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June 19, 2023 | “All propaganda is lies, even when one is telling the truth,” George Orwell concluded after working for the British Broadcasting Company (1941-1943). “I don’t think this matters so long as one knows what one is doing, and why.” Orwell's time as an editor at BBC followed a period working as a colonial policeman in Burma. "“In a time of deceit telling the truth is a revolutionary act,” he said years later. Chairman Powell and the Federal Open Market Committee need to accept that they cannot raise fed funds further without causing serious financial problems for banks and other institutions. Time for truth. Readers of The Institutional Risk Analyst know our views on Fed interest rate moves, but last week’s market action really begs the question as to the credibility of FOMC policy. Until the Committee completes the circle and starts to actively sell mortgage backed securities (MBS), the markets simply don’t and won’t believe that Powell and the FOMC are serious about raising interest rates to fight inflation. The big takeaway from last week’s FOMC meeting is confusion on the part of the Committee members and the markets about the direction of interest rates. Komal Sri-Kumar wrote last week : “Credibility is a terrible thing to waste. I wrote in January about at least two instances when Powell either turned dovish when hit by a cratering stock market (December 2018), or persisted in forecasting “transitory” inflation to justify his vastly expansionary policies (2020 - 2022). Market’s belief that he is a soft touch when it comes to inflation reduction explains why equities have rallied despite his seemingly tough message at the press conference.” Why does the Fed need to sell MBS from the system open market account (SOMA)? Because only by releasing that massive duration locked away inside the sterilized confines of SOMA back into the markets can the FOMC get long-term interest rates above 4%. Adjusted for option-adjusted duration , the Fed's $2 trillion MBS position is larger than its portfolio of Treasury debt. Ponder that Chair Powell. Selling bonds is also a tangible manifestation of FOMC policy, distinct and apart from the speculations of the media & economist chorus about the target for fed funds. Finally, selling bonds and pausing further fed funds rate increases will not put additional pressure on banks and will actually increase asset returns. The FOMC should not mistake the current calm in the bank funding market for a solution to the illiquidity and losses created by raising short-term interest rates over 500bp in a year. The chart below shows bank deposits through the first week in June vs the Treasury General Account. Bank deposits fell $80 billion in a single week. Total runoff for the rest of 2023 could be more than half a trillion dollars even if the Fed does not raise the target rate for fed funds again. It has always been strange to us that an institution like the Fed, which is explicitly devoted to managing emotional intangibles like expectations about inflation, does not appreciate the impact of previously unannounced open-market operations. In the 1980s, the Fed of New York did not pre-announce bond or currency market operations. We did system RPs for breakfast or late lunch, sometimes before the market opened in New York or just before the close. The Fed manipulated currencies and changed expectations because the markets were surprised . At present, the Fed is boxed-in by the economist/media rat pack, which focuses attention on the Fed’s intentions regarding the target for federal funds to the exclusion of all else. By giving the FRBNY’s desk in New York a broad mandate to manage the SOMA portfolio of MBS, the FOMC can sprout a second front for conducting policy and, yes, managing market expectations. The FOMC could also move to a quarterly schedule for press conferences to calm media hype concerning rate changes. As Chairman Alan Greenspan taught us, the Fed must control the agenda. While the direction of fed funds is pretty cut and dry, the bond trading activity of the New York Fed is conducted away from public and even media scrutiny. And secondary market sales of MBS, unlike redemptions of Treasury paper owned by the Fed, do not put direct pressure on bank deposits . Chairman Powell needs to take a hint from the author of Animal Farm and pivot, but not to lower interest rates. Instead, Powell needs to shift the narrative from a single-dimensional fight against inflation to a two track approach to lowering inflation and managing investor expectations about the most important price of all, LT interest rates. Focusing on bond sales and pausing further fed funds hikes gives the Fed a way to push back against a market that seems intent upon forcing interest rates lower. Not raising fed funds for the balance of the year also gives US banks a chance to catch up with the rapid increase in short-term funding costs. Chairman Powell and the other members of the Committee may conceal themselves behind a beautiful and opaque tapestry of “open market operations.” Fact is, with low new issue volume, and even with the mortgage paper being sold by the FDIC and many banks, there is still a massive shortage of risk-free assets that is pulling LT interest rates down. Look at the fact that spreads between the 10-year Treasury note and mortgage rates are back down to the narrowest spread in months. The Fed of New York should be selling into market strength right now. Pushing LT yields higher will also help with the gradual reduction of the Reverse Repurchase Agreements which are costing the Fed billions in losses every month. The Fed's RRPs peaked over $2.5 trillion in January and have since trended lower to just below $2 trillion last week as funds flowed into Treasury bills. Notice that the series for $8.5 trillion of total holdings (red line) and $2.8 trillion in MBS (green line) are barely declining. Another reason to accelerate MBS sales is to frankly reduce the impact of the Fed on private markets and the economy. The complexity of the Fed’s balance sheet is now arguably an obstacle to normalizing policy. The Jay Powell hedge fund is losing $1 billion per day. The Fed’s loans to the FDIC, to finance the resolutions of Silicon Valley, Signature and First Republic banks have recently been disclosed in more detail. To date, the Biden Administration has not disclosed to Congress "the expected final cost to the taxpayers" of the program as required. Is Treasury Secretary Janet Yellen hiding the full cost of the three bank failures from Congress? “On June 9, the Federal Reserve Board posted information on loans in the ‘other credit extensions’ category in the H.4.1, currently $180 billion,” writes Bill Nelson of Bank Policy Institute . “The new information is available here . The Fed explains that the obligor to the credit extensions is the FDIC. All the loans began as 1) discount window loans to Signature and First Republic, 2) discount window loans to the bridge banks that the FDIC established for SVB and Signature, or 3) a BTFP loan to First Republic. All the loans are now in the receiverships established for each of these institutions; the FDIC is the receiver. The interest rate on the loans is the applicable discount window or BTFP rate plus 100 bp.” These emergency loans by the Fed illustrate the cost of the bank failures caused by the FOMC’s aggressive interest rate hikes in the first quarter of 2023. These losses and the prospect of more bank failures down the road has made the cost of the Fed’s support for FDIC a highly sensitive topic within the Biden Administration. Nelson suggests that while the Fed may eventually be repaid, the Treasury may ultimately take a loss on these three bank failures. Of note, the FDIC and Fed interaction with respect to the loans made to FDIC receiverships is being left to the respective agencies and their legal offices. Former Fed Governor and now White House economic czar Lael Brainard and former Fed Chair and now Treasury Secretary Yellen reportedly are being briefed directly on the Fed loans without involvement of career staff. Another large bank failure might require direct support for FDIC from the Treasury. Also, another bank failure might force the FOMC to drop short-term interest rates. As we've noted previously, in a rising interest rate environment, other banks will avoid purchasing the assets of dead banks. Nelson notes that there is still considerable uncertainty as to when the Fed will be repaid by the FDIC receiverships. Last week, BlackRock announced that it will not sell Ginnie Mae Project Loans held by the FDIC, Bloomberg News reports. Why? A very low price. These agency commercial mortgage backed securities (CMBS) came from Silicon Valley Bank and Signature Bank, Nomura Securities (NMR) said in a client note. Instead, the FDIC decided to consider “alternative disposition strategies,” according to Nomura. Pushing up the sale of MBS from the SOMA gives the Fed another tool to continue the fight against inflation, especially if liquidity problems at banks force the FOMC to reduce short-term interest rates earlier than now expected . Banks, the Fed and the FDIC all have the same problem: massive mark-to-market losses on assets that ultimately render markets illiquid. If the FOMC raises fed funds further, bank failures and perhaps even a market access crisis for the Treasury are next. Markets know that many banks are literally hanging on by a thin thread. A pivot by Powell and the FOMC to stand pat on fed funds and accelerate bond sales will take the crosshairs off the banks and restore the Fed’s credibility with the markets. As George Orwell noted almost a century ago, it all depends on whether we know what we are doing and why. In the next Premium Service issue of The Institutional Risk Analyst, we'll be looking at Morgan Stanley (MS), Goldman Sachs (GS), Charles Schwab (SCHW) and the other asset gatherers in The IRA's bank surveillance group. The Institutional Risk Analyst is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

