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September 7, 2023 | Premium Service | Over the past 6 weeks, US financials have given back much of the ground covered earlier in the year. JPMorgan (JPM) peaked at $157 around the end of July and has headed downhill along with the rest of the group. Meanwhile in the world of fintech, two of the high-beta names in our surveillance group are floating ever higher on the hype regarding AI and show no concern regarding the economy or credit or mediocre financial results. When you are in a big crowd, nothing else matters. Source: Bloomberg (09/06/23) Back in April we noted that Affirm Holdings (ARFM) and Upstart (UPST) were both trading at a steep discount to the rest of our fintech surveillance group. Right on schedule, the entire tech complex led by Nvidia (NVDA) began a frantic climb upward that ran through the end of August and then continued. It’s not that either firm has a particularly good results financially, but this does not prevent the inhabitants of the Sell Side analyst community from pumping the stock. UPST's was up almost 150% YTD at yesterday's close. AFRM’s public valuation has basically been moving upward in hockey stick fashion as the Sell Side analyst community put all of its weight behind the stock. The key to understanding stocks such as AFRM, UPST and SoFi Technologies (SOF) , which became a bank in 2022, is that the conversation is about tech, volumes and customer conversion, and not conventional financial performance. Just as the crowd pushed up stocks like Block (SQ) in part years, this surge in valuation is about Buy Side managers seeking tech exposure. Notice that SOFI is up 80% YTD, but SQ is actually down. As one manager noted to us last year, becoming a bank helps these former tech darlings lose their luster. Notice that UPST and AFRM trade on betas above 3x the six month average market volatility calculated by Bloomberg , roughly twice the rest of the group. With AFRM, the Street analysts have convinced themselves that issuing new credit cards is the path to value, but we keep looking at the rising portfolio of loans held for investment by this nonbank finance company. It was not too long ago that the likes of AFRM and UPST got slapped around pretty hard by analysts when they first disclosed to investors that they were retaining rather than selling loans. In an originate-to-sell model, retention is always bad. But obviously Buy Side managers have become comfortable. The chart below is from AFRM’s Q2 2023 disclosure. The last earnings call (FY Q4 for AFRM) saw CFO Michael Linford setting the stage for AFRM’s business model pivot by noting that the firm’s retained portfolio had grown significantly, generating more income as loan coupons have also risen. He then dropped the bomb, but nobody on the call reacted. Nothing. “What's important, from our perspective, is the ability to do that at the point of sale. And to do that in a way that doesn't impact conversion really reflects our true technology leadership in a way that I think is pretty difficult for other people to match. With respect to the forward-flow program, or selling whole loans, it is definitely the case that the volatility in the macroeconomic conditions definitely changed the mix of business that we were doing with respect to on-balance-sheet or off-balance-sheet loan funding. That being said, the tone and tenor of conversations with capital partners today is very constructive. We have really differentiated credit performance. That's something that I think loan investors really appreciate about our platform.” The credit performance of the AFRM paper is OK, somewhat north of Ally Financial (ALLY) in terms of delinquency but below CapitalOne (COF) . The chart below shows the delinquency of the various vintages of AFRM paper excluding fallen angel Peloton (PTON) . Notice that the delinquency rate on the 2020-2021 vintages produced during QE is well-below the other cohorts. Of course AFRM is continuing to report large GAAP losses, although the company steers investors to its adjusted results. For AFRM, the point is growing users and getting those users to choose their card so as to capture a “fair share of donuts and coffee.” Yet we feel compelled to point out that ARFM’s operating losses, which more or less equate to the equity award expense for insiders, have grown with revenue rather than being reduced. But, again, the Buy Side is apparently comfortable. If you go to the last page (49) of the earnings supplement, the reconciliation from GAAP to the “adjusted” results used by AFRM management in their communications with investors lays bare the charade. Of $2.8 billion in revenues, AFRM subtracts $130 million in depreciation and amortization, $450 million in stock based compensation for insiders, $500 million in “Enterprise Warrant & Share Based” compensation for partners such such as Amazon (AMZN) , and $43 million in restructuring and other expenses. The result is a $1.6 billion “adjusted” expense number. The relevant table is below. Clearly the Sell Side analyst community is comfortable with the fact that commercial partners and management are taking hundreds of millions of dollars per quarter in value out of AFRM in return for whatever consideration. With US tech stocks now selling off more broadly, the peak valuation for AFRM this year of ~ $7 billion may come under pressure. China’s decision to ban the use of Apple (AAPL) iPhones and other factors may take the air out of aspirational stocks such as AFRM. But more to the point of the mania clearly present in stocks with even a hint of technology influence, if you get big profits in a short-term move that seems irrational, take the money off the table. When we took a more than 200% LT gain in Nvidia (NVDA) after it rose above $400 a month ago, we watched as our remaining taxable stake almost touched $500. We felt some remorse, but we also like the pile of cash sitting in T-bills. 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.

… It's the end of the world as we know it It's the end of the world as we know it It's the end of the world as we know it and I feel fine REM September 5, 2023 | A couple of weeks ago, when China Evergrande filed for bankruptcy in the US, many observers started to ponder what seemed like China’s Lehman Brothers moment, when the decision was made to allow a large issuer of debt to default. Now China Garden , the country’s largest developer, has narrowly missed a default on dollar obligations, but the company’s debt is trading for pennies on the dollar. Stay tuned as China’s dollar ponzi scheme implodes. Meanwhile in Washington, the grand parade of mediocrity continues apace. This week the FDIC hopefully will release the US bank data and peer metrics for Q2 2023, a week late. The data has actually been compiled and completed for weeks, but the FDIC, Federal Reserve Board and other prudential regulators drag their feet. Why? Because the largest banks want to make sure that investors don’t pay attention to the detailed financial data and metrics. Barring further delays, we’ll be releasing The IRA Bank Book for Q3 2023 next week. Meanwhile in the credit channel, a number of analysts and media are getting positively fussed and bothered about rising levels of delinquency on credit card and auto loans , two of the largest categories of consumer credit after 1-4 family mortgages. This is part of a false narrative that is literally oozing up from the ground that says the US economy and especially consumers are headed for the worst credit default event since 2008. Really? Looking at the data, however, the headline in the New York Post seems to be completely wrong. But this is not the first time. As we noted in previous posts, we are worried about the volatility of bank credit , but consumer credit is way, way back at the end of the line in terms of urgency. Commercial real estate and related exposures are clearly bigger problems, followed by commercial bank loans on government-insured residential mortgages and Ginnie Mae MBS. But the conflicted political and media narrative seems instead focused on how rising interest rates impact consumers. Oh me, oh my. If we look at the data from S&P Experian , the latest release simply does not support the idea that consumer defaults on auto loans and credit cards are about to explode. Quite the contrary. The S&P/Experian Auto Loan Default index is shown below. As the chart suggests, defaults on auto loans are still tracking significantly below historical levels going back a decade. Note the sharp decline in auto loan delinquency during the period of QE. Will auto loans now rise above the 10-year average? Possibly. But we are not in an existential consumer credit crisis quite yet. Frankly, the New York Post should retract this story. Auto loan delinquencies reported by banks are up, but hardly in a way to cause the markets to go “risk off” on financial stocks. The herd mentality of Wall Street is so strong that we apparently have decided to equate “high for longer” on short-term interest rates with the 2008 subprime mortgage collapse? Looking at JPMorgan (JPM) , net losses on auto loans were just 41bp in Q2 2023 vs 15bp a year ago during QE. The average net loss on auto loans for the 140 banks in Peer Group 1 was just 41bp. Is there a crisis here somewhere? Total bank-owned auto loans are about $500 billion or one-third of the $1.5 trillion in total auto loans. The $1 trillion of subprime auto loans are mostly sold into heavily over-collateralized asset-backed securities (ABS) held by bond investors. These ABS have performed extremely well in 2008 and through the COVID lockdown, with the ratings of specific deals often upgraded as the ABS matures. So while defaults on subprime auto loans are significantly higher than bank owned loans, investors rarely take a loss. " While there were some rare instances of speculative-grade (rated BB+ and below) subprime auto ABS which took losses through the Global Financial Crisis, bonds rated investment grade (BBB- or better) were able to weather the downturn," Laura Mayfield of Ft Washington Investment Advisors wrote last August . "This remarkable performance through the most severe economic recession since The Depression is widely regarded as having validated the modern-day subprime auto ABS model." Consumers are defaulting on car loans in growing numbers, but like 1-4 family mortgages, the biggest (indeed, only) spike is among subprime borrowers. Borrowers who have credit scores of 600 and below are defaulting on subprime car loans and, yes, FHA and VA mortgages, but the rest of the credit stack is barely moving. Moving to the broader view of consumer credit, the New York Post report again seems to be in error and very deliberately. While the report references the S&P Experian data, in fact the chart below shows that defaults on consumer credit exposures are still tracking below pre-COVID levels and are nowhere near 2008 levels or even a 10-year high. Now there may be some people in the media and among the hedge fund mafia that want you to believe that consumer credit is about to collapse, but the data from the credit agencies and banks do not yet support this pessimistic view. Some consumers may be “struggling,” to borrow one tired media cliche, but default rates on credit cards are nowhere near 10-year highs. One of our favorite “oh no” media headlines involves the fact that credit card receivables are climbing above $1 trillion. This is actually a positive for US banks, which charge well into double digit rates on credit card assets. JPMorgan’s net default rate for credit cards was just 2.3% in Q2 2023 vs 3.3% for Peer Group 1, but as the chart below suggests, we are miles away from a 10-year peak much less anywhere near 2008 levels of default. Source: FDIC Fans of the false impending collapse of consumer credit narrative should not be impressed by the fact that credit card outstandings are above $1 trillion. Rather, the more astute members of the media and hedge fund community should focus instead on the fact that credit card utilization is just barely 25% of the $4.4 trillion in unused total card capacity . This is what we call “exposure at default” under Basel I. Duh. Source: FDIC So if tomorrow morning, every American with a credit card maxed out their credit lines and then immediately filed bankruptcy, that would be a financial crisis. But sadly for the bears in the audience, that is not likely to happen. Indeed, nothing would make the banks happier than if consumers would use more credit. Don't hold your breath waiting to read that in the mainstream media. The Institutional Risk Analyst (ISSN 2692-1812) is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

