widened considerably and, indeed, is near the 2016 wide of 209 bp, profits remain elusive. We note, for example, that Ditech Holding Corporation (DHCP), which emerged from bankruptcy less than a year ago, just missed a debt payment and saw its COO depart. Read the latest DHCP 10-Q for a fascinating discussion of ties to other mortgage firms. Despite a lending profit uptick in Q2 as reported by our friends at the Mortgage Bankers Association, both bank and non-bank loan originators are still losing money on a large portion of their new residential mortgage production. The wise in the industry warn that this earnings winter could last for several more years. This raises very specific questions of survival for some industry players if the anticipated arrival of the Army of the Dead (aka rising loan defaults) occurs before lending profits recover. Source: MBA But the Creator does have a sense of humor. In December the Federal Housing Finance Agency, which regulates the three GSEs (Fannie, Freddie and the FHLBs), issued new rules for lenders regarding the use of credit scores in loan underwriting. “Chief among those rules is a provision that would prohibit the government-sponsored enterprises from using the VantageScore credit scoring model because of conflicts of interest with the company’s backers,” reports Housing Wire. Suffice to say that former agency head Mel Watt had his revenge upon the three credit repositories – Experian, TransUnion (TRU) and Equifax (EFX). See our 2017 comment, "Experian, Equifax & TransUnion want to sell you new mortgage credit scores." This odious triopoly has poured hundreds of millions of dollars into pushing their own consumer credit measure -- Vantage Score -- in Washington. Now that FHFA has spoken, will the big three in the consumer data triopoly be forced to quietly euthanize Vantage Score? More, will the big three be forced to take a write-down of their investment in Vantage Score? Sure looks like a goose egg to us. To add insult to injury, the big three consumer data repositories must now contend with a revivified FICO, which finally realized that incorporating the non-mortgage data components pushed by the Housing Affordability mafia in Washington into the existing FICO benchmark solves the proverbial problem. Viola! Truth to tell, the key constituency in this discussion, namely global bond investors and the credit rating agencies, were never asked and did not care at all about replacing the familiar FICO credit scores. Another recent victim amidst the sideways shuttling financial market is the notion of green investing in big power. The bankruptcy of electric utility PG&E in the aftermath of the California wildfires basically suggests that providing electricity in CA may be an entirely uneconomic proposition, begging the question as to policy driven green investments. “[T]he California political class has been trying to find some way for every stakeholder group (except the shareholders) to remain intact. I would not bet on magic here.... The group's crash is becoming the failure of a model – that of private equity financed green infrastructure based upon notionally permanent fully prices contracts,” writes John Dizard in his must read column in the Financial Times. “[T]he current system of green finance has probably suffered a near-mortal blow.” So even though global equity markets are essentially moving sideways, don’t think there aren’t lots of important and even amusing things going on away from the TV cameras in the world of credit and risk. With the S&P 500 still down single digits vs a year ago, and financial bellwethers like JPMorganChase (JPM) lingering in the red by a like margin vs the exuberant valuations of last January, the global equity markets still have a long way to go before reaching solid ground. Adjusting to a world with no Fed bond market intervention and a very ambitious forward Treasury borrowing calendar will take a great deal of time. We suspect that the real test of the present market stability will come when China starts to aggressively sell dollars to prop up its sagging currency. Notice in the Treasury yield curve chart above that short-term T-bills out to 6 months are still rallying, but the rest of the complex is moving higher in yield/lower in price. Remembering that former Fed Chairs Bernanke/Yellen et al dispensed with the inverse relationship between stocks and bonds as a result of QE, the next surge for the exit may look different from December. When we see all of the yields on the Treasury curve heading higher, this under the dead weight of new issuance, then the great unwind in equities may also accelerate. More Reading Martin Luther King: Notes on American Capitalism https://kinginstitute.stanford.edu/king-papers/documents/notes-american-capitalism Jim Dorn: Irving Fisher's Search for Stable Money: What We Can Learn https://www.alt-m.org/2019/01/17/irving-fishers-search-for-stable-money-what-we-can-learn/ The Institutional Risk Analyst (ISSN 2692-1812) is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

January 13, 2019 | Once again it is time for earnings in the world of financials. Go back and compare the Sell Side view of financials at the end of Q2 ’18 with the narrative today. What you see is that the group basically has gone sideways for the past year. Peak gains for sector leaders like JPMorgan Chase (JPM) and U.S. Bancorp (USB) were about 5%, but both are down more than that amount since the great slide began in earnest in December. We can blame the sudden downdraft on various externalities and global trade yada yada, but the simple fact is that financials were very fully valued at the end of June. They are less so today. Is this the signal to run back into the water with the Meg? Yes and no, depending on whether you are buying quality exposures for the medium term or merely seeking a quick flip. As the recently released 2013 FOMC transcripts confirm, unwinding the great Bernanke/Yellen asset bubble means above-normal market volatility going forward. Thoughts: * There are some relative values in the financials compared with 6 months ago, but we would be cautious as the "great unwind" of the Fed balance sheet is going to continue to put pressure on valuations generally and also spreads, regardless of whether the FOMC raises interest rate targets for Fed funds. The easy days of up, up and away c/o quantitative easing are over for stocks. * To us, the sensible risk position is to stay away from complexity and "high beta" plays, but look for bargains among the low beta exemplars. The upside optionality we all thought was free a