June 14, 2023 | Premium Service | In this edition of The Institutional Risk Analyst , we go down the list of banks in our surveillance group and provide some color to the updraft that has pulled PacWest Bancorp (PACW) back towards half of book value. Some names in the group like Comerica (CMA) are of special interest and were of particular concern back in April and May, when Fed and Treasury officials were tracking the level of bank deposits via telephone. In the age of AI, US bank regulators verify end-of-day deposits by telephone. IRA Bank Surveillance List Source: Bloomberg (06/13/2023) The first word of caution for our readers is that bank stocks are going up because institutional managers are buying despite the operating outlook. Are exemplars such as U.S. Bank (USB) cheap at 1x book, unequivocally yes but with the caveat that book value may decline over the next couple of years. Please note that top-five bank laggard Bank of America (BAC) still wallows below book despite the rally. A combination of mark-to-market losses, negative spreads and, last on the list, credit concerns are the negatives weighing on the analysis of US banks. But none of these very real world concerns seem to matter in a market starved for duration in bonds and lacking new, large-cap offerings in equity markets. Meanwhile, large swaths of the investment map like China are now off the menu for global equity managers, who have watched AUM fall for most of a year. Our foray into New York Community Bank (NYCB) is a long-term play that is a function of interest rates falling and mortgage volumes rising. Same goes for Guild Holdings (GHLD) , which is busily rolling up dead mortgage banks. The fact that CMA announced its intention to exit commercial lending to mortgage banks, Inside Mortgage Finance reports, is good for #2 warehouse lender NYCB, which operates in the wholesale channel under the Flagstar brand behind #1 wholesale lender JPMorganChase (JPM) . The leader of the group in terms of equity returns over a 1-year time horizon is SoFi Technologies (SOFI) , the $19 billion asset BHC that reported a loss at year end. As we’ve noted in the past, investors still attribute tech magic to SOFI, which is essentially a consumer finance company with a bank license. With an efficiency ratio of 116, the bank is losing money and needs to grow 2-3x in order to generate sustained profitability, assuming that the firm can control operating expenses. SOFI is up 90% in the past month for a 1.7x book value multiple, but not because of any tangible growth in shareholder value. The stock has almost touched $10 in the latest rally, but investors should remember that SOFI was above $20 in 2021. The slide below from the SOFI earnings shows management's preferred presentation of the bank's financials focused on EBITDA, a metric inappropriate for a bank. The SOFI financial disclosure follows the idiotic style of Silicon Valley techno spin rather than that of a bank holding company. You must get to Page 15 of the SOFI Q1 2023 presentation before they tell you that they lost money, again, in the first quarter of 2023, although at a falling rate of loss vs Q4 2022. Hallelujah. When the folks at SOFI decide to grow up, they should follow the public disclosure presentation format of the larger consumer finance banks. Like most banks, SOFI saw its interest expense rise dramatically in Q1 ‘23 (+166%) but is likely to see funding costs rise even faster in Q2 2023. At Q4 2022, SOFI reported a gross yield on loans and leases of 8.51%, slightly below CapitalOne (COF) and about half of the gross spread of our new addition to the bank surveillance list, Synchrony Financial (SYF) . SOFI is basically +300bps to the gross yield over at Ally Financial (ALLY) , not our first choice of a competitive position. SOFI acquired cloud-based banking platform Technisys for $1.1 billion in 2022. And SoFi just announced that it is acquiring Wyndham Capital Mortgage , which explains why a company that reports consistent operating losses managed to report higher tangible book value in Q1 2023. As and when SOFI begins to report profits, then the fact that this is just another small bank focused on consumer finance will perhaps become apparent to investors and financial media. Next after SOFI is Discover Financial (DFS) , one of the more profitable banks in the US year in and year out. DFS saw interest expense rise 267% in Q1 2023 vs the year before and will likely see another jump in Q2 2023. Despite this, revenue net of interest expense rose 29% in Q1 2023. Rising operating expenses (+22%) and a 10-fold increase in credit loss provisions drove DFS into a $266 million loss in Q1 2023, something we expect to see more with other banks in Q2 2023. The table below comes from the DFS Q1 2023 earnings presentation. DFS reported a gross yield on its loan book of 13% at year-end 2022 and 14% in Q1 '23, a figure that is likely to rise in coming quarters. Like SYF, DFS manages its $131 billion asset business to maximize asset turns and returns on earning assets, yet the operating environment will remain challenging. Note in the most recent financial that DFS has raised its liquidity portfolio and has not been shy about using the FHLBs and the Fed discount window. Even if US banks are reporting losses in Q2 2023 because of surging funding costs, we expect to see continued share price appreciation. Equity managers neither know nor care about the considerable operating challenges facing US banks in terms of funding costs and, down the road, credit expenses. Yet, leaving aside the fintech crowd, look for the better performers to outpace the laggards in 2023 as funding costs chase T-bill yields. With inflation fears moderating, we expect Buy Side managers to construct a rationale to buy bank stocks – even if earnings performance remains constrained due to the legacy of COVID and the Fed’s radical manipulation of interest rates and the bond market. That said, volatile credit and operating factors may provide some unpleasant surprises for investors during the balance of 2023. The Institutional Risk Analyst is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

June 12, 2023 | As the Treasury begins its refunding this week to raise the largest pile of cash since COVID, ponder how US banks are going to manage to compete with T–bills yielding north of 5.5%. Remember, for every $1 in debt redeemed on the books of the Fed, a bank deposit disappears. If an investor sells a money market fund and buys a T-bill, a bank deposit disappears. This is the newest take on "crowding out" incidentally. The chart below shows the Fed's total securities holdings and RRPs. Notice that the holdings of MBS are barely running off and that RRPs have climbed above $2.1 trillion as Treasury T-bill issuance came to a halt. We do indeed hope that most of the Treasury refunding will come from migration of investors out of reverse repurchase agreements (RRPs), but one way or another the US banking industry needs to shed a trillion or so in deposits over the next year. The chart below shows the Treasury general account at the Fed and total deposits for all US banks reported weekly to the Federal Reserve Board. Back in May , Treasury expected to borrow $726 billion in privately-held net marketable debt during the second quarter of 2023, assuming an end-of-June cash balance of $550 billion. The borrowing estimate was $449 billion higher than announced in January 2023, primarily due to the lower beginning-of-quarter cash balance ($322 billion), and projections of lower receipts and higher outlays ($117 billion). The delay in the debt ceiling has now made the Treasury's cash need even larger. As banks head into a new funding crisis in Q2, we watch with amusement the growing number of analysts confess to having no clue as to the direction of the markets or interest rates. This lengthening list is only exceeded by the outright capitulation by the bears, though this did not dissuade us from taking a gain on Nvidia (NVDA) around $390 last week. As memories of crypto fade into a haze of private securities litigation, the optimists in the equity crowd proclaim the Age of AI. The managers of confidence at the Fed and Treasury are trying mightily to get the narrative back on track after the disaster of Q1, when the FOMC’s clumsy handling of monetary affairs tipped over three good sized regional banks. The Fed’s Bank Term Funding Program put a tourniquet on the severed fingers, metaphorically speaking, but the negative cash flow continues to silently eat away at bank book value even as funding costs rise. Let’s say you’re a bank with a pile of Ginnie Mae 2s and 2.5s sitting in your portfolio. You can repo these mortgage backed securities (MBS) with the Fed at par but at the prevailing rate for repo set by the Fed, dollar swaps + 10bp or over 6%. Yikes. You’re receiving 2% or 2.5% from the Ginnie Mae MBS, but paying out 6% or more for the financing from the Fed? Private repo at fair value is even worse. The Fed has not taken our suggestion to simply charge the bank the coupon on the MBS. Why is the Fed so miserly? Because it is already losing $1 billion per day, according to Bill Nelson at Bank Policy Institute . As the Treasury refunding proceeds, hopefully a large chunk of Reverse Repurchase Agreements at the Fed will run off, reducing the Fed’s losses. But the fact is those MBS sitting on the books of the Fed now have average maturities measured in double-digit years. Like banks, the Fed earns ~ 3% on its portfolio of MBS, funded with cash from money market funds that it pays more than 5% on RRPs. While much of the great economics punditry may be clueless as to the next move by the Fed, we can see more policy obfuscation and market volatility ahead. The mechanical process of allowing the Fed's portfolio to shrink will place enormous pressure on banks. Ignoring market concerns, Federal Reserve officials are signaling they plan to keep interest rates steady in June while retaining the option to hike further later in the year. Just as the spread between Fed funds and the rate paid on RRPs is widening, so too late vintage mortgage paper with 5% and 6% coupons is trading wide of the troublesome low coupon MBS. We suspect the divergence is due to a certainty that interest rates will fall in 2024. “We are now over 150 bps away from a meaningful refi event (sub 5.50% primary rate),” notes Scott Butchta at Brean Capital . Yet it is interesting to note that the widening spreads on higher coupon MBS and related mortgage servicing assets reveals a fear that these assets could evaporate in an interest rate rally. Depending on how things go for the banks over the next little while, that Fed interest rate cut could come sooner or later. The big question facing investors, at least those not fixated by the shiny sparkle of AI, is when to go long duration to take advantage of a period of interest rate ease. That eventuality may be a long way off, however, especially if the consumer economy ignores higher interest rates. Meanwhile, look for the level of bank deposits to continue to fall as the Treasury raises nearly $1 trillion in the next couple of weeks. Don't miss WGA Chairman Christopher Whalen on Business Radio on SiriusXM Channel 132 at 9:00 AM this Wednesday, June 14th. The Institutional Risk Analyst is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

