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April 3, 2023 | Premium Service | Over the past two weeks, a number of readers of The Institutional Risk Analyst have asked about Charles Schwab (SCHW) . The name is down 36% YTD, but is still trading at 3.6x book value. As a courtesy to all of the readers of The IRA , we are posting this profile for general readership. If you send questions to info@theinstitutionalriskanalyst.com , we’ll try to answer on Twitter @rcwhalen.com . In addition, at the bottom of this comment, subscribers to our Premium Service may download our presentation last week to the advisory board of Sagent, an exciting new entrant into the world of mortgage servicing technology. Sagent combines the tested loan servicing platform developed by Mr. Cooper (COOP) and financing from Warburg Pincus and Fiserve (FISV). Like Silicon Valley Bank (SVB) , Bank of America (BAC) and many other institutions, SCHW has a large portion of its assets invested in “AAA” rated mortgage backed securities (MBS). Unlike SVB and a number of other banks, however, SCHW is not insolvent. Moreover, the bank is so low risk in terms of credit exposures and has such a liquid balance sheet, that we view SCHW as having a low likelihood of failure. Why? First and foremost comes liquidity. SCHW is the tenth largest depository in the US as of Q4 2022 with $550 billion in assets or roughly 2.5x the size of SVB. The deposit base of SCHW is a function of advisor balances and market activity. Thus earlier in the year, SCHW was number six in the US in terms of assets. SCHW was actually larger than U.S. Bancorp (USB) , which itself is now close to $700 billion in size. Most major banks grew larger during quantitative easing or “QE” and now many of these banks will shrink in terms of assets and also earnings. Second is credit risk. Net loans and leases are less than 20% of total assets at SCHW, with the remainder held in securities. Since the bank takes little credit risk and has a default rate near or below zero, balance sheet size is really a matter of management preference and managing duration. With the US Treasury paying 4% for 90 day bills, it is natural that non-interest bearing deposit balances are moving to time deposits and Treasuries. Like most large banks. one-third of SCHW's earning assets reprice every year. Source: FFIEC Third is the nature of the business model. The bank unit of SCHW receives captive business flows from the advisors that work on the SCHW platform. The bank is essentially a convenience for the advisors and their clients, growing or shrinking with interest rates. Between Q3 and Q4 2022, SCHW shed 18% of assets, but this declining trend in asset size goes back more than a year. As a result of rising interest rates, SCHW reported negative accumulated other comprehensive (AOCI) at the end of 2022 of -$20 billion. Unlike SVB which was visibly insolvent in Q3 of 2022, SCHW had positive net worth at year-end 2022 net of AOCI to the tune of $40 billion in Tier 1 capital. Remember, the negative AOCI position for SCHW and most other US banks will be lower when Q1 2023 earning are reported in two weeks . Your surrogate for this key relationship is the 10-year Treasury note. In Q3 2022, the 10-year Treasury was over 4%, but today it is closer to 3.5%. That's a hint. Source: FFIEC Going back five years, net-interest income and non-interest fee income have been relatively equal parts of SCHW earnings, but at the end of 2022 the bank unit accounted for two-thirds of consolidated earnings due to balance sheet growth. The growth in interest income at SCHW is largely due to the increase in the size of the bank, which has far more liquidity than it can lend. The parent company realized $10.1 billion in income in 2022 and received another $10 billion in interest payments from subsidiaries. The breakdown in the sources of income to the parent holdco, the company we all know as SCHW, is found in the Form Y-9 . Source: FFIEC The chart above illustrates how QE from the Fed first inflated and now will deflate SCHW and many other banks. The bank has grown in recent years to 65% of consolidated income, but reversing this growth is easily done and, indeed, is likely in the current interest rate environment. Notice that noncore funding is a relatively small part of the overall SCHW business. Since the bank’s risk weighted assets for measuring regulatory capital for Basel are only $150 billion, SCHW could essentially write down the MBS to the current market tomorrow and shrink the bank down to one quarter of the current size. As CEO Walter Bettinger told the media last week, he can liquidate the bank without selling a single security. Note to hedge funds: That's a hint. As we’ve noted previously, SCHW has the lowest cost of funds vs Peer Group 1, in large part because they don’t need the cash. Interest expense as a percentage of total assets was just 0.24% vs 0.5% for Peer Group 1 at the end of 2022. The cost of funds for Peer Group 1 may double in Q1 2023, but SCHB is unlikely to care. If clients migrate from deposits to T-bills, SCHW will simply shrink the bank. The sharp difference between SVB and SCHW illustrates why qualitative factors must be considered when assessing a bank’s business model. Simply looking at the top level data, you might think that banks of like asset size are comparable. But, in fact, institutions such as USB or Truist (TRU) or PNC Financial (PNC) that are close in size to SCHW have little else in common. In the data driven (i.e. numeric) world of trading, immediacy often trumps understanding. When it comes to SCHW, Raymond James Financial (RJF) , Morgan Stanley (MS) , UBS AG (UBS) and other “asset gatherers,” the broker-dealer is most of the income, capital and liquidity of the group. Moreover, we should be mindful of the fact that the bank units access business because of the broker-dealer and the advisory business. Source: Google Finance At year-end 2022, 35% of the SCHW group’s income came from non-interest sources or twice the average for large banks, but shrinking the bank down to $300 billion or less in assets would restore balance to the business model. We suspect that this is precisely what is going to happen over the next year or so, not only for SCHW but for other advisory businesses as well. Bottom line: We look for all large US banks to shrink in terms of both baance sheet assets and earnings in the next 24 months. The $100 billion plus in monthly runoff from the Fed's balance sheet will slowly reduce liquidity in the system, pushing down balance sheet assets and also asset returns. Subscribers to the Premium Service of The Institutional Risk Analyst login to download a copy of the presentation to Sagent. 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.

March 30, 2023 | Watching the testimony by various officials of the Fed and FDIC this week, it occurred to us that the central bank is replaying several scenarios at once. This may account for the confusion and, at times, contradictions in some of the congressional testimony this week. First, we are replaying the 1980s, when Fed Chairman Paul Volcker pushed market rates points above bank funding costs, and annihilated a whole class of non-banks known as Savings & Loans. By pushing benchmark interest rates above bank deposit rates, many S&Ls and commercial businesses died. Second, we are replaying the scenario of the Great Crash of 1929, when the FOMC slammed on the brakes in mid-1928, raising short-term rates from 4% to 6% to stamp out “speculative behavior.” That relatively large increase in interest rates led to the Great Crash of 1929. As we noted in “ Financial Stability: Fraud, Confidence & the Wealth of Nations ,” the Fed applied its gold standard model and hiked interest rates through 1928 and the first half of 1929. By May 1929, the crisis of which GM founder William Durant warned President Herbert Hoover “was already visible and would increase like a massive storm.” In a timely comment, Greg Baer and Bill Nelson at Bank Policy Institute asked the obvious question: Why is the FOMC competing with federally insured banks, even as regulators fret about the cost of resolving Silcon Valley Bank and Signature Bank? They write in “Why Is the Federal Reserve Abetting a Drain of Deposits from Banks?.” “Every day, the Federal Reserve borrows money from money market mutual funds, GSEs and certain other nonbanks at its overnight reverse repurchase agreement (ON RRP) facility. The facility is subsidizing money market funds as an attractive alternative for uninsured bank depositors. Why is the Fed continuing to operate it at its current $2.2 trillion size?” Baer and Nelson are two of the best analysts of the Fed and banks in the business. When we asked Nelson why the Board of Governors does not push down rates on reverse repurchase agreements and reserves deposited with the Fed, he responded: “I think they are in a pickle. If they just lower the rate on [overnight reverse repurchase agreements] ON RRP, fed funds will trade at the bottom of the range