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January 20, 2024 | Last week, a reader of The Institutional Risk Analyst  named Jeffrey asked a good question about our last missive. Why did we compare an equity REIT  like Brookfield Downtown LA Fund Office (DTLAP)  with a mortgage REIT like Blackstone Mortgage Trust (BXMT) . The former holds the equity in office buildings and the latter typically holds the senior mortgage debt. But in today's market, mortgage REITs are becoming equity REITS. Source: Google Finance Notice in the chart above that BXMT is down less than half as much as DTLAP, doubtless reflecting the belief by investors in the former that there is still equity underneath their debt. Yet since the COVID pandemic, the public equity of many equity REITs focused on office properties is down significantly. In normal times, comparing an equity REIT with a mortgage REIT is like comparing apples and oranges.  Given that most commercial properties have 50% equity in first loss position, the holders of the secured debt are relatively senior in the credit stack. But when asset prices are falling and the value of the equity has been wiped out, the holder of the debt is now in the first loss equity position. That is, the debt is now equity. If you are a bank or REIT holding a first mortgage or mezzanine debt on an office building in downtown (aka “East”) Los Angeles, odds are pretty good that you are in first loss position. The equity is gone. Thus we looked at DTLAP first and foremost as a benchmark for the mark-to-market haircut on asset prices. Second, the more than 95% diminution of value in the stock price of DTLAP over the past several years gives you a sense for the overall value of the portfolio and the market.  Truth to tell, commercial buildings from East Los Angeles to West Palm Beach are in trouble, in some cases because of the change in use cases and consumer living patterns since COVID. Another factor, ironically enough, is that the surge in new construction in many markets has resulted in a drop in the value of existing assets in that same market. That 20-year old strip mall in south Florida that has been a cash flow cow for decades now goes begging with the new malls starting to arrive. In a strange way, the decision by the FOMC in 2019 to flood the market with reserves not only cushioned banks and other leveraged vehicles with cheap and plentiful cash, but also created a tsunami  of new commercial real estate investments that has reduced the value of existing assets. If we look at the Invesco KBW Premium Yield Equity REIT ETF (KBWY) , for example, we can see a broader picture of the discount being applied to equity REITs across the country.   With the increase in interest rates since 2021, the FOMC has now left many investments made in 2020-2021 underwater in terms of net cash flow. Indeed, many commercial assets financed over the past decade are underwater . If one assumes that interest rates are likely to stay in the current range for most of 2024, then the likelihood of a serious contagion affecting banks and other holders of equity and debt on office assets grows.  The key thing to remember with commercial real estate is the change in price volatility and direction that has occurred since COVID. Since 2020, we have seen the market for commercial real estate go from a secular assumption of asset price inflation to a presumption of price deflation. The world where CRE assets were financed with interest only mortgages has disappeared. Now “owners” of commercial properties find themselves trying to rationalize putting new cash equity into assets that have falling valuations and net operating income. The Greenstreet Commercial Property Price Index provides a graphic description of what's happened to property values since COVID compared with the past 25 years. Much of the mounting value destruction in commercial real estate has to do with COVID and the change in behavior since the lockdown forced upon Americans by the Biden Administration and many blue state governments. But the conduct of monetary policy by the FOMC and particularly the decision to flood the markets with excessive levels of reserves is also to blame.  If you ask a banker to state the appropriate quantity of bank reserves at any point in time, what is the answer? More. Bill Nelson at Bank Policy Institute observes in his latest Forward Guidance missive on the just released 2018 FOMC minutes: “The Fed’s estimate today of the necessary quantity of reserves is probably about twice the level Chair Powell stated in 2018 would give him buyer’s regret. Why hasn’t the Committee changed their mind?  One of the problems with the excessive reserve approach, as opposed to the necessary reserve approach, is that there is no binding upward limit on the size of the balance sheet.  As a consequence, like the proverbial boiled frog, staff and leadership of the Fed may have become somewhat complacent about balance sheet size. Such complacency may have contributed to the Committee continuing QE4 in 2021-22 even though the economy was clearly recovering…”   The complacency and lack of care by the FOMC with respect to reserve levels over the past five years may cause many tens of billions of dollars in losses to banks, REITs and other lenders on commercial real estate. These policies will also cause the Fed to report massive financial losses for years to come, losses that are a very real cost to the Treasury and taxpayers. When the cost and benefit of Fed actions during 2020-2021 are tallied, the net balance likely seems to be negative and stretches into the trillions of dollars. The Institutional Risk Analyst (ISSN 2692-1812) is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

January 18, 2024 | Premium Service  | In this issue of The Institutional Risk Analyst , we mourn the passing of David Stevens , former FHA Commissioner, President of Long & Foster, and head of the Mortgage Bankers Association. Dave represented the mortgage industry at MBA from 2011 through 2018, and dealt with some of the most challenging times following the 2008 market collapse. The IRA  interviewed David back in 2022  and collaborated with him on many initiatives .  Meanwhile, as earnings roll out for Q4, one reader commented about the obvious question: Why do the banks go first with earnings?  The short answer is that banks are prepared to drop their minimal quarterly disclosure early in the quarter, then file the full quarterly data with regulators and the SEC about 20 days later.  Since banks are seen as higher quality credits, they tend to go first in terms of public disclosure. The less attractive names or issuers that simply need more time to prepare interim financials tend to hide in the back of the disclosure period.  This week’s earnings are confirming a number of trends for banks that we have noted over the past year. The down trend in industry earnings is confirmed by the results from JPMorgan (JPM)  and other large commercial banks. The hiatus on credit build seen in Q3 2023 clearly is at an end. We discuss our takeaway on earnings so far below.  The folks at Goldman Sachs (GS)  managed to bring in a decent quarter and annual result down “only” 8% YOY. The stable results in wealth management help bolster GS overall, but the sharp 30% decline in advisory fees illustrates the state of Wall Street. We like seeing the provision for credit loss falling, just $570 million vs almost $1 billion in 2022.  The big issue coming out of Q4 2023 earnings is not whether investment banking revenues will come back at GS and Morgan Stanley (MS) . Rather, the BIG question is how large will be the haircuts on commercial real estate exposures by banks and REITs.  A good benchmark for what is happening with commercial real estate (CRE) lenders is Brookfield DTLA Fund Office Trust Investor Inc. (DTLAP) , which was trading at $21 per share in 2019 and is now hovering above $0.04 per share.  Back in April of last year, DTLAP disclosed that one of its trophy properties in Downtown Los Angeles lost more than a quarter of its value due to recent legislation passed by CA progressives. The law passed by the City of Los Angeles taxes CRE transactions 5% for deals above $10 million in value.  Our colleague Nom de Plumber summarizes: “ The Brookfield CRE REIT writedown is a good reference point for BREIT hidden losses.” If we impute a similar or larger haircut to all of the CRE assets of DTLAP, then the REIT is clearly insolvent as the stock price suggests. But a more interesting question is what is going on inside similar, higher profile REITs such as Blackstone Mortgage Trust (BMXT) , which has similar assets to DTLAP but has so far avoided the ugly disclosure that has caused the value of the less known REIT to crater. The chart below from Yahoo Finance shows BMXT vs DTLAP. Source: Yahoo Finance (1/18/23) Many observers have commented on the fact that BXMT has showed no pain from the secular drop in CRE values around the country. The problem with REITs, of course, is that they are passthrough vehicles with little in the way of permanent equity capital. This is why REITs cannot own banks or act as issuers of Ginnie Mae MBS. Because they must pay out at least 90% of income to investors to qualify as a pastthrough for tax purposes, a REIT has a difficult -- but not impossible -- task accumulating equity capital. Over the past century, as CRE valuations basically rose every year, a REIT could easily invest in the equity or debt of office buildings and have relatively minor concerns about loss. In today’s market, however, with asset values falling, equity REITs focused on CRE are facing an extinction event. Losses on asset values could wipe out their meager capital and leave the REITs upside down. The same deflationary dynamic that will destroy much of the thin equity of CRE REITs will also cause losses to bank lenders.  The question, however, is the timing of the loss recognition. Looking at the iShares CMBS ETF, investor sentiment regarding commercial real estate has been on the rise. Look at JPM, for example. Loan loss provisions doubled in Q4 2023, albeit from a low base of the $1.4 billion in reserve build in Q3 2023. Note that JPM was actually pulling provisions back into income in Q3 2023, a measure of the GAAP adjustments required by auditors given low loss rates last year. But in Q4, JPM doubled provisions on the consumer line and tool commercial exposures up three-fold. Like all banks, JPM is slow walking a lot of commercial and CRE defaults. The example of Texas Capital Bank (TCBI)  and the Reverse Mortgage Investment Trust default in November 2022 is extreme but by no means unusual. In Q1 2024, TCBI has still not reported the loss to investors because of the litigation. Banks and REITs have substantial leeway as to when and how they recognize commercial losses, especially if the obligor has filed bankruptcy.  