June 9, 2023 | Premium Service | We recently added Synchrony Financial (SYF) to our bank surveillance group, replacing the institutions f/k/a Signature Bank and Silicon Valley Bank. For those of our readers not familiar, SYF was established in 2003 as GE Capital Retail Finance Corp , a thrift holding company based in beautiful Draper, UT. In March of 2014, SYF changed its name to Synchrony, which is today the largest white-label credit card issuer in the US. What can SYF tell us about the bleeding edge of unsecured consumer credit? The first thing to notice about SYF is that it is more profitable than most banks and also has a higher default rate. We would not insult SYF by comparing them to Citigroup (C), which has a gross spread on its loans of 6% and a default rate 3x the large banks in Peer Group 1. No, SYF has a gross yield of almost 15% or 50% higher than CapitalOne Financial (COF) at 9.5% at year-end 2022. Source: FFIEC Now COF’s gross spread near 10% suggests an internal default rate target of “B,” so at 15% gross spread SYF is looking for more like a “CCC” target customer. Net losses of 3% at year-end 2022 put SYF in the “BB” category, but the real question is where will the loss rate be a year from now? The average net loss rate for Peer Group 1, of note, is just 0.09% at year-end 2022. SYF’s default rate is orders of magnitude above Peer Group 1. The high default rate makes SYF maintain very high loss reserves equal to more than 10% of total loans. The bank also maintains mid-teens equity capital, a level that is appropriate to the level of risk and the unsecured nature of much of SYF’s lending. Non-core funding dependence of 25% of total assets of $110 billion is another notable component of this relatively high risk business model. SYF mitigates this concern by maintaining a large pile of liquid assets, but ultimately net loans and leases are 150% of core deposits. SYF describes the deposit base in its last Form 10-K: “The Bank obtains deposits directly from retail, affinity relationships and commercial customers ("direct deposits") or through third-party brokerage firms that offer our FDIC-insured deposit products to their customers ("brokered deposits"). At December 31, 2022, we had $71.7 billion in deposits, $58.0 billion of which were direct deposits and $13.7 billion of which were brokered deposits. At December 31, 2022, deposits represented 84% of our total funding sources. Retail customers accounted for the substantial majority of our direct deposits at December 31, 2022. During 2022, retail deposits were received from approximately 506,000 customers that had a total of approximately 980,000 accounts. The Bank had a 87% retention rate on certificates of deposit balances up for renewal for the year ended December 31, 2022. FDIC insurance is provided for our deposit products up to applicable limits.” The bank buys and securitizes consumer loans from its customers in a variety of channels including home & auto, health & wellness and other verticals that are less easy to describe, as shown below. Notice that SYF is taking 10% out of these subprime loan categories in terms of spread and fees. The bank also charges significant late fees on loan delinquencies, another point of vulnerability in a recession. Defaulting customers don't pay late fees. The bank also raises deposits from this same base of customers, a novel and to date successful strategy. But the $30 billion plus in noncore deposits at SYF presents the same market funding risk that eventually took down three large regional banks in Q1 2023 and caused others to fail. Like all banks, SYF has seen its funding costs galloping higher, rising 219bp to 3.4% at the end of Q1 2023. Given that net interest margin is still over 15% and the efficiency ratio is just 35%, SYF has a lot of extra profitability to absorb loss mitigation expenses. That said, net charge-offs were barely above 2% this time a year ago and at the end of Q1 2023 were at 4.49%. COF, by comparison, was just 1.35% net loss at year end 2022. “Credit normalization remains in line with expectations,” SYF reported to shareholders in Q1 2023. “Delinquencies will approach pre pandemic levels by mid year. Net charge off dollars to generally rise sequentially through year; not expected to reach pre pandemic levels on an annual basis until 2024.” We generally agree with SYF on the timing, since credit cards generally are still a long way from pre-COVID loss rates. Source: FDIC Ultimately, we must measure SYF against the other bank providers of consumer credit. The SYF model is well north of COF in terms of spread and defaults, but frankly this bleeding edge of the world of retail finance is the most important component of economic growth and job creation – and also among the most profitable. There are dozens of smaller bank issuers of credit cards with much higher gross spreads, default rates and profits than SYF. At just over 1x book value and with a six month beta of 1.3x, SYF is hardly a speculative name in the bank group and is at the top of most rankings in Peer Group 1. But that is the problem. The mere fact that it is arguably the outlier among large banks above $100 billion in assets in so many metrics measured by the FFIEC begs the question, as shown in the table below. The operating results of SYF speaks to a superior operating team that understands asset turns and credit equally. Note for example, that SYF manages to achieve more than 100% of total assets in terms of earning assets, a remarkable metric. But the hyper-efficient operating metrics of SYF make us take a step back in wonder and awe. If there is a consumer recession lurking in the next year or two in the US, you’ll see the early signs of that event in the results of SYF. Just as Citi is the early indicator for the top five money centers, SYF is the bellwether for credit card issuers. We must confess to a certain bias in favor of the consumer finance world because it is literally the oil in the crankcase of economic activity. We like SYF a lot more than Ally Financial (ALLY) , for example, because the total returns are higher and have been in the age of QE. COF is a good comparable for SYF among the larger banks, but SYF is really more like the smaller specialty bank card issuers with gross yields in mid-double digits. Fact is, the operating metrics of SYF put them in the same league as American Express (AXP) , but SYF gets no such respect. Yet the lingering concern that we raise for our readers is the combination of a one-third market funded book and the highest default rate in Peer Group 1. We could see net defaults on the SYF book pop to 6% this year and, along the way, drag most of Peer Group 1 to above average net loss rates. The volatility we see everywhere in the world of funding and credit tells us to take caution. Below is our bank surveillance group, sorted from lowest to highest in terms of total return. We note that SOFI leads the group followed by NYCB, our sole bank common stock holding at this time. SYF is in the middle of the pack, but note that investors like Warren Buffett have exited the stock recently because of the prospect for higher credit costs. Source: Bloomberg (06/08/2023) The Institutional Risk Analyst is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

June 6, 2023 | Watching the latest example of human nature in the hype surrounding stocks that refer to “artificial intelligence,” we remind readers of The Institutional Risk Analyst that if it’s artificial, then it’s not intelligent. Muscular pattern matching is not deliberate intellect, one reason why we agree with Mark Cuban and others that “A.I.” is probably more a risk rather than a help . And yeah, we’ve got the stop loss order right underneath our position in Nvidia (NVDA) . H/T Jim Cramer . Source: Google Even as the cult of AI reaches a fever pitch, the members of the regulatory and law enforcement communities are tightening the lasso on the world of crypto fraud. Federal regulators sued Binance , the world’s largest crypto trading scheme, accusing the company of running an illegal securities exchange and commingling billions of dollars’ worth of customer funds. The Securities and Exchange Commission alleges the company acted in “blatant disregard” of US securities laws. It also named Binance’s CEO Changpeng Zhao , known as “CZ,” as a defendant. “Through 13 charges, we allege that Zhao and Binance entities engaged in an extensive web of deception, conflicts of interest, lack of disclosure, and calculated evasion of the law,” SEC Chair Gary Gensler said Monday. Meanwhile in the world of fintech, the wheels are coming off the wagon for several familiar vehicles. Last summer, we wrote about Upstart Network (UPST) , a financial startup that promised to avoid credit risk by using AI to underwrite unsecured consumer loans (“ Update: Upstart Holdings & Cross River Bank ”). UPST is up over 100% in the past month, but is still down 40% over the past year, reflecting the powerful updraft from the AI hype fest led by NVDA. Source: UPST We notice that Giuliano Bologna at Compass Point in Washington has a “sell” rating on UPST and an $8 price target, this vs a ~ $27 price for UPST today. Why the concerns from Compass Point? First, the primary source of loan purchases historically, Cross River Bank , is now the target of an enforcement action by bank regulators led by the FDIC and is likely to be reducing funding for UPST. Second, the other bank lenders that have