or below. So they need to simultaneously lower ON RRP and raise [interest on reserve balances] IORB rate. But they don’t want to raise the IORB rate because they are losing a couple $billion a week.” So true. At the Fed, because “confidence” is considered a factor in “policy,” it is OK to fib and obfuscate about the true cost of monetary policy. For example, when Fed Vice Chairman Michael Barr said that the monetary policy and bank supervision staff “communicate quite well,” that was a fib. We invite VC Barr to document these meetings between monetary policy and bank supervision staff. Our pal Nom de Plumber is certainly more agitated than usual. He offers this sage observation upon hearing that the resolution of SIVB and SBNY will cost the FDIC’s bank insurance fund $23 billion. He relates: Uninsured depositors fled from small and regional banks, to large banks, money-market funds, and Treasuries. The FDIC guaranteed the leftover uninsured deposits, in hopes of preventing more outflow, and shuttered regional banks. To pay for the wind-down losses, FDIC will levy special assessments, hitting insured depositors at large banks. So the depositors of large banks pick will pick up the tab for two bank failures that should never have happened in the first place. Had the Fed’s monetary policy staff and bank supervision personnel actually discussed QE before the fact, would the FOMC authorized a doubling of the central bank’s balance sheet in 18 months? No. While the Federal Reserve Board is busy trying to balance its various active interventions in the markets, we think that the time may have come for Congress to tell the FOMC to reduce its balance sheet. The losses to the Fed (and, indirectly, the Treasury) will mount, but unless we force the Fed to reduce the scale and range of its market intervention, we may never emerged from “quantitative easing.” For example, while the Fed has rightly taken steps to provide cash to banks, it has not yet addressed the hundreds of billions or more in cash flow losses facing banks that own securities issued during 2020-2021. Even if the Fed does not raise the target for federal funds (FF) above current levels, these losses will threaten the existence of dozens more banks, large and small, later this year. So, what is to be done? The FOMC needs to gently push money market funds out of the RRP facility and into the private markets. At the same time, the FOMC should sell MBS from the system open market account (SOMA) with the goal of keeping the 10-year bond above 3.5% yield. Don't worry if Fed funds trades on the floor, we want to keep LT rates positive and stable. Give the Street back the duration that is sitting, passive and sterilized, inside the SOMA. Market rates will start to stabilize and volatility will decrease. While the Fed does not hedge the SOMA portfolio, private investors will and this shift in duration and related hedging activity will help to stabilize markets. The Street will start to repackage this low-coupon MBS into interest-only and principal only bonds. Problem solved. But even as the FOMC forces investors off of the public teat and back to the market, it must shoulder another burden, namely helping banks to deal with the funding mismatch between the Treasury and MBS issued in 2020-2021 and the current production issued today. Just by way of comparison, the average coupon for all $13 trillion in outstanding MBS is a 3% coupon. Ginnie Mae 3s were trading around 90 cents on the dollar this AM. The FOMC should order the FRBNY to offer term repurchase agreements to banks and dealers for any Treasury note or bond, or agency/govt MBS, that was issued during 2020-2021, at par. The rate charged should be <= the debenture rate on the security. This facility should be rolled every 30-days until the bond price reaches 5 points from par. If the Fed helps banks to avoid most of the cost of QE/QT, the savings in terms of bank failures avoided will be considerable. The cost of this operation to the Fed will be enormous, swelling the negative equity position of the central bank. The political cost of revealing this colossal expenditure of public funds will also be enormous, but the time for hiding the losses incurred by the Fed as a result of QE is at an end. As Robert Eisenbeis taught readers of The Institutional Risk Analyst years ago, the Federal Reserve System is always a net-expense to the U.S. Treasury. Fact is that t he Fed’s purchase of Treasuries bid up bond prices and put downward pressure on interest rates. Now is the time to reverse this trade. 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.

March 20, 2023 | Premium Service | As the Fed-induced banking crisis in the US rolls into another week, markets and investors are already starting to pick winners and losers. As we’ve noted earlier, the past several decades of steadily declining interest rates allowed a number of niche business models to bloom and even prosper, both in banking and nonbank finance. Now that process is being reversed as the Fed bumbles the post-QE adjustment process. Less stable bank business models are under attack by a 4% yield on Treasury bills and concerns about bank asset quality. Reserves at the Fed are being paid almost 5% this AM, an act of idiocy that suggests every member of the FOMC ought to be impeached immediately. The indifference and insensitivity shown by the FOMC with respect to the banking sector and the bond market reveals a level of incompetence that borders on the criminal. Interest expense/average assets for all large US banks at year-end 2022, of note, was a smidge over 1%. What else need be said? Source: Federal Reserve Board For marginal banks, the trouble starts on the asset side of the balance sheet due to unrealized losses on securities and also loans. Then the trouble quickly migrates to the liability side, when large depositors depart in favor or T-bills. Sure, Silicon Valley Bank committed ritual suicide by buying too many mortgage-backed securities, but have no doubt that 4% T-bill and similar yields on reserves deposited at the Federal Reserve Bank are a primary source of deposit runs on small banks. One bank that we believe will weather the storm created by the Federal Open Market Committee is New York Community Bank (NYCB) , which acquired Flagstar Bancorp (FBC) on December 1, 2022. We previously profiled the combination of NYCB and FBC in May 2021 (“ Profile: NYCB + Flagstar Bancorp ”), but due to progressive yowling and political extortion in Washington, the merger was delayed over a year. Below we update that profile and reflect on how the acquisition of assets from the failed Signature Bank will make this $90 billion asset lender even more interesting. Because the NYCB + FBC combination only closed on December 1st of last year, there is limited information available. NYCB provided pro-forma financials in their year-end earnings release. The Form 10-filed by NYCB on March 1, 2023, includes the balance sheet and income statements for the two banks. We also now have available the consolidated Bank Holding Company Performance Report from the FFIEC for 12/31/22 to facilitate our analysis. We encourage subscribers to our Premium Service to review the May 2021 profile as a background for this comment. The merged NYCB has several interesting attributes, but above-peer credit performance is perhaps the most important. As we noted in 2021: “NYCB has consistently ranked among the bottom 10% of large banks in terms of credit losses, in some cases reporting zero or negative loss given default (LGD). As a result, the load on earnings from loan loss provisions is very low, in the bottom 5% of the 128 large banks included in Peer Group 1. Again, on a risk adjusted basis, the equity returns for NYCB seem to be better than its asset peers and its performance displays less variability.” Likewise, FBC historically displayed loss rates below its peers even as it has grown into the second largest mortgage warehouse lender in the US after JPMorgan (JPM) . We interviewed Flagstar mortgage head Lee Smith in August of 2021 . Unknown to most investors, FBC is one of the largest servicers of residential loans in the US, but primarily as a sub-servicer. FBC ranks 26th in the US in terms of its owned servicing assets, according to Inside Mortgage Finance , yet it ranks sixth in terms of overall loans serviced with $265 billion in assets under management (AUM) at year-end 2022. To understand the value proposition of FBC, they have focused on the higher return aspects of the mortgage ecosystem, while shedding the more problematic areas of risk in the residential market and especially Ginnie Mae mortgage servicing exposures. FBC services loans for a fee, lends money on a fully secured basis to other bank and nonbank lenders to finance production, issues its own MBS and provides high-touch default servicing on the same platform using some of the best partners in the industry. FBC is reckoned to be one of the better bank servicers of FHA/VA/USDA loans, yet FBC has deliberately sold its Ginnie