September 1, 2023 | Premium Service | As Labor Day 2023 arrives, investors, risk managers and just plain folks are confronted by hungry monopolies on one side and predatory politicians on the other. The Fed has engineered what may become the mother of all credit cycles, this even as prudential regulators prepare to radically increase bank capital requirements (and decrease leverage and profitability). Really can't make this stuff up. Meanwhile, the largest Buy Side ”passive” fund sponsors now control as much as half of the daily flow in US equities, according to several researchers , and essentially act as a permanent source of stock price inflation, at least for indexed stocks. The ability of the passive fund sponsors to push equity valuations is hardly a new revelation, yet in the conflicted world of American equities the fact hides in plain sight. On Wall Street, nobody has any clothes. Republican presidential candidate and tech entrepreneur Vivek Ramaswamy claimed financial investment giants BlackRock, State Street and Vanguard "represent arguably the most powerful cartel in human history." So true. Former South Carolina Governor Nikki Haley compares Ramaswamy to AOC, a frightening possibility, yet he is clearly in step with the times. But we digress. Even with the active connivance and conspiracy found so easily on Wall Street, the largest banks have been giving up ground all month. Bank of America (BAC) is down double digits, as are PNC Financial (PNC) and NY Community Bank (NYCB) , but the last is still up 25% for the year. Citigroup (C) is likewise down mid-teens and is approaching 0.4x book value? Our bank surveillance group is shown below. Source: Bloomberg (08/31/23) Last week we had the latest in a series of conversations with analysts and fund managers who asked: What happened to Citi during COVID? The opinions are varied. Yet even with the powerful gravitational pull of the great Black Rock (BLK) /Vanguard long only conspiracy posited by Michael Green and others, the unsleeping goddess piloted by CEO Jane Fraser staggers from one restructuring effort after another with no resolution in sight. If you compare Citi with JPMorgan (JPM) , for example, it is pretty clear that the former stock took a torpedo during COVID and never recovered. Vanguard, BLK and State Street (STT) are naturally the largest holders of Citi, but that has not helped the stock even as positions in these passive sponsors have increased and institutional ownership grows. Passive investing means buying the good with the crapola apparently, but as Green notes, are any funds truly "passive?" Notice in the chart below that Citi still follows the large cap bank herd, but the movements are truncated and muted, especially on the upside. Notice also that the beta on Citi is just 1.1x the market average volatility, which means nobody cares either way. And even as the institutional holdings in the stock have actually grown over the past year, Citi continues to wallow like a fully loaded oil tanker. Source: Google Prince Alweed bin Talal is still a shareholder of Citi, at least according to Bloomberg , but apparently the amount is so small that it does not require disclosure. Several decades back, the Saudi Kingdom reportedly saved Citigroup by moving funds from a deposit account to equity, but those days are long gone. Indeed, the only SEC ownership disclosure document for Kingdom Holding for the past five years seems to be a 6% stake in BDC Hercules Capital (HTGC) . Why are banks under pressure? First and foremost, higher interest rates for longer means that credit is likely to become a significant factor in earnings after more than five years of free ride ℅ the FOMC. As we noted in our last comment, QE had the effect of pushing down loss given default across most asset sectors. Sadly the delightful joy juice is wearing off now and credit costs are likely to figure in bank earnings going forward. The second, related reason for the weakness of bank stocks over the last month is the prospect of new regulations via the latest Basel capital proposal. The new rule will raise capital requirements for large banks some 20% and increase the risk weighting for 1-4 family loans to prohibitive levels. The proposal is so radical that it has caused a diverse coalition of groups to come together to defeat the new Basel proposal. “This unnecessary proposal will increase borrowing costs and reduce credit availability for the very consumers and borrowers this administration ostensibly seeks to assist,” said Mortgage Bankers Association President and CEO Bob Broeksmit . “Experience with such significant capital changes tells us that equity markets will react immediately, and banks will respond to that pressure in real time, long before the final rule is issued.” More, the latest rule proposed by federal regulators will impose GSIB-like regulatory requirements on banks down to $100 billion in assets. These institutions will be forced to issue debt at the bank level to offset the potential cost of resolution to the FDIC, further weakening the claim of equity and debt holders at the parent bank holding company (BHC). If a bank has 6% debt to assets, what is the equity of the parent BHC worth? Given this latest rule proposal, should all large US banks simply shed their BHC and adopt a unitary bank model? GSIBs already issue debt at the bank level, subordinating the equity and debt holders of the parent BHC to the depositors and the FDIC. Given the Basel proposal from the Biden Administration, why would any investor want to hold BHC debt vs the debt of the subsidiary bank? The latest proposals from US regulators will have the effect of throttling access to credit at precisely the time when banks are already stepping back from many markets and credit exposures. Less credit availability means more defaults and more losses for banks. In past decades, federal regulators understood the connection between credit availability, default and market contagion. No longer. Today US regulators seem more concerned about their own personal and bureaucratic convenience than in serving the needs of consumers and the nation. Consider the political message of the Biden Administration to US consumers, especially low-income families. You can deposit your savings in a large US bank like JPMorgan, but that same bank cannot give you a mortgage to buy a house. Basel runs the risk of appearing to be explicitly racist in progressive Washington. Just ask the folks at FICO . "When consumer/civil rights advocates & industry stakeholders align on an issue, you should listen very, very closely to what they’re saying & why they’re saying it—and don’t disregard the nuances," notes mortgage industry leader Eric Kaplan . But we fear that federal bank regulators are in a panic over the bank failures in Q1 2023, thus their natural tendency is to make things worse. Whether you are an investor in a bank with FDIC insurance or an independent mortgage bank facing Ginnie Mae as guarantor, your property rights are qualified by the legal power of the sovereign. As federal regulators try to protect themselves from the public embarrassment of further bank failures, they are alienating equity and debt investors and making more bank failures increasingly likely. Happy holiday. 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.

August 28, 2023 | For several years now going back almost a decade, we’ve pondered the net, net impact of artificially increased asset prices on the volatility of credit. This is not the volatility measured by the VIX, mind you. The Chicago Board Options Exchange's CBOE Volatility Index is a measure of the stock market's expectation of volatility based on S&P 500 index options. But this is not the volatility that worries us. The Oxford Dictionary defines volatility as the "liability to change rapidly and unpredictably , especially for the worse." The volatility that concerns us is the after-effects of a decade of market manipulation by the Fed and other central banks, which lowered visible rates of credit default by temporarily boosting asset values. One of the more frightening revelations in this regard came in the past week from Fed Chairman Jerome Powell during the annual meeting at Jackson Hole, WY: “ As is often the case, we are navigating by the stars under cloudy skies. At upcoming meetings, we will assess our progress based on the totality of the data and the evolving outlook and risks. Based on this assessment, we will proceed carefully as we decide whether to tighten further or, instead, to hold the policy rate constant and await further data.” The statement above by Powell about stars and clouds is scary. First, it suggests that the FOMC adjusts policy based upon the relative assessments of short-term changes in data and risk – a recipe for a repeat of the December 2018 disaster. This is the equivalent of the pilot of an Airbus A321 telling the passengers that the radar and automated landing system are unnecessary on a foggy evening. Somehow promising to "be careful" while navigating by the stars does not quite cut it. Second, this remarkable confession clearly reflects Powell’s worry about past missteps and the impact of those decisions on the Fed LT as an independent institution within the Executive Branch. Third, it confirms that Powell and other FOMC members have no idea how to measure or benchmark changes in interest rate targets vs bond sales, much less unwind the Fed’s $8 trillion balance sheet. Given the huge increase in the now $33 trillion federal debt under first President Donald Trump and now President Joe Biden , the Fed may never be able to significantly reduce the size of its balance sheet. The chart below compares the Fed's balance sheet, including system open market account (SOMA), with the US banking system. As we’ve noted previously, the FOMC’s decision to “go big” in 2019-2021 ties the Fed’s hands today in terms of fighting inflation. If the FOMC was selling $50-100 billion per month in mortgage backed securities, then mortgage coupon rates would be over 8%, home prices would be falling slowly, liquidity would be reduced and there would be no need for further short-term interest rate hikes. And BTW, the markets could easily absorb the SOMA assets. But a chastened Chair Powell is not selling. Nick Timiraos of the Wall Street Journal precisely summarizes the fact that central bankers cannot quantify any of the key benchmarks of current monetary policy beyond metaphors about stars and clouds. The chart below shows the inversion of the Treasury two-year and ten year notes from FRED. When the VIX measures future expectations of market volatility, it captures the worries of a marketplace that is pathologically bullish and rightfully so given the true underlying inflation rate in dollars. The reason that Buy Side managers seek 20% annual returns or more on alternative strategies is that public equity and debt markets barely offer real returns. But the VIX does not measure the increased volatility observed in economic and financial variables due to QE. No, the volatility we worry about is also impacted by inflation, but goes to the issue of loss given default (LGD) on credit. Readers of The IRA are familiar with our Basel I era measures of post default loss we calculate for banks. Charge-offs less recoveries gives you a measure of loss severity (and management efficacy) that is very valuable when assessing a bank, for example. The wider measure of LGD across the spectrum of secured lending, however, provides a striking measure of the equity left in a given distressed asset or portfolio. The chart below showing LGD (aka "net loss") on $12.2 trillion in bank loans illustrates the profound impact of Powell's decision to "go big" with QE on realized losses. Source: FDIC/WGA LLC Goodman and Zhu (2015) note that outside of the world of mortgages, there are few studies on loss severity (the percentage lost in the event of default) because of limited data. Gathering the actual losses post default on bonds or privately held commercial real estate, for example, is difficult and expensive because of the cost of acquiring and aligning the data. Yet anecdotal evidence suggests that LGD on leveraged buyouts are rising and surprising event veteran participants. “In previous default cycles, leveraged-loan providers would expect to get 70% to 80% of their cash back from failing companies,” writes Lisa Lee of Bloomberg News regarding a leveraged loan loss by KKR & Co (KKR) . “Those days are over.” GenesisCare was an international cancer treatment company backed by the private equity firms KKR and China Resources Group. Earlier this year Genesis Car e filed for bankruptcy under Chapter 11, with reorganization plans to sell its 130 U.S.