JPM CEO Jamie Dimon noted on the Q4 2023 conference call: “[C]redit costs were $2.6 billion, reflecting net charge-offs of $2.2 billion, and a net reserve build for $474 million. Net charge-offs were up $1.3 billion, predominantly driven by Card and single-name exposures in Wholesale, which were largely previously reserved. The net reserve build was primarily driven by loan growth in Card and the deterioration in the outlook related to commercial real-estate valuations...” Banks tend to hold senior positions in commercial and CRE loans, but the magnitude of loss that we are seeing in some commercial markets suggests that JPM and other lenders will face significantly higher losses in commercial exposures in 2024.  The location and quality of these assets, however, varies widely with each bank, REIT or investor. CFO Jeremy Barnum noted that JPM avoids high-priced assets, “higher-end stuff in much less supply-constrained markets that is under more pressure. And as you know, our multifamily portfolio is much more affordable, supply-constrained markets. And so the performance there remains really very robust.” Wells Fargo (WFC)  CFO Mike Santomassimo  likewise noted a rising rate of loss coming from commercial exposures:   “As expected, net loan charge-offs increased, up 17 basis points from the third quarter to 53 basis points of average loans, driven by commercial real estate office and credit card loans. The increase in commercial net loan charge-offs reflected the higher losses in commercial real estate office, while losses in the rest of our commercial portfolio were stable from the third quarter.” As reflected in the valuations for JPM, WFC and BXMT, institutional investors are still not that concerned about commercial real estate losses even though the flow of valuation comps coming from the special servicing industry is decidedly bearish. The chart below confirms the relatively positive investor sentiment regarding CMBS over the past year, but we think this rally may provide some opportunities for short-sellers. Source: Google Finance (01/18/24) Most equity investors are not focused on credit and especially commercial and CRE credit, which is largely obscured from public view.  As and when this changes, we expect to see that increased level of awareness reflected in stock valuations.  The progression of loss from commercial exposures will be piecemeal because every commercial real estate asset is different. Every asset has a diversity of equity owners, creditors and also secured lenders who ultimately own the asset in a declining market. As one banker in Dallas told us years ago, "anything about 50% loan-to-value ratio in commercial real estate is unsecured." We think that the loss rates on commercial loans owned by banks could be higher than the loss severities seen in 2008. More, the unrealized losses that banks have taken on all assets from the 2020-2021 period weaken the bank's ability to absorb loss. Unless we see interest rates fall pretty dramatically, it will be difficult for banks already hobbled by unrealized losses to sell properties taken on a defaulted commercial mortgage . The NBER paper we referenced previously concludes: "The median value of banks’ unrealized losses is around 9% after marking to market. The 5% of banks with worst unrealized losses experience asset declines of about 20%. We note that these losses amount to a stunning 96% of the pre-tightening aggregate bank capitalization." 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 3, 2024 | In this issue of The Institutional Risk Analyst , we provide our comments on the Basel III Endgame ("B3E") proposal from the Fed and other prudential regulators. Suffice to say that the B3E proposal reads like a bad comic book for banks and the US economy. “This proposal reflects a view of financial risks facing US banks that is decades out of date and ignores the public record regarding recent bank failures,” notes WGA Chairman Christopher Whalen . “Specifically, the current proposal continues the historical focus of Basel on credit risk and gives too little weight to market risk."   We also discuss the Risk Based Capital rule proposed by Ginnie Mae and how this ill-considered initiative may combine with Basel III to hurt the housing sector and especially government-insured loans, servicing and MBS. Happy thought: If a Republican wins the White House in November, the Ginnie Mae RBC rule may never take effect. Our letter concludes: "While the proposed risk weights for 1-4 family loans in this proposal are clearly too high, the Board and other regulators need to take another look at the market risk weights for conventional and government MBS. These securities are all government insured to some degree against credit loss, yet the peculiar market attributes of MBS make these assets problematic for many banks. The market volatility that makes mortgage servicing assets (MSAs) appear risky makes MBS very dangerous as a matter of fact. This proposal largely ignores the very real risk from MBS and instead mistakenly demonizes whole loans and MSAs." The full text of the comment letter and related charts may be downloaded using the link below. As always, please send your comments and questions to us at info@theinstitutionalriskanalyst.com  or on X at @rcwhalen . We post replies to many reader questions on X.   And remember that our sale lasts through Little Christmas, January 6, 2024! The Institutional Risk Analyst (ISSN 2692-1812) is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

January 1, 2024 | Premium Service  | A number of readers have asked about our recommendations for the New Year. This is the obvious question because the narrative of approaching economic pain and woe that prevailed at the beginning of Q3 2023 has been replaced in a matter of weeks by less than cautious optimism, even exuberance.  Buyer beware. There are more than a few questions as we head into the New Year, but one certainty is that market risk in the form of volatility remains the most notable factor as it was in 2023.  The other, very large question hanging over equity and fixed income markets is the federal budget deficit. Treasury auctions prior to the New Year were weak and securities were allocated near the top of the range, suggesting rising LT rates in 2024.  The most remarkable stock in terms of the percentage move in 2023 across our bank, mortgage and fintech groups remains Affirm Holdings (AFRM) . This operationally mediocre company saw results weaken, yet the stock rose 400% in 2023, peaking at over $50 just after Christmas. The crowd is exuberant, but this trade is getting very old. We persist in reminding our readers that AFRM is still well-below the all time-high of $160 in October of 2021. Coinbase (COIN) , Upstart (UPST) , and SOFI Technologies (SOFI)  followed behind AFRM in terms of triple digit gains, but you could argue that SOFI performs better with less volatility.  It is interesting to see the Street research analysts abandoning AFRM, perhaps because the recession-is-coming story that drove up the stock is now moribund in a no-recession, soft-landing narrative. Several analysts are talking about the stock falling double digits in 2024. We would take the cash off the table. News that WalMart (WMT)  is expanding the buy-now-pay-later offering to sell at the self-checkout aisle was seen as a catalyst for POS providers like AFRM, but maybe not.  Of note, PayPal (PYPL)  and Block (SQ)  both have a bigger share of BNPL than does AFRM. Given the small dollar size of these transactions, why do we care? There is so much momentum and nonsense already priced into the AFRM story that we could indeed see a sharp selloff in the New Year. Why? First, the prolonged lack of GAAP profitability is starting to weigh on the stock. Second, as we’ve noted earlier, AFRM is maturing from a hot new fintech entrant to a familiar face headed for a bank license?? Mizuho Securities analyst Dan Dolev  has a 12-month target of $65 for AFRM, yet he describes the bear case very directly in a recent report. "We expect the debate around Affirm to increasingly shift from BNPL and partnerships like Walmart, to [Affirm] becoming a full-fledged financial services firm with direct deposits, saving, etc.," Dolev wrote in a note to clients. Yikes.  Fintechs that become banks become, well, boring. The fundamentals of both PYPL and SQ are strong, yet excitement is lacking. If readers of The IRA recall the stories of SQ , PYPL and Lending Club (LC) , all became banks and then immediately became dead money as fintech stocks. Both now trade reasonably well compared to banks but at the bottom of our fintech group. It is less than clear just who are the next fintech players, suggesting that the whole episode was a mirage created during QE. Of note, we added Nu Holdings (NU)  to our fintech list. This is a mature payments platform in Brazil that is an interesting comp for Mercardo Libre (MELI) in Uruguay. NU is touted by some analysis for having better operating results in prospect in 2023, but again there is a certain lack of excitement.  Fintech Source: Bloomberg (12/29/23) Speaking of fintech, one of the better performing banks of 2023 was Customers Bancorp (CUBI) , the PA-based regional lender that has been providing “fintech forward”  banking to its customers. The Upstart Securitization Trust 2023-3 ("UPST 2023-3") just rated by Moody’s, for example, consists of unsecured consumer installment loans originated by Cross River Bank , FinWise Bank , Customers Bank, all utilizing the Upstart platform.  While only $21 billion in assets, CUBI punches above its weight in terms of the diversity of activities and its willingness to take risks. In many respects,  CUBI pursues many of the same customers and markets as Signature Bank, but avoided the fatal taint of a deposit run fueled by crypto currency activities. CUBI manages to operate in many of these same markets without suffering similar negative repercussions. We met CEO Jay Sidhu almost a decade ago when we rated the bank for KBRA. The bank has excellent asset returns, with a gross loan spread over 7% vs 5.9% for Peer Group 1. As you would expect, the bank’s net loss rate is also above peer and capital has a "7" handle. The bank’s brutally low operating expenses, resulting in an efficiency ratio of 45%, vs 60% for Peer Group 1, leaves a lot of room for the bank to manage credit. We like the fact that CUBI is repricing its balance sheet aggressively. Note that CUBI has a positive number for other comprehensive income in Q3 2023 when much of the rest of the industry was insolvent. You don't need to tell Jay Sidhu about duration risk. Back in March of 2023, CUBI was trading below half of book value and today is 1.3x book on a 1.6x market beta.  