year ago now has a cost as does short-term funding. Spreads were widening as the year closed, killing HY issuance in December, but now spreads are going the other way. We believe that the real storm in terms of credit is still 12-18 months away, but equity markets are already discounting that reality. * We were a seller of PMT and NRZ going into year-end. Mortgage exposures are going to become more influenced in '19 and '20 by credit concerns. We've been a buyer of USB common and preferred because 1.7x book seems relatively cheap for the best performer of the top five banks. The USB common yields 3.25% and preferred is over 5%. LOW BETA. We like other boring, consistent names like BBT, STI and KEY for same reasons. * We are not impressed by JPM at 1.4x book or BAC at 1x. Same with Citi and Capital One (COF) at a 25% discount to par value. These last two are subprime shops and thus trade at a discount to book, period. Different business model than JPM or USB. Likewise don't like Deutsche Bank (DB) or Goldman Sachs (GS) because of the multiplicity of "known unknowns," namely continuing fears of further operational risk surprises from these investment banks. Sad to say, we still believe GS CEO David Solomon may need to fall on his sword in order to settle the 1MDB mess. Goldman Sachs is accused of facilitating fraudulent securities offerings that were ostensibly for Malaysia, but the proceeds were then stolen by various parties -- people that GS thought were clients. The Malaysians are seeking the return of the full amount of the bogus offerings plus fees, some $7 billion or thereabouts. As we noted last month, the big issue facing GS may be with US regulators and the bank's internal systems and controls. Saying that the firm was deceived by its investment bankers is not the right answer, for example, if you are speaking to the Federal Reserve Board. "I don't want to touch Goldman Sachs," analyst Dick Bove said on CNBC's "Trading Nation" last Wednesday. "People really don't understand what the issue is concerning Goldman Sachs. It's that they were involved in this huge scandal related to Malaysia. It's the fact that their compliance operations internally seem to have broken down." Ditto. The market volatility in December was good for volumes at many dealers, but not so much for clients. We could see an upside surprise from GS, Morgan Stanley (MS) and Citi as a result of the December tumult. That said, Citigroup is showing 2% sales growth for the full year 2018 and 2019 as well, but 21% plus earnings growth in Q4 ’18 and the full year. The C common is down 21% for the year vs just -11% for JPM, but if you consider the greater enterprise risk that comes with Citi that valuation differential seems about right. Consider that C has a market beta of 1.6 vs 1.1 for JPM. As we noted in the latest issue of The IRA Bank Book, the key issue facing banks in 2019 will be whether the rate of increase in funding costs – roughly 60% year-over-year – continues even as the FOMC shows signs of pulling up in terms of further increases in the target rate for Fed funds. The runoff of the Fed’s system open market account or SOMA is going to continue to tighten the US domestic deposit base regardless of whether the FOMC takes any further action in 2019. A pickup in capital markets volume, regardless of the reason, would be a nice surprise. More important, the debt issuance by the US Treasury will be an even greater weight on short-term funding costs – this as the 10 and 30- year Treasury bonds rally while high yield spreads are falling. Thus funding costs for banks and non-banks are rising, but the investor exodus from the equity markets is driving long-term bond yields and credit spreads lower. In normal times, such bullish bond market indicators like falling yields and credit spreads might suggest a substantial leg up awaits in the equity markets. Today, however, the market indicators are muddied by the side effects of QE, making traditional indicators less useful than ever. Then-Fed governor Jerome Powell said in the FOMC deliberations in January 2013: “Although it doesn’t show up yet in the dealer survey, some investors are saying that they sense the end of quantitative easing over the horizon, and as a result, there’s a sense of a rotation into equities and away from the safety of Treasuries, which accounts for some of the very large increase in the yield on the 10-year. And we should welcome all of that and consider whether our statements and actions reinforce or restrain the positive feelings that are out there.” As Powell predicted, the US equity markets delivered a stunning performance since 2014, with stock market valuations increasing by several orders of magnitude above the rate of US economic growth – what we lovingly refer to as the Bernanke/Yellen inflation. Now, however, with the Fed’s balance sheet shrinking and the fiscal deficits soaring, investors are seeing a sharp and somewhat contradictory pattern in the markets that was predicted by Chairman Powell in 2013. He said: “While financial conditions are a net positive, there’s also reason to be concerned about the growing market distortions created by our continuing asset purchases… Many fixed-income securities are now trading well above fundamental value, and the eventual correction could be large and dynamic. You hear that all the time now in the fixed income markets—and in the media, for that matter, which actually may suggest that it won’t happen, of course. But you hear it all the time; we all do. The leveraged finance markets are a particular concern. Rates are low; spreads are not that low yet, but they’re definitely tightening; and terms are deteriorating rapidly. There are many examples of bubble-like terms, which we can talk about at the next meeting. The Dell leveraged buyout, if it does happen, may be very prolific in that theater. I don’t think there’s an imminent crash coming. I do think that the incentives will rule in the end, and the incentive structure that we put in place with the asset purchases, is driving securities above fundamental values. So there is every reason to expect a sharp and painful correction.” Although the 2013 FOMC transcripts make clear that Chairman Powell was leading the charge against the Bernanke/Yellen tendency when it came to the scale and duration of SOMA asset purchases under QE, the markets still don’t seem to get the joke. Unwinding the Fed's asset price bubble is going to be a long and painful process. For financials in Q4 2018 and beyond into 2019, look for rising funding costs and still tough pricing for assets on the one hand, and lots of volatility on the trading book – good and bad. The Institutional Risk Analyst (ISSN 2692-1812) is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