-based practices. Lee reports that KKR could take as much as 80% loss on debt to GenesisCare. This is a far higher loss severity that experienced a decade ago, suggesting that there is significantly less equity under later vintage deals. Through a 2020 merger with 21st Century Oncology, which had filed for bankruptcy in 2017, GenesisCare took on debt, as well as outdated technology and equipment, according to the bankruptcy filing. “It’s yet another financial weak spot exposed by the end of the easy-money era, as tighter credit pushes over indebted businesses toward the brink,” writes Lee. “While some investment banks hope for a softer economic landing than feared, the crash in leveraged-loan recoveries is ominous for lenders.” In a major study on LGD for corporate exposures of failed banks conducted by the FDIC, Shibut & Singer (2015) place the loss as a percentage of total exposure at default (EAD) around 40% and the percentage of the total loss closer to 80% for commercial and industrial loans (C&I) and construction and development loans (C&D). Our proprietary measures for LGD for these two bank asset classes are below. Notice that LGD for C&I loans has normalized, but C&D loans were still below average net loss at 50% in Q1 2023. Source: FDIC/WGA LLC Source: FDIC/WGA LLC According to Equifax (EFX) , 90+ day delinquent auto loans nationally are back at pre-COVID levels, but interest rates are far higher than they were in 2019. If the historical connection between employment, interest rates and consumer loan defaults is still valid, then we should expect to see default rates on auto loans and consumer loans move higher. Source: Bloomberg More to the point, most credit exposures other than 1-4 family loans are likely to see above-average loss rates as the US economy slows. If we assume that Chairman Powell is ready to sacrifice a quick victory over inflation in favor of hiding past mistakes through deliberate inaction (aka "caution"), then we may see loss rates start to approach 2008 levels in some asset classes. The volatility of changes in credit loss rates is perhaps among the most pressing question facing the FOMC and the one you can be pretty sure has not been discussed around the big table. "Major U.S. department stores including Macy's (M) and Nordstrom (JWN) are flagging delays in store credit card repayments, another risk to revenues as consumers pull back from discretionary spending ahead of the crucial holiday shopping season," Reuters reports. Macy's disclosed last week that rising delinquencies cut credit card revenues to $120 million in the second quarter, down $84 million from the previous quarter. Nordstrom's credit card revenues rose 10% in the first half of this year, but the company executives that delinquencies are now above pre-pandemic levels and could "result in higher credit losses in the second half and into 2024." Below is the chart from The IRA Bank Book showing LGD for bank-owner credit card receipts through Q1 2023. The FDIC should release the Q2 data and peer group information this week. Notice how the Fed's market intervention pulled down net losses and the 40-year average loss rate. So here's the question: How much higher will these numbers go? Could we go back to 2009 levels of net loss? Yes we can. Source: FDIC/WGA LLC The Institutional Risk Analyst (ISSN 2692-1812) is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

August 24, 2023 | Premium Service | Over the past several years, The Institutional Risk Analyst cataloged the credit and operational issues a t Goldman Sachs (GS) . We’ve noted that the ultra-high net worth customer base at GS was not the same crowd that were causing the alarming credit losses. Say what you want about the madness of crowds, we think GS deserves to be trading closer to Citigroup (C) at 0.4x book than to JPMorgan (JPM) at 1.5x book value. We published the chart below back in June of 2023 (“ Update: GS, MS, SCHW, RJF & SF ”). Notice that Charles Schwab (SCHW) is crawling along the bottom of the chart in terms of net credit losses. Source: FFIEC Some of our readers think that SCHW is a good short trade, but we think it is merely expensive. While Schwab is an amusing situation, the retrenchment at GS is significant for several reasons. First, the retreat from an organic growth strategy is going to put pressure on the stock and on the BOD to fashion a new plan. Since it is obvious that GS has no skill at commercial banking, as opposed to trading and doing deals, does retaining the bank charter model still make sense? Most of the GS business is regulated by FINRA and SEC rather than the bank regulators. Why is Goldman Sachs a bank? If we assume that GS will refuse the idea of a bank acquisition, will they give up the banking license? The second issue faced by GS leadership is what to do with the business long term. Given the global shakeout in asset gatherers, the winners in the group include UBS AG (UBS) , Morgan Stanley (MS) and SCHW. GS and Citi are the two also-rans among the asset gatherers group, the least well-positioned of the investment banks. Does it make sense to combine these two laggards and rationalize the institutional market share? There are few other partners on the dance floor for either firm. Some key metrics from both firms are shown below. Source: FFIEC These two firms are very dissimilar, but also have some notable similarities. Both have relatively high funding costs and finance a large portion of their businesses in the institutional money markets. Both lead with capital markets and both are globally focused in terms of market. And each have significant pieces like payments and consumer lending for Citi and investment banking at GS that the other partner lacks. We continue to believe that combining Citi and GS may make sense in terms of consolidating two capital markets businesses and two small asset management businesses that are dwarfed by the other players. Citi has half a trillion in core deposits and a payments platform that is worth more than the rest of the business – all trading at less than half of book value. Call the bank Citibank, call the broker-dealer Goldman Sachs and think of a good name for the survivor. Citi CEO Jane Fraser is in the process of restructuring Citi yet again, perhaps creating an opportunity for a real solution to a decades old problem. “Putting [Fraser] in closer contact with operating units gives her an opportunity to assess their business directly," Dick Bove told Bloomberg . "The fact that this needs to be done after 53 years of reshaping and restructuring is quite frankly very discouraging." We concur. Meanwhile, going from the sublime to the ridiculous, Softbank portfolio company Better.com (BETR) has completed its merger with SPAC Aurora. When people ask why Softbank went ahead with Better.com listing, our supposition is that the Japanese fund is actively liquefying the entire Softbank portfolio. Given the losses realized to date, there is little downside in proceeding. Q2 earnings for BETR have yet to be released, of note. “Better.com, the young mortgage fintech started by former Morgan Stanley (MS) employee Vishal Garg , completed its merger with “blank check” company Aurora Acquisition Corp. and expects the combined entity’s stock will begin trading on the NASDAQ Thursday,” Inside Mortgage Finance reports. “SoftBank and NaMa (formerly Novator Capital) are Better’s sponsors.” Until there is an interest rate decrease by the Fed on the horizon, it will be hard to generate attention for the BET stock. The same could be said of a possible spinoff of NewRez by Rithm Capital (RITM) . As we noted in our Housing Finance Outlook , we could be in an extended period of stable interest rates at levels 3-4 points above the average 3.6% MBS coupon today. This is a very difficult market for lenders and investors alike. “Mortgage desks continue to face challenges pricing coupons that do not exist,” writes Adam Quinones . “Definitely getting lots of questions on hedging liquidity in the mortgage market. This tends to happen when the curve bear steepens in size. Traders are now trying to make prices on 7.0% coupons and they're basically flying blind. Slow migration up-the-stack so far but there's been a clear shift in pricing recipe weightings. The benchmark pricing coupon is actively moving from FNCL 5.5s to FNCL 6s and 6.5s.” Speaking of RITM, there seems to be an auction developing for Sculptor Capital (SCU) . A group of investors made a rival bid for the company at $12.25/share, this in an effort to break up the deal announced late last month for Rithm to acquire SCU at $11.15. The SCU transaction is important to RITM’s plan to transition from a focus on residential mortgages, but as noted above, we don’t think a spinoff of NewRes is possible in the current environment. “The preliminary proxy filed by SCU on Monday details the competitive bidding process leading up to the RITM acquisition,” writes Eric Hagen at BTIG , “which included a number of offers above $11.15, but with more subjective terms, which leads us to believe the valuation alone might not be enough to break up the deal.” Another banker thinks that the Sculptor deal has been well received by the markets and has helped RITM's market value. With the 10-year trading close to 4.25%, federal regulators need to prepare for some ugliness in bank earnings disclosure for Q3 results five weeks out. Members of the FOMC seem to be comfortable with another rate hike in September, but there is also a growing consensus that interest rates cannot go any higher without the risk of serious dislocation. With the average mortgage coupon around 3.6% now, a 6% SOFR rate is pretty daunting. Federal Reserve Chairman Jerome Powell is expected to set future expectations this Friday “as policymakers enter what he’s called the most difficult stage of the inflation fight — calibrating how much more tightening is needed, with little certainty about how their actions have affected the economy so far,” writes Catarina Saraiva of Bloomberg . We'll see. Markets are declaring the inflation fight over, but we are not so sure. The key problem in assessing future Fed policy is that neither Powell nor the other members of the FOMC have a good metric for gauging how a given interest rate change or increased bond sales would impact the markets. As a result, other than hiking short term rates up to 6%, we do not expect much deviation from the current script from Powell. 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.