With JPMorgan (JPM)  at 1.7x book, the banking group is not particularly cheap – unless you expect above-consensus growth in 2024. We do not and, in fact, expect a soft recession in 2024, with credit costs slowly rising in lower quality consumer portfolios. Consumer lenders such as Ally Financial (ALLY) and CapitalOne (COF) which rallied in Q4 2023 may give ground in 2024. Aggregate default indices show consumer delinquency still below the troughs of the pre-COVID period.  This won’t be your father’s consumer-led recession, more of a selective blood letting in terms of higher credit costs. And meanwhile some (but not all), commercial and multifamily assets will remain under pressure. So the answer on financials, for our portfolio, is to pick the better performers.  Bank Equity Source: Bloomberg (12/29/23) Among the top ten names in 2023, we own New York Community Bank (NYCB) and have started to accumulate Wells Fargo (WFC)  because of the bank’s steady operating improvement.  Among the top five depositories, WFC is to us clearly the name with the most upside potential among JPM and top five asset peers. JPM has become a parking lot for unimaginative equity managers and ETFs, so finding upside among the top names is tough.   We now own two bank common equity positions, WFC and NYCB, but readers need to be patient as we may get a chance to buy both names cheaper in 2024. But God does have a sense of humor. We note that the top three names in the world of mortgage issuers were Fannie Mae, Angel Oak Mortgage (AOMR) and Freddie Mac. Q: Why are two GSEs sitting in government conservatorship racing ahead of private issuers? And why on earth is AOMR a public issuer? Mortgage Equity Source: Bloomberg (12/29/23) A while back, a well-placed Washington observer tolds us a story about a possible release from conservatorship for the GSEs by the Biden White House.  The name of a prominent investment banker long associated with the cause of GSE shareholders was also mentioned as spending a lot of time trying to sell the idea to team Biden. We don't believe that operationally either GSE is prepared to return to private control and we'd expect bad things to occur in the event. For a start, most of the personnel at both GSEs with real market competence have departed, leaving behind an angry cadre of bureaucrats focused on progressive idiocy. Just try taking a pool of new conventional loans to the cash window of Fannie for a bid. Second, Moody's is likely to downgrade Fannie and Freddie to "A+" prior to release. There is a reason that the GSEs have a 20% risk weight under Basel III compared to a zero capital risk weight for Ginnie Mae MBS. We disagree with this rating scheme, as we discuss in our comments on the Basel 3 Endgame proposal later this week. Third is timing. This is not a great time to seek a new public listing for a mortgage company. Given the record levels of financial incompetence in the Biden Administration, however, anything is possible. The driver for a quick release is said to be fiscal, possibly creating a couple hundred billion in spare cash for Ukraine. We kid you not. Nothwithstanding a modest decline in short-term interest rates in 2024, we expect to see at least one more Ginnie Mae reverse mortgage issuer default and slide into government control. Even with SOFR at, say, 5%, the advances on a portfolio of home equity conversion mortgage (HECM) notes are deeply underwater. Of the four remaining HECM issuers, we think that at least two could fail in 2024. Readers of The IRA will recall the trevails of Texas Capital Bank (TCBI) and the litigation in TX with Ginnie Mae regarding the bankrtuptcy of Reverse Mortgage Investment Trust (" GNMA, FNMA Seize Assets from Reverse Mortgage Funding Estate "), which filed bankruptcy on November 30, 2022. You will notice that officials of Ginnie Mae are maintaining especially low profiles of late. We hear in the credit channel that TCBI has been quietly stepping back from commercial lending on HECMs, a bad sign for the dwindling number of lenders in the reverse space. Another default among HECM issuers could have serious ramifications for forward lenders in the Ginnie Mae market more broadly. Disclosures The Institutional Risk Analyst (ISSN 2692-1812) is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

December 27, 2023 | Christmas came early to the owners and managers of federally insured depositories. After a year of near death experience c/o trillions of dollars of unrealized losses on COVID-era securities and loans (aka “toxic waste”), US banks were handed a very nice zero risk trade from Uncle Jay Powell and the Equity Market Chorus. As bond yields fell, one-year swap rates also declined, handing banks a risk-free arbitrage opportunity at the Fed, as shown in the chart below. 1-Year Overnight Index Swaps Source: Bloomberg The Fed's Bank Term Funding Program (BTFP) prices off of one-year Overnight Index Swaps (OIS). The interest rate for term advances under the BTFP is the one-year OIS rate plus 10 basis points. As of December 22, 2023, the BTFP rate was 4.85%. This morning, banks are buying funding from the BTFP below 4.85% and selling Fed funds at 5.5%.  Back in September, the BTFP was trading near 5.5%, but today the trade is worth more than three quarters of a point risk free. The chart below shows total outstandings at the BTFP. FRED reports that the BTFP was over $120 last week and is likely to grow in January 2024. The little present to the banksters from Uncle Jay and the other members of the FOMC was unexpected and, indeed, is being done in size by a growing number of institutions. Yet the growing popularity of the program means that the Fed will likely discontinue the BTFP in March as currently planned. Of note, Fannie Mae 3s for January 2024 are 88-04 bid this AM on the Bloomberg . Not only did the Fed's messy public capitulation on inflation move swap rates 80bp, but it also shook public confidence that the US central bank is actually concerned about long-term price stability. Perhaps it is time for Chairman Powell to end the discordant cacophony of FOMC members in the media. How is it helpful for members of the FOMC to parade around in the media mosh pit? We believe that members of the Committee should express the consensus of the FOMC or resign in protest. Over the holiday weekend, Komal Sri Kumar wrote in “ Confusing Messaging Continues” : “Federal Reserve Chairman Jerome Powell put risk assets into overdrive with his press conference December 13 strongly hinting that the next move by the Federal Open Market Committee would be to lower interest rates. Since then, a long line of Fed officials have made public statements alternating between agreeing with, and contradicting, the Chairman. Both the Treasury and equity markets have decided for now that it is Powell’s view that matters.” We are pleased that the FOMC tamed most aspects of inflation, at least as the Committee defines the rate of change in prices. Housing, however, stands as a striking rebuke to the FOMC when it comes to long-term inflation. The powerful subsidy provided to millions of homeowners because of the $6 trillion in new mortgages underwritten in 2020-2021 (roughly half of all residential mortgages) is exerting positive pressure on consumer liquidity and downward pressure on home sales.  Mortgage lenders and allied media are cheering for a return to the good old days of mortgage refinance transactions. There is a growing population of borrowers with WACs of 6.875% and higher “that will be seeing their first-ever and best-ever opportunity to refinance their loans should rates fall to 6.50% or below,” writes Brean Capital’s MBS strategist Scott Buchta . We are a structural seller of the refinance opportunity, sad to say. Simon White wrote in Bloomberg before Christmas: “The surfeit of lower-rate loans means that the effective rate remains considerably lower than the rate for new mortgages, and is rising only slowly.”  White notes that the teaser rate so loved by the media is in the 7s, but the effective mortgage rate is still in the 3s thanks to quantitative easing. Remember, we use Fannie Mae 3s as our mark-to-market benchmark. Home sale volumes are at decades lows, but home prices continue to rise. Zillow and Redfin think that home prices and mortgage rates will decrease slightly in 2024, while inventory rises. Really? Again, we are a seller of falling home prices outside of the legacy urban centers. If the FOMC drops interest rates, housing prices in the suburbs will soar, starting an inflationary process that will likely end in a significant correction when the FOMC is forced to again respond to inflation. In fact, some of the smart money in residential mortgage finance is preparing for precisely this outcome, a pop in home lending volumes for a couple of years, followed by a sharp deflation. Meanwhile, “the Fed’s 3Q flow-of-funds report shows private wealth, mutual funds, insurance companies, overseas buyers and broker-dealers increased their market shares in MBS while Fed and bank runoff continued,” writes Erica Adelberg of Bloomberg . That is, banks remain sellers of MBS. Source: FDIC * Nine months 2023 Since the FOMC lacks the courage (and the political capital) to actually force home prices down, the Powell “pivot” portends another cycle of asset price inflation and, eventually, price deflation like that visible in commercial real estate. The residential home market will be the next example of the Fed's commitment to long-term price stability, followed by a maxi reset in home prices back down to ~ 2020 levels that may not even wait for 2028.  In our next comment for subscribers to the Premium Service, we'll be reviewing the top-ten performers in financials of 2024. The Institutional Risk Analyst (ISSN 2692-1812) is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