January 9, 2019 | The 10 year Treasury bond peaked in yield at just shy of 3.25% around Thanksgiving. Since then, the world’s most important interest rate benchmark has rallied, pushing yields back down to just shy of 2.55%. Most of this move is probably due to the exodus of investors from equity markets, but even with a stable dollar and relative market calm the 10 year continues to climb in price/fall in yield. QE and a lot of talk aside, deflation remains the dominant underlying tendency in US markets. So is now the time to pick up exposure to US financials? Maybe. Will refinance volumes return to the US mortgage sector? Deo volente. Bank OZK? Thinking (see below). Readers of The Institutional Risk Analyst know that credit metrics for all manner of bank real estate exposures are dramatically skewed in the too-good to be true direction. When will the proverbial pendulum swing the other way? Ralph Delguidice puts the opportunity into sharp focus in a missive this week: “The banks will present a GENERATIONAL buying opportunity in due time, when the FED has tightened financial conditions to deflate what is clearly a systemic bubble in COMMERCIAL REAL ESTATE (CRE) and, to a lesser extent, corporate loans. CRE and LL fundamentals can be debated to be sure, but the securitization bid is the CORNERSTONE of valuations in credit and it is never easy to ‘make the water fall up these ABS structures.’ Zero loss assumptions have been baked into the equity residual math for almost a decade, and there just isn’t room for ANY error. Like the equities, there is just too much asymmetry of return here. Eventually-- yes to the banks. In the meantime, the flat curve is going to make them too hard to own.” Ralph’s observations from the credit channel touch on a point we have long noted, namely that the monetary excess of the Federal Open Market Committee has made credit markets flaccid, now grown accustomed to zero or even negative net loss. As and when credit ratings for leveraged loans and related ABS start to slip below investment grade, the whole game will stop and “investment grade” assets that were liquid six months ago will be no bid. That’s what happens when you fall off the edge of the ratings table. Now if you ask former Fed Chairmen like Ben Bernanke or Janet Yellen, they will tell you that default rate expectations are low because the system is less risky. Yellen said back in 2016: “One reason that risk premiums may be low is precisely because the environment is less risky... The Fed has long focused on ensuring that banks hold adequate capital and that they carefully monitor and manage risks. As a consequence, banks are well-positioned to weather the financial turmoil.” The magical mystery tour of self-congratulation featuring Ben and Janet made an appearance last week, joining Fed Chairman Jerome Powell for a round robin session of carefully curated yet mindless nonsense on national television. For the record, Chairman Powell knows better. But their statements are important for investors because they illustrate just how far down the rabbit hole of economics are the internal discussions at the Fed and other agencies. The idiotic “capital will make us safer” view that underlies much of official thinking on the question of market risk sets the stage for a perfect systemic surprise. Ponder the views of Prerequisite Capital in Australia: “Ironically, when most investors study the top 15 global banks in the world ‘in isolation’ of the interrelationships and issues that arise when you take a broader look at the complex global system – you will hear them mistakenly talk about the improved ‘capital’ positions of these banks, thereby implying the relative ‘safety’ or strength of the banks globally. However, when you step back and ‘take into account larger and larger numbers of interactions as an issue is being studied. [...You are led to] strikingly different conclusions than those generated by traditional forms of analysis’ ... you start to realize that the banking and financial system globally is more (not less) fragile than it was in 2007.” The more capital = less risk construct that has become the intellectual foundation of prudential regulation in the US is a perfect analog to the Maginot Line of WWII. After WWI, the French built fixed fortifications along the eastern border with Germany in the hope that these extended castles would protect them from attack. It’s like the French version of China’s Great Wall. But the key failure of the Maginot Line was that it was an incomplete solution to a public problem, both physically and in a technological sense. George Ball wrote in The New York Review of Books in 1984: "Contrary to myth, the Maginot Line was, as far as it went, quite effective in blocking a German attack. France’s failing was that it had not finished the line and extended it to the sea or modernized its army units on the left flank.” We can think of capital in major global banks as a Maginot Line type of linear, static defense. But what was needed to counter the blitzkrieg warfare of the Nazi armies was a mobile, flexible defense comprised of tanks, infantry, and mobile artillery combined with close air support. The Allies did not have these tools or tactics and early on almost lost the war. In rare cases such as General George Patton, a horse cavalry soldier who became one of the fathers of modern mobile warfare, there was understanding, but not yet broad acceptance among US military leaders. Because the Maginot Line ended at the Luxembourg border, the Germans simply drove their Panzers around it via Belgium and the Ardennes Forrest. To apply the metaphor to finance, capital is fine, but regulators and officials responsible for monetary policy need to think about risk dynamically, especially when that market risk is the result of extreme forms of monetary policy. As curves flatten and funding costs soar, the possibility of contagion rises exponentially and regardless of capital – because liquidity ultimately is about confidence. Think about the fact that the 10 year T-bond has rallied three quarters of a point since November at a time when the Treasury is borrowing record amounts. The unwind of the Fed’s extraordinary policy is causing asset classes to correlate and other distortions in both demand for duration and funding. Any pretense at making rational investment decisions in such a muddled environment seems to stretch credulity to the