“How did you go bankrupt?" Two ways. Gradually, then suddenly.” ― Ernest Hemingway, The Sun Also Rises August 22, 2023 | This week, The Institutional Risk Analyst is on the west coast, spending some quality time with one of the leaders in the world of jumbo mortgages. Over the weekend, we got a classic note from a longtime reader named Alan, who knows a few things about markets and also politics. “China is melting” was the headline. “The yuan is looking like it is about to collapse,” he continued. “That makes all the raw materials China imports more expensive.” We agree. But notice that the yuan is hardly a freely-traded currency, as shown in the chart below from FRED. That flat blue line running along the bottom of the chart is the yuan. Markets and media are fussing about an active “defense” of the yuan mounted by the People’s Bank of China , but the Chinese currency is as stable as a cold dead corpse lying in Tiananmen Square. Compared with the Japanese yen or the dollar, the yuan is an irrelevancy. And there seems little question that the yuan and China are greatly overvalued. Operating behind what is effectively a fixed currency, China has been on a debt-fueled journey over the past decade. This is a familiar process to students of China. The communist nation absorbs resources from overseas during a period of supposed “opening,” followed by an equally long period of political retrenchment and economic contraction as access to foreign finance is withdrawn. Offshore investors are the dupes in this narrative. The yuan is monumentally overvalued given the true hidden financial and economic weakness of the Chinese state. China's debt $14 trillion in debt as a percentage of GDP is 3x the United States and, more important, has exploded over the past year, increasing over 40% during 2022. But here's the key question: How big is the Chinese economy, really? Over $100 billion of China property debt has defaulted over the past two and a half years, according to JPMorgan (JPM) . Prior to Country Garden , CNBC reports, China's property sector already chalked up $109 billion in defaults since the beginning of 2021, which is 94% of total defaults in Asia during that period. Note that Beijing is defaulting on the dollar debt, but supporting local currency debt. Our view is that China has experienced a debt crisis since before the collapse of HNA, an allegory for Chinese society today under communist party misrule. In “ Great Leap Backward, ” Liu Binyan and Perry Link wrote 30 years ago in The New York Review of Books : “Most of the good news from China during the Deng Xiaoping era concerned the country’s economy. It grew at an average annual rate of 10 percent from 1981 to 1991, and 12 percent from then until 1995. Average personal income more than tripled in the 1980s, and doubled again in the first half of the 1990s. Some Westerners were dazzled. In November 1992, The Economist referred to “one of the biggest improvements in human welfare anywhere at any time,” and six months later Business Week told of “breathtaking changes…sweeping through the giant nation.” Foreign corporations, eager to be part of the China boom, poured investment in at record rates. China’s foreign currency holdings soared.” The creation of HNA in 1993 came in the same year as the start of the Three Gorges Dam project, a massive state initiative that showed the power of the Chinese Community Party to direct – and misdirect – economic resources on a global scale. But the growth of HNA into a symbol of Chinese economic power also involved the active assent and permission of the CCP. Beijing opened the currency window to foreign direct investment on a scale that would make even the most reckless Tokyo speculator blush. Back in 2017, when we resumed publication of The Institutional Risk Analyst , we focused on HNA because of our previous experience at Kroll Bond Ratings. About a year before, a new aircraft lessor called Avolon had arrived on the doorstep, seeking to be rated for the global market in secured aircraft leases. Based in Ireland, Avolon was a copy of the proven celtic model for aircraft leasing, but was owned and controlled by HNA. Around this same time, HNA started opening offices around Manhattan and hanging their logo on the sides of office buildings. In fact, HNA put their logo on an office building across Third Avenue from Kroll’s offices. HNA purchased a large corporate conference center across the Hudson River in Nyack. HNA officials hosted vast parties in the most expensive Manhattan eateries. In 2017, there was little information about HNA other than the fact that it was from China and at least indirectly supported by Beijing. The fact that the Chinese company was acting in such an ostentatious, ill-considered manner suggested instability, but at nobody in the world of finance seemed to care. Like fascist Nazi Germany a century before, authoritarian China was the wonder of the world and its corporate progeny could do no wrong. Avolon today provides a key dollar financial conduit for China's aircraft market. KBRA notes in a May 2023 surveillance report: “Avolon is a global leader in aircraft leasing with a fleet of 830 aircraft owned, leased, or committed for the service of 147 airlines across 65 countries as of March 2023. The company is based out of Ireland and has multiple other office locations in the United States, Dubai, Singapore, Honk Kong, and Shanghai. Currently, Avolon is 70% owned by an indirect subsidiary of Bohai Leasing Co., Ltd. And 30% by ORIX Aviation Systems.” Avolon is still apparently controlled by the Chinese government, which controls HNA. But more important, Avolon is one of the few businesses that came out of the 2020 collapse of HNA that continues to operate. The misallocation of capital and a lot of debt by China’s emerging corporate flowers was monumental, but still pales compared to the economic calamities engineered by the CCP. And our key insight, then and today, is that there is precious little equity underneath these Chinese “investments.” During the early 2010s, Beijing allowed HNA and other firms to acquire foreign companies including Deutsche Bank AG , Hilton Worldwide Holdings , properties such as golf courses, landmark hotels across six continents and 245 Park Avenue in Manhattan. Think of this shopping binge as imitating Japan circa the early 1980s but with 100x dollar leverage. Credulous western regulators welcomed HNA’s “investment” in the stricken Deutsche Bank, until they realized that the whole transaction was financed with derivatives. Adam Tan , chief executive of HNA Group Co., told an adviser he thought the conglomerate was growing too quickly in 2017, the Wall Street Journal reports. But in fact the whole of China was growing too quickly and in many cases without a viable plan for the expenditures and related dollar debt. The fact that dollar interest rates were being kept artificially low by the FOMC encouraged even more risky behavior. In many ways, low interest rates in the US may have set China up for a big fall. By 2017, HNA reported 1 trillion yuan (US$154.8 billion) of assets, with at least 500 billion yuan of debt – much of it in dollars. By the beginning of 2018, the Chinese government seized control of Anbang Insurance Group Co , starting a formal retreat from offshore foreign investment such as the “Belt & Road” fiasco. These debt-fueled speculations propelled China’s offshore investments to absurd heights and also financed internal property speculation. The financial rot in China is a function of a deeper moral decay under CCP rule. Xu Jilin writes in his 2020 book, “ Rethinking China’s Rise. ” “Chinese today are like nineteenth-century Europeans, bursting with ambition, industrious and thrifty, full of greed and desire; they believe that the weak are meat for the strong and that only the apt survive—they are vastly different from traditional Chinese, who prized righteousness over profit and were content with moderation. What kind of victory is this?… We’re like Japan in the nineteenth century, and what we’re seeing is the report card of a student that copied Western civilization. It’s the report card of a seriously unrounded student.” Our view is that China has been caught in a debt deflation for the past five years, but western media and investors refuse to recognize the obvious signs of contagion. Observers point to China’s large reported reserves as evidence of financial solidity, but this only works if you believe the data released by the CCP. None of the economic statistics in China are worthy of attention, but the western media and investment community seem indifferent to such concerns. We suspect that lot of that Treasury collateral reportedly owned by China is already leveraged in the offshore market for dollar swaps or stolen by communist party cadres. After all, the whole point of being a member of the CCP, now some 10% of China’s population, is to steal as much as you can and move it offshore… into the safety of dollars. As China's debt crisis unfolds, finding the offshore cash and assets secreted away by CCP officials will keep the lawyers busy. Perhaps the more important lesson, however, is that the economic growth that has so impressed western apologists for China like Jeffrey Sachs may be a state-financed mirage. It was not so long ago that Professor Sachs himself warned western audiences to beware of Beijing's economic data. European Central Bank board member B enoit Coeure , in an apparent reference to China, said last year there was a growing prevalence of poor quality data which risks fuelling economic manias and panics. “Just as there are concerns about ‘fake news’ dominating social media, there is a risk of ‘fake’, or at least poor quality, statistics driving out better quality ones in public discourse,” Coeure said in Paris. “Actions by economic agents could become less anchored to actual activity and more prone to manias and panics, with obvious implications for economic and financial stability,” he added. China's economy under Xi Jinping is the case in point. 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.