Mae MSR to other parties. Fact is, you can lose more than your initial investment on a Ginnie Mae MSR. Like other banks, FBC made the obvious decision and sold these MSRs to more optimistic investors. Even as it shed exposures to Ginnie Mae, however, FBC retained the sub-servicing business and, most important, control over the escrow balances. If a loan Flagstar services on behalf of an investor or correspondent happens to slide into distress, FBC already has that loan on its platform, with the customer support, financing and other services necessary for effective loss mitigation immediately available. As the US mortgage market heads into a period of higher credit losses, we believe that FBC will be nicely positioned to address this market need and grow earnings accordingly. But it is important to emphasize that 1-4 family loans represent only a single-digit slice of NYCB’s owned portfolio. The combination of FBC with NYCB creates an overall servicing portfolio that is still predominantly comprised of commercial and multifamily loans, as shown in the chart below. Source: NYCB Looking that the most recent report from the FFIEC, we have month’s income for FBC, but the full balance sheet and capital accounts for the consolidated bank. The last form 10 filed with the SEC and form Y-9 filed with the Fed was Q3 2022. In terms of key metrics for NYCB and FBC, below are several charts we can use to compared the performance of the two banks and how they stack up against the 131 largest US bank holding companies in Peer Group 1. The Peer Group 1 numbers are simple unweighted averages that exclude unitary banks but do include our two subjects. First, we look at net losses/average assets for the two lenders. You can clearly see NYCB tracking well-below peer in terms of net loss rates, but FBC is above peer and shows far more motion in terms of the rate of change quarter-to-quarter. Recall that in 2020-2021, loan payment moratoria were in effect and millions of American families had sought forbearance on loans and leases. In 2022, when foreclosure activity resumed, many banks and nonbanks saw sharp upward spikes in delinquency. Source: FFIEC After credit, the next metric to consider is the pricing on the bank’s loan book, a key indicator of profitability and management. As shown in the chart below, FBC tended to track Peer Group 1 in terms of gross loan spread, before funding costs and SG&A expenses, while NYCB historically has reported below-peer loan spreads. As we shall discuss below, these results for NYCB are mitigated by the low credit expenses and superior operating efficiency. Source: FFIEC The next area to consider in our analysis is funding costs and again NYCB shows above peer funding expenses compared to FBC and other large banks. Part of the reason for this is that the bank historically had a high reliance on non-core funding costs, comprising more that 1/3 of total funding. The reason for this above-peer reliance on non-core funding has to do with the fact that NYCB has far better utilization of its balance sheet than most banks. Net loans and leases at NYCB equaled over 77% of total assets at year-end 2022 vs just 63% for Peer Group 1, including the balance sheet footings of FBC . While many banks have been content to buy securities during the period of QE and take the attendant market risk, NYCB took a different approach historically, minimizing securities holdings and maximizing lending. NYCB carries just half of the liquid securities investments of the Peer Group 1 average of 22% and, importantly, keeps all of its securities in available-for-sale . More, the bank has maintained 3:1 ratio between short-term assets and short-term liabilities going back five years. As a result, the bank’s accumulated other comprehensive income (AOCI) in Q4 2022 was just -$600 million vs $8.3 billion in Tier 1 capital. By avoiding securities investments and marking its securities to market every day, NYCB minimized the market risk that now plagues many other banks. And now with the close of the purchase of FBC in the Q4 2022 and the purchase and assumption from Signature Bank in Q1 2023, the funding profile for NYCB is improving dramatically. The chart below shows the net income/average assets for NYCB, FBC and Peer Group 1. Notice that FBC shows more variability than NYCB, which has tended to track Peer Group 1 closely. FBC shows the variability of the wholesale lending and securitization business, which is closely tied to interest rates, while NYCB displays far less variability. Since the NYCB income numbers only include one month of FBC results, the full impact of the non-interest income of the Flagstar business is not apparent. In Q3 2022, FBC’s non-interest income was over 5% of total assets vs less than 1% for the average of Peer Group 1, a powerful new income stream for NYCB . Source: FFIEC While the analysis so far is mixed in terms of the overall view of NYCB, it is only when you compare the bank’s operating overhead to other banks that you start to understand the significant advantage that NYCB has over many other banks. Although FBC has tended to have high operating expenses because of the variability of the wholesale side of the business, NYCB’s operating expenses, including one month of FBC results, were in the bottom 3% of Peer Group 1 or just 1.09% of average assets. In Q4 2022, NYCB’s efficiency ratio (Overhead expenses / Net Interest Income + non-interest income) was 42.3% or 15 points below the average for the 131 banks in Peer Group 1 . FBC had an efficiency ratio in the 80s in Q3 2022, largely because of the sharp drop in mortgage lending and MBS issuance in the residential and commercial markets. This led NYCB to take the decision to shut-down all of FBC’s loan production offices nationwide in Q4 and to shrink the bank’s footprint in correspondent lending. The chart below shows the efficiency ratio for NYCB, FBC and Peer Group 1. Source: FFIEC Even with the inclusion of one quarter of the results of FBC, NYCB remains in the low 40s in terms of operating efficiency vs the average for Peer Group 1 in the high 50s. More, as discussed below, the addition of the assets and liabilities from Signature Banks is now going to allow the post-FBC merger NYCB to de-lever its balance sheet and pay-down some of those non-core deposits mentioned above, leading to a stronger and more flexible banking franchise. Signature Bank It is important for readers of The Institutional Risk Analyst to understand that when you buy assets from the Federal Deposit Insurance Corp acting as Receiver of a failed bank, the initial cost basis of the assets is zero. NYCB acquired a highly liquid, mostly cash balance sheet from the FDIC with a $2.725 billion excess asset position at no deposit premium . This included $34 billion in deposits (all deposits other than deposits related to crypto currencies) and significant noninterest bearing deposits assumed. NYCB purchased $18 billion in loans and received a total of $34 billion in cash in the transaction. NYCB has stated in its press release following the announcement of the FDIC deal that it will use this excess liquidity to pay down a substantial amount of wholesale borrowings, leaving the balance sheet with a strong liquidity position. FDIC received an equity stake valued at $300 million in NYCB as consideration to offset the cost of the takeover of Signature Bank. The table below summarizes the transaction with the FDIC. Notice again that the net assets of the transaction (assets-liabilities) is just $2.7 billion for $38 billion in assets . Source: NYCB Of note, NYCB is not acquiring the remaining loan portfolios (includes fund banking, CRE, or multifamily) from Signature, QFCs or the credit card business. Nor is NYCB acquiring crypto related deposits and Signet. The transaction with the FDIC adds new branches on both coasts in NY, CA, CT, NC and NV and new business verticals to drive revenue in the future. As a result of the FDIC transaction, NYCB’s core deposits increase from $59 billion to $93 billion, including a significant amount of noninterest bearing deposits. NYCB receives $25 billion of cash from FDIC to pay down wholesale borrowings, which lowers loan to deposit ratio from 118% to 88%. This transaction should be immediately accretive to NYCB shareholders, including a 20% increase in terms of earnings per share and a 15% increase in tangible book value estimated by NYCB due to the discount structure of the transaction. We liked the NYCB + Flagstar story prior to the transaction with the FDIC for the assets of Signature Bank. We like the story even more now. We believe that the asset purchase and deposit assumption transaction with the FDIC transforms NYCB from an interesting story into a compelling opportunity. Assuming that the Fed does not destroy the US economy in the next few weeks, we intend to add NYCB to our portfolio. Disclosures L: CS, CVX, NVDA, WMB, JPM.PRK, BAC.PRA, USB.PRM, WFC.PRZ, WFC.PRQ, CPRN, WPL.CF, NOVC, LDI, WAL, GHLD 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.