breaking point. But life continues, in defiance of the apocalyptic. Bank OZK Let’s take a case in point, Bank OZK (formerly known as Bank of the Ozarks). Long one of the performance darlings in the US banking industry, OZK was known for being a well-run regional bank from Little Rock that had a big footprint in CRE lending nationwide. The common is off 50% over the past year, a reflection of some credit write downs that we not well handled with investors and an expensive name change and corporate name change and restructuring effort that leaves many puzzled. When you look at the available disclosure on OZK, which is greatly reduced since the bank dissolved its parent holding company and became a unitary state-chartered non-member bank, the numbers look fine. Strong capital, low credit losses. BTW, a great resource when you need to follow the growing number of publicly traded unitary banks is the TBS Bank Monitor (see below), which scored OZK an “A+” in Q3 2018. Ping Dennis Santiago at TBS for more information. Source: TBS/FDIC After cratering to down 60% YOY on Christmas Eve, OZK rebounded 10% in the past month. Do you go in and start to increase exposure to this tainted dove, this one time exemplar of the CRE syndication world that now trades at a discount to subprime players like Citigroup (C) at 0.75 x book value? Not to mention U.S. Bancorp (USB) at 1.75 x book? The answer to that question depends on your view of risk and particularly unexpected risk. We could spend a fine evening debating where that floor, that average equity market volatility rate, really ought to be for OZK given the perceived embedded risk. But looking at larger comps, the market swings of the past six weeks confirm that change is underway. The high volatility players such as Goldman Sachs (GS), Deutsche Bank (DB) and Citi all trade at a discount to book because of the potential for large operational risk events. You could argue that GS wishes for a higher beta. All of these stocks reflect a lack of visibility on future risks, something the folks at Wells Fargo (WFC) also learned about over the past several years. OZK with a beta of 1.8 is twice as volatile as GS at about 1 beta or roughly in line with market volatility. OZK at 0.89 book value is down 50% from a year ago, but since the unexpected credit write downs and the other fumbling around, the bank has lost that special bond with investors. Based on the historical performance, we want and expect to see OZK deliver solid earnings and strong credit, quarter after quarter. But once you start to lose confidence in bank management and start to think about unexpected risk events, then that premium valuation goes out the window. The fact that OZK is head-to-head in CRE lending with some of the largest banks in major metros is not exactly a cause for confidence given loan pricing. The point of the story is that consistency pays big dividends, but once you introduce the risk of uncertainty into the equation, investors quickly forget past performance and start to discount the promised outcome no matter the historical track record. Will the once premier names of WFC and OZK return to that premium pricing band above 1.5x book value? Yes, but it may take years to happen. Credit spreads have widened considerably and given the softening of collateral values in residential and commercial real estate, worry about the unknown is certainly going to dominate financials going forward. The key question for the future is when will actual default rates follow spreads and how rapidly. Further Reading: China's Stability Is at Risk The National Interest The Institutional Risk Analyst (ISSN 2692-1812) is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

January 2, 2019 | In this issue of The Institutional Risk Analyst, we feature a timely comment from Robert Eiesenbeis, Vice Chairman & Chief Monetary Economist at Cumberland Advisors in Sarasota, FL. Dr. Eisenbeis was formerly Executive Vice-President and Director of Research at the Federal Reserve Bank of Atlanta. While explaining the market mechanics of the Fed's balance sheet manipulations over the past few years, he makes a key point, namely that the increase in the federal deficit is the main driver of rising interest rates and widening credit spreads. "Treasury is the driver here and all the had wringing about shrinkage in the Fed’s balance sheet is missing the gorilla in the room," he opines. Perhaps President Donald Trump should stop criticizing Federal Reserve Chairman Jerome Powell and start to focus on raising revenue and/or cutting federal spending. Meanwhile, yields on fixed income benchmarks such as the 10-Year Treasury bond and 30-year mortgage rate have been falling since mid-November. Yogi Berra, the Fed’s Balance Sheet, and Liquidity January 1, 2019 The story is that the Fed’s quantitative easing program injected large amounts of liquidity into financial markets, causing bond rates to fall and stock prices to accelerate. Consequently, the argument goes that, the shrinking of the Fed’s balance sheet through maturity runoff will cause bond rates to increase and, presumably, stock prices to retreat. But what are the essential mechanics of Federal Reserve asset purchases, and how might they affect liquidity in the market? When the Federal Reserve began its quantitative easing program, it purchased Treasury obligations in the marketplace through the primary dealer facility and paid for those securities by writing up the reserve accounts of the sellers’ banks, simultaneously increasing the sellers’ bank deposits.[1] Effectively, the Fed created money in the purchase transactions, but as far as the public’s asset position is concerned, the purchases substituted demand liabilities for Treasury obligations. The sellers received deposits; their banks’ reserves increased by the same amount; and the sellers’ Treasury holdings were reduced. From the perspective of the consolidated government balance, Treasuries were removed from the public; and on-demand Fed liabilities were substituted in their place, bearing a lower interest cost than the Treasuries they replaced.[2] One form of very liquid asset (Treasury securities) was replaced by another (reserve deposits at the Fed, with corresponding deposits held by the public in its bank). The Fed’s purchasing Treasuries bid up bond prices and put downward pressure on interest rates. One of the main effects of QE was to redistribute the ownership both of Treasuries and of bank reserves and their associated deposits. We can’t quantify or identify the sellers of securities, but we do know that a large portion of the excess reserves associated with those purchases ended up with US affiliates and subsidiaries of foreign banks. Presumably sellers were institutional investors, hedge funds, and money market mutual funds but could also include individuals.