August 15, 2023 | Premium Service | Almost nine months since the failure of Reverse Mortgage Investment Trust (RMIT) on November 30, 2022, and the seizure of the firm’s reverse mortgage servicing rights (RMSRs) several weeks later by Ginnie Mae , the bankruptcy continues to fester. The as yet undisclosed losses by several of RMIT's bank lenders could present a serious threat to the stability of individual issuers and the government loan market. The RMIT reverse mortgage business was sold to Longbridge Financia l for $1 several months ago, but the US Treasury still owns the RMSR and may never be able to sell it. Most or all of the lenders involved with RMIT apparently took total losses, but no disclosure has been made so far. Yet there are still some lenders that pretend to pursue repayment in the Delaware Bankruptcy Court action ( Case 22-11225-MFW ). Akio Matsuda at the Wall Street Journal nicely summarized the events leading to the collapse of Reverse Mortgage: “As rates rose, more of the RMIT’s older loans reached the 98% limit, requiring the company to take out more market-rate loans to meet the program’s obligations. Because RMIT had to buy out the loans at face value, it had to put up more of its own money for every buyout, until the obligations overwhelmed its capacity to borrow.” The reckless actions of the FOMC regarding interest rates and the Fed portfolio are creating big losses for independent mortgage firms, losses that federal agencies may not be able to manage. Simply stated, RMIT is the first government servicing asset to be seized by Ginnie Mae since Taylor , Bean & Whitaker . The credit markets assume that the mortgage servicing right (MSR) of a failed mortgage lender will be acquired out of bankrutpcy, as in the case of Ditech (2019), but the change in interest rates over the past year makes this difficult if not impossible. When insurance and finance conglomerate Conseco collapsed into bankruptcy in 2002, the mortgage servicing portfolio was upside down. Specifically, the MSR was at the very bottom of the credit waterfall and there were many parties above feeding on the servicing. In theory, the MSR for manufactured homes had a gross spread of 50bp on the unpaid principal balance, but all that was left was about 10bp to cover the cost of servicing and remidiation of a lot of delinquent loans. This rendered the Conseco portfolio of government and conventional loans unsalable. Fortunately, the judge in the Conseco bankruptcy threw away the U.S. Bankruptcy Code and assumed the more traditional role of bankruptcy courts, namely social worker. He attacked the economic problem and restructured the Conseco mortgage trusts, moving the MSR to the top of the credit waterfall and thereby made the business more attractive for sale. In the case of RMIT, however, the massive movement in interest rates rendered the RMSR completely unsalable. Unlike the FDIC, Ginnie Mae lacks the legal authority to restructure an MSR or make advances to potential buyers to help reduce the ultimate cost to the taxpayer. So unless the creditors of a failed mortgage bank are lucky enough to have a proactive Bankruptcy Court (and active stakeholders like Fannie Mae), the result is likely to be bad for the creditors and the taxpayer. As a result, the auction of RMIT in December failed and the MSR was seized by the US government. The taxpayer and lenders on government assets now face the worst possible outcome. Texas Capital Bank (TCBI) took a $5 million reserve for the RMIT default in Q1, but the total amount of the loss on the bank’s financing of participations (aka "tails") on reverse mortgage loans appears to be $43 million, according to Bankruptcy Court records. TCBI declined to comment when contacted by The IRA , but in private bankers complain that Ginnie Mae specifically asked them to continue funding RMIT after the bankruptcy filing. As investors and counterparties come to understand the full scope of the losses on RMIT, the willingness of banks to finance government assets is likely to ebb. A summary of the parties in the RMIT bankruptcy is below from the first day statement showing $1.4 billion in financing. Source: US Bankruptcy Court Barclays Bank (BCS) had over $200 million in warehouse lines secured by pledged collateral with RMIT. Indeed, all of the warehouse lines above are in theory money good because the lender controls the MBS collateral. But here’s the rub: The HECM collateral provided by RMIT may not be worth par. And there may be other issues with the collateral that can result in loss to the lender. When Ginnie Mae or the GSEs seize an MSR from a defaulted issuer, the "secured" lenders usually take a total loss. With a government insured loan or Ginnie Mae MBS, the lender never really has a clean and perfected security interest in the asset. Unlike dealing with loans guaranteed by or securities issued by Fannie Mae and Freddie Mac , the legal rights of the loan guarantors like FHA, VA and USDA, and Ginnie Mae as the guarantor of the MBS, are unassailable. In other words, bank loans on government insured loans or Ginnie Mae securities are essentially unsecured. Since lenders cannot bifurcate the government insured mortgage note from 1) financing for advances of principal, interest, taxes and insurance and/or 2) financing for MSRs, there is no practical and enforceable security for lenders. Because the mortgage note already is encumbered by the Ginnie Mae security, and the underlying guarantee of the loan, there is no collateral available for bank or nonbank lenders. The fact that RMIT's RMSR could not be sold in bankruptcy now exposes this ugly reality. Credit Suisse , now a unit of the bad bank at UBS AG (UBS) , had a warehouse facility of $114 million and a $40 million repo facility to RMIT at the end of November 2022, but the Swiss bank has said nothing about the loss. Likewise UBS has said nothing about the failed auction of Select Portfolio Services after UBS turned down bids on some of its private label servicing portfolio. If we take Credit Suisse as an example, all of the warehouse lenders may face significant losses. TIAA Bank (f/k/a Everbank) had a $50 million warehouse facility to RMIT and has entered a claim for $34 million with the Bankruptcy Court. TCB had three facilities to RMIT totalling $335 million, including a $61 billion facility for financing participations on Home Equity Conversion Mortgage loans, or “HECM Loans”), which are typically pooled into Ginnie Mae securitizations. HECM participations or "tails" fund cash payments to homeowners and are a key source of revenue for reverse issuers. Unfortunately the HECM participations have no claim on the mortgage note, suggesting that TCBI faces a total loss on the financing for the tails. Nomura Securities (NMR) had a $260 million warehouse facility and a small repo facility to RMIT. But one of the largest losses was BNGL, an investment vehicle sponsored by Starwood Property Trust (STWD) . BNGL had $160 million in equity financing for RMIT that was apparently wiped out. BNGL supported RMIT post-filing with additional cash to avoid the seizure of the RMSR. None of the public companies listed above have bothered to disclose the losses on the RMIT bankruptcy. In the world of public company disclosure, this is called dragging your feet. The magnitude of the hidden losses and related regulatory forbearance would disturb even the cynics in the group. But the losses faced by these lenders may be the start of a larger problem. Ginnie Mae President Alana McCargo , reportedly decided to participate in a conference call last December 2022 where more than 20 creditors of RMIT and their legal counsel were present. McCargo did not respond to a request for comment about the call. Not only did McCargo reportedly participate in the conference call, a remarkable occurence in and of itself, but she actually decided to speak . She encouraged the RMIT lenders to continue to support the HECM market and specifically asked lenders to continue to advance funds to the bankrupt RMIT in order to protect consumers. McCargo then reportedly offered hope to RMIT creditors that Ginnie Mae would do something to protect them from financial loss if they continued to lend to RMIT. Two weeks later, on December 20, 2023, Ginnie Mae siezed the MSR and effectively handed the lenders a total loss. As a result, some of RMIT's lenders are considering legal action against Ginnie Mae and the Treasury based upon McCargo’s statements. It is interesting to note that even the Bankruptcy Court and the experts hired to manage the bankruptcy do not understand the tenuous nature of any “secured” claims against Ginnie Mae assets. When lenders to RMIT tried unsuccessfully to negotiate a debtor-in-possession (DIP) financing facility last December, for example, the Bankruptcy Court stated that “a substantial majority of the Debtors’ assets are encumbered by valid and perfected liens…” Really? In the case of RMIT, the reality is that lenders may take a total loss on positions that these banks reported to regulators and investors as “secured." When Ginnie Mae seized the RMSR under its statutory authority, the banks have no recourse against the asset or Ginnie Mae. Despite statements attributed to President McCargo, Ginnie Mae has no obligation to RMIT's lenders. For the record, we think trying to sue Ginnie Mae for McCargo's puffery is a waste of time and money. The bankers ought to know better. When the servicing book of RMIT was seized by Ginnie Mae two weeks after the conference call in early December, the “secured” lenders were left with no recourse except to file a claim in the bankruptcy. The Treasury lost something like $2 billion on reverse loan buyout costs and other expenses over the next six months and now must pay to service the MSR and fund future buyouts until the portfolio is extinguished. So when the lenders discussed above say they are pursuing repayment in the RMIT bankruptcy proceedings, we say what? The RMSR is gone and there are few substantial assets left in the bankruptcy estate and certainly nothing approaching the prospective losses outlined above. Of interest, if you search EDGAR for RMIT over the past year, this is what you find. https://www.sec.gov/edgar/search/#/q=%2522Reverse%2520Mortgage%2520Investment%2520Trust%2522&dateRange=1y At the time of the bankruptcy, RMIT and its affiliates estimated that they collectively owed the lenders approximately $1.1 billion under the loan, tail, and buyout warehouse facilities. Between the filing on November 30 and the seizure by Ginnie Mae on December 20th, these figures may have increased. But the key factor for investors and risk managers looking at HECM exposures to consider is that the terms of the business are deteriorating. The operating cash flow of most HECM issuers -- indeed, most small and mid-sized government issuers -- is negative and that is not likely to change between now and the end of next year. Former Ginnie Mae President Ted Tozer published a thoughtful comment fo r Urban Institute where he sets forth the pressing need for funding government-insured loans, both forwards and reverses. Tozer enumerates the mind-numbing buyout requirements facing Ginnie Mae issuers as interest rates rise. He suggests that Ginnie Mae guarantee advances on delinquent government loans, an evolution of Tozer's earlier idea to guarantee issuer debt. Tozer's scheme is timely but is unworkable because the advances would be unsecured. The statute requires that Ginnie Mae only guarantee assets, not a derivative unconnected to the mortgage note like an advance or MSR financing. Since by law government insured loans cannot be separated from advances or financing for MSRs, any extension of credit by a bank or even Ginnie Mae would arguably be unsecured. Let's call them "government insured participations." As interest rates have risen, the collateral value of existing HECM loans has fallen and the haircut required for warehouse financing has grown. HECM lenders historically obtained advances that are 89-98% of the full principal balance of the reverse mortgage, but recently some advance rates have fallen to or below 80%. We think that advance rates generally on government assets are going to decline, reversing a decade long liberalization of advance rates. And as the likelihood of another event of default grows, lenders will back away further. Barring a drop in interest rates, we think further defaults by government lenders are inevitable. Unlike forward issuers that can leave delinquent loans loitering in Ginnie Mae MBS pools for months, HECM issuers must buy the loan out of the pool immediately at par. As HECM lenders are forced to finance buyouts and advances to clients at progressively higher interest rates and with bigger haircuts, the likelihood of another event of default soars. Source: MBA, FDIC Earlier this year, Ginnie Mae ended the special accommodations for government issuers implemented during COVID. Specifically, the waiver of the requirements of Chapter 18 of the Ginnie Mae Guide allowed issuers to borrow 100% of escrow funds, a change that helped issuers finance COVID loan forbearance. Now, however, Ginnie Mae issuers must limit borrowed escrows to 60% of total payoffs even as bank lenders decrease advance rates and increase haircuts on forward and reverse government assets. As federal regulators battle with the banking industry over new Basel capital proposals, we would all do well to remember that it will take just one of the lenders mentioned above stepping back from financing government insured assets to force another Ginnie Mae issuer default – perhaps several at one time. Credit Suisse/UBS is already gone. The HECM sector is the most vulnerable to rising interest rates, but forward issuers are also under enormous pressure as we head to the end of 2023. As we discuss in our latest Housing Finance Outlook, the mortgage finance complex continues to perform better in the equity markets than the fundamentals of the industry deserve. At the very least, we expect to see massive consolidation in government lenders over the next two years. Hopefully these combinations will occur in the normal course of business and without intervention from Ginnie Mae. Given the anti-inflation agenda of the FOMC and the worsening inversion of the Treasury yield curve, we expect that President McCargo and her team will face multiple defaults by government issuers over the next year. Hopefully they will not also face an adversarial litigation by one or more government warehouse lenders ensnared in the RMIT bankruptcy. Hope is not a strategy. At present, the Biden Administration has no real strategy for addressing the growing stress in the market for government insured mortgage loans and securities. Subscribers to The IRA Premium Service login to download our latest Housing Finance Outlook. A stand alone copy is available in The IRA Store 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.