March 23, 2023 | Years ago, when there were no personal computers or smart phones, we worked as an analyst at the Federal Reserve Bank of New York . First we worked in the Bank Supervision function, reporting to Chief Leroy McNally and Manager Gerry Minehan in the foreign bank applications function. William Rutledge was the Vice President for Bank Supervision. When we joined the bank, Anthony Solomon was the President. By the time we moved across Maiden Lane to the Foreign Exchange Department under Gretchen Green , Gerald Corrigan had moved from the Minneapolis Fed to the New York bank to cover the flanks of his mentor and long-time friend, Paul Volcker . Tall Paul, a family friend and member of The Lotos Club , moved from New York to Washington in 1979 to become Fed Chairman. We had an opportunity to talk about those years and his relationship with Corrigan at lunch in Volcker’s hideaway at 30 Rock in 2017. In 1985, the Fed of New York was engaged in an extensive effort to devalue or at least slow the appreciation of the dollar. On behalf of the Treasury using the Exchange Stabilization Fund, and the Fed’s own account, the desk sold dollars and bought foreign currencies. “In what became known as the Plaza Accord, the officials agreed to an unprecedented joint intervention in currency markets, the Wall Street Journal wrote. “Ultimately, it worked. The dollar fell sharply over the coming decade while the Japanese yen soared.” But now many economists wonder if this massive intervention did not doom Japan to economic malaise for the next decade. One of the more active defensive efforts conducted by the FRBNY was to support the Canadian dollar against persistent short-selling. The spot market in the Maple Leaf was a mere fraction of the offshore forward market and the futures in Chicago. Traders shorted the Canadian dollar and went long yen, netting out the margin cost. So in response, our traders called a couple of futures dealers and told them to buy Canadian dollar futures contracts, in their name, until we told them to stop. During this period, President Corrigan would come into the foreign exchange room before 7 AM after a meeting with the NY Fed's bank supervision function across Maiden Lane at Jim Brady’s. Like the Fed in those days, Jim Brady's was essentially open 24/7 to serve the liquidity needs of the cash and check clearing personnel working at the Fed. Our responsibility was the futures desk. Corrigan’s first question to the spot traders and analysts every morning was whether our market intervention the previous day had caused any collateral damage to the primary dealers or traders in the street. If we did, an out of market trade was executed to make the counterparty whole. And none of this was documented or disclosed. Today, sadly, the Federal Reserve Board seems to have forgotten that monetary policy is executed through and with banks in the bond market. By doubling the Fed’s balance sheet between 2020-2021, from over $4 trillion to now $9 trillion in nominal dollars, the FOMC has injected vast amounts of market risk into the US banking system. What few members of the FOMC seem to appreciate is that in duration-adjusted dollars, that $3 trillion in mortgage-backed securities (MBS) owned by the system open market account (SOMA), is today more like $12-15 trillion in terms of the risk to US banks and the Fed itself that own these low-coupon securities. Below is a snapshot from Bloomberg showing the market prices for Fannie Mae securities for delivery in April, what is known as "TBAs" in the bond market. This market not only prices your residential or commercial mortgage, but it is also the foundation of the US Treasury market and is a primary avenue for interest rate hedging. In Q3 2022, those Fannie Mae 2s that banks purchased at 103-104 in 2021 were trading in the high 70 cents on the dollar of face value. As we’ve noted in earlier comments, the massive amount of refinancing that occurred in 2020-2021 has concentrated the coupons of about three-quarters of the $13 trillion market for mortgage securities between 2% and 4.5%. The average coupon is about 3%, which today is trading at a ten-point discount to par. Most of the production in that period is found in the 2s and 2.5% MBS, a ghetto of highly volatile securities that are now points under water vs SOFR funding costs. Given the market distortions of QE, how much can the Fed raise interest rates from 2021 levels before holders of those 2 and 2.5% MBS are insolvent? About 300bp or 3%. But the FOMC has already moved the FF rates nearly 6% in 18 months. Likewise with bank deposits, the Fed's 600bp move in FF rates has destabilized those heretofore stable business deposits at banks, large and small. "Banks often assume that retail term deposits are stable, because individuals would forego all the accrued interest as penalty for early redemption," our friend Nom de Plumber observed overnight. "However, for example, if a seasoned one-year deposit has been paying only 0.25%, but money-market mutual funds, short-maturity Treasuries, or new deposits are paying 4% or more, the customer will readily terminate that seasoned deposit and roll the funds to elsewhere. Hence, banks have been losing huge amounts of 'stable' funding as the Fed quickly raised interest rates." Strangely, no significant questions about these issues of liquidity were asked yesterday during Powell’s press conference, specifically about the impact of the Fed’s actions on banks and markets. As writers and journalists, we are embarrassed for the profession. Not a single challenge was made of Chairman Powell as to whether he felt responsible for the failure of three large banks in a week. It’s as though the Fed’s public affairs staff writes all the questions. The key question for Powell is why he thinks the FOMC shift in monetary policy is credible without explicit asset sales at the same time? Given the change in the effective average life of its mortgage portfolio, for example, the Fed ought to be selling the MBS from the SOMA and allow the balance sheet to shrink. But the same concentration of bond and loan coupons that is causing trillions of unrealized losses for banks has also tied the Fed’s hands when it comes to fighting inflation. Treasury Secretary Janet Yellen and Fed Chairman Jerome Powell are another bank failure or two away from returning to the private sector. Many banks with large, unrealized losses on the books are going to become targets for short-selling and rumor mongering, precisely what led to the collapse of Silicon Valley Bank and Signature Bank (“ Who Killed Silicon Valley Bank?; The IRA Bank Book Q1 2023 ”). Banks that have weak funding or poor asset-liability management will become targets. The good news is that the modest rally in the bond market from March 2nd, when the 10-year bond touched 4%, will force down the unrealized losses disclosed by banks in Q1 2023 earnings. Do you think anybody at the Fed understands that the 10 yr Treasury is unlikely to rise and remain above 4% until sales from the SOMA begin? The bad news is that there is still a huge chunk of mortgage, corporate and Treasury securities that are under water in terms of funding costs. Weaker banks may be forced to sell these money-losing securities out of held-to-maturity portfolios later this year, provoking a revaluation of all such assets owned in portfolio by banks. In the event, the Fed will have created the very 1930s style debt deflation that the central bank has pretended to hold at bay via QE for a decade. 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 4, 2021 | Premium Service | In this issue of The Institutional Risk Analyst , we assess the acquisition of Flagstar Bancorp (NYSE:FBC) by New York Community Bank (NYSE:NYCB), one of the largest Main Street community banks in the US. The transaction is remarkable for several reasons, as noted below. First, it is the latest in a series of M&A transactions in the housing space, which we discussed last week in National Mortgage News (“ Why independent mortgage banks might want to sell themselves now ”). Suffice to say that we anticipate more deals in the mortgage sector in coming months, but these deals are priced at the top of the real estate market cycle. Second, NYCB is currently trading at 0.9x book value and FBC is trading at book, so the acquirer is paying up (1.2x book) to buy a more expensive, better performing bank. FBC shareholders will control more than 30% of the post-merger entity. These stocks, of note, are up nearly 40% or more in the past year, but still trail the pack vs say top performer U.S. Bancorp (NYSE:USB) at up 50% in the past year. Third, this transaction apparently reverses a decision by NYCB to exit the residential mortgage business not four years ago. In 2017, NYCB sold much of its mortgage business to Freedom Mortgage , the leading non-bank lender. Of note, Freedom was the largest government MBS issuer in 2020, supplanting long-time leader Wells Fargo (NYSE:WFC) , which has allowed its new originations and mortgage servicing book to run off in recent months. Four years ago, Freedom agreed to buy approximately $500 million of selected residential mortgage assets from NYCB’s mortgage banking operation and an MSR for $20 billion in residential loans. But here we go again, combining NYCB's large multifamily portfolio, which is geographically concentrated in New York, with a $1 trillion national single family mortgage lending and sub-servicing business in FBC. New York Community Bank At $56 billion in assets, NYCB has operating results that track at or just below peer, but outstanding credit performance, suggesting above peer risk adjusted returns. NYCB is not a stellar performer in terms of nominal asset or equity returns, and falls somewhere in the bottom third of Peer Group 1 on some metrics published by the FFIEC. Thus, looking just at the numbers, the deal seems most compelling for NYCB shareholders. NYCB has consistently ranked among the bottom 10% of large banks in terms of credit losses, in some cases reporting zero or negative loss given default (LGD). As a result, the load on earnings from loan loss provisions is very low, in the bottom 5% of the 128 large banks included in Peer Group 1. Again, on a risk adjusted basis, the equity returns for NYCB seem to be better than its asset peers and its performance displays less variability. NYCB + FBC But even with the stellar credit performance, interest expense at 1.2% of average assets at year-end 2020 (vs 0.52% for Peer Group 1) is too high. The reason for this is quite simple, namely the fact that 43% of NYCB's total funding is sourced from the markets rather than from core deposits. The average for non-core funding for Peer Group 1, of note, is just 3%, in part due to the Fed’s vast expansion of liquidity in the past year. This makes NYCB an outlier in terms of this key liquidity metric, a surprising data point given the bank's community footprint. The bank has an astounding concentration in real estate loans, mostly multifamily mortgages in the New York area, at 70% of total assets vs the peer average of 36% for large bank real estate exposures. While the historic performance of this multifamily portfolio has been excellent