been supporting UPST are apparently heading for the door, a bad sign for an originate-to-sell model. Compass Point notes that Customers Bancorp (CUBI) may have been purchasing up to a third of the production from UPST. Bologna writes: “Cross River Bank (CRB, private) and one other bank have likely been a significant majority of UPST's bank funding channel and that those two partners have materially reduced loan purchase volumes and could potentially stop buying loans from UPST during 2Q23.” The concern about UPST is warranted, in our view, because of both funding and credit. As banks pull back from third-party originators such as marketplace lenders, originate-to-sell models like UPST become problematic. Nonbank lenders that are forced to retain production on heavily leveraged balance sheets are not long for this world. Note that PacWest Bancorp (PACW) stabilized near $8 after selling its loan business. Take the hint. Compass notes that concessions made by UPST today to retain funding may mutate into credit risk down the road. Moreover, the visible default rates disclosed by lending facilitators like UPST are still understated due to QE. By this time next year, we expect that the default rates on production from UPST will look pretty much like other unsecured marketplace products. AI does not make superior credit decisions, it simply makes your loan underwriting mistakes look like the mistakes made by everyone else. Consumer defaults are still running at very low rates, as we noted in The IRA Bank Book for Q2 2023 . By the time that credit card default rates normalize, we expect that subprime consumer lenders like UPST will also see rising losses appropriate for their select clientele. But it could be worse. You could be a developer of commercial real estate with legacy assets in Lower Manhattan. Jeff Blau , The Related Companies CEO, just put a bullet in the head of the return to work tendency in New York City. Blau’s advice to the owners of B & C grade commercial properties in Manhattan: “Take what you can and run,” The Real Deal reports . “Every landlord thinks they have Class A,” said Blau. “There is a big difference between a 50-year-old, well taken care of building and a new building.” We notice that new buildings in markets like San Francisco are also trading at distressed prices. Blau's less than kind remarks about other commercial properties, it seems to us, amount to wishful thinking in terms of the long-term prospects for urban office space of whatever description or vintage. While Blau is happily disparaging the owners of older commercial properties, he claims that Hudson Yards is 80% leased and that he will be able to harvest $200 per square foot rents indefinitely, even as the rest of Gotham slides into the East River under the weight of progressive destruction. The fact that anchor tenant Neiman Marcus fled the barren wasteland of 10th Avenue & 34th Street does not deter Blau, who is reportedly turning the vacated retail space into, wait for it, more offices. Perhaps if the lucky tenants of The Related Companies buy some of the new Apple (AAPL) Vision Pro Mixed-Reality Headsets , they can pretend that there are people and actual economic activity on the streets around Hudson Yards. Mr. Blau can also wear the headsets and pretend that Hudson Yards is the Westfield World Trade Center , with real people and shopping. He can even pretend that Hudson Yards is Time Warner Center, also with real people and shopping. No word yet on when Related is starting Phase 2 of the construction of Hudson Yards. But one thing that Blau and other real estate developers cannot change, with or without AAPL goggles, is the deteriorating economics of core cities like New York. Blau can pretend that he can demand $200 per square foot for newer commercial properties while the rest of the city is deteriorating. We suspect that the dismal outlook for most commercial real estate in NYC will soon be reflected in the fiscal situation. Without commercial tenants, New York City does not work. Just ask your favorite co-op owner or realtor. Down-sizing of investments in urban commercial real estate is a long-term reaction to the invention of the automobile and related car-centric development patterns of the past century. Enabled by technology, the COVID lockdown allowed Americans to break free of the commuter model that was an allegory to the world of automobiles created by Henry Ford . Fifty years later, Robert Moses turned New York into a car-centric metropolis, a model that is now dying a most natural and timely death. Knight Frank reports that a survey of 350 large employers, those with more than 50,000 employees, found that half of employers planned to downsize office space by 10-20%. Smaller employers, not surprisingly, plan to expand their office space needs. While observers of the world of corporate real estate like to refer to working at home as “hybrid working,” in fact it reflects a more traditional pattern of local working and living that actually predates the age of the automobile. As we noted in Ford Men: From Inspiration to Enterprise , the cities built two centuries ago along the St Lawrence seaway and Great Lakes no longer have a clear economic purpose. The compact, grid layout of New York City reflects an economic reality that died fifty years ago, but humans are creatures of habit. It took the shock of COVID to change behavior patterns and create new possibilities, even if the “new” model of working at home looks a lot like the pre-automobile model of America before WWI. Joe Costello wrote back in December : "I n an era where America must transcend the automobile as the primary means of transportation, how can information technologies help us restructure our transportation and distribution infrastructure? Here’s a clue, it would mean a company like Amazon wouldn’t exist. We have no politics to even ask these questions." And we don't even begin to have the politics to discuss the restructuring of great cities like New York, Chicago, San Francisco and Los Angeles. The Institutional Risk Analyst is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

Whalen Global Advisors has released The IRA Bank Book for Q2 2023 , including a review of the latest financial results for the banking industry and our outlook for the rest of 2023. Copies of the IRA Bank Book for Q2 2023 are available to subscribers to the Premium Service of The Institutional Risk Analyst . WGA Chairman Christopher Whalen commented on the industry outlook: “Since the failure of Silicon Valley Bank in March, the cost of funds for most US banks has risen two or even three-fold. Many banks face an unprecedented interest rate environment that could push many institutions into loss this quarter." Highlights from the latest edition of The IRA Bank Book include: A $19 billion, one-time uptick in noninterest income saved the US banking industry from a down quarter in Q1 2023. Net interest income and broad banking industry earnings may decline again in Q2 due to unprecedented deposit interest rate re-pricing. As Treasury rebuilds cash position via $700 billion refunding, bank deposits will come under pressure from 5.5% yield on T-bills. Every new T-bill sold to private investors results in a bank deposit disappearing, part of the deflationary mechanics of QT. “With industry gross asset returns around 5-6% in Q2 2023 and funding costs approaching these levels, many banks may report GAAP losses in Q2 because of severe asset/liability mismatch,” notes Whalen. “The cost of credit to the economy will also rise as banks aggressively reprice assets.” Source: FDIC Copies of The IRA Bank Book for Q2 2023 are available to subscribers to the Premium Service of The Institutional Risk Analyst . Standalone copies of the report are also available for purchase in our online store . Media wishing to receive a courtesy copy of the report please email: info@theinstitutionalriskanalyst.com Subscribers to the Premium Service login to download the latest copy of The IRA Bank Book for Q2 2023

June 1, 2023 | Premium Service | As we process the data from the FDIC for the first quarter of 2023, we have a couple of observations. We’ll be releasing our Q2 2023 IRA Bank Book industry outlook next week. For investors in banks and other forms of leveraged credit, a couple of obvious points are raised by the latest bank data release. First, in terms of future earnings, the Q1 2023 numbers for the US banking industry included a big surge in non-interest income. The FDIC Quarterly Banking Profile states: “The accounting treatment of banks’ acquisition of two failed banks and record-high trading revenue led the growth in noninterest income. Interest income increased $19.1 billion (7.9 percent) from fourth quarter 2022, but was offset by a $23.7 billion (38.2 percent) increase in interest expense. From the year-ago quarter, net operating revenue rose $47.0 billion (21.9 percent), as net interest income grew $37.7 billion (27.3 percent) and noninterest income expanded $9.3 billion (12.2 percent).” Why is this important? Because neither above-normal trading revenues nor GAAP adjustments to income due to the acquisition of failed banks are going to repeat $19 billion worth of income for Q2 2023. The chart below illustrates the sharp drop in net interest income and the upward surge in non-interest income because of these two non-recurring events. Source: FDIC As we write these lines, Goldman Sachs (GS) is on the wire guiding down trading revenue 25% and preparing a further cull from the banker ranks. The message coming from GS and the other major trading houses is that deal volumes and new issuance is going to be sluggish across the board with the possible exception of jumbo mortgages. This leads to our second point, which is that the gyrations seen in terms of non-interest income are likely going to continue in Q2 2023 and beyond as banks focus on reducing bond positions to 2018 levels. It is remarkable to us that Morgan Stanley’s (MS) bond analysts went to overweight MBS yesterday. MBS spreads over Treasury paper are at decade wide levels, yet selling pressure from banks, which still own $2 trillion in MBS, will continue. Source: FDIC Banks have reduced available for sale securities by about a third since the peak of $4 trillion in Q4 2021. After