August 9, 2023 | Premium Service | Moody’s (MCO) downgraded the credit rating of a number of banks this week and put more on watch for a future downgrade. These were institution-specific downgrades that were more attributable to the bank failures in Q1 2023 than to the downgrade of the US by Fitch Ratings earlier this month. A couple of readers asked about the impact of the US ratings downgrade on the largest globally systemically important banks (GSIB). Here's what you need to know: First, in the world of credit we always use the lowest rating. Now that S&P and Fitch are at AA+ for US risk, the whole credit market must go there in terms of using the lowest rating for asset allocation purposes. We could ignore S&P for a decade. Not now. Second, GSIBs tend to have 1-2 ratings notches of "uplift" in the rating on the assumption of sovereign support. In the US, one notch. Japan, two notches for GSIBs. Most of the agencies have explicit sovereign support in their published criteria. When the sovereign goes down, everything else in the world of credit ratings that depends upon it goes down, GSIBs, GSEs, agencies, etc. The sovereign credit of the US is now AA+. The rating on Ginnie Mae MBS is now AA+. And the sovereign rating may go lower before we are done. Large banks will definitely move lower as Moody and other agencies adjust their view of the industry’s prospects. The Basel capital proposal, in this regards, is pretty much a guarantee of downgrades for the largest US banks, first because it hurts profitability. The increase in risk weights for high-LTV loans will basically push commercial banks out of lending to low-income households. The Mortgage Bankers Association (MBA) has voiced strong opposition to the Basel capital rule changes, pointing out seven key areas that could affect major banks and regional banks, lenders, servicers, and borrowers within the housing finance ecosystem. Western Alliance Bancorp In February of 2021, when The Institutional Risk Analyst wrote about the combination of Western Alliance Bancorp (WAL) and Apollo Global Management (APO) offspring AmeriHome , we described the marriage of a great wholesale bank with one of the leading aggregators of conventional loans. Built by APO on a greenfield platform, AmeriHome remains one of the dominant bidders for conventionals – sometimes maybe too dominant — but within a bank that has changed dramatically in the past two years. As we noted in our last comment, the fact of APO being a seller of AmeriHome in 2021 may have been the point, with industry total new issue volumes below $2 trillion with 90% purchases mortgages. With industry losses on every loan closed well north of 200 bp, you might ask yourself why WAL would still be buying conventional loans. Several issuers tell The IRA that AmeriHome has been bidding more than half a point above other aggregators for conventional loans. The answer in simple terms is coupons above 7% and rising. Even before acquiring AmeriHome, WAL excelled at achieving levels of interest earnings well-above its peers. In Q1 2023, WAL had increased its gross yield on loans and leases to over 6.2% The bank’s yield on earning assets is a full point higher than the average for Peer Group 1. As the chart below suggests, the $70 billion asset WAL is outpacing most of the regional leaders in Peer Group 1 in terms of gross yields. Source: FFIEC Like most banks, WAL has seen an uptick in delinquent loans, but the bank’s credit performance remains stellar vs its peers. WAL’s expenses have risen as its insured deposits have grown, but the bank now has the highest ratio of insured and collateralized deposits and tangible capital in Peer Group 1. The chart below comes from the WAL Q2 2023 earnings presentation. In most ways, WAL outperforms its asset peers and the larger players in Peer Group 1 by a considerable margin. So why is the stock just 1x book value, this after running up 40% in the past month? Short answer is that many people recognize the superior operating performance of WAL and want to benefit from management’s aggressive restructuring of the loan portfolio and funding base. WAL, for example, is expecting to expand net interest margin in 2H 2023 after several quarters of house cleaning. It is interesting to note that WAL has managed to retain 1/3 of total deposits in non-interest bearing balances. The cost of funding has risen in line with Peer Group 1, but the $80 billion asset bank's funding seems quite solid. But perhaps the larger reason to look at WAL is management's consistent track record of delivering value to shareholders in terms of tangible equity. The chart below comes from the Q2 2023 WAL earnings presentation. The bottom line on WAL for us is that the bank has stabilized from the problems seen in the first quarter of 2023. It is good to see the stock trading above book value again, especially since WAL was the best performing large bank in the US in 2021. We prefer holding New York Community Bank (NYCB) to WAL at the present time because of NYCB's strong funding, but as and when an interest rate cut comes into view, WAL will likely benefit. Given the growing distress at many non-bank mortgage firms, we suspect that WAL and other depositories will be long-term survivors in the mortgage lending channel. Source: Google 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.

August 7, 2023 | In the wake of last week’s credit downgrade of the United States, a number of analysts are turning their attention to the next shoes to drop. Many are worried about bank failures, but what about sovereign defaults? Major cities such as Seattle, Portland, San Francisco, LA, St Louis, Memphis, Chicago, Philadelphia, NYC, Baltimore and even Washington, D.C. all seem headed for credit ratings downgrades in the next year. “Are all losing tax revenue, population, and absorbing illegals,” one prominent banker argues in a weekend missive. ”Money is moving away. Corp HQs and affluent taxpayers, who pay most of city and state taxes, are heading south.” Here at WGA, we can think of at least four corporate clients that have moved HQ out of the New York metro area in the past two years. As large, heavily indebted cities are hit with credit downgrades, these systemic events will make it difficult for failing issuers to sell new bonds, accelerating the process of default and debt deflation. Several observers foresee a scenario where the US Treasury, joined by several financially crippled cities, will come to market together, possibly dragging down the credit of the US just months before a general election. Neither President Joe Biden nor Treasury Secretary Janet Yellen have anything to say about debt reduction, at least not for public consumption. And the leading Republican candidate, the indicted felon and former President Donald Trump , likewise is not known for spending a lot of time talking about deficit reduction. We suspect that a US fiscal crisis before the 2024 election will likely help the political fortunes of President Trump, but his re-election will take the US down the path to eventual debt default. One of the things that supporters of President Trump fail to notice is that his government was largely dysfunctional, especially after the 2017 Charlottesville debacle. Once former Goldman Sachs (GS) banker Gary Cohn left the White House in 2018, the Trump Administration descended into chaos. Only the Treasury under Secretary Steven Mnuchin (2017-2021) showed any cohesion. Cohn, who was the 11th Director of the National Economic Council and chief economic advisor to President Donald Trump from 2017 to 2018, was the glue that held the Trump project together from a managerial perspective. Ponder the fact that in the two years following the departure of Cohn, President Trump could not manage to sign the revisions for Executive Order 12866 , perhaps the most important conservative project on the agenda. Secretary Mnuchin and the career staff at Treasury opposed EO 12866, of note. Whether we have Donald Trump or Joe Biden in the White House next Christmas, the US seems to be on a trajectory to a financial crisis. “The US Treasury boosted the size of its quarterly bond sales for the first time in 2 1/2 years to help finance a surge in budget deficits so alarming it prompted Fitch Ratings to cut the government’s AAA credit rating a day earlier,” Bloomberg reports. As the White House ostensibly is preparing to win another four year term, the Biden Administration is seemingly sleepwalking into a sovereign debt crisis. With yields on the 10-year Treasury now well-above 4%, the losses on legacy bonds and loans on the books of US banks will surge, along with the cost of funding to the Treasury, US cities and states, and banks and other private issuers. Since the FOMC shows no indication that it will accelerate the reduction of its balance sheet, the yield curve inversion will continue – even as residential home prices in markets outside of the great northern cities continue to appreciate . We have been focused on the rising levels of multifamily loan defaults for the past several years, in part because once prime bank paper has normalized and then some since 2021. “From the third quarter of 2023 through the end of 2025, a record number of CMBS multifamily loans will come due, and it looks to be messy,” notes The Real Deal . Messy is an understatement. As the chart below illustrates, loss given default on prime bank multifamily loans are already at pre-COVID levels. hSource: FDIC/WGA LLC As the once premium debt stack comprised of Treasury and municipal debt heads for the waste bin, it is not surprising that Apollo Global Management (APO) CEO Marc Rowan told the FT of the end of the golden age of private equity buyouts. Since the Fed and other central banks seem to be done with massive asset price inflation, returns in the $4 trillion PE industry will no longer be driven by ever rising valuations. When valuations fall, of course, loss given default rises. Apollo Commercial Real Estate Finance, the real estate investment trust arm of APO, wrote off a junior mezzanine B loan at 111 West 57th Street in Midtown West, Bloomberg reports. The write-off comes with an $82 million hit for the REIT. There are many, many more of these types of losses being incurred in private transactions. The bond market gave up the equivalent of July’s performance in the first couple of days of August, suggesting that things will only get better with time. We almost tossed the WeetaBix this weekend when we read that Tiger Global is accumulating