[3] Foreign banks’ share of reserves peaked at about 50% in the fall of 2014 and is presently about 35%. Those excess reserves in US and foreign subsidiaries were potentially available to generate a large increase in bank loans and the money supply. A dollar of excess reserves would support an estimated $20 increase in credit and the money supply if it were converted to required reserves as part of the bank credit creation process.[4] But this obviously didn’t happen. Indeed, the ratio of bank loans and leases to bank reserves in Oct 2008 was 26.0, whereas that same ratio as of October 31, 2018, was only 5.6; so bank credit did not expand nearly to the same degree that bank reserves expanded. Interestingly, despite the series of QE experiments, in September 2014 a dollar of reserves was associated with only 2.9 dollars of bank loans and leases right before the Fed stopped adding to its portfolio in October 2014.[5] In short, the degree of stimulus, as far as bank lending was concerned, was muted. In fairness, business investment demand for credit was not great. The NFIB (National Federation of Independent Businesses) reported in March 2014 that 53% of its respondents indicated no need for a loan. Only 2% reported that financing was a major problem; and only 30% reported borrowing on a regular basis, a near-record low. One of the reasons was pessimism about investment and expansion prospects. The report stated that “The small business sector remains in maintenance mode, no expansion beyond a few firm starts in response to regional population growth.”[6] In December 2016 the Fed began a series of 25 bp increases in its target rate for federal funds, and in October of 2017 it began the process of shrinking its balance sheet by letting assets mature and run off naturally. As of December 19, 2018, the Fed’s balance sheet stood at $4.084 trillion, down from its peak of $4.5 trillion on October 14, 2015. Critics have complained that the balance sheet shrinkage process has contributed to a liquidity shortage; but they have not defined exactly what the nature of liquidity problem is, who is or is not constrained, and how that constraint is manifested. The size of the Fed’s balance sheet is determined by the outstanding reserve balances (both required and excess reserves), the volume of currency in circulation (which is of course the most liquid of assets), the volume of funds in the Treasury’s account with the Fed, the volume of reverse repo transactions outstanding, deposits in foreign official accounts, and of course capital. The only way the Fed’s balance sheet can shrink in size is if outstanding currency declines, bank loans shrink, Treasury or other official balances decline, or assets are allowed to mature, in which case the Fed’s liability to the Treasury declines, offsetting the maturing assets. Several factors have actually put upward pressure on the size of the Fed’s balance sheet since October 2014, including an increase of $330 billion in Treasury balances, an increase of $314 billion in added currency outstanding, and an increase of $82 million in foreign official and other deposits. This increase was offset by a decline of $1.07 trillion in bank reserves. How can we explain the drop in reserves if other factors seem to be pointing to an increase in the balance sheet? The source of Treasury balances is tax revenues that are deposited in Treasury tax and loan accounts at commercial banks. When the Treasury transfers funds from those accounts, the reserve accounts at the affected commercial banks are drawn down. So, in fact, the increase in the Fed’s liability to the Treasury is offset by a decrease in the reserves of the tax and loan account banks. Similarly, when bank customers withdraw funds in the form of currency, currency demand increases. That currency is obtained from the Fed in exchange for a reduction in banks’ reserve accounts. So again, rather than actually increasing the size of the Fed’s balance sheet, the composition of its liabilities is changed – currency outstanding is increased, and bank reserves are decreased. Of the $1.07 trillion decline in bank reserves, there was a corresponding increase in Federal Reserve liabilities to the Treasury and the increase in currency outstanding together accounted for $653 billion of the decline. The remainder is largely associated with the runoff and shrinkage of the Fed’s asset holdings.[7] It is important to note that when the Fed engages in what it calls reverse repo transactions, the securities sold remain on the Fed’s balance sheet. Bank reserves are temporarily reduced, but corresponding liabilities to banks under the account “reverse repurchase agreements” are increased. The composition of Fed liabilities changes but the volume does not. When the repo transaction is reversed, bank reserves go up and “reverse repurchase agreements” are reduced. The bottom line is that the apparent decline in bank reserves, far in excess of the change in the decline of the Federal Reserve’s balance sheet, is offset by changes in the other factors absorbing reserve funds, which simply represent a reallocation of the ownership of Federal Reserve liabilities. In the case of the Treasury, it accumulates funds to spend on entitlements, purchases, salaries, etc., which when paid reduce Treasury balances but reappear as an offsetting increase in bank reserves when the funds are deposited with the banking system. As for the notion that the Fed’s reducing its balance sheet holdings of Treasuries contributes to a so-called liquidity problem, again the mechanics are not clear, especially when we consider what has happened to Treasury debt issuance. To be sure, the Fed’s portfolio of Treasuries fell by $213 billion since the decision to let maturing issues run off, while MBS holdings declined by $132 billion.