that time, the industry saw bond valuations slide 20% as the FOMC raised interest rates 500bp. The mark on AFS and HTM securities in Q3 2022 was negative $800 billion or so. The reduction in the size of bank securities holdings now pushes the negative market down to a more managable $500 billion. This is a very welcome development and also entirely necessary. The good news is that aggressive sales of securities have pushed down the ugliness of mark-to-market disclosure on legacy, COVID era exposures. Loss on securities sales in Q1 2023 were only $2.1 billion. We look for AFS securities owned by banks to fall another $500 billion back to 2018 levels over the next year. The bad news is that banks face a difficult couple of quarters ahead when rising funding costs could push some banks into a loss. Loans and securities currently held in portfolio could end up being reclassified and sold with the attendant ugly disclosure. We did the math with Bank of America (BAC) in our last comment . Below let’s take the numbers for Peer Group 1 for year-end 2022 and then extrapolate based upon the Q1 2023 actuals. If we assume that asset returns will continue to rise low double digits, but that bank funding costs will rise 3-5x asset returns, then the US banking industry is barely making money in Q2 2023. The Q1 2023 numbers for non-interest income skew up to $80 billion, but then return to the $65 billion average in Q2 2023. Source: FFIEC, WGA LLC FDIC Chairman Martin Gruenberg set the stage for Q2 2023: "The banking industry has proven to be resilient. In the first quarter, net income was flat but still high by historical measures, asset quality metrics remained favorable, and the industry remains well capitalized. However, the industry’s quarterly results do not yet fully reflect the stress that began in early March . The banking industry also faces significant downside risks from the effects of inflation, rising market interest rates, slower economic growth, and geopolitical uncertainty. These risks have the potential to weaken credit quality and profitability and could result in further tightening of underwriting, slower loan growth, and higher provision expenses." The Institutional Risk Analyst is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

May 30, 2023 | A longtime reader of The Institutional Risk Analyst sent us a link to a post on Reuters from 2011 , wherein we talked about the world of credit when the supposedly superior government credits are all insolvent or headed that way. Our relationship with Reuters ended not long after that post, when we suggested that Bank of America (BAC) should be restructured to rid it of the toxic mortgage liabilities of Countrywide Financial. After a decade under CEO Brian Moynihan , BAC remains an example of why large banks need to be broken up -- to protect shareholders rather than just consumers. Since the 2012 National Mortgage Settlement that enabled Vice President Kamala Harris to buy a seat in the US Senate , large American banks have backed away from mortgage lending and investing in mortgage loans, especially government lending. But they continue to hold “AAA” rated agency and government mortgage backed securities (MBS), bonds that are arguably too dangerous to be suitable for most investors. Why? Under Basel III, Ginnie Mae MBS have zero risk weighting and MBS issued by the GSEs is weighted 20%, even though both Fannie Mae and Freddie Mac remain in government conservatorship. Whole loans, on the other hand, have at least 50% risk weightings and infinite compliance and reputational risk, especially if the bank is facing a lower-income household with an above-average likelihood of default. The message to banks from the 2012 Mortgage Settlement and related litigation, and Basel III, was simple: don’t lend to poor people. But as the $3 trillion asset BAC proves pretty conclusively, fleeing mortgage lending entirely is bad business. The bank's deposits are under-utilized and most of BAC's assets are invested in securities. And the bank owns lots of MBS. After it purchased Countrywide in 2007, BAC destroyed tens of billions in shareholder value by withdrawing from correspondent lending. Under Moynihan, responsible growth means being number four or five in the top five largest US depositories. The chart below shows the gross spread on loans and leases for the top US banks and Peer Group 1 from the FFIEC. Source: FFIEC Wells Fargo (WFC) is following BAC’s bad example and exiting correspondent lending in 1-4 family mortgages, leaving the $1.8 trillion bank few good alternatives for deploying liquidity into earning assets. This means that both BAC and WFC are only lending in footprint, via the banks’ branches, and cutting off wholesale warehouse liquidity to nonbank lenders and smaller banks that were once correspondents. Of note, the Federal Home Loan Banks only face one quarter of the US residential mortgage market because three quarters of 1-4 lending is now controlled by nonbank firms. The net result of progressive, pro-consumer policies is to marginalize two of the largest banks in the country, including $5 trillion in assets, and decrease the availability of credit to the underserved. Since BAC and WFC now restrict their activities to internally originated loans and then only high quality loans that will be retained in portfolio, economic growth suffers along with shareholder returns. But as Silicon Valley Bank shows, the fact of a good credit portfolio does not mean low risk. Since BAC and WFC don’t make enough loans to deploy the trillions in deposits the banks control, what do they do? They buy “AAA” MBS and other securities, in the process taking on huge market risk. The increase in interest rates by the Fed in 2022 wiped $7 trillion off of the global ledger, notes Gillian Tett in the FT . A good bit of this deficit came from the extension of maturities of MBS as interest rates rose, home mortgage volumes fell and bond prices sank accordingly. In the event of a “balance sheet recession" Ms Tett describes, we are likely to wipe off a good bit more apparent equity from the books of banks and other credit investors that hold MBS. The irony of Silicon Valley Bank being rendered insolvent because of a bad bet on government-backed MBS speaks to the changes which have occurred in the markets since 2008. Federal debt has swelled, even as interest rates plummeted to the zero bound for two years during COVID. Volatility in the markets has also increased as interest rates fell, making it near-impossible to hedge the very low coupon securities created in 2020-2021. What does a federal guarantee against credit loss on a Ginnie Mae 2% MBS matter when the Fed causes the markets to issue trillions in low-coupon mortgages, then raises market interest rates 6% in less than 18 months? The snapshot below shows mortgage TBAs at the close on Friday. Notice Fannie Mae 3s for delivery in June are trading at 87. Lenders were writing 7% home loans last week and selling the new loans into 6% MBS for June, which were trading just over 101 at the close on Friday. Source: Bloomberg (05/26/23) At the end of 2011, MBS equaled 11% of the $13.4 trillion in total banking assets in the US. By the end of 2021, the banking industry’s holdings of MBS rose to 15% of total assets. But what total assets? The total assets which almost doubled over a decade and then rose 20% in 2020-2021 thanks to QE and the Fed’s $9 trillion in bond purchases. You could not create a more perfect trap for killing banks. And we did. The chart below shows MBS holdings by all banks vs deposits through year-end 2022 as a percentage. Deposit growth is generally how the Street thinks about MBS holdings. Banks’ mortgage backed securities holdings have been “dropping like rocks,” with Q1 2023 marking the fifth straight decline on depository balance sheets, according to Robert W. Baird & Co . “Banks lost almost $67 billion of MBS since the start of this year alone,” wrote portfolio strategist Kirill Krylov . Source: FDIC The one thing you can be pretty sure about is that bank holdings of MBS are likely to fall as balance sheets shrink in Q2 2023 and beyond. This will put selling pressure on MBS and push home mortgage rates even higher. Widening of the primary-secondary spread between loan coupons and MBS yields has yet to entice buyers enough to offset sales by banks and the FDIC . And the flood of banks looking to reduce market risk and raise cash is also adding to selling pressure. One bank we hope to see reducing MBS holdings is Bank America, which was 50% above Peer Group 1 in terms of MBS exposure vs total assets over the past five years. BAC also retains a lot of whole loan exposures, one reason why the gross loan spread is so low vs other banks. The table below shows BAC MBS holdings as a percentage of total assets vs Peer Group 1. Note that BAC is in the 73rd percentile of Peer Group 1 in terms of MBS/Total Assets. Bank of America | MBS/Total Assets (%) Source: FFIEC As of Q1 2023, BAC held $229 billion in 1-4 family mortgage loans with a weighted average coupon (WAC) of just 2.9% and $851 billion in debt securities with a weighted average coupon of just 2.58%. Yikes. BAC's gross loan yield on the entire book was just 4.36% at Q1 2023 and has been in the bottom third of Peer Group 1 going back five years, according to the FFIEC. We know a wealth management client of BAC that has a 30-year, 2.25% mortgage from BAC. The 2021 loan is still owned by the bank. What is wrong with this picture? Readers will be thrilled to hear that BAC was earning well-north of 4% on deposits with other banks at the end of Q1 2023. This tells you where funding costs for BAC and all banks are headed. You can see from the numbers above that we have a problem, yes? The rate of turnover for the $3 trillion total asset bank is very low, less than 10% per year, but funding costs are changing weekly. The snapshot below is from the Q1 2023 BAC earnings supplement. For some time now we have been telling our readers that the threat to the US banking system posed by the policies of the Federal Open Market Committee is not limited to small banks. Some of the biggest holders of MBS and whole loans as a percentage of assets are among the largest banks. Banks like BAC, which originated and retained many low-coupon assets during the COVID ease by the FOMC, now face a funding mismatch of existential proportions. When Zero Hedge wrote provocatively last week that the Fed Is "Foaming The Runway" For Big Bank Problems Ahead, the comments from noted monetary analyst Zoltan Pozsar reflected a degree of comfort with Fed actions that is way too optimistic. If you believe that the Fed is going to keep interest rates at or above current levels through to 2024, then we have a problem with several large banks led by BAC. Foaming the runway is a great metaphor, but that assumes that the Fed actually understands the problem and is willing to act accordingly. We suspect that the general lack of focus and silliness that prevails in the world of finance and particularly in Washington may ultimately allow for a range of outcomes that are less than acceptable to the markets. Michael Hofman sums up the current state of things nicely in The New York Review of Books : "Now that we’ve had it with uncomplicated greatness, just give us our supernatural machinery. What a poor, gaslighted, meme-riddled, spook-spooked species we are. We can no longer count to three, but by golly you should see our numerology. I don’t know what we should be more ashamed of: our stupid credulity or our oh-so-clever suspicion ." The Institutional Risk Analyst is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