going back decades, like other New York area lenders, NYCB lives and dies on the health of multifamily residential assets. Flagstar Bancorp At $30 billion in assets, FBC is a better than peer performer relative to other banks its size, in large part because it has non-interest income that is two times the bank’s interest income. Most banks are lucky to have 25% of total revenue in non-interest bearing business lines. The Michigan-based savings and loan holding company reported $324 million in non-interest income, roughly two thirds of pretax revenue. Net interest margin was also impressive at 3% at the end if Q1 2021. In terms of funding, FBC tracks below the industry average cost of funds at 0.21% as of Q1 with only 5% brokered deposits. Some 36% of the bank’s $20 billion in deposits come from custodial balances associated with the residential mortgage business. Mortgage originations have provided a substantial amount of income for the bank over the past year, as shown in the chart below from the FBC Q1 2021 earnings presentation. FBC has 158 branches, mostly in WI, IL and IN, but also has branches in Southern California. FBC has a national residential mortgage business with 87 loan production offices and three regional operations centers in TX, FL and CA. More than 1,600 correspondents and 1,400 brokers sell loans to FBC, which then issues the MBS and sells the servicing. FBC was the sub-servicer for $1.1 trillion in 1-4 family residential mortgages at the end of Q1 2021, making them the 6th largest servicer overall in the US and, of note, the third largest warehouse lender. The bank has steadily de-risked, selling its mortgage servicing rights (MSRs) and retaining the servicing business as sub-servicer. This arrangement gets the risk asset off the books but allows FBC to retain the related fiduciary deposit for the mortgage escrows. Of note, in Q1 2021, FBC sold MSRs representing $4 billion in unpaid principal balance of loans. FBC’s credit loss profile is far more mainstream than that of NYCB, with results fluctuating between average to excellent. At the end of 2020, for example, FBC was in the bottom decile of Peer Group 1 in terms of net credit losses. More, because of the bank’s strong non-interest income, coverage of actual loss was four times the Peer Group 1 average of 22% at the end of 2020. The Bottom Line Combining FBC with NYCB is an interesting transaction in that the former brings funding and a broader income base to the table. NYCB has a one-dimensional business focused on community banking that now picks up a much desired commercial dimension, including a national correspondent and wholesale mortgage franchise that has relatively low risk. The plan apparently is to operate Flagstar as yet another brand under the NYCB umbrella, which currently includes a number of legacy community bank brands that have been collapsed into a single depository, including: Queens County Savings Bank, Roslyn Savings Bank, Richmond County Savings Bank, Roosevelt Savings Bank, Atlantic Bank in New York, Garden State Community Bank in New Jersey, Ohio Savings Bank in Ohio, and AmTrust Bank in Florida and Arizona. The new company will have nearly $90 billion in assets and operate almost 400 traditional branches in nine states and 87 loan production offices across a 28-state footprint. The headquarters will remain in Westbury, N.Y., with regional headquarters in Troy, MI, including Flagstar's mortgage operations. The combined company will maintain the Flagstar Bank brand in the Midwest. Flagstar's mortgage division will also maintain the Flagstar brand. Other states will retain their current branding. It will be interesting to see if NYCB operates the FBC bank unit separately due to the large mortgage business. Bottom line is that we see this transaction as a positive for both banks. Specifically: The all-stock transaction will keep the Flagstar mortgage business intact and under the current leadership of veteran operator Lee Smith , meaning that NYCB should avoid the need for protracted regulatory approvals regarding the servicing business. The additional funding that FBC controls adds stability to the holding company overall as does the strong non-interest revenue stream. The new branches add to the geographic reach of NYCB, satisfying a desire for expansion that has been a priority for both banks. Finally, the FBC commercial lending team and wholesale mortgage business will diversify the NYCB business model away from an excessive concentration in multifamily real estate assets in New York and improve the profitability of the combined entity overall. A key risk to watch in the future is the condition of the New York multifamily real estate market, which in turn is heavily influenced by the finances of New York City and the commercial real estate sector. The IRA Bank Profile is published by Whalen Global Advisors LLC and is provided for general informational purposes. 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 IRA Bank Profile. Information contained herein is obtained from public and private sources deemed reliable. Any analysis or statements contained in The IRA Bank Profile are preliminary and are not intended to be complete, and such information is qualified in its entirety. Any opinions or estimates contained in The IRA Bank Profile represent the judgment of Whalen Global Advisors LLC at this time, and is subject to change without notice. The IRA Bank Profile is not an offer to sell, or a solicitation of an offer to buy, any securities or instruments named or described herein. The IRA Bank Profile 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 IRA Bank Profile. Interested parties are advised to contact Whalen Global Advisors LLC for more information.

March 17, 2023 | Premium Service | In the first quarter of 2019, Credit Suisse (CS) was trading north of $17, but earlier this week was below $2 in choppy markets. The credit default swaps (CDS) were trading north of 3,300 basis points over swaps on Wednesday, implying a “D” bond equivalent rating for the bank. JPMorgan (JPM) wrote a note this week saying that CS is likely to be acquired by UBS AG (UBS) . Maximum Number of Basis Points 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 Earlier this week, the Swiss National Bank provided emergency funding to CS , allowing the bank to initiate a pre-emptive tender offer for its debt. We have been a buyer of the stock below $2 and as discussed below, are inclined to add to the speculative position opportunistically. Several readers have asked about various banks. We direct your attention to the most underutilized public resource on US banks, namely the National Information Center maintained by the Federal Reserve Board and the other members of the Federal Financial Institution Examination Council (FFIEC). NIC, as we affectionally refer to her, provides detailed performance reports on large bank holding companies down to $10 billion in assets. One bank that comes up a lot in reader emails in Bank of America (BAC) . The major question is how BAC compares to other banks such as JPMorgan (JPM). We published the most recent for JPM earlier (“ Who Killed Silicon Valley Bank?; The IRA Bank Book Q1 2023 .” We also thank our readers for comments and corrections on this analysis. Suffice to say that the presentation for GAAP filers and the regulatory data provided on NIC are very different. Below we show the mark-to market (M2M) for BAC. Source: FFIEC/WGA LLC Notice that BAC held $539 billion in MBS and another $270 billion in Treasury debt at the end of 2022. If we do the same analysis as JPM, BAC ends up worse in terms of negative M2M on capital because of the large MBS position. At 17% of total assets, BAC MBS position is in the 73rd percentile of Peer Group 1, vs the average for the 131 banks in the peer group of 12.5% of total assets. The good news is that as interest rates fall, the M2M deficit for banks also falls. Update on Credit Suisse & Guild Mortgage We first took a position in CS earlier in the year on the presumption that neither the US government not the Swiss National Bank would not allow the bank to fail. Our thesis turned out to be right, but the stock remains under intense selling pressure, in part because management has been unable to complete the restructuring of the US business. The sale of the structured finance group to Apollo (APO) portfolio company Atlas Securitized Producsts has been a bit of a fiasco, in large part because the buyout firm was not willing to acquire the $20 billion in Ginnie Mae assets and servicing operation, Select Portfolio Servicing (SPS) . Readers of The IRA will recall that last September, SPS entered into a definitive asset purchase agreement with Rushmore Loan Management Services LLC to acquire certain Rushmore assets. The deal was never completed, however, leading us to conclude that US regulators had informally said no to the transaction. Since then, CS has conducted an auction process to sell SPS, including the non-agency servicing book and the Ginnie Mae assets, including warehouse loans and MSR financing commitments. We hear that roughly half a dozen Ginnie Mae seller/servicers made it to the final round of the auction, but no result has been announced. The slow process inside CS, combined with the deterioration in the credit performance of government-insured loans, has made the CS Ginnie Mae book near impossible to sell. Residential Mortgage Loans Source: MBA, FDIC The government loan market is under intense pressure, both in terms of the perception and some tough realities. The collapse of Reverse Mortgage Funding (RMF) last year has already cost Ginnie Mae over $1 billion so far and more losses are in prospect. Buyout obligations are expected to increase over time to an average of $189 million a month over the next 24 months, reports Reverse Mortgage Daily . The lenders to RMF included Leadenhall Capital Partners , CS, Nomura Securities (NMR) , Barclays Bank (BCS) and Texas Capital Bank (TCBI) . Leadenhall reportedly was wiped-out entirely when Ginnie Mae seized the MSR. A key lender in the space, TCBI, reportedly took a significant loss on warehouse financing of participations in the HECM loans. Because the mortgage note is contained in the first securitization of the reverse mortgage loan into a Ginnie Mae pool, TCBI did not possess the note and therefore lost the entire warehouse asset. As a result of the loss, some observers thought that TCBI would step back from the MSR market, but in fact the opposite is reportedly the case. TCBI is said to be contacting Ginnie Mae issuers to support forward or HECM assets. TCBI is also expanding its capital markets capability to offer issuers TBA execution and warehouse financing. More, there have reportedly been several completed MSR financings involving other large Ginnie Mae issuers in Q1 2023, including PennyMac Financial (PFSI) , Freedom Mortgage and Mr. Cooper (COOP) . These deals are reportedly being arranged by the former CS banking team now at Atlas. The transactions include a variety of banks in syndications of “promissory notes” rather than the bonds used in previous deals. As we’ve noted earlier, the securities market execution for MSR financing going back to 2017 now must