[8] Treasury debt held by the public increased by $956 billion through the end of the third quarter of 2018 as the Fed’s portfolio began to run off. But the actual net issuance of Treasury debt is even greater than that because the Fed’s portfolio is treated from an accounting perspective as part of the public’s ownership of the debt. Since the Fed’s ownership declined by $213 billion, the Treasury securities owned by the public, not including the Fed, increased by $1.169 trillion. This issuance dwarfs the rundown in the Fed’s portfolio and its potential impacts on securities markets. The decrease in the Fed’s marginal demand for Treasuries is far offset by the increase in supply. That supply, depending upon the maturity structure of the Treasury’s refunding, puts downward pressure on rates across the Treasury curve relative to the impact that the FOMC’s rate increases have had on short-term rates. This issuance pattern probably is the major explanation for the overall upward shift in the yield curve that we have experienced since the Fed began letting its portfolio run off. In the meanwhile, more liquid assets are now in the marketplace as a result of the increase in currency outstanding and the increased supply of outstanding Treasuries, and banks still have a huge volume of liquid reserves. Note that, like cash and bank reserves, Treasuries satisfy the banking regulatory agencies’ liquidity requirements, so it isn’t clear what the nature of the claimed liquidity problem is or who is experiencing problems.[9] Liquid assets are supposedly those that can be sold with little or no impact on their price. But we must be mindful that in order for an asset other than cash or deposits at the Fed to be liquid, there must be a buyer on the other side. If there is no buyer, then assets that were thought to be liquid suddenly are not. Indeed, the Fed in essence became the buyer-of-last-resort during the financial crisis. If Yogi Berra were asked to define liquidity, he might have said the following: “Liquidity is what you have when you don’t need it; but when you need it, you don’t have it.” Notes [1] The following discussion of asset purchases and sales omits much of the institutional detail and mechanics behind the transactions and focuses instead on the key results. [2] We have noted before that the Treasury pays the Fed interest on its Treasury holdings, and the Fed pays interest on reserves out of those proceeds (as well as covering its other operating costs) and remits the remainder back to the Treasury. The effect is that the Treasury’s financing cost on the Fed’s Treasury portfolio is the cost of interest on reserves and not the interest payments on the Treasuries themselves. [3] Foreigners and foreign institutions own about 50% of the outstanding debt held by the public. [4] Author’s estimates [5] Source: FRED FRB St Louis [6] See http://www.nfib.com/Portals/0/PDF/sbet/sbet201403.pdf. [7] It is important to note that when the Fed engages in what it calls its reverse repo transactions, the securities sold remain on the Fed’s balance sheet, and bank reserves are temporarily reduced, but liabilities to banks under reverse repos are increased. The composition of Fed liabilities changes, but the volume does not. When the repo transaction is reversed, bank reserves go up. [8] Data from Oct 2017 through December 19, 2018 [9] If Secretary Mnuchin understood banking, the last institutions he would have called to inquire about liquidity problems would have been the nation’s largest banks, which hold the bulk of the excess reserves and have ample liquidity. 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 26, 2018 | Those of us who anticipated a quiet holiday break have been greatly disappointed. It is tempting to blame the electronic flatulence of the POTUS for the market selloff of the past few weeks, but in fact the credit for the great unwind must go to the members of the Federal Open Market Committee. First, the FOMC embraced unconventional policy after 2008, greatly expanding the liquidity in the US financial markets and thereby boosting valuations for stocks, bonds and real estate to astronomical levels. Second and most important, the FOMC lied to the American public about these policies. Specifically, by adopting a largely conventional policy narrative that ignores the real world impact of unconventional policy, the FOMC has misled the public and confused the markets. In simple terms, the FOMC refuses to accurately describe its policy for what it is – namely a reckless embrace of asset price inflation. Recall that after the 2008 liquidity crisis, when Fed Chairman Ben Bernanke wanted to call quantitative easing (QE) “large scale asset purchases,” the Fed’s Washington staff instead came up with the absurd and largely inaccurate euphemism of “quantitative easing.” QE, properly understood, was a direct violation of the legal mandate from Congress that instructed the central bank to seek “price stability.” During the period of radical FOMC policy measures like QE and Operation Twist, the US equity markets rationalized the extraordinary. Economists and Sell Side market analysts told investors that everything was fine, when in fact the FOMC was engaged in a vast and largely speculative experiment that distorted all manner of asset prices in the US and globally. Asset prices rose and investors cheered -- even as Washington's red ink became a torrent of new debt. From 2014 through the middle of 2018, the S&P 500 and DJIA rose by nearly 60% while the US economy was growing at barely 2%. Say what you want about central bank independence, at some point we need to hold members of the FOMC responsible for their policy actions. If the price of achieving full employment is to set the US economy on a course toward another asset bubble and financial crisis, then it is time for Congress to repeal the Humphrey-Hawkins Full Employment Act of 1978. Part of the reason why the FOMC finds it impossible to accurately describe its policy actions is that the second part of the mandate, namely “price stability,” has largely been discarded. Humphrey-Hawkins, let us recall, mandated zero inflation given full employment, a goal that was probably never possible. The political pressure from both national parties makes it problematic for any Fed Chairman to repeat the anti-inflation policies of former Chairman Paul Volcker in the 1970s. The demographic patterns of fifty years ago rightly put the emphasis on wage and consumer prices, this at a time when offshore capital inflows did not figure significantly in the economic equation. Today, however, the vast growth in the global use of the dollar as a means of exchange and store of value has changed the calculus for assessing “inflation” in profound ways. In the 2000s, vast capital inflows financed the US economy with the appearance of low inflation, but now the tide is going out. Of course, economists point to the heavily adjusted statistical measures of wage and price inflation as evidence that the FOMC is largely fulfilling the dual mandate. But how can any reasonable person watch annual double digit gains in stock market