May 25, 2023 | Premium Service | In this issue of The Institutional Risk Analyst , we return to the world of credit and secured finance after spending two days at the Mortgage Bankers Association Secondary Conference in New York. Suffice to say that the area around Times Square and 8th Avenue in the lower forties is reverting to conditions circa the early 1970s. Commercial property values are soft, the smart money is long gone and vultures are gathering in great numbers. And yes, we've seen this movie before. In residential mortgage land, the good news is that default rates are still running below prepayment rates, allowing servicers to float the cost of advances on delinquent loans. The bad news is that persistent talk about a 5.5% 30-year mortgage rate later this year is badly wrong as TBAs flip from 5.5% to 6% coupons for delivery in June. The industry is writing 7% mortgages as we enter the Memorial Day weekend. The MBA Secondary was lightly attended, with the vast majority of industry executives focused on meetings with counterparties and regulators. News that Credit Suisse restarted the auction for Select Portfolio Servicing was welcomed, though it remains to be seen whether a deal gets done. We hear also that CS extended a long-term credit facility to Apollo Global Management (APO) portfolio company Atlas SPG as part of the deal to sell some investment banking businesses to APO. Bidders in the SPS auction tell The IRA that the business and the MSR are being offered separately, but that still may not be a sufficient concession given the recent sale of HomePoint, which basically liquidated after a 2021 IPO. Our earlier report of the HomePoint mortgage servicing right going for just under 5x multiple may have been optimistic. Several issuers argued that when boarding fees and other offsets are considered, the price paid falls below 3x vs a 6x mark by HomePoint at year-end. This does not give us great confidence in some of the other 6x MSR marks among public issuers. But let's recall that a continued move higher in the 10-year Treasury yield will also mean higher fair value marks for some MSRs, the ideal negative duration asset for a lender portfolio. A number of comments were heard about the acquisition of Angelo Gordon by TPG (TPG) , which will give the acquirer control of two public REITs: AG Mortgage (MITT) , and TPG Real Estate Finance (TRTX). Eric Hagen at BTIG notes that both REITs have market caps below $1 billion, making us wonder about the play going forward. Of course, we'd be remiss not to mention that TPG was the investor in Washington Mutual a decade ago. Other residential mortgage REITs are facing erosion of book value due to Fed interest rate tightening and difficult spreads. In the event of Fed ease, margin calls on suddenly disappearing MSRs become the new concern for investors. We exited Annaly Capital (NLY) when they began to buy MSR because of our long-held belief that only mortgage lenders should own servicing assets, especially Ginnie Mae servicing assets. A number of attendees were concerned about the increasing tide of loan repurchase requests coming from the GSEs, Fannie Mae and Freddie Mac. One prominent industry CEO known for his ability to "see around corners" laughed at the fuss so far and told The IRA : “The GSEs are just practicing for the real push back. This is just a dress rehearsal.” Federal Housing Finance Agency Director Sandra Thompson continued to hear criticism in private meetings about the changes in the loan level pricing adjustments (LLPAs) for the GSEs. As we noted in National Mortgage News (“ FHFA Should Nix Its Credit Score Plan, Too ”), there are few loans below 680 FICO scores going into conventional assets to move the needle for the White House. Thompson oversold the impact of the LLPA changes. Several issuers tell The IRA that personnel at the GSEs are desperately, urgently asking lenders for “mission loans” – meaning loans to underserved and generally low-quality borrowers. Some issuers approaching the GSE cash windows have been told that they will not receive attractive pricing unless the pools include mission loans. But sadly, there are few cases where a lender could advise a consumer to take out a conventional loan vs FHA/VA. Another telling comment from a top correspondent CEO: After more than a decade in conservatorship, the GSEs more and more resemble government agencies rather than private issuers. Any hope of ever taking Fannie Mae and Freddie Mac out of conservatorship is pretty much dead when the cultural changes made at the GSEs are taken into account. The pricing of the GSE cash window, for example, is so bad that several large bank issuers have shifted conventional volumes to the Federal Home Loan Banks. The changes in GSE loan pricing and other policy changes reflect the FHFA’s focus on implementing the enterprise capital requirements put into place by Thompson. Consultant Garrett Hartzog, Principal of Fundamental Advisory and Consulting notes in a comment in NMN : “The Enterprise Regulatory Capital Framework is going to dramatically transform GSE pricing in ways the industry hasn't begun to contemplate. Understanding the ERCF means being able to mentally reconcile increasing risk-based pricing (the DTI-based fee) and decreasing the level of risk-based pricing (the credit score/LTV matrices). What's more, people need only read Fannie Mae and Freddie Mac's comment letters during the rulemaking process to understand that g-fees will ultimately experience a dramatic increase as a result of the ERCF.” If Garrett is right about FHFA raising guarantee fees for the GSEs in line with the capital rule, then Fannie Mae and Freddie Mac would no longer be competitive for larger, high-FICO loans and could price themselves out of existence. FICO 10 & Vantage Score The big news regarding FHFA and the GSEs was the back-peddling on the plan for using two credit scores for conventional loan approvals . "We're very aware of the many challenges out there," Federal Housing Commissioner Julia Gordon told attendees. As we noted in the NMN comment , using two different credit scores for a loan underwriting process is technically problematic and may create significant liability for issuers. The ideal solution to this latest progressive initiative from FHFA is to let the lender pick which score to use in underwriting the loan. The lenders own the risk, after all, because the GSEs can put back the loans. If the GSEs want both scores delivered with the loan at sale, fine. But lenders cannot compare the two scores arithmetically, so let the market choose. For rating agencies, bank regulators, institutional investors, et al this proposal is a huge mess (and prospective expense) because the century of consumer credit data that rests on the FICO classic model approach is useless for benchmarking FICO 10. All of the models and ratings criteria used in 1-4s must be recreated from scratch. There is no transition table between FICO 10 and Vantage Score. And there is no historical data for either score, a fact that may come to haunt Thompson and FHFA when they finally engage with federal banking regulators. Amidst all of the fuss, Director Thompson and the Biden White House are missing a big opportunity to move the industry forward in terms of credit ratings and access to credit for the underserved. FICO 10 incorporates many qualitative factors used by Vantage Score and demanded by progressives. Problem solved. Let the lenders pick the score and the markets will quickly tell issuers which model works best. Merely requiring the conventional market to migrate to FICO 10 and allowing Vantage Score is a huge change that should satisfy the White House and consumer advocates. Ginnie Mae Default Rates One topic that many issuers mentioned again and again was the steady climb of default rates for FHA/VA/USDA loans in Ginnie Mae securities. Default rates are not yet near critical levels, but when prepayments are not well above default rates, liquidity becomes a concern. The table below shows the largest Ginnie Mae issuers with delinquency and prepayment rates (CPR). Source: Ginnie Mae The Ginnie Mae table above shows that many significant issuers are already at default rates where prepayments are insufficient to fund default advances. One reason that PennyMac Financial (PFSI) was able to report zero default advances was that prepayments were running high enough to finance the cash. Now, however, defaults at PFSI and other large issuers are moving higher as prepayments fall, thus utilization rates on advance lines should be up in Q2 2023. Of note, the FHA is in the process of making changes to the rules for reimbursement to allow government issuers to make multiple partial claims on a delinquent loan. With interest rates rising, issuers are unwilling (or unable) to buy delinquent loans out of Ginnie Mae MBS pools, thus the favored approach now is to leave the loan in the pool and simply modify