December 21, 2023 | Premium Service | We last looked at Citigroup (C)  in our post-earnings snapshot in October of this year. With the release of the Q3 2023 bank holding company data by the Federal Reserve Board, let’s see how CEO Jane Fraser  is doing on the road to improved operating leverage and equity market valuation. The good news is that the equity market valuation of Citi rallied in Q4 with the interest rate updraft.  Source: Google Finance Note that C is in the middle of the pack over the past several months, which is better than being at the bottom of the group with Bank of America (BAC) . C picked up almost 10 points of book value since the end of Q3 2023. Why? First came the announcement of layoffs and management buyouts. Then Fraser decided to drop loss-leading municipal bond trading. Most recently, C dropped another loss leader business, ending trading in distressed debt. These moves represent a significant decrease in liquidity in the related markets but are a net positive for Citi in terms of aligning revenue and expenses.  We start our analysis with a factor that usually comes at the end, namely the return on earning assets (ROEA) for the consolidated company. It might surprise many readers of The Institutional Risk Analyst  to know that Citi has a significantly higher level of asset returns than the other top-five depositories. Yet because of above-peer operating expenses and rising funding costs, the net results are decidedly mediocre.  Note that BAC has the lowest ROEA of the top banks. because of the large retained portfolio of COVID-era loans and securities. Source: FFIEC Bank asset returns flattened over the past three quarters as the FOMC’s interest rate hikes have reached an effective ceiling. The increase in bank asset yields slowed dramatically over the past year. Fortunately, the rate of change in funding costs also slowed, but Citi's interest expenses are rising much faster than the other depositories, as shown in the chart below. This is another factor contributing to Citi’s poor overall financial performance as shown in the chart below. Source: FFIEC The compensation for the higher funding costs is a higher gross spread, which in the case of Citi is today 300bp above the average for Peer Group 1 at almost 6% vs almost 9% for Citi . This higher gross loan spread is why Citi has survived up to this point, yet we must note that a 9% spread is equal to a “B” credit rating from S&P. Citi has enhanced its gross spread considerably since COVID, another positive achievement for Fraser, yet a higher gross loan spread also means more risk The subprime consumer focus is a legacy of the bank going back to before the early 1980s and Citi’s first foray into global subprime lending. The chart below shows the gross spread on loans and leases. Source: FFIEC It was not the Savings & Loans nor the few nonbank mortgage firms that existed in the 1980s, but Citibank N.A. that actually offered one of the first subprime, “no doc” mortgages in the US market. The operational mess that Fraser grapples with today literally goes back decades, but the subprime credit book still generates outsized asset returns that keep Citibank N.A. afloat. The traditional method used by lenders to assess the credit worthiness of an individual, based on the three C’s of credit (capacity, character, and collateral), were cast off by Citibank in the 1970s under CEO John Reed  in order to win new business. By discarding the traditional rules of credit, Citi hoped to create a new market for subprime consumer finance using the loan underwriting techniques of consumer lenders like Household Finance and Associates Corp, which Citi acquired in 2000. John Reed wrote way back in 1976:   “We are creating something new. I refer to a fundamentally new business starting with a dedication to the consumer, and to the proposition that we can offer a set of services that will substantially satisfy a family’s financial needs under terms and conditions that will earn the shareholders an adequate profit while creating a healthy, positive and straightforward relationship with the customer.”   If John Reed almost five decades ago sounds like the head of a fintech lender today focused on buy now pay later, you are correct. There is nothing new in consumer finance, only new faces. The role of Citi as inovator began in the 1970s and ended four decades later in 2008 with the bank’s collapse into government ownership. Since that event of default, the bank has battled with poor operating returns and a capital structure distorted by the ownership stake held by the U.S. Treasury, which was sold at the end 2010.  A year earlier, Citi agreed to merge its Smith Barney brokerage unit with Morgan Stanley (MS) , a bad decision that deprived Citi of a key asset management business going forward.   Today Citi is a three-legged stool, with a subprime consumer lending business, a second-tier capital markets business that is slowly disappearing and a global payments platform, which really is the bank's most valuable asset. In terms of funding, less than half of the bank’s $2.4 trillion in assets is supported by core deposits. As a result, one of the key factors in any analysis of Citi is credit expenses and how credit impacts funding costs.   Net credit losses at Citi are higher because of the bank’s elevated target default rate for the bank’s portfolio.  Historically, Citi has seen net losses running 3x Peer Group 1 and the other top-five banks, although at present losses are running around 2x the top five bank cohort. We expect to see the differential between net loss for Peer Group 1 and Citi widen as consumer credit losses mount in 2024.  Source: FFIEC Notice in the chart above that U.S. Bancorp (USB) and other members of the top five depositories actually saw net losses fall in Q3 2023, a particular example of why the industry saw a drop in credit provision expenses. Yet Citi and other consumer lenders such as CapitalOne Financial (COF)  saw loss rates continue to rise slightly. Once the present pause in consumer credit loss rates ends, we look for C and COF to lead the large banks higher in terms of credit expenses. Of note, COF is a monoline credit card issuer that is now just shy of $500 billion in total assets. Next we look at the bottom line, namely net income vs average assets. The first observation to make is that Citi has been at the bottom of the top-five banks since 2020, when the stock fell off the edge of the table and did not rebound along with the rest of the large bank group. Notice also that Wells Fargo (WFC)  has been steadily improving throughout this period. We are looking to add WFC to our portfolio in 2024, hopefully after the momentum-crazed crowd of equity managers retreat from financials, again.  Source: FFIEC Lastly we look at operating leverage (aka “efficiency”) and, again, Citi is trailing the rest of the group at 66%.  If you want to state in simple terms what CEO Jane Fraser needs to do to get Citi’s equity market value back into line with its peers, then pushing the bank’s efficiency ratio down into the high 50s is the prerequisite. At a minimum, we think that Fraser needs to get her bank’s operating efficiency to at or below the average for Peer Group 1, currently at 60%, and keep it there.  Notice that USB is about even with WFC and above Peer Group 1 in terms of efficiency ratio as it digests the acquisition of Union Bank . Source: FFIEC Bottom line on Citi is that Jane Fraser is slowly making progress to address some of the immediate and long-term challenges to get the bank back into a competitive position in relation to other large depositories. Because Citi is a higher risk business, it must deliver higher asset returns and superior operating efficiency in order to be credible with investors. We still think that Citi will be forced to merge with another bank as it rationalizes its remaining businesses. With JPMorgan (JPM) in the low 50% range due to the accounting for the acquisition of First Republic Bank, the bar in terms of operating leverage is set very high. At a minimum, we think that Jane Fraser needs to keep Citi closer to the middle of the pack in terms of asset and equity returns . BAC is likely to be the laggard among the top five banks in 2024 because of poor balance sheet management decisions by CEO Brian Moynihan . If Fraser remains focused on improving Citi's operating results, then BAC could become the very clear problem bank in the group. 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 20, 2023 | Merry Christmas and a safe and happy New Year to all of our readers.  Please note our holiday sale through 12/31/2023 . We’ll be publishing an update on Citigroup (C)  and some other developments later this week for subscribers to our Premium Service . Below is a link to Jaquie Lawson greetings , one of our favorite vendors. As you enjoy the year-end holiday at home with your family and friends, ponder this: Are you the big dog or the little dog? Remember those who have the least. The past year was challenging for many people in the world of finance and credit, but 2024 may be even more problematic. The tidal wave of irrational progressive politics seems to be ebbing in favor of a more realistic and informed view. Could it be that the soaring number of bankruptcies may have something to do with this more sober perspective? Or perhaps still positive home price inflation? Poor results at the last several auctions of U.S. Treasury debt is another case in point. Q: How many 10-year notes do you suppose Treasury Secretary Janet Yellen can sell at 4% yield come January 2024?  Think about that all you risk managers. Below we juxtapose the assets of the FOMC vs the VIX index. Do you suppose the FOMC is selling VIX contracts? VIX vs SOMA There has been a lot of debate recently about the state of the REIT market, both commercial and residential. The residential sector is generally unremarkable, but resi REITs are trading at a discount to the managers. Given the havoc in the commercial real estate sector, we'd say that commercial REITs are camped out at ground zero for 2024. By no coincidence, Nom de Plumber wrote to us in a touching pre-Christmas note: "When a private REIT redeems some investors at its “stated” NAV, any overmark within that NAV gets stuffed to the remaining investors. Magically, perhaps via Myth, the Blackstone and Starwood non-traded REITs have performed far better then publicly traded REITs, in terms of reported share prices, despite both REIT types owning comparable commercial real estate, especially office buildings." Many participants in the equity markets are chewing on ski tips this holiday season, this after boldly predicting lower interest rates in Q1 of 2024 . In the world of credit, however, risk professionals and allied counsel are preparing for battle. We look for more defaults in the world of nonbank finance in the New Year. If as we suspect the FOMC does not cut short-term interest rates until 2025, we think a couple of issuers in nonbank land may roll over.  