valuations or real estate prices and conclude that inflation is under control? We note in the most recent edition of The IRA Bank Book that inflation in real estate prices finally has skewed the net-loss given default for $2.5 trillion in bank owned 1-4 family mortgages negative in Q3 2018 (see chart below). Source: FDIC The same skew in the credit loss characteristics of 1-4 family mortgages is also visible in multi-family and commercial real estate, thus begging the question to the FOMC: Is the same volatility and price deflation now visible in US stocks eventually going to be seen in real estate as quantitative tightening (QT) proceeds with the shrinkage of the Fed’s balance sheet? Real estate markets move far more slowly than stocks, but is the same dynamic that has taken away almost half of the stock market gains since 2014 also pushing property valuations inevitably lower? A: Yes Our contributor Ralph Delguidice ("Are Leveraged Loans a Problem? Yes, and No. And YES") reminds us that noted economist Zoltan Pozsar has long argued that QE-created bank reserves are not --and have never been --“excess.” In fact, he notes, they remain the ONLY settlement medium that can be used to meet the now binding (intra-day) liquidity requirements and all the other regulatory constraints on bank capital and assets. Pozsar wrote in his paper “A Macro View of Shadow Banking” (2015): “The swapping of excess reserves for reverse repos and boosting the supply of Treasury bills (whether in a reserve neutral or reserve draining fashion)… would both lead to shrinking bank balance sheets (as reserves are swapped into RRPs deposits flow out of banks to fund RRP counterparties such as money funds) as well as shrinking dealer balance sheets as more Treasury bills and RRPs offer alternatives for money funds that are safer than dealer repos. And on the flipside, reduced matched-book repo volumes mean less funding for levered bond portfolios and fewer opportunities for lending low intrinsic value securities, both of which will reduce opportunities to deliver excess returns via levered betas for pension funds and other real money accounts that struggle with structural asset-liability mismatches.” The obvious points to take from Pozsar’s work are two: First, the FOMC cannot withdraw the liquidity provided to the US financial system via QE without causing the system to implode. Chairman Jerome Powell needs to publicly state that the Bernanke-Yellen inflation in asset prices will entirely reverse as the FOMC tries to reduce “excess reserves” to pre-crisis levels. Regardless of whether the FOMC raises the Fed funds target rate or not, continuing to shrink bank reserves via QT implies a significant reduction in prices for stocks and real estate. Second and more important, Powell needs to inform Congress that so long as the Treasury intends to run trillion dollar plus annual deficits, the Fed’s balance sheet must grow rather than shrink. To have the FOMC try to follow a narrative set in place half a century ago when fiscal deficits were minuscule is obviously impossible given the Treasury’s borrowing needs. This implies that the FOMC must embrace an explicit policy of inflation that is at odds with the legal mandate enshrined in Humphrey-Hawkins. As we’ve noted previously, the POTUS is right to criticize the Fed’s policy actions, but for the wrong reasons. The fixation of markets and the financial media on whether the FOMC raises the target rate for Fed funds or not is misplaced, part of an time worn policy narrative that is completely antiquated. Since 2017, the only important trend in credit markets has been whether the Fed’s balance sheet is shrinking and at what rate. The move in credit spreads that started in August signaled that there is a growing problem with liquidity, yet the FOMC ignored the warning. Trapped in a policy path that is at odds with actual fiscal and economic realities, the FOMC is now the destabilizing factor in the markets. And remember that credit leads, equities follow. Our prediction for 2019 is that the FOMC will be forced to resume QE and again grow the System Open Market Account (SOMA) portfolio to maintain a ratio (yet to be determined) between the SOMA and the rapidly growing stock of outstanding Treasury debt. This is a pattern familiar to observers of other heavily indebted developing nations. Welcome to Brazil. 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.

In this issue of The Institutional Risk Analyst, we feature a comment from our friend Ralph Delguidice, a veteran fixed income markets observer based in San Francisco. He provides important detail and context to the evolving credit dynamics of leveraged loans and collateralized loan obligations (CLOs). December 20. 2018 | December has been a cruel month for investors in “Leveraged Loans” as winter came in like a lion, early and cold. Primary and CLO spreads have exploded wider suddenly and loan prices have fallen below par going into the year end, stranding dozens of deals in bank warehouse lines and postponing the pricing on hundreds of other deals. This has drawn considerable media and market attention of late, as the asset class has grown to $1.1 trillion and now eclipses the high yield (HY) bond market it used to shadow. The Fed has been outspoken in their concerns as ETF and mutual fund buying has fed an insatiable demand for yield that naturally followed a decade of QE, and now with accommodation in process of being withdrawn the questions on possible systemic vulnerabilities are back front and center. The question of where and how fast this market might be going is complex to say the least, and there is room to disagree to be sure. That said, a couple of things are important to keep in mind from a MACRO and structural point of view that may hold the answers: The current correction is a natural and inevitable consequence of the widening in IG (investment grade), as the CLO markets are dispositive with respect to loan pricing and the quality of the CLO arbitrage—and expected loss adjusted returns—is a straight line-function of IG liability costs at the top of the “stack” (AAA, AA, A) that trade with corporate IG markets and FX swap costs It is not an exaggeration to point out that AAA tranches are now priced entirely in Japan by a small handful of buyers—most notably Norinchukin (a huge deposit funded agricultural co-op) many of whom were big buyers the last time around in 2008. They forgive easily. But should FX swap costs and/or alternative sovereign yields offer a more attractive option the CLO bid could close altogether. From a more MACRO