the note. This is why bank balances for early buyouts from Ginnie Mae MBS have been falling sharply, as shown in the chart below. Source: FDIC The fact that FHA is working at maximum speed to modify the rules for partial claims on delinquent loans should tell readers all they need to know about the outlook for credit in 1-4 family mortgages. This is perhaps why Ginnie Mae President Alanna McCargo and her team have been very accommodating to issuers in the past few months since the failure of Reverse Mortgage Funding in December. During an MBA session, McCargo made positive comments about excess servicing strip (ESS) transactions in the context of the agency's Risk Based Capital rule, although no final statement has been forthcoming. Several issuers tell The IRA that Ginnie Mae officials have been very focused on understanding problems faced by issuers. There were also suggestions that Ginnie Mae would tailor the RBC framework to issuers by size and market footprint, a sensible change that would go a long way to addressing industry concerns As the CEO of one veteran government issuer that focuses on underserved communities told us: "I think Ginnie Mae understands that they need to get out of the way and let us run our businesses as delinquency rates rise. Until interest rates fall and volumes improve, this is a war of attrition among lenders. The issuers that are hoping for lower rates and are dragging their feet on cost cutting will not survive. Hope is not a strategy." The Institutional Risk Analyst is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

May 23, 2023 | Readers ask if the banking crisis of 2023 ended last month. The short answer is no. There are banks that are insolvent and need to be closed, but the FDIC has run out of cash and, more important, ready buyers of failed banks. The market volatility that the Fed has injected into the banking system, first with QE and now by ending this irresponsible policy, makes it virtually impossible to value bank equity today. Matt Levine of Bloomberg, in a brilliant analysis of First Republic's acquisition by JPMorgan (JPM) from the FDIC Receivership, describes why ready buyers are essential to federal deposit insurance: "The goal is to have banks with ample capital, whose assets are worth much more than their liabilities; the acute problem with a failed bank is that it has negative capital; the solution is for someone to put in more money so that the system as a whole is well capitalized again. Sometimes the FDIC puts in the money." The federalized system of federal deposit insurance only works if there are good banks and bad banks. The former buy the assets of the latter, and the FDIC provides a small subsidy in terms of a discount to create new capital to support the assets of the dead bank. But when the FDIC and the US banks that stand behind it are forced to take over dead banks without a buyer to carry most the the load, the system fails. PacWest Bancorp Meanwhile, the narrative coming from within the Federal Open Market Committee continues unaffected by market turmoil. Fed officials assign blame for bank failures everywhere but where it belongs. Federal Reserve Bank of Minneapolis President Neel Kashkari, for example, says bank capital requirements should be lifted significantly to help “backstop financial institutions against distress.” Really? The distress to which Kashkari refers was caused by the FOMC. And the childlike naivete displayed by Kashkari accurately reflects the consensus within the committee. The truth is that dead banks like Silicon Valley, Signature Bank of New York and First Republic all had plenty of book capital. More capital would not have changed the outcomes for any of these banks in a market where risk-free assets are trading at 10 or 15 point cash discounts to levels of two years ago. Sadly, the liquidity provided by the Fed during QE is now causing outsized losses to banks and investors as interest rates rise. The Federal Reserve Bank of St Louis reminds us that the “Three Cs” of credit are “ capacity, character, and collateral ,” not the mantra of static book equity capital that passes for deep thinking in Washington. Since Kashkari and most other FOMC members have little actual experience in the world of finance, the discussion defaults to “capital.” This simple financial measure is about as complex a concept as most political appointees and members of Congress can understand. The relevant discussion when it comes to banks is not capital, but “capacity and collateral.” Capacity speaks to cash; the ability to fund obligations and meet financial demands for holding long-term assets. If you are Bank of America (BAC) or JPMorgan (JPM) and you own a bunch of 2.5% conventional mortgages, do you have the capacity to hold these assets to maturity? When your cost of funds gets to 5% by year end, BAC and JPM will be losing several points a year on these loans. Collateral is the other side of the equation. Even though the 2.5% mortgage loans owned by JPM or BAC or many other banks are government guaranteed, risk-free assets with “AAA” ratings, these assets are impaired because of the rate hikes by the Fed. If the entire $13 trillion residential mortgage complex has an average coupon of 3%, when you move the fed funds rate 5.5%, everyone is insolvent. As we old our friends at Nomura last week , the agency and government MBS is the most dangerous security on the planet and should have 100% risk weight for Basel III. PacWest Bancorp Take the case of PacWest Bancorp (PACW) , the parent of $44 billion asset Pacific West Bank. At the end of Q1 2023, PACW had 10% simple capital leverage and 14% Tier One Capital, so by any measure the bank met regulatory capital guidelines. But the tangible capital of the bank, after allowing for the unrealized losses on securities caused by rising interest rates, was in low single digits. The fact that 20% of the balance sheet was funded with non-core funding opened the door to the short-sellers. Unlike many larger banks, PACW has a gross yield on its loan book that is well-above peer. The weighted average coupon on the bank’s new production was over 8% in Q1 2023. Funding costs are also above peer, which we view as a positive because the bank is accurately pricing its liabilities. To borrow from progressive newspeak, PACW’s balance sheet is a lot more “sustainable” than most regional banks, yet it was still singled out by the shorts because of the non-deposit funding supporting 20% of total assets. At Q1 2023, PACW’s cost of deposits was about 2% and the yield on total assets was over 6% or well-above its larger peers. The bank’s $12 billion in non-deposit funding had a cost of 5.3% All of these measures for funding costs will move higher in coming months as will the asset returns. As long-term interest rates rise, however, the mark-to-market losses on securities and loans in the banking industry will grow. Just as there was nothing hideously wrong with Silicon Valley Bank or the other victims of the FOMC’s intemperate interest rate policies, there is nothing really wrong with PACW. The bank is relatively small and easily attacked by short-sellers, but the bank is well-managed. As we described last week (“ Fed Asymmetry Threatens Credit Crisis ”), the short selling trade against smaller regional banks has required vast amounts of derivatives. The crescendo of selling pressure on PACW was May 4th, when the stock traded down to $2.48 at 10:00AM. By May 8th the stock was back up in the high $7s, but fell back to below $7 until yesterday. Management has announced plans to sell assets and are considering other strategic alternatives. All of these moves are laudable, but do not change the fact that all US banks have a basic problem with solvency that arises from the large increase in interest rates by the Fed. PACW closed yesterday at 0.35x book value on huge volume. The stock has a beta of 3.8x the 6-month average market volatility, a measure of the speculative attention on the stock and other banks. Just above PACW in terms of book value multiple is Citigroup (C) wallowing dead in the water with a beta of 1. Next is Truist Financial (TRU) at 0.7x book and a market beta of 1.4x. Then comes Western Alliance (WAL) , now back up to 0.75x book but with an eye-watering beta of 2.8x. To survive long-term, both WAL and PACW need to get that beta back down below 2 and closer to 1, but the hawks on the FOMC may not cooperate. The moral of the story is that capital is only worth the fair value today of the assets invested, that is, cash. Since 2021, the FOMC has decreased the cash value of bank capital by roughly 10-20% because the value of bank assets has declined. When PACW announced the fire sale of a portfolio of commercial loans, the bank is shrinking back down to a size funded entirely by deposits. But can PACW raise its deposit rates fast enough to buy the time needed to reprice its entire business? Since it is presently impossible to value bank and nonbank assets from 2020-2021 with any precision, the usual pool of banks ready to buy failed institutions has dried up. This is why the FDIC has stopped resolving struggling banks, preferring to buy time until additional funding is available. Zombie banks are being kept alive by liquidity provided by the Fed, but with no exit strategy to recapitalize the banks. With the 10-year Treasury yield rising toward 4% and the TBAs rolling from 5.5% to 6% for new MBS production, we expect the mark-to-market disclosure for banks in Q2 2023 to be ugly. Only the fact of bank securities sales will hold down the dollar value of the asset impairment. The number of banks on various forms of life support from the Fed will grow, creating a backlog of bank resolutions for the FDIC. And as we never tire of reminding our readers, the banking industry cleans up the mess. As we’ve written previously, the repricing of bank assets and liabilities during the rest of 2023 will be an existential event for many lenders, but there may not be any bids for the banks in the event of failure. We see a growing risk that regulators will simply keep zombie banks on cash life support rather than incur the cost of a closure and sale. Bankers can take some comfort, however, that their clients in the world of commercial finance are suffering the same ill-effects from rising interest rates as the banks. The Institutional Risk Analyst is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