a large position in APO , this in search of diversification far beyond tech. Really? The trouble with the Tiger Global strategy is that it seems to go against the sage wisdom of Rowan and his colleagues in the world of multi-asset management. The days of the FOMC bidding up EBITDA multiples into the teens on new business services firms is over. Likewise, the efficacy of holding mortgage lenders like AmeriHome was clearly ending at the end of QE. Rowan’s Athene (ATH) platform was a seller. Pay attention. With the Treasury Borrowing Advisory Committee (TBAC) now in charge of monetary policy, look for rates from the belly of the curve out to 30s to rise. Didn’t we hear former PIMCO bond manager and fisherman Paul McCulley wax ecstatic over the belly of the Treasury curve on CNBC couple of weeks ago ? When we heard that comment, our eyebrows hitched. Then TBAC did its thing. “Going forward for nominals, I’d expect 2s, 5s and 10s to be more heavily leaned on, while 7s and 20s see relatively smaller increases, writes Charlie McElligott at Nomura (NMR) . “For TIPS, the increase in 5s was a departure from the calendar year-based approach. Small increases to the next new issue 10s seem likely. TBAC’s debt optimization modeling prefers belly issuance, small TIPS increases, and if low term premium persists, increases in longer dated issuance.” If the 10-year Treasury rises to say 4.5%, then the losses on the books of US banks, REITS and other holders of bonds will surge. If we assume that the average coupon in the $13 trillion asset mortgage complex is now 3.5% vs 3% a year ago, the industry will still report $750 million in negative AOCI in Q3 2023. More importantly, healthy banks will balk at buying troubled banks. Imagine this scenario, informed by the fact that neither Secretary Yellen nor Fed Chairman Jerome Powell have the guts to stand up in public and demand that Congress reduce the federal deficit, now. Treasury slides into a debt crisis later this year after Moody’s finally downgrades the United States. The failure of several more regional banks could force the Fed to ease interest rates, but the resulting bond market rally will result in margin calls that could take down several heavily leveraged nonbanks. Stay tuned. The Institutional Risk Analyst (ISSN 2692-1812) is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

August 4, 2023 | Premium Service | Several readers asked about the results for Rithm Capital (RITM) , one of the more aggressive hybrid REITs in the world of mortgage finance, both residential and commercial. CEO Mike Nierenberg just delivered a record quarter, surprising a lot of analysts. RITM's NewRez taxable appendage is the fourth largest mortgage servicer with over half a billion in loans serviced RITM’s upside earnings surprise illustrates how difficult it is for even sophisticated investors and analysts to parse the public disclosure of earnings from mortgage companies. Even as RITM works to redefine its business purpose as a manager of alternative assets, it is preparing to spin-off virtually its entire residential mortgage business. But will that interesting possibility ever be a reality? See below. “Rithm had one of its best quarters ever,” said Nierenberg with considerable pride. “We had near record earnings, grew book value, acquired $1.4 billion of consumer loans and grew our SFR business with the acquisition of 371 units... With the introduction of new capital rules being instituted on banks and the highest level of rates seen in 20+ years, the investing environment has not been this good in years.” Nierenberg is absolutely right that the Fed has turned over the proverbial card table, to use a Bear, Stearns metaphor. The range of assets being abandoned by banks and other investors as interest rates rise is impressive and mounting. The change in the RITM business is dramatic as illustrated by the table below from the Q2 2023 earnings release. In Q2 2023, RITM reported net income of $387 million vs $89 million in Q1 2023. What changed? First there was a $160 million swing in realized gains in Q2 vs a loss in Q1. Then RITM took a $45 million gain on its mortgage servicing rights (MSR) and added $82 million more to “income” from MSR related investments. This took net servicing revenue up to $487 million vs $328 million in Q1. Who says mortgage banking is unprofitable? While RITM only took a small $22 million gain on the value of the MSR to income, it added $161 million in non-cash to servicing income for “change in valuation inputs and assumptions.” This offset the amortization of the MSR of $139 million in Q2 2023. Of note, the MSR realization and the offset for changes in modeled income and assumptions for RITM were exactly the same in Q1 and Q2 2023. We asked RITM if this remarkable coincidence was an error but received no response. What is interesting about the sharp increase in servicing income for RITM is that the unpaid principal balance (UPB) of loans barely changed in the first couple of quarters of 2023, illustrating how difficult it is for investors to anticipate changes in net income related to servicing. Indeed, RITM's servicing fee revenue, net and interest income from MSR financing receivables, and UPB of servicing, were actually down slightly in Q2 2023. The big question for RITM shareholders is the timing of a spinoff of the NewRez mortgage business, which is roughly two-thirds of the current assets. In a falling interest rate environment, a spinoff for the mortgage business could create significant value for RITM shareholders. But at the same time, the size of the highly leveraged MSR portfolio and the toppy valuations for these assets could create significant downside risk if rates fall rapidly. As one of the most respected operators in mortgage finance told The IRA : “In this market, Michael will have a tough time spinning off NewRez, but someone will buy it at a price he will be happy to take.” RITM is currently dependent upon Goldman Sachs (GS) for warehouse and MSR financing, not an ideal pairing in our book. GS has no comparative advantage in funding for a mortgage warehouse business. The fact that RITM has been buying consumer loans from GS suggests a less than arm's length relationship. We expect to see several smaller bank warehouse lenders exit the mortgage space as volumes remain low and purchase mortgage business predominates. Texas Capital Bancshares TCBI had a very good Q2 2023 earnings report, with interest income up 65% YOY and interest expense up a mere 360%. Yet the bank doubled net income since last year and has been shrinking both its balance sheet and its shares outstanding in a very disciplined and prudent fashion. The table below shows the income statement from the Q2 2023 TCBI earnings release. Total assets are down 10% YOY and the bank’s mortgage finance portfolio is down 20%. Net interest margin has risen to 3.3% and asset returns have doubled since last year, but are still under 1%. Non-interest bearing deposits are down 25% YOY and the bank has shed $1 billion in short-term debt. In many ways, this profile illustrates how the runoff of reserves at the Fed will slowly force all banks to shrink their balance sheets. Our worry regarding TCBI is that one-third of the bank’s book is mortgage finance and that sector is going to undergo a fairly radical consolidation over the next 18 months. We barely did $2 trillion in new loans in 2022 and we could remain at this level of production for several years to come. That means that half of today's capacity needs to leave mortgage finance . Lenders are losing a couple points on every loan they close, meaning that many independent bankers will be closing their doors if they have any market sense. Back in March, we wrote in National Mortgage News about the bankruptcy of Reverse Mortgage Funding (RMF) . The documents filed with the Bankruptcy Court suggest that TCBI took a $40 million loss on advance lines for Home Equity Conversion Mortgage (HECM) participations (aka “tails”). As yet, TCBI has not reported the loss to investors. So the bottom line seems to be that TCBI is not going to tell investors about the $40 million loss the bank incurred when the US Treasury took possession of the reverse servicing book of RMF. When we asked TCBI yesterday about the RMF bankruptcy, they replied: “We do not provide comments on either clients or ongoing bankruptcy proceedings.” Got it. We look forward to your timely disclosure. Since the RMF MSR has been sold, we assume that ends any possibility of the Treasury reimbursing TCBI. The financing for the HECM tails were repudiated by the US government, seemingly with finality, because only the first financing of a HECM loan into a Ginnie Mae MBS includes the mortgage note. The subsequent advances are participations, which are easily repudiated by a sovereign. Of interest, after incurring over $1.5 billion in losses on the RMF book, Ginnie Mae finally sold the festering HECM MSR to Longbridge for $1. TCBI’s efficiency ratio was 65% in Q2, the best level in some quarters, vs 59% for Peer Group 1. We think that the bank is going to need to cut expenses in a pretty serious fashion over the rest of 2023, figure 10%. In terms of overhead, TCBI was in the 72nd percentile of Peer Group 1 with 2.6% overhead vs total assets compared with 2.3% for Peer Group 1. TCBI needs to keep efficiency in the 50s if they want to survive the coming drought in mortgage lending. Only banks at or below peer levels of operating efficiency have a chance to grow shareholder value, one reason why we beat up Bank of America (BAC) CEO Brian Moynihan . The efficiency ratios for the top banks in Q1 are shown below. In Q2, JPM was at 49. As one of our friends in the world of finance who came from big time collegiate sports likes to say: "Get in the game." Source: FFIEC The Institutional Risk Analyst (ISSN 2692-1812) is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