point of view, the Fed hostility to leveraged loans (LLs) is actually ironic, especially given what is a clear and present intent on the part of the central bank to use the Non-banks (CLOs, hedge funds) as a loss absorbing “buffer” to protect the systemically critical GSIBs from the fallout as rates rise. This is perhaps the most important distinction of all for the asset class—as the Fed will not be quick to cut rates this time around in the face of non-continuous price discovery. It has become evident that the dramatic easing of LIBOR in 2008 and 2016 was Central Bank driven and was critical to the “out-performance” of LL’s (vis-a-vis HY) in the past. Remember, cutting LIBOR rates offers IMMEDIATE relief to FRN’s that makes refinancing unnecessary. But this time around the Fed has neither the room nor the desire to bail out the LL markets. Either way, the Fed is comfortable with credit vol. contained in the non-banks that they view as expendable (at best), and that is a BIG RED FLAG. Away from CLO’s--where volatility in the BB tranches was 8X the vol of the similarly rated loan collaterals-- the loan market has been saturated with demand from so-called SMAs (separately managed accounts). These are pension fund and family office investors who were attracted by the decade of flip-chart “out-performance” and who have joined HUNDREDS of brand-new—and totally untested—managers of hedge “credit funds” in what seemed to be an easy- Alpha trade. The question of how well (and stably) funded these SMAs and hedge funds will turn out to be--and how serious is their intent --we will see in time. But retail fund flows are already suggesting significant outflows from the ETFs and loan funds, and this is not going to be lost on those institutions, especially those who may not have fully understood what it was they were buying into. It is vital to remember that CLO deals that are half ramped (many of them) and that all own many of the same names already--are not going too be cash flowing fully to the residual (equity) tranche until they can manage to get fully loaned up. What this says about incentives (and other people’s money) as the market becomes volatile may be open to some debate, but transparency is in VERY short supply here, lags are long and management fees are, still, what they are. The FED has 2 REAL questions where systemic risk and the potential for contagion are concerned that need to be watched carefully. The first is the question of liquidity transformation where the ETFs are concerned. Loan settlements can literally take MONTHS and ETF/Fund liquidity is minute to minute. Should the BKLN or SRLN ETF see outflows that test the integrity of sponsors and force-clear pricing the rest of the credit ETF/mutual fund market—8T$ AT LEAST— will certainly be impacted. The second, and perhaps more important question (given the FED resolve in re the non-banks), is the degree to which so-called “collateral upgrades” have been done with CLO debt and LL’s themselves. In a nutshell, the now near total mandate to clear ALL interest rate and most credit swaps has created a pressing need for cash collateral to be posted at CCPs as initial margin. The BIS has estimated that swaps re-novated to CCPs have resulted in margin shortfalls are in the 4T$ range, and the primary users of swaps (insurance, hedge funds) are short of the acceptable sovereigns and cash to nearly this amount. Over the past several years the custody banks and prime brokers have quietly managed to offer the users of derivatives the ability to swap corporate securities OF ALL KINDS WITH ALL RATINGS for UST collateral that can be REPOed for cash. Of course it is hugely profitable. The problems are equally obvious, and; ironically, are a repeat of what went wrong in 2008 as REPO funding market runs suddenly become, as Vince Lombardi once said: "not just everything, but the only thing.” The above are some of the known-unknowns that LL and credit investors and will be dealing with in coming quarters. It is important to remember ALWAYS that these are specific issues that will be playing out against an economic backdrop that has become clearly hostile to credit of all kinds; and when all is said and done LL’s, CLOs and ETFs are all just different ways of packaging what is essentially raw credit risk—with few covenants and even fewer supporting market makers—into “securities” that are designed to appeal to retail investors that have been yield starved for more than a decade. If ever there was a text book smart money/stupid money trade, it is probably this market right now. Several of the MOST experienced mangers—those FEW who actually were doing the trade just 2 years ago—have started CLO funds that will offer a designed predatory flexibility to buy busted debt and collaterals from the less fortunate and prepared. Ellington and Highbridge know the risks, and they are getting ready for a GOT-style Red Wedding. My advice is don’t go -- more later. The Institutional Risk Analyst (ISSN 2692-1812) is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

September 9, 2026 | Over the Labor Day weekend, Gina Heeb at the Wall Street Journal got a nice scoop by reporting on the reverse merger between WaFD, Inc. (WAFD) and EverBank. The latter was bought from TIAA-CREF by a group of private-equity firms in 2023 and has assets of around $47 billion. Assuming the transaction is approved, the new bank will be added to the WGA Bank Top 50 test group. The PE firms involved with EverBank included Stone Point Capital, Warburg Pincus, Reverence Capital Partners, Sixth Street and mortgage giant Bayview Asset Management. The group of investors and TIAA, which kept a stake in the 2023 sale, would collectively own around 59.2% of the combined company after the deal with WAFD, the WSJ reports. WAFD will remain a publicly traded company in the deal, change its name to EverBank Financial and trade under the ticker “EVBK.” The fractious group of private-equity firms bought EverBank from the pension fund TIAA in 2023, but the club deal never really worked and the firms were reportedly at odds from the start. The obvious strategy was to let the veteran Warburg lead the deal, but apparently it was not meant to be. Below for subscribers to our Premium Service, we talk about what this transaction means for the two banks and the US industry. As we noted in the most recent update to the WGA Bank Top 50, the banking sector has not participated in the strong US equity markets in 2026, unlike the stellar performance in 2025. No surprise, the WAFD stock has traded down since the transaction was announced.