Consider the big picture. The Powell Fed is imposing interest rate discipline on an economy that is heavily over-levered and sports a rate mismatch (aka "under water") of 5-6 points between average coupon rates and funding. The time of endless cash enjoyed is now replaced by an era of constraint, symbolized by the mounting public debt of the major industrial nations. Both Joe Biden and Xi Jinping lead nations up to their gills in debt and neither has a plan beyond more of the same. As we noted in our last issue, the question is not how low inflation must go to satisfy the requirements of Fed Chairman Jerome Powell and the other members of the FOMC. In the near-term, the answer is at or below 2% for some period of time. The real question to us, though, is how high must inflation be over the longer-term to keep the US and other major industrial nations from defaulting on their debt. Most of the debt issuance by the US and other industrial nations is merely to refinance existing IOUs for yesterday’s spending . This debt is a dead weight on future economic growth and will eventually be repudiated to some extent, mostly via inflation. That may sound pretty dire, but the US situation is manageable. And we'd rather have the US portfolio than China any day. Professor Brad DeLong  writes in The International Economy  about the end of what he calls the Second Gilded Age: “Some of us are more optimistic than others about the future. We optimists recognize that it is still possible to escape from the traps that America’s Second Gilded Age has laid. During a gilded age, productive capabilities are direct-led away from providing most people with necessities and conveniences, and toward exorbitant spending on status-seeking and other worthless activities... What is the case for optimism? For starters, it is worth remembering that the United States did eventually emerge from the original Gilded Age in the late nineteenth century, and it did so by embracing immigration, expertise, and shared interests—the basis of the American Century that followed.” Of course there is constructive progressive reform and then there is destructive progressive socialism. A big part of the fiscal and economic problems facing the US comes from the plunge into debt fueled politics since the 2008 financial crisis. Progressive socialism, fueled by zero interest rate policies by the FOMC, encouraged a vast accumulation of public debt long before COVID. This debt is now a serious drag on the economy and private borrowers. Crowding out returns as a public policy issue. At the same time, new layers of regulation have been added to the mix, slowing growth and stiffling market liquidity. We'll be posting our written comments on the Basel III Endgame proposal early in the New Year. Read our latest column in National Mortgage News on the appalling state of the mortgage market after three years of progressive chaos. Budget deficits have actually led the Biden Administration to propose cuts in funding for Ginnie Mae and the FHA. Down the road not so far, the FOMC may eventually be forced to run the economy “hot” in terms of inflation – think mid-single digits – just to keep the swollen Treasury market liquid and asset prices stable. Double digit long bond yields anyone?? Imagine a political environment where unemployment is not a problem -- everyone must work -- but real wages are falling so rapidly that it becomes the most pressing domestic political issue. The heavily indebted progressive state is powerless to respond. Think Argentina, which is now at an effective exchange rate 1,000 pesos per $1.  Notice that the folks at FRED cannot keep up with the rate of depreciation of the peso since the election of President Javier Gerardo Milei , an academic economist who wants to dollarize Argentina’s economy. While he does not have the power to declare dollarization outright, Milei is going to talk the peso down until all of his citizens flee into dollars. Memo to Powell: Better schedule more pallets of dollars for the next flight to BA. Let’s hope that the New Year brings a change in government in Washington and with it a more serious appreciation for some of the risks facing the US economy and the global financial system.  Even if the FOMC were to drop short-term interest rates 100bp tomorrow, it would not have much impact on the direction of commercial credit losses in 2024 . When you see that the FDIC's Receivership was only able to sell single-digit stakes in the rent controlled assets of the former Signature Bank, that tells you all you need to know about the state of money and credit in the final ridiculous year of the Biden Administration. Merry Chistmas!   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 15, 2023 | 溢价 | After the past week of market exuberance, we take a look at the banking, mortgage and fintech sectors to see who is on top in terms of the equity markets and who is not. Some of the results may surprise readers of The Institutional Risk Analyst , but that is not remarkable given that the 10-year Treasury has rallied to below 4% yield in a week. Basically, today we are back where the industry stood at the end of Q2 2023. The key term for risk managers and investors in 2024 remains unchanged from this year: Volatility. Our basic view is that the global equity markets are way ahead of the FOMC and the US Treasury when it comes to long-term interest rates. Those optimistic souls at Goldman Sachs (GS) are telling clients that the first Fed rate cut will come in the first quarter of this year , but we think that the Boys of Broad Street may have the wrong year. With the US economy roaring along with no recession in sight, we suspect that Powell will err on the side of patience. Indeed, the inaction from the FOMC may allow Powell to return to a quarterly media event instead of the current monthly spectacle.  Here are a few high level takeaways from the past week.  First, the rally in the bond markets has taken away some of the immediate pressure on banks. Instead of adjusting bank asset prices by more than 20% as we did at the end of Q3 2023 in our fire sale assessment, the adjustment now is close to 12%, reflecting the current prices on corporate debt and Ginnie Mae MBS. GNMA 3s were trading around 89 this AM vs closer to 80 a month ago.  Second, the enormous volatility evident in the interest rate markets has caused an equally sharp swing in levered positions and hedges at banks and nonbanks alike. Bankers made money on their cash positions, but may have taken significant losses on hedges as the 10-year Treasury moved a point in yield in less than two weeks.  “ MSR holders are seeing a drop in value due to lower credit on escrow balances,” notes one advisor. “The folks that are long standing MSR hedgers have on paper adequate hedge coverage but that coverage is misplaced at the 10 year point versus the point of the curve where escrow credit is earned / applied.” Third, the sharp drop in LT rates has caused a rally in banks and other financials, but not always in a way that makes sense. Looking at the banks, for example, the group is being led by $22 billion asset Customers Bancorp (CUBI) , which is up 96% over the past year and is now trading 1.1x book.  Why is CUBI outperforming its larger peers?  First and foremost, the bank has astutely managed its balance sheet, selling low coupon assets and redeploying capital into higher yielding loans and securities. GAAP earnings almost doubled between Q2 and Q3 2023, boosted by the bank’s focus on PPP loans. The tangible book value of CUBI has continued to grow over the past several years.  Bank Surveillance Group Source: Bloomberg (12/14/23) Another bank stock that has moved significantly is Citigroup (C) , which is up 12% this year and is once again trading above 0.5x book value.  What has caused this remarkable development? Cost cutting by bank management, including aggressive layoffs and a number of business changes, such as winding up the bank’s loss leading muni trading business. It is probably too soon to say whether CEO Jane Fraser  will continue to improve the bank’s expense profile vs its peers. As we've noted previously, Citi needs to get its efficiency ratio down into the low 60s to be credible. UBS Group (UBS) has been one of the better performing names in the group for some time, this even though the bank is now finalizing its merger with Credit Suisse.  We think the merger with CS will continue to be a source of loss for the giant Swiss asset manager, but the bank’s leading position in the advisory business seems to be offsetting any investor concerns about the legacy CS business. It is entirely possible that UBS may write off its US mortgage business, including the biggest remaining subprime mortgage portfolio and a large Ginnie Mae servicing book. Also in the top-ten performers among banks are CapitalOne Financial (COF) and Ally Financial (ALLY) , in both cases benefitting from the broad assumption that the economy is headed for a “soft landing.” We beg to differ with the consensus view and believe that investors buying consumer facing banks based upon the idea that there will be no uptick in credit costs are mistaken.  The question is timing. "The blunting of the pass-through from higher rates to mortgages has been the game changer for households this cycle," writes Simon White of Bloomberg . He continues: "The debt-service ratio (the ratio of total debt repayments to disposable income) is only back to its pre-pandemic average, despite the consumption DSR hitting highs not seen since just before the GFC... Undoubtedly there are many households feeling a strain from rising rates, but the data shows that in the aggregate the sector is in much better shape than some pessimistic-looking charts would suggest." Our single common stock holding in banks, New York Community Bancorp (NYCB) , has also benefited from the happy narrative among stock investors. At 0.8x book, we think NYCB is still good value, but remember that the bank has significant exposure to New York multifamily assets.  As and when the equity crowd wakes up from their pleasant dreams of soft landings for the US economy, we may see NYCB, ALLY and COF trade off due to credit concerns.  In the world of mortgage issuers, the one year total returns are equally impressive, with Angel Oak Mortgage (AOMR) leading the group. Like many of the stocks we cover, it is important to look at both the short-term and LT charts to gain perspective.  AOMR is an issuer of non-QM mortgages and is up almost 150% over the past year.  