be replicated with a bank loan. The good news is that despite the turmoil caused by the failure of RMF, MSRs were being financed in Q1 2023 – at least until the failure of SIVB and Signature Bank (SBNY) , which has participated in many MSR deals. The bad news is that many issuers are now worried that the market turmoil may cause some banks to back away from the MSR market. One of the leading warehouse lenders, however, tells The IRA that he is not concerned about the market turmoil and their pipeline of Ginnie Mae MSR financings is full. Meanwhile, in a related development last week, PennyMac Financial (PFSI) dropped an 8-K confirming that APO portfolio company Atlas and several new vehicles are stepping into the shoes of the crippled Swiss lender with respect to PFSI's Ginnie Mae MSRs. The 8-K states in part: "On March 16, 2023, PennyMac Financial Services, Inc. (the "Company"), through its direct, wholly-owned subsidiary, Private National Mortgage Acceptance Company, LLC (“PNMAC”) and two of its indirect, wholly-owned subsidiaries, PNMAC GMSR ISSUER TRUST (“Issuer Trust”) and PennyMac Loan Services, LLC (“PLS”), consented to assignments of all of the credit facilities provided to the Company by Credit Suisse First Boston Mortgage Capital LLC, as administrative agent (“CSFB”) and Credit Suisse AG, Cayman Islands Branch, as a buyer or purchaser (“CSCIB”), and Alpine Securitization LTD, as a buyer or purchaser (“Alpine”). All of the credit facilities are assigned to Atlas Securitized Products, L.P. (“Atlas SP”), Atlas Securitized Products Investments 3, L.P., Atlas Securitized Products Funding 2, L.P., and Nexera Holding LLC (each an “Assignee Buyer”). Only time will tell what happens with the process of refinancing MSR bonds as they come due. Falling loan volumes are going to make commercial banks hungry for quality C&I assets once the dust settles from SIVB. If interest rates now fall as a result of efforts by the Fed to stem the deposit run on smaller banks, this will assist lending in terms of higher productions volumes. But the heavily skewed distribution of loan coupons in the market due to QE means that lenders will not see significant refinance volumes until mortgage rates are in the 5s or lower. Guild Mortgage In the past couple of years, we have sung the praises of Guild Mortgage (GHLD) , a purchase mortgage lender with one of the few legitimate retail channels in the industry along with Caliber, now part of Rithm Capital (RITM) and Freedom Mortgage . Since GHLD focuses on higher cost purchase mortgage loans, the nonbank lender is obsessively focused on managing expenses. The result is that GHLD is consistently profitable and is among the most efficient operators in the mortgage business. As a result of the discipline shown by CEO Mary Ann McGary and GHLD’s veteran and very stable operating team, the firm reported solid profits in 2022 as much of the rest of the industry was thrown into disarray. Like our longtime friend Stan Middleman at Freedom Mortgage, what we see in GHLD is an old-fashioned appreciation of the operating realities of the mortgage business. Residential mortgages are 100% correlated to interest rates and employment. So long as the Federal Open Market Committee is compelled to pursue the conflicted dual mandate of full employment and price stability, the mortgage industry will be a roller-coaster. Guild Mortgage Despite this challenge, GHLD has managed to cut the ends off the risk curve and delivery steady, middle of the fairway results that are the envy of the industry. In 2022, over 80% of GHLD’s production was purchase mortgages. Adjusted EBITDA totaled $103.5 million compared to $366.2 million in 2021, one of the better comparable periods in the industry. GHLDs in house servicing portfolio increased 11% to $78.9 billion from 2021, with retained servicing rights on 89% of loans sold. The purchase component the GHLD servicing book means that the loans tend to payoff slower than the industry average. More, delinquency is below industry averages and GHLD manages to recapture one-third of the refinance transactions on its servicing book, a best-in-class metric. (Note: When you see a residential mortgage issuer reporting recapture rates in the 70s, they are not doing the math right.) In Q4 2022, GHLD reported a small loss, but compared to some of the larger players in the business their results were stellar. We believe that we are at an inflection point of sorts, where stronger players like GHLD and Mr. Cooper (COOP) are going to continue taking market share. GHLD acquired Inlanta Mortgage in December 2022 and just acquired Cherry Creek Mortgage, a privately held Colorado-based lender with 68 physical branches in 45 states. Guild Mortgage Portfolio We recently added Western Alliance (WAL) and GHLD to our portfolio, which is shown below. L: CS, CVX, NVDA, WMB, JPM.PRK, BAC.PRA, USB.PRM, WFC.PRZ, WFC.PRQ, CPRN, WPL.CF, NOVC, LDI, WAL, GHLD 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.

March 20, 2023 | In times of financial crisis, stuff happens on the weekend. But in watching the sale of Credit Suisse (CS) to UBS Group AG (UBS) , we are reminded that 2023 marks the end of twelve years of quantitative easing (QE) and related distortion of the loan and bond markets. During QE, the FOMC explicitly embraced inflation. Credit loss rates went negative and asset prices soared, making any bank, nonbank or fintech large or small seem like an investment grade proposition. The largest part of QE came in 2020 during the dislocation caused by the COVID virus developed in Wuhan, China. The COVID crisis unleashed a torrent of progressive nonsense and related financial giveaways that saw Congress discard any pretense of fiscal probity. Crypto tokens replaced real assets as investment vehicles while government officials responsible for financial institutions spent their time talking about global warming and ESG. Mark Twain called Washington ''the grand old benevolent National Asylum for the Helpless'' in his classic " The Gilded Age ." What would Twain say of Washington today? Even as the FOMC sends the US economy into a new period of uncertainty, the Administration of President Joe Biden is populated with an army of articulate incompetents led by former Fed Chair and now Treasury Secretary Janet Yellen. Although none of these platonic guardians recognized the approaching bank crisis of 2023, the readers of The IRA were forewarned . Lee Adler at Liquidity Trader puts the current situation succinctly: “The Fed is playing a new game. The problem is that nobody knows what the rules are, not even the Fed. In fact, nobody even knows what the game is. Especially not the Fed.” With the end of QE, asset quality and credit are now again real-world concerns as default rates revert to the mean. The past few years of QE and exemptions to Basel have been very friendly to the regionals/super regionals, but that’s coming to an abrupt end even if Congress passes no new regulations for banks. Source: FDIC/WGA LLC During the period of QE, a lot of narrow niche banking businesses soared. Business customers migrated to smaller banks to get better service. Many mortgage lenders, for example, used Signature Bank as the custodian for escrows and other uninsured deposit balances related to mortgages. Startups used Silicon Valley Bank for payroll and other business services. But now that basic business of custody and payments is flowing back to the larger money center banks. Over the past several days, the Federal Deposit Insurance Corp brokered the sale of part of Signature Bridge Bank to New York Community Bank (NYCB) , which acquired Flagstar Bank last year. NYCB’s Flagstar Bank NA units purchased assets of approximately $38 billion, including cash totaling approximately $25 billion and approximately $13 billion in loans. This means most of Signature Bridge Bank is still owned by the FDIC. NYCB assumed liabilities approximating $36 billion, including deposits of approximately $34 billion and other liabilities of approximately $2 billion. Significantly, the NYCB is working on an agreement to sub-service the legacy Signature multi-family, commercial real estate (“CRE”), and other loans it did not acquire. NYCB also acquired Signature’s wealth-management and broker-dealer business. Most of the deposits assumed by NYCB are related to the wealth management business of Signature on both coasts. The fact that NYCB did not acquire the Signature multifamily and commercial assets illustrates our earlier point that these loans are essentially unsalable . Because of the COVID-era rent control legislation passed by the New York State legislature in Albany, rent stabilized multifamily properties in New York are impaired assets. NYC landlords cannot increase rents to reflect rising operating costs or refurbishment of apartments. These moribund assets really cannot be financed by banks and will ultimately be purchased by less reputable owners who will seek returns by reducing services, maintenance and other expenses. “Flagstar has gotten a very fair deal,” we told Steve Gandel at the Financial Times . “And it doesn’t surprise [us] that the FDIC is going to have to take a loss, in part because of the low quality of the remaining assets.” Meanwhile in Europe, UBS has cemented its monopoly status in the European banking market by taking out the last major competitor in CS. Of note, the UBS purchase appears to include the Select Portfolio Services (SPS) servicing unit of CS as well as the Ginnie Mae advance book and the non-agency mortgage servicing right (MSR) owned by CS. CS had been attempting to sell the SPS business, but after an auction process concluded last month there was no announcement of a winner. According to Inside Nonconforming Markets , Utah-based SPS was the largest residential servicer of nonprime mortgages at yearend with an estimated portfolio size of $141.0 billion and a market share of 42.9%. It looks like UBS Looking at the Eurozone, UBS is now the dominant bank in Switzerland and the only franchise in Europe that seems to have the capital and earnings to prosper. A reader named Paul in Europe puts the situation succinctly. “Let’s face it. There are six global investment banks left: JPM, GS, MS, BAML, UBS, Citi. UBS is the only remaining powerhouse in Europe and now is a monopoly in Switzerland. The devil is in the detail. Use weakness to accumulate UBS.” Our flutter in CS did not generate the desired outcome, but we are going to take the UBS shares and accumulate more on weakness -- assuming the deal closes. The table below summarizes the banking landscape in Europe. Unlike the US, in Europe zombie banks don’t die, they just become part of the background like the ornate buildings in European cities. Some statistics on UBS and its EU peers is shown below. Portfolio Notes While our trade on CS back in January was not successful, we tend to like UBS as a long-term holding. Also, one of our favorite mortgage lenders, Western Alliance Bank (WAL), bounced into the low $30s after trading in single digits. We’ll be publishing a detailed analysis of the post-close NYCB in the next Premium Service issue of The Institutional Risk Analyst . 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.