August 2, 2023 | Premium Service | As this edition of The Institutional Risk Analyst was going to press last night, Fitch Ratings downgraded the United States from “AAA” to “AA+” in an unexpected move. Given that the US is going to run a deficit of over $2 trillion in 2023, we think the Fitch action is appropriate and long overdue. Among the two remaining agencies with “AAA” ratings, Moody's Corp (MCO) and Kroll Bond Rating Agency , who will be the last to recognize the obvious deterioration in US credit standing? S&P was the first to call out the growing lack of fiscal discipline in Washington, downgrading Uncle Sam to "AA+" in 2011. Given the trajectory of federal spending, even a resumption of QE may not be sufficient to avoid a US debt default and eventual restructuring. But more important, will the downgrade and rising long-term interest rates be sufficient to push dollar swaps back into a premium market after a decade of fixed/floating swap contracts trading through Treasury yields? The blue line shows US Treasury yields. The green line is dollar swaps out to 50 years. Source: Bloomberg (08/01/2023) This past week we saw a lot of decent earnings from banks and nonbanks alike, but nothing spectacular. Yet for reasons known only to the gods and members of the Federal Open Market Committee, a number of stocks have soared by triple digits over the past month. We attribute this upsurge in stocks to the inflation still bouncing around the financial system and expectations for a change in Fed interest rate policy. But when? Our surveillance list for fintech stocks is below. Source: Bloomberg (08/01/2023) One way to understand the movements in the markets is that the FOMC has taken $9 trillion worth of duration out of the markets and the position is not hedged. The tweet below from Adam Quinones at Refinitiv gave this concise description. He provides an excellent discussion on LinkedIn of why the inverted yield curve has not led to recession. Quinones writes: "Unfortunately, in this go 'round, while the curve did flatten ahead of the rate hike cycle, it never stopped flattening. Why? The Fed owns $5t in mortgage and TSY duration and they don't hedge it. We call that convexity hedging and convexity hedging begets more hedging. That's why you'll hear vector heads commenting on looming "snowball selling" events or "duration ledges" in the bond market. We haven't had that event. If the Fed was a traditional convexity hedger, you can bet your keister 10yr yields would be at least 50-75bps higher today and mortgage rates would be closer to the 8 handle. Textbooks clearly need a rewrite following endless Fed QE/vol suppression." The artificially surfeit of liquidity created by the FOMC’s lack of selling/hedging of its MBS and Treasury portfolio has helped to fuel a truly ridiculous melt-up in selected financials. Look at Upstart Holdings (UPST) up over 400% YTD and 90% in the past month. The Street is predicting a 40% drop in revenues for Q2 2023, of note. Another fintech darling that has run during the recent updraft in stocks is SoFi Technologies (SOFI) , the student loan refinance platform that became a bank. SOFI was up 27.5% in the past month and 130% YTD. The bank lost $35 million in Q1 2023 and $47 million in Q2 2023. As we’ve noted previously, this business needs to double in size before it makes sense as a bank – and that is before the new Basel capital rules come into play. SOFI seems to want to hide their actual GAAP financial results behind a lot of non-GAAP measures more appropriate for a technology company. As we’ve noted previously, EBITDA is not especially relevant to a bank, especially when interest rates are rising. SOFI hides its one page of GAAP financials on Page 17 of its investor presentation. The table below is on Page 3 of the SOFI investor presentation. If you follow the Silicon Valley narrative of the SOFI earnings, shareholder value is a matter of growing users and engagement. At least the Street has a positive earnings growth number for SOFI in 2023. Today SOFI boasts $5 million in assets per employee vs $12 million per employee at JPMorgan (JPM) or $33 million per employee at Goldman Sachs (GS). The big question is this: what is the lifetime value of a customer of SOFI?? Management hints at this question, but provides no answer. Bottom line for SOFI is that growing customers and particularly non-loan products is the path to greater shareholder value seems to be at odds with the flat revenue and EBITDA. The “financial services productivity loop” looks a lot like the “financial supermarket” of Sandy Weill and Citigroup (C) from three decades ago. We’ll see how SOFI looks after a couple more interest rate increases. Another surprise is Wise LTD (WISE) , the global money exchange service we began to follow several years ago. WISE ran up to over £700 last year, then fell back below £550 before taking off to reach $775 yesterday. The positive in the stock is the higher prospective growth rate which has caught the attention of Sell Side analysts. The negative is that this is still a young firm that generates a lot of noise, like the CEO needing to publicly sell shares to pay UK taxes. We still have a position in WISE and expected continued volatility. How does one describe market action in fintechs? One prominent hedge fund manager put it like this: “Bouncy, bounce, bounce. AI!! Yippee!!!” With the yield on the 10-year over 4%, we are seeing more and more evidence that interest rates are starting to put the entire US financial complex in great danger of a systemic break. The definition of a systemic event is when markets are surprised. The downgrade of the US will put renewed pressure on lower investment grade and junk credits in coming weeks. But the big event lies ahead, when Moody's eventually downgrades the US credit. The Institutional Risk Analyst (ISSN 2692-1812) is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

July 28, 2023 | Premium Service | This past week The Institutional Risk Analyst was in Washington, D.C. for meetings in the mortgage and banking channels. Suffice to say that with interest rates rising, career officials in the Executive Branch are preparing for an eventual market break as the federal deficit explodes. “The last Treasury Secretary that tried to extend the maturities of government debt was Jack Lew (2013-2017), but Secretary Janet Yellen missed a big opportunity,” says a senior career official. The chart below shows the interest expense for the federal government. The official reckons that the FOMC has perhaps a year to finish its inflation fight before rising funding costs become a critical issue for the Treasury. Sources at UST worry that ability to extend maturities at current yields is limited and that short-term funding strategy could "break" forcing longer yields higher. Meanwhile, a number of investors have been concerned that the Financial Stability Oversight Council (FSOC) might designate large fund managers or mortgage servicers as "systemically significant." Our sources at UST and OMB say there is no initiative for a SIFI designation on IMBs and/or funds coming from Secretary Yellen. UST staff are protective of the agency's authority in this area and do not see any request coming from Fed or OCC at this time. CFPB's Rohit Chopra has been most vocal on the issue of systemic risk and could float a proposal to name nonbanks as “systemically significant," but Yellen Fed, OCC, FDIC must support. As we noted previously, FSOC like the FOMC is not a policy making body. Unless the head of a member agency with purview over systemic risk makes a request for action, nothing is going to happen. The WH has shown zero support for or interest in FSOC action on IMBs, a necessary precursor. The WH (Lael Brainard ) is not even engaged on Basel bank proposal or housing. Mr. Cooper This week a number of nonbank mortgage firms reported financial results. Mr. Cooper (COOP) reported strong earnings driven by rising servicing revenue, even as lending volumes surprised on the upside. COOP is approaching $1 trillion in mortgage servicing, placing them just behind JPMorgan (JPM) . COOP’s origination’s generated positive income, illustrating the low cost of the direct-to-consumer channel at COOP. The graphic below is from the Q2 2023 presentation from COOP. We have written positively about COOP in the past, but don’t own the stock because WGA acts as an advisor currently. We view COOP as one of the best managed firms in the world of mortgage finance. We like the superior operating efficiency and the focus on direct to consumer (DTC), which allows COOP to control the cost of loan acquisition. Our current portfolio is shown below. A number of issuers had relatively good volumes in Q2 2023, pushing up net issuance of MBS above Street estimates. “June’s pickup in net MBS issuance — at $30.3 billion — was a “bit surprising” and as that supply is historically back-loaded, is a negative when it comes to the supply and demand picture for mortgages, Morgan Stanley (MS) analysts Jay Bacow , Zuri Zhao and Janie Xue wrote, Bloomberg reports. PennyMac Financial Services PennyMac Financial Services (PFSI) also reported earnings, with positive results in lending and servicing. PFSI’s servicing book is only half the size of COOP, a significant point of differentiation between two market leaders. PFSI reported that production revenue margins were higher in all three channels, but PFSI saw correspondent volumes and related decrease in PMT correspondent volumes from the prior quarter due to a higher proportion of conventional loans sold to PFSI by its companion REIT, PennyMac Mortgage Trust (PMT) . Of course, many large issuers are deliberately reducing conventional production because of fear of putback claims from the GSEs, but with loan delinquency still falling PSFI is taking all of the volume that it can. PFSI took a $118.9 positive non-cash mark on its MSR, but reported a large, $155 million in cash loss on the interest rate hedge. The graphic below is from the Q2 2023 PFSI presentation. Looking at PFSI, the firm has only reduced operating expenses by about 7% over the past year. PFSI's benefits from the fact that correspondent volumes are growing as an overall percentage of industry volumes. But the fact remains that net revenues are down and, like many lenders, PFSI is betting that delinquency rates and related expenses will remain low and that the Fed will reduce interest rates sooner rather than later. A careful examination of the balance sheet of PFSI shows a sharp increase in liabilities for loans eligible for repurchase since Q2 2022, part of a larger industry trend of allowing delinquent loans to remain in MBS pools for extended periods. An increase in loan delinquency could impose sharply higher expenses on PFSI and other large Ginnie Mae issuers. As one reader commented earlier: "The irony of the Fed increasing capital requirements on banks well north of ten percent the same day that PFSI demonstrates you don’t need capital for a $260 billion loan portfolio is killing me." 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. 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