That said, the stock is still trading at half of its value in September 2022, when it fell off the edge of the proverbial table, and less than half of the $19 high from June 2021.  Buyers beware.  BMO Capital Markets strategist Brian Ye says that a Fed rate cut in 2024 will not lead to a refinancing waves. Next year’s anticipated rate cuts are best proxied by cuts in 1995, which were shallow and coincided with lower spread volatility as well as lower overall spreads. “Those experiences bore some similarity to the current environment”: Ye writes. He says that the cuts came on the heels of an aggressive rate-hike campaign, in 1995. "The Fed fund rates went from 3% to 6% in a hurry but did not trigger a recession," he writes. "As in 1995, next year’s shallow cuts should come as relief and likely accompanied by lower volatility and more range bound MBS spreads." Next on the list are Fannie Mae and United Wholesale Mortgage (UWMC) , two thinly traded nonbank stocks that are not names we would encourage our readers to follow. Next is PennyMac Financial (PFSI) , one of the more substantial names in the group which just completed a new $750 million debt offering.  Mortgage Equity Group Source: Bloomberg (12/14/23) Next on the list is LoanDepot (LDI) , which is up high double digits for no particular reason other than investor hopes for immediate rate cuts. Given that the bond market rally is unlikely to result in a surge of loan refinance business, we wonder about the motivations of buyers of this stock. LDI has been bleeding cash for two years. We have been in and out of LDI, but at almost 3x nominal book we are definitely not a buyer. Last but certainly not least, we arrive to the fantastic world of fintech. Leading the way is Affirm Holdings (AFRM) , one of our favorite subjects for writing but a stock we have avoided. With a beta of 2.8x the 6 month average market volatility, AFRM is more an option than a stock, mostly recently on option on the “buy-now-pay-later” craze that has captured the minds of many equity managers. Fintech Surveillance Group Source: Bloomberg (12/14/23) To be clear, we view BNPL as another way of saying delayed event of default, but there is a large crowd of speculators that love the AFRM name and are acting accordingly. The 1 year total return on AFRM is over 300%, followed by crypto currency play Coinbase (COIN) , consumer lending channel Upstart Holdings (UPST) and SoFi Technologies (SOFI) .   The ranking of these names has not changed in some time, making us wonder how these fintech leaders will look a year from now – especially if consumer credit deteriorates.  In the meantime, flush consumers and businesses are still driving a very positive narrative for consumer lenders. Just remember, don’t fight the Fed. Look at where these stocks were trading a couple of years ago, during the period of hyper-low interest rates and zero credit costs. If you believe that the economy will slow and credit will weaken, then these high flyers may be equally attractive shorts. Source: Google Finance 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 12, 2023 | 両替料  | For some time we’ve been meaning to return to PNC Financial (PNC) , the eighth largest bank in the US right behind U.S. Bancorp (USB)  at just over $600 billion in assets. When we looked at PNC back in January of 2023 (“ Update: Truist, Charles Schwab, U.S. Bancorp & PNC Financial ”), the bank’s credit profile was pristine. Yet by October 2023, PNC reported its non-performing commercial real estate (CRE) loan balance more than doubled to $723 million in the third quarter from $350 million in the second quarter. PNC stated during their conference call: "While overall credit quality remains strong across our portfolio, the pressures we anticipated within the commercial real estate office sector have begun to materialize. Non-performing loans increased $210 million, or 11%, linked quarter. The increase was driven by multi-tenant office, CRE, which increased $373 million, but was partially offset by a decline of $163 million in non-CRE NPLs." Reading the latest comment fro m Bill Moreland  at BankRegData , it seems that the carnage in commercial real estate is starting to bleed through into bank public disclosure and soon earnings. What does PNC tell us now about commercial loan exposures in 2024 and beyond? The chart below shows loss given default (LGD) for the $500 billion in bank owned multifamily commercial mortgages. Source: FDIC/WGA LLC PNC is a significant commercial lender with a national portfolio and also a significant loan servicing business in both residential and commercial assets. The $557 billion asset bank provides a good surrogate for bank exposures in the commercial sector. Bill notes in a 12/6/23 comment to his clients that PNC’s commercial real estate exposures are starting to show mounting levels of stress and, of course, forbearance in the form of troubled debt restructurings (TDRs).  “ Starting with Non Owner CRE on the left it's fairly clear that PNC has a significant NPL issue,” Bill writes. “NPLs have leapt from $181.7 million in 2022 Q4 to a staggering $722.8 Million  in 2023 Q3. The NPL % went from 0.97% to 4.04% - a doubling and then another doubling. While stunning, Citi and Goldman Sachs also experiencing similar issues.” As the chart below from the bank's Q3 2023 earnings presentation illustrates, PNC has done a good job of repricing its balance sheet over the past year and more, but commercial credit risk remains the largest exposure for the bank. We assume that 2024 is going to see rising levels of delinquency for commercial credits, both at PNC and other large regional lenders. Readers will  recall that we have noted outlier credit loss behavior from both Citigroup (C)  and Goldman Sachs (GS)  for some time.  The developments at PNC, however, track the recent market reports on distress in a wide variety of CRE assets across the banking industry. That is, if PNC is seeing a surge in delinquency in its CRE portfolio, then you can be pretty sure that other regional banks with significant CRE exposures are seeing the same. In its Q3 2023 Form 10-Q, PNC reveals a 41% increase in non-performing loans, which now includes “Troubled Debt Restructurings and Vintage Disclosures, nonperforming loans as of September 30, 2023 include certain loans where terms were modified as a result of a borrower’s financial difficulty. Prior period amounts included nonperforming TDRs.” As with retail consumer facing exposures, banks are using TDRs more and more to avoid foreclosure on commercial borrowers. Similar to a consumer default, the idea of a TDR is that processing the foreclosure is more costly than keeping the borrower in place at a lower interest rate.  The only problem is that the bank’s portfolio becomes impaired with weak assets that are now TDRs and may or may not be fully disclosed. As we've noted with the Ginnie Mae exposures of Texas Capital Bank (TCBI) , litigation can be used as a reason to delay disclosure. PNC states in its most recent 10-Q: “On January 1, 2023, we adopted ASU 2022-02 Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures, which eliminates the accounting guidance for TDRs and enhances the disclosure requirements for certain loan modifications when a borrower is experiencing financial difficulty. Refer to Note 1 Accounting Policies and Note 3 Loans and Related Allowance for Credit Losses for additional information on our adoption of this ASU.” Moreland notes, for example, that tracking the movement of NPLs, TDRs and actual charge-offs of delinquent credits is neither seamless nor transparent under GAAP.  The changes visible in the CALL reports for PNC’s subsidiary bank, for example, do not necessesarily track in the GAAP disclosure. Following the movement of delinquent loans into TDR status, including assets acquired from BBVA and the FDIC from the estate of Signature Bank, makes the analysis daunting, but the bottom line seems to be higher credit loss exposures in the future for PNC. In Q2 2023, PNC was already reporting nonaccrual loans and leases that put them in the 90% percentile of Peer Group 1.  The bank notes in the most recent 10-Q: “TDR disclosures are presented for comparative periods only and are not required to be updated in current periods. Additionally, our vintage disclosure has been updated to reflect gross charge-offs by year of origination.” Of note, PNC shows non-performing consumer assets falling in Q3 2023 vs a year ago, a pattern consistent with the experience of other banks in the second half of the year. Commercial defaults are higher, as you’d expect, and we think that the levels reported in Q4 and 2024 are likely to be significantly higher. The volume of loan defaults and restructuring in commercial assets is unprecedented and is likely going to increase in volumes and net loss rates next year. Table 42 below shows PNC's nonperforming assets. Table 58 below from the most recent PNC 10-Q shows the reconciliation for loan loss provisions for loans and also unused credit lines, “exposure at default” in the language of Basel III. Of note, PNC has $42 billion in delinquent consumer loans and almost $60 billion in delinquent commercial exposures that it services for third parties. PNC owns $1.1 billion in commercial mortgage servicing rights (MSRs) and $2.3 billion in residential MSRs, in both cases double the levels of a year ago. Advances on these assets are not yet significant but warrant close attention going forward. PNC had a comprehensive loss on securities of $14.9 billion at the end of Q3 2023, which is roughly a third of the bank’s tangible equity. The bank’s commercial loan book was $174 billion at the end of Q3 2023, down from $182 billion at the end of 2022. The bank’s residential loan book is just $47 billion, by comparison, and has strong FICO and loan-to-value (LTV) metrics.  Apparently, PNC is deliberately managing down CRE exposures and increasing consumer loans. Bottom line on PNC and other regional lenders: Defaults in CRE are headed higher, both for loans that are disclosed and loans that are "managed" or subject to modification via a TDR. For every commercial loan being walked to the curb for disposal, there are several more in the portfolio being managed. Because CRE loans are all different and because most commercial loans have some degree of real estate exposure, the wave of CRE losses facing banks like PNC over the next several years could be significantly larger than expected by many analysts. 