Interview on Bloomberg Radio March 14, 2023 | Several days have gone by since our post on the collapse of Silicon Valley Bank on Friday. On Sunday, we saw Signature Bank of New York also collapse into the arms of the FDIC. If you are a depositor of either of these banks, you likely have little risk. If you have questions, please contact the FDIC. Big Picture: Is the crisis affecting US banks over? Not by a mile. In fact, to paraphrase our friend Josh Rosner in a client note: “The regulators have not gone far enough to address this crisis. Markets are aware of this and there has not been a full-throated enough or strong enough response from regulators or the Hill.” Ditto The first thing we want to say to our readers is that both SVB and SBNY failed due to deposit runs, but for different reasons. In each case, idiosyncratic and even unprofessional behavior by management led to a bank failure, but the risks were greatly magnified by rising interest rates and QE. Today, we have several large commercial clients that continue to use both institutions, but only because of the guarantee on uninsured deposits. When Treasury Secretary Janet Yellen appeared on television Sunday, she had no plan but the former President of the San Francisco Fed had another agenda: protecting her former colleagues who so badly dropped the ball supervising SIVB. Yellen knew that if the bank were allowed to collapse, people would start making the obvious comparisons to the same assets at other larger banks and in the system open market account. Since the 2008 crisis, the Fed’s Board of Governors in Washington took control of most bank supervision matters, further removing the central bank from the real world of money and markets. When Chair Yellen pushed for the Fed to “go big” with QE, the NY Fed was not even consulted. Now we have toxic waste killing our banks and inflation that looks to be permanent rather than transitory. By any reasonable standard, Secretary Yellen should have already resigned, but not in the strange world of Washington. It is increasingly clear that Yellen and the other economists that run the FOMC had no idea about the downside risks of pushing interest rates to zero. And Yellen did not ask for input from Congress. Today the Fed’s Board of Governors remains largely clueless about the damage done by QE to the US financial system, banks and nonbanks alike. And the clock is ticking on a number of smaller community and regional banks. The irony is that QE has now made regional and community banks more risky than nonbank lenders. Consider that. The Treasury debt and mortgage-backed securities (MBS) created during the 2020-2021 period of “Max QE,” are toxic waste despite the “AAA” rating. The fact of below-market coupons makes these securities unusually volatile and impossible to hedge. Why did the Fed even allow banks to buy these risky securities? Janet Yellen needs to address this issue publicly. The big question that Steve Liesman , Nick Timaraos , Kate Davidson and our other colleagues that cover the Fed need to ask is this: Why did the Fed create Treasury debt and MBS that cannot be hedged? The hedge cost for a Ginne Mae 2.5% MBS, for example, is 2-3x the coupon. Why would anybody want to own this security (other than a central bank, of course)? SIVB & Signature Bank With that background, we come to the disaster at SIVB. Not only did the State of California, the Fed and FDIC drop the ball, but SVB made a number of management mistakes, most notably investing more than a third of the bank’s assets in mortgage-backed securities (MBS) in 2021 and even more in US Treasury debt. When interest rates rose 500bp, no surprise, the bank became insolvent. Just to be clear about the significance of a 5% rise in interest rates, note the corporate ratings breakpoints below from S&P: Maximum Number of Basis Points 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 What is interesting is that SIVB maintained an outsized position in MBS for years, yet neither the State of California nor the Fed nor even the FDIC seem to have noticed. Of note, none of the SIVB Board committees responsible for risk and asset liability management (ALM) were actually financial professionals. The rest of the SIVB Board were either decorative or focused on tech companies. As we Tweeted to Sara Eisen earlier today, what is the point of new regulation proposed by President Joe Biden if regulators and auditors are too incompetent to read a financial statement? The drumbeat from Washington by Senator Elizabeth Warren (D-MA) for new regulation of smaller banks is part of the problem. We need to regulate the Fed and prevent any future FOMC from doing QE. Source: Federal Reserve Board What is fascinating about the chart above is that SIVB added to their MBS exposure as interest rates rose. At the end of 2021, thirty-year mortgage rates were at a bit over 3% and MBS yields were in the 2s. SVB added to the portfolio in the next year as mortgage rates peaked over 7% and MBS followed into the 6s. “It seems that SVB management anticipated a recession on the heels of last year's tech meltdown,” notes a veteran fund manager and long-time reader of The IRA . “Not only was new biz going into hibernation but the credit quality of the SIVB loan book was going to be in jeopardy as were the potentially juicy returns of their warrant book and other holdco assets.” He continues: “So, in anticipation of recession and the consequently assumed Fed pivot, they decided to proactively make a very large, long duration Treasury/MBS bet, figuring they'd hit the ball out of the park on that play which would more than offset the ensuing pain in the loan book, warrants, etc.” At Signature Bank of New York, different errors in judgment by management led to a deposit run on this systemically important institution. In the chart below from the Q4 2022 earnings for SBNY, the flight of deposits at the bank is very clear. Starting first with the volatile crypto deposits and then business deposits, SBNY saw a classic bank run of 20% of total deposits in less than a year. Crypto started the run and then real deposits followed out the door. The decision to support SIVB and SBNY was essential, yet as Politico reports, the Biden Administration almost balked at providing cover to the failing banks. “President Joe Biden began the weekend highly skeptical of anything that could be labeled a taxpayer-funded bailout, according to four people close to the situation, who were not authorized to speak for attribution,” Politico reports. “Biden, who as vice president had watched then-President Barack Obama get hammered over his role in bailing out giant banks during the financial crisis, had little desire for a repeat, Politico relates. And why is SBNY, a bank half the size of SIVB, systemically important? Because SBNY is a major player in both the commercial and residential real estate markets. The $110 billion asset bank, which traced its lineage bank to Edmond Safra and Republic National Bank , focused on serving the Jewish community in New York. SBNY is the last lender willing to finance rent stabilized multifamily real estate in New York City. Do you think that New York Governor Kathy Hochul understands this? As mortgages mature on these properties, SBNY will not be there to roll the assets. The Real Deal reports that the bank has already stopped issuing letters of credit to landlords of these properties. "Withdrawing deposits, drawing down loans and replacing letters of credit are among the issues borrowers and depositors are facing after the Federal Deposit Insurance Corporation took the bank into receivership Sunday," TRD reports. Not only is SBNY the ONLY bank now willing to lend on rent stabilized apartments in New York City, but the prospect of a purchase of the bank means that these assets and the businesses that own them will be basically orphaned. When the New York legislature in Albany crippled the ability of landlords to recover costs on multifamily rentals with the latest rent control law, this entire asset class was impaired. Once SBNY is sold to a larger lender, these assets will be impossible to finance with a bank. But there is more. Not only is SBNY a major player in multifamily, but it also plays in financing residential real estate and has participated in most of the financings for mortgage servicing rights (MSRs). SBNY will be but the latest lender to exit this market for MSR financing. The bank also manages escrow balances for a number of nonbank lenders, all of whom may now need to find a new bank at a time when many regionals are fighting for their lives. The Yellen Banking Crisis When we say that the Yellen Banking Crisis is not over, what exactly to we mean? First, by creating a two-tier approach between large and small banks, Yellen is exacerbating the run by businesses away from regionals to the largest banks. Consider a recent report from our risk manage pal Nom de Plumber , who is currently embedded inside one of the larger TBTF zombie banks. “In a desperate move to retain business deposits, some regional banks are pressuring corporate clients to make uninsured deposits which sound like repos (repo sweep investments), but which are not truly documented and secured as repo transactions,” he reports. "The clients want to buy Treasury bills, but regional banks are offering high yields to retain the cash." Essentially the banks take the uninsured deposits, then sweep them into a repurchase transaction overnight. The only problem is that the transaction is not in the name of the client but rather the bank. This is the same scam run by SBF at busted crypto scheme FTX. There is no documentation provided to the client and no lien on the collateral. If the bank fails, the customer will take a total loss because the FDIC receivership will repudiate the transaction in favor of the estate of the dead bank. Bottom line: The Yellen and then Powell FOMC created the present banking crisis by embedding “AAA” rated toxic waste into the balance sheets of US banks. The steps taken so far are inadequate to address the threat. Since most members of the Biden Administration responsible for financial markets and institutions are incompetent (they’d rather talk about ESG and inclusion), the White House remains in the dark about the true scope of the problem. Unless Congress acts quickly to extend blanket coverage (and deposit insurance fees) for all deposits, we will see more regional banks fail. Large banks are GSEs. Smaller banks are not, yet, but we suspect that the era of the uninsured deposit is over. FDIC should prepare to insure all deposits of US banks and tax the industry accordingly. The alternative is a debt deflation and return to 1933. In the next issue of The Institutional Risk Analyst, we'll be reviewing changes to our portfolio and looking at some opportunities in banks and nonbanks. 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.