May 22, 2023 | Premium Service | Whalen Global Advisors today published the Mortgage Finance Outlook for June 2023 , the unique review and outlook for the US mortgage industry. WGA Chairman Christopher Whalen comments on some of the key findings in the report on the eve of the Mortgage Bankers Association Secondary Market Conference in New York. “A lot of lenders tell us and their clients that mortgage rates are headed to 5.5% this year, but we beg to differ,” notes WGA Chairman Christopher Whalen. “We think that further Fed tightening, plus sales of MBS from FDIC and banks generally, may force mortgage rates higher into the 7% range in 2023." Other findings: Home prices in the US rose 40% during the period of massive open market intervention by the Federal Open Market Committee from 2020-2021, yet the average loan-to-value ratio at the end of 2022 was 91% for first time home buyers. Questionable loan repurchase claims by the GSEs, Fannie Mae and Freddie Mac, are soaring as these agencies desperately try to shed low-coupon loans created during the Fed’s period of “quantitative easing.” In many cases, the conventional loans subject to repurchase demands are performing and show no signs of delinquency, yet FHFA Director Sandra Thompson is pressing repurchase claims nonetheless. Low coupon loans represent a dire threat to mortgage lenders and even the GSEs themselves, which must repurchase delinquent loans from conventional MBS pools at par. The Community Home Lenders of America report that lenders are losing as much as 30% of the original face amount of the loan when these mortgages are modified, re-pooled and sold into MBS in the secondary mortgage market. “Home prices have only fallen 5% since the peak of average prices nationally a year ago,” notes Whalen. “Yet somehow, we have less than 10% equity supporting the residential mortgage market generally after almost a decade of extraordinary policy from the Fed.” The report notes that the equity beneath FHA/VA loans is basically zero, with a 97% average LTV nationally. Further declines in home prices will be manifest in higher credit losses for the GSEs, and the FHA and other government insurers. WGA expects residential home prices in high-cost blue states to continue to weaken, while lower cost red states are likely to see continued gains. Copies of the IRA House Finance Outlook are available to subscribers to the Premium Service of The Institutional Risk Analyst . Standalone copies of the report are also available for purchase in our online store . Media wishing to receive a courtesy copy of the report please email: info@theinstitutionalriskanalyst.com Subscribers to the Premium Service login to download the report

May 17, 2023 | Premium Service | Bank stocks have stabilized at low levels over the past week. PacWest (PACW) closing above 0.2x book value is a victory of sorts for the smaller banks, but don't start celebrating just yet. As we noted in our last comment, maintaining the long large banks/short regional banks trade that is currently popular on the Street grows more problematic as market caps fall. Is this the time to buy credit? The first response to our question is to orient readers as to where markets are today vs 24 months ago, when 1-month Treasury bills were yielding 0.00% (May 17, 2021). Today T-bills are around 5.5%. If we think of what a move of 5.5% implies for credit spreads and, by connection, credit ratings, we refer you to the legacy ratings breakpoints from S&P. AAA: 1 bp AA: 4 bp A: 12 bp BBB: 50 bp BB: 300 bp B: 1,100 bp CCC: 2,800 bp Default: 10,000 bp A move of 5.5% takes you from high investment grade to junk in terms of credit spreads and default probabilities. This is one big reason why a parade of Wall Street managers are focusing on credit and particularly 1) corporate credit and 2) commercial real estate, two related asset classes that are headed for an historical reset in terms of valuations and therefore capitalization rates. When we talk about commercial real estate, the cap rate is generally calculated as the ratio between the annual rental income produced by a real estate asset to its current market value. As rents on legacy office buildings in cities such as New York, San Francisco and Chicago fall, the values fall. Falling rent rolls lead to reduced market value and eventually lower property taxes, which attacks the basic fiscal viability of these cities. So let’s say that in 2020, your building had $1 million in net operating income (NOI) and a cap rate of 4%, resulting in a value of $25 million. But if in 2023 the NOI of the building falls to $500,000 due to lease concessions to tenants, the value of the building is cut in half to $12.5 million at a 4% cap rate. But what if investors now want a higher yield? At an 8% cap rate, the value of the building with the $500,000 NOI falls to $6.25 million. This is precisely the calculus that is leading to some building sales well below the published valuations of only several years ago. When the value of the building is cut in half, the holder of the mortgage is going to want to see more equity to bring the loan back to 50% loan to value (LTV). But if the rent roll is falling and the “owner” of the building already knows that NOI is likely going to fall further, the incentive is compelling to hand the lender the keys and walk away. Without a substantial reduction in interest rates, many commercial buildings in urban areas face foreclosure. The Fed's 5.5% increase in short-term interest rates has thrown the pricing for trillions of dollars in real estate into disarray. The same math that caused investors to question the solvency of US banks is likewise attacking the credit position of real estate assets and corporate credits. A bank that made a 50 LTV mortgage loan on a commercial building in 2020 can in 2023 potentially face a foreclosure and sale of the building at a valuation that may result in loss given default over 100% of the loan. Remember that banks operate at 15:1 leverage, so such large percentage losses can quickly consume the bank's earnings and capital. When banks take possession of defaulted urban real estate, they must support and preserve the asset until it is sold. Commercial real estate is not the only sector being negatively impacted by higher interest rates. Bloomberg reports that the declining fortunes of highly leveraged companies and startups has squeezed the arbitrage to such an extent that new issuance of collateralized loan obligations is suffering. If early-stage firms cannot offer the prospect of an IPO to incentivize lenders and particularly the equity portion of CLOs, then they are cut off from financing. If you cannot sell the equity piece, then the deal does not get done. Of note, Bloomberg reports that 80% of the CLOs done in Q1 2023 were funded with captive equity vehicles of the largest banks. As the credit markets tighten further this year, we look for increased default activity from early-stage companies that relied upon leverage loans as a bridge to an IPO. Whether we look at corporate credit or commercial real estate or bank loan portfolios, the change in the interest rate environment suggests a degree of credit losses that we have not seen in the US since the oil bust of the 1970s and the S&L collapse in the 1980s. While the 2008 financial crisis was certainly horrific in terms of credit losses and bank failures, the basic narrative for higher valuations for commercial real estate remained intact. Junk loan defaults could reach double-digits by Q1 2024. Net loss rates on relatively prime bank C&I loans peaked at 2.75% in Q4 2009. Loss rates in 2009 were over 90% of the original loan amount. In this cycle, however, we are seeing a rapid repricing of commercial risks, suggesting that banks, nonbanks and even municipal credits will be affected adversely. The rapid normalization of losses on commercial loans held by banks and rising defaults in commercial real estate and corporate credits suggest a perfect storm of credit losses facing investors. In such an environment, we have a hard time justifying a long position in bank stocks and other equity exposures in real estate. We expect to see credit losses for banks rise well-above long-term average rates and losses on commercial real estate generally setting new records commensurate with the magnitude of the past Fed market intervention. We can take some comfort from the stabilization of bank stocks, but not too much. It is important to recall that Western Alliance (WAL) at current levels is right back where it was before COVID and QE distorted the credit markets. The adjustment in credit that follows from this fact will be extraordinary and painful for banks and other investors. The Institutional Risk Analyst is published by Whalen Global Advisors LLC and is provided for general informational purposes only and is not intended for trading purposes or financial advice. By making use of The Institutional Risk Analyst web site and content, the recipient thereof acknowledges and agrees to our copyright and the matters set forth below in this disclaimer. Whalen Global Advisors LLC makes no representation or warranty (express or implied) regarding the adequacy, accuracy or completeness of any information in The Institutional Risk Analyst. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The Institutional Risk Analyst are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The Institutional Risk Analyst represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The Institutional Risk Analyst is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The Institutional Risk Analyst is not intended to provide, and must not be relied on for, accounting, legal, regulatory, tax, business, financial or related advice or investment recommendations. Whalen Global Advisors LLC is not acting as fiduciary or advisor with respect to the information contained herein. You must consult with your own advisors as to the legal, regulatory, tax, business, financial, investment and other aspects of the subjects addressed in The Institutional Risk Analyst. Interested parties are advised to contact Whalen Global Advisors LLC for more information.