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 11, 2023 | Over the weekend, Bill Nelson , Chief Economist at Bank Policy Institute, put out an intriguing note (“ Forward guidance:  The Fed is probably solvent”) that argues that the central bank still has positive net worth despite its substantial operating losses. Nelson concludes: “So before taking into account the value of seigniorage, the Fed’s economic value is $1 trillion ($6.7 trillion minus $5.7 trillion).  If currency plus the TGA is expected to grow, as it always has before, the value of seigniorage is positive and the Fed is definitely solvent.  For example, assuming a discount rate of 4.5 percent (the 10-year Treasury rate), if currency plus TGA is expected to grow at 3.8 percent per year (the FOMC’s outlook for nominal GDP growth in the long-run), the value of seigniorage is $15.9 trillion.  But if currency is expected to shrink 2.5 percent per year, the value of seigniorage is -$1.05 trillion, the economic value of the Fed is negative, the Fed is insolvent.” Our view of the Fed is that it is merely the alter-ego of the U.S. Treasury, a convenient canard whereby an additional layer of leverage was added to the American economy on the eve of WWI in 1913. A liability of the taxpayer is treated as an asset on the books of the central bank, which was not even allowed to own government debt at inception. The Fed was focused entirely on financing the private sector. So is the solvency of the central bank an important issue for public policy? Not really. It is part of the growing insolvency of the U.S. Treasury. The assets and liabilities of the central bank, net of private equity contributions of member banks, ultimately belong to the United States, just as with all of the parastatal creations of Congress.  And for this reason, the Fed can never actually show a profit in a true economic sense and is always an expense to the taxpayer.  As a result, the only truly relevant fiscal question when it comes to the Federal Reserve System is how much of an expense does the central bank represent? Nelson and other former employees of the Fed, ourselves included, have long fretted over the growing operational and financial stress visible at the central bank. As we opined last week with a chart published by the Federal Reserve Bank of St Louis (FRED), the deviation in financial performance by the central bank is extraordinary and begs the question as to why nobody in Congress has asked Fed Chairman Jerome Powell for an explanation. The chart below shows historical “remittances” from the Fed back to the Treasury.  While Nelson and other researchers like to pretend that the Fed is a separate institution independent from the U.S. government, in fact the central bank lost its prized independence more than half a century ago. In 1966, when Congress “allowed” the central bank to purchase debt from agencies that are owned or guaranteed by the federal government, the central bank lost any real independence and became a captive funding vehicle for the Treasury. Many economists, of course, have trouble accepting the reality of the fiscal relationship between the Fed and the Treasury. Nelson notes a paper published by Federal Reserve System Staff in 2016 – “ Fiscal Implications of the Size and Composition of the Central Bank’s Balance Sheet ,” which largely supports the idea of separateness and also solvency. Fed staffers Bi, Cavallo, Del Negro, Frame, Malin, and Rosa (2016) observe that a central bank is solvent if the market value of its assets minus the market value of its interest-bearing liabilities plus the expected present discounted value of future seigniorage is positive.  Put another way, the central bank is solvent if the expected present value of its "profits" is positive.   Nelson relies upon two main factors to support the idea that the Fed is solvent.  First, the natural inflation of the currency and second, the likewise inflating value of seigniorage  (the monopoly on providing the public with currency).  We tend to discount these arguments, however, because ultimately the legal tender monopoly of the greenback that goes back to the Civil War belongs to the Treasury itself and not its instrumentalities. Consider an example. “In August 1861, a couple of weeks after the Union’s disastrous defeat at Bull Run, Treasury Secretary Salmon P. Chase traveled from Washington to New York in search of money,” writes Nicholas Guyatt  in a wonderful review in the NY Review of Books  (“ Blues, Grays & Greenbacks ”). At the time, there was no central bank and the nation’s paper currency was issued by private state-chartered banks, with paper money backed by gold. Any potential for seigniorage related to public money obviously belonged to the Treasury. When Chase demanded that the largest banks lend the Treasury all of their gold, the banks naturally refused. This led Chase to eventually decide to issue unbacked paper money, “greenbacks,” to finance the war. If the bankers in Boston, New York and Philadelphia refused his request for financing, said Chase: “I will go back to Washington, and issue notes for circulation; for it is certain that the war must go on until the rebellion is put down, if we have to put out paper until it takes a thousand dollars to buy a breakfast.” As we noted in " Inflated: How Money & Debt Built the American Dream (2010) , " Treasury Secretary Chase’s famous gambit to finance the Civil War with fiat money ultimately succeeded and in the process made the US stronger financially. The natural growth of the economy and insatiable demand for currency inflated the value of greenbacks back to parity with gold, this after paper lost much of its value during the conflict.  The difference, of course, is that the audacious actions of Chase to finance the Civil War without borrowing gold from the banks helped grow the value of the US economy. The US had little debt in 1865 and even the float represented by greenbacks was quickly absorbed. The more recent experience with quantitative easing and fiscal largesse from Congress in the wake of COVID, however, begs the question asked by Nelson about the “value” of the Fed in a deflationary environment. If the value of the Fed's esatz assets falls instead of inflates, then the central bank is insolvent using Nelson's methodology. Fortunately, the dire prediction made by Secretary Chase about paying $1,000 for breakfast has not yet arrived.  Ultimately, the real question facing the Fed and the economist community is not whether the Fed is broke or whether the FOMC can get inflation back down to the 2% target, but rather whether the central bank can keep asset prices growing indefinitely. As the deflationary pressure of tens of trillions in public debt relentlessly pushes us toward a general deflation event, possibly led by a home price correction later in the decade, the Fed’s job remains promoting inflation. In our next comment, we'll be providing an update on PNC Financial (PNC) for subscribers to our Premium Service. 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 8, 2023 | Premium Service  | It is more than a little surprising to see how few Fed watchers appreciate that the Street’s rotation out of Reverse Repurchase Agreements (RRPs) and into T-bills essentially provided the catalyst for the November rally – and the cash to fund the ¾ of a point decline in yields in the Treasury market. As we were sitting in the trading room this AM, the jobs number came out and the 10-year Treasury moved from 4.17% to 4.25% in less than a minute. In this issue of The Institutional Risk Analyst , we take stock of the world of fixed income and credit as the year ends. As in December of 2018, the Street has essentially closed its books for the year.  Large banks led by JPMorgan (JPM) have in so many words told the Street “no thanks” to new exposures, meaning that we may see more trouble in Repo land before the New Year.  Look at the upward spikes in the Fed funds rate over the past two weeks. First let’s set the stage with a little data. The two major “adds” to the US markets in the past month have come from the runoff of RRPs at the Fed and expenditures by the Treasury from the TGA.  As we noted in our last post, when the Treasury spends cash, it results in increased reserves/deposits at banks.  Indeed, the inflows have largely offset the Fed’s QT policy to reduce reserves. The chart below from FRED shows RRPs (red) falling fast as the Treasury spends cash from the TGA ((blue). Over the past year, as the Treasury has issued a large amount of T-bills to raise cash, the outflow from RRPs and also normal payment flows from the TGA into banks has more than floated the Treasury’s cash needs. The balance was available to flow into stocks and longer-dated Treasury debt, and it did! The result was a pop in stocks and also a rally in the long-end of the Treasury curve. Our view is that once liquidity tightens in the markets in December and the next Treasury refunding approaches, the markets are likely to retreat in both stocks and fixed income. The Treasury plans to auction $816 billion in debt in the first quarter of 2024. This is in addition to $776 billion in debt that will be auctioned off in the final quarter of 2023.  Many of the names that have rallied in the past month such as Customers Bancorp (CUBI) . CapitalOne Financial (COF)  and Ally Financial (ALLY)  all rallied based upon an assumption of no recession in 2024. Even Citigroup (C)  managed to rally 15% based upon announced layoffs to improve operating results. Note that despite the rally, Citi is still trading below 0.5x book. Source: Bloomberg (12/7/2023) Many of the names in our surveillance group continue to trade at significant discounts to book value, including our one common holding in New York Community Bank (NYCB) .  The rally in November is likely to be very helpful to NYCB’s Flagstar unit because of increased lending volumes for the bank’s warehouse and loan servicing businesses.  We note in this regard that PennyMac Financial (PFSI)  just completed a $750 million six-year unsecured debt offering that was upsized from $650 million. The notes pay 7.875% and are rated Baa2 by Moody’s. The moral of the story is that November was a good time to be an issuer of debt, especially if you understood the context of what is going on at the Fed in terms of cash flows into the financial markets. We believe that many of the consumer-facing names that rallied in November may now be set up for an equal or larger sell-off in the next month or so.  Notice in the chart below that T-bills (blue) are trading significantly above the yield on RRPs (red). As markets come to appreciate that the FOMC may not be cutting short-term interest rates for some or possibly all of 2024, we think that the dynamics of the Treasury refunding in January and the near-complete runoff of RRP’s back into T-bills is likely to weigh on the markets. Simply stated, with T-bills trading significantly above the yield on RRPs, there is no reason for money market funds and other counterparties to leave cash at the Fed. 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 5, 2023 | Premium Service  | In this issue of The Institutional Risk Analyst , we release the latest edition of The IRA Bank Book for Q4 2023  for subscribers to our premium service. Copies will be available for purchase in our online store later this week. While the banking industry’s insolvency reached its worst position ever at the end of Q3 2023, the subsequent rally in interest rates has made the ugliness of unrealized losses a little less horrific. The industry’s negative mark-to-market position is shown below with a $1.8 trillion capital deficit below. Source: FDIC/WGA LLC Stocks soared over the past month on the promise of lower interest rates. No surprise, we heard from a reader named Eric, who is a prominent bank owner and also an advisor to banks. He  asks whether the surfeit of liquidity being maintained in the Treasury General Account at the Fed is behind the rally in stocks. By no coincidence, Simon White wrote a comment in Bloomberg  on 11/28/23 claiming that the movement of cash out of the Fed’s reverse repurchase (RRP) facility and Treasury's account at the Fed helped stocks.  White: “The change in the change of reserves typically leads the one-month performance of the S&P (as shown in the chart below). Reserve growth began to accelerate about a month ago, the same time as when the market began to rally.”  The connection between bank reserves held at the Fed and stock prices has long been a favorite topic of conversation on Wall Street, yet we think that the apparent correlation may be coincidental. We asked Bill Nelson  at the Bank Policy Institute  about the connection between stock prices and bank reserves. His reply: “ I can’t think of any reason why reserve balances and stocks would be correlated.  Can you?” No, we can’t.  The chart above from FRED shows yields on T-bills ( red) vs Reverse Repurchase (RRP) agreements with the Fed ( blue ). Obviously the yield on T-bills is significantly above RRPs. Big question is whether the FOMC will maintain the yield differential on RRPs vs T-bills as a floor on rates rather than a ceiling, as was the case for many months. White is correct that the Treasury’s decision to focus new issuance on T-bills helped to reduce the number of money market funds purchasing RRPs from the Fed. He is also correct that when the Treasury spends cash from the sterilized TGA, it results in a net-cash injection into the banking system as payments are received throughout the economy. Again White: “Funding much of the deficit using bills as opposed to longer-term debt has allowed money market funds (MMFs) to absorb the new supply of government debt. The Fed's higher-for-longer message has kept the rate on bills higher than the rate on the reverse repo facility (RRP), meaning that MMFs have been incentivized to draw down on the RRP to buy bills.” Under the Volcker Rule banks cannot buy securities directly using reserve cash except for LT treasury investments. These treasury holdings are entirely passive, one of the more bizare downsides of the Volcker Rule that reduces market liquidity. In The IRA Bank Book , we note that bank securities holdings fell more than 10% in Q3 2023 alone. Since more than 90% of the assets of most banks belong to a customer and industry assets are shrinking, only the holder of a bank liability  can actually convert bank reserves into an equity investment. With banks, all things start with the liability, not with the assets. Thus only bank customers/depositors, who have a claim on the reserve asset cash, can buy stocks in a meaningful way. We queried White about the causal link between reserve growth and equity markets and he kindly replied over the weekend: “Reserves have a balance-sheet cost associated with them, so there is an incentive for banks to do something with them. Even more so recently as the GSIB buckets are decided towards the end of the year (they were announced last week I believe), so banks want to make sure their surcharge is limited.They can consider secured or unsecured lending surplus dollars, eg repo or FX swaps, or funding eg equity future basis trades, etc. FX swaps have been coming in, suggesting some of the new supply of dollars has been lent offshore, but this is becoming less lucrative. So they can also fulfill client demand for buying equity futures, by selling them to them, using the dollars to fund a long in the cash market. Facilitating a natural demand for long equity positions (eg start of month) can gain its own momentum. Overall, the rise in reserves should be equivalent to the rise in reserves from QE, with one of its aims to reduce risk premia through the portfolio effect. But I think the above helps explain how the effect can be pretty much immediate when there's a sudden rise of reserves to the system. This would tie into your t-bills/S&P point, but again I'm not sure that fully explains the immediacy of what happens.” Does this answer the question? Not really. While the return of funds from the sterilized confines of the Fed’s balance sheet to T-bills definitely represents a significant increase in liquidity, the amount of Buy Side cash that has been parked on the sidelines over the past two years is also quite large.  Indeed, every time that officials of the FOMC say that it is too soon to conclude that tightening is over, the bond market rallies. and so do stocks. “Jerome Powell probably did not mean to trigger a significant easing of financial conditions on Friday, but that’s exactly what he did,” wrote Jim Bianco  on X  over the weekend. “The chairman of the Federal Reserve gave a talk today at Spelman College in Atlanta in which he declared that it was ‘premature’ to conclude that monetary policy was ‘sufficiently restrictive’ or to speculate on when the central bank might start cutting rates. He even added that the Fed is prepared to tighten further if needed. The market’s reaction was a flat-out rejection of that idea.” Whether we attribute the rally in stocks to rising reserves due to expenditures from the Treasury General Account or the vast piles of cash on hand among Buy Side managers, the fact is that the inflation injected into the financial system by the Fed has impacted the effectiveness of US monetary policy.  We have a solution for the Fed's messaging problem. Instruct the FRBNY to at least hit the $35B cap on MBS runoff every month from the System Open Market Account. That is, actively sell MBS. As rates fall and MBS prices rise, the Fed should be selling MBS into market strength. Seling more MBS will accelerate the normalization of the yield curve. The FOMC is already losing trillions. Time to double down. Inflation has skewed the investment risk preferences of funds and other nonbanks to such a degree that private credit seems attractive. Going long credit at the top of a LT cycle in asset prices strikes us as a profoundly bad idea. We’ve heard from a number of fund sponsors seeking to enter the world of private credit in the past month and there will no doubt be more.  The common refrain from the large mutual fund managers seeking to stand up a credit trade is that “there is so much cash looking for a strategy.” Very true. When the credit trade goes sideways a year or two from now, however, please do remember that funds and nonbanks have no comparative advantage in managing credit risk compared with a commercial bank. Meanwhile, we note that the Bitcoin ponzi has reached $40k, the highest levels seen since last year. The resurgence of Bitcoin is a fascinating phenomenon, but as we wrote last week, regulators in the G-20 nations are increasingly treating crypto as a legal and compliance problem that triggers anti-money laundering and know-your-customer conserns. No thanks. More notable, in our view, is the rise in gold prices, which is due to a shift in Asian risk preferences from Treasury debt to gold. One long-time reader named Henry, who manages an offshore gold fund, wonders if gold is not slowly going to supplant the dollar and Treasury securities as the prefered risk free asset. With gold, Henry notes, there is no counterparty risk and price discovery in gold has now shifted to Asian markets dominated by China. We'll be looking at how the Treasury's strategy to fund its mounting deficits with T-bills is helping Jay Powell out of his RRP problem but is also forcing offshore counterparties to seek out substitutes like physical gold. You can use gold as collateral in an ISDA swap. Yellen's clumsy management of the Treasury's funding needs is undermining the dollar and setting the US for a funding crisis down the road. Finally, we note the bankruptcy of Rene Benko's Signa Holdings , an Austrian based real estate developer that provides a lovely example of the Basel III concept known as Exposure at Default. Exposure at Default (EAD) measures unused but committed credit lines banks make available to consumers and business. These bank lines are committed and may be drawn at any time. The debt of the Signa group held by some 200 lender banks ballooned in the months before the default, illustrating that committed but unused credit lines can be a significant source of risk for banks. For every $1 of loans held by US banks, there is another $0.80 of unused commitments that can be drawn by the obligor at any time prior to bankruptcy. Sad to say, banks rarely cut unused lines in time to avoid a loss after a default event. Source: FDIC The level of EAD in the industry is over 80% of total loans and illustrates the current high risk appetite of banks. Since the COVID crisis, US banks have added $2 trillion in unused credit lines. Despite worries about an imminent consumer recession, banks remain aggressively positioned with almost $10 trillion in undrawn credit vs $12.4 trillion in total loans. Even with the current carnage in multifamily and commercial real estate that we document in this issue of The IRA Bank Book for Q4 2023 , the great asset price reset for stocks and residential homes is still a couple of years out. Maybe Treasury Secretary Yellen will return to the private sector by then, leaving the mounting mess in the Treasury debt market for some one else to manage. Subscribers to the Premium Service  of The Institutional Risk Analyst  login to download the latest version of The IRA Bank Book for Q4 2023 below. 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.