March 13, 2023 | Premium Service | Why did Silicon Valley Bank, the 18th largest bank in the US fail last week? Because the bank’s management naively invested half the bank’s assets in “risk free” securities. The bank had 43% of total assets in mortgage-backed securities vs an average of 12% for the 132 largest banks in the US. Extension risk killed Silicon Valley Bank. Source: FFIEC What is now the most sought-after list on Wall Street by short-sellers? The list of banks with above-peer holdings of MBS. We first wrote about the risk of duration to US banks back in 2017 (“ Banks and the Fed’s Duration Trap ”): “As and when the balance between buyers and sellers in the MBS market slips into net supply, volatility will explode on the upside and the considerable duration extension risk hidden inside current coupon Fannie, Freddie and Ginnie Mae MBS could prove problematic for the banking industry.” When you see the FDIC forced to stand up a bridge bank and issue IOUs to large depositors of Silicon Valley Bank, this is not an ideal situation. Fed Chairman Jerome Powell and Treasury Secretary Janet Yellen need to address the growing crisis of confidence in smaller US banks. With the sudden failure of Silicon Valley Bank and its parent, SVB Financial Group (SIVB) , investors have started to come to grips with the liquidity risk created by the Fed since 2008 and particularly since 2020. To review, let’s go through the steps taken by the FOMC to create our shared predicament. First the FOMC began quantitative easing or “QE” in November 2008, expanding the balance sheet to compensate for the huge retreat of investors from the financial markets. QE is Fedspeak for massive open market purchases of securities. We can call this early use of securities purchases “good QE” and by 2010 the Fed had essentially achieved its goal. QE should have ended. Second, the Bernanke FOMC began the first of a series of efforts as social engineering, expanding asset purchases to compensate for the fact that interest rates were already at the zero bound. The pro-inflation tendency on the FOMC led by Yellen pushed for even more asset purchases and other market manipulations. Yellen argued that inflation was too low. Few of the members of the FOMC other than Jerome Powell publicly raised any concerns about the negative impacts of QE on the economy and the financial system. Second, the FOMC began the first of a series of efforts at social engineering, launching QEs 2 and 3. In 2012, the FOMC stated: “To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee agreed today to increase policy accommodation by purchasing additional agency mortgage-backed securities at a pace of $40 billion per month.” For several more years, the Bernanke and then Yellen FOMCs engaged in various market manipulations that have left the US bond market and the term structure of interest rates in shambles. In particular, one of the more idiotic policy proposals of the FOMC was “operation twist,” where the Fed used redemptions on short-term securities to load up the portfolio with long-dated Treasury debt. Bond purchases continued under the Bernanke and the Yellen FOMC, through to 2017 when the FOMC announced a move toward “balance sheet normalization.” By 2019, however, after the market meltdown in December 2018, the FOMC retreated from earlier commitments to normalize the balance sheet and indicated that a ~ $4 trillion balance sheet was the "new normal." By refusing to reduce the size of the portfolio, the Fed essentially agreed with earlier warnings from Chairman Bernanke and others that once you start QE, you cannot later withdraw the liquidity. The inflation of the Fed's balance sheet is permanent. When the FOMC reinvests principal repayments from the portfolio, this represents a permanent debt subsidy to the US Treasury. The Treasury, after all, is the primary beneficiary of QE. By the first quarter of 2020, the onset of COVID provided the FOMC with a pretext for ramping up asset purchase to even larger levels, pushing the total Fed balance sheet from just below $4 trillion to $10 trillion. COVID allowed the US Treasury to borrow trillions more to fund various fiscal giveaway schemes from Congress that added to inflation. The massive scope of the Fed’s purchases of debt and lowering of interest rates in 2020-2021 helped to refinance two-thirds of all mortgages and an equal portion of corporate debt at very low yields. But the Fed’s actions also concentrated this huge amount of debt within a band of just three percentage points, roughly between 2 and 5 percent. As we noted earlier, 75% of all mortgage backed securities fall between 2% and 4.5% MBS coupons. When the Fed began to tighten policy and end asset purchases in 2021, much of the COVID era debt was quickly left underwater. As we noted in an earlier post (“ QT & Powell's Liquidity Trap ”), as the Fed pushed up short-term interest rates, the effective duration of the Fed’s $3 trillion in agency and government MBS ballooned to over $10 trillion today, with a commensurate reduction in price. The MBS owned by SIVB and other banks went from a three-year average life to in excess of 15 years today. The change in duration of MBS is responsible for the huge unrealized losses on the books of US banks. By the time that SIVB collapsed in March of 2023, the FOMC had moved short-term interest rates nearly six percent. Any first year associate at a bank knows that if you issue a security at 3% and then the Fed raises interest rates by 500bp, the value of that security is going to fall by about 20 points from its original value. SIVB had half its balance sheet in “low-risk” government and mortgage backed securities (MBS), but the market risk overwhelmed the bank and caused a deposit run. Now you know why the short-sellers focused on SIVB. As Q1 2023 comes to a close, the US banking industry is on a knife’s edge. The bond rally in Q4 2022 helped to reduced the unrealized losses of all banks, but the movement in the bond market may push these losses higher in Q1. Rising market volatility will only further reduce the value of trillions of dollars in low coupon securities issued in 2020-2021. The table below shows the mark-to-market for the US banking industry at Q4 2022. Source: FDIC The table below shows the same analysis for JPMorgan (JPM) as of Q4 2022. Source: EDGAR The fact that not a single member of the Big Media managed to ask Fed Chairman Jerome Powell about the state of the US banking system during two days of testimony is breathtaking. Fortunately, we don’t have this problem. Members of the financial media need to start asking some questions. The IRA Bank Book Q1 2023 As the US banking sector heads to the end of Q1 2023, the chief concern of CEOs is managing the growing number of risks being created by the conflicting policies of the FOMC. Banks large and small are spending more time dealing with the curve balls coming from the Fed and other regulators than they are running their businesses. How is this helpful to achieving full employment and price stability? Below subscribers to the Premium Service of The Institutional Risk Analyst may download the latest edition of The IRA Bank Book for Q1 2023 , where we describe some of the current and emerging risks to US banks and financial markets. Stand-alone copies of The IRA Bank Book report are available in our online store . 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.

November 28, 2022 | Watching the Buy Side Pivot Platoon rev up for a new surge of asset allocation into large cap bank stocks, we remind readers of The Institutional Risk Analyst that US depositories currently are not particularly cheap, in nominal or real terms. In fact, in a stressed scenario, the liabilities of banks exceed the value of the assets by over $1 trillion, the classic definition of insolvency. Once you adjust reported book value for the asset price inflation & now deflation of the QE/QT roller coaster ride, it is fair to ask: Just where is the value? If we told you that the capitalization of the industry was negative by over $1 trillion at the end of Q2 2022, would you still buy bank stocks for your clients? Let’s have a look at industry paragon JPMorgan Chase (JPM) just for giggles, but first we’ll start off with the industry view. At the end of Q2 2022, the US banking industry had $2.2 trillion in total capital. That is, book equity. But much of total capital is not tangible, which is why regulators use Tier 1 Capital as the base measure for solvency. The legal definition of Tier 1 Capital, which excludes many items we discuss below, is found at 12 CFR Part 324 of the federal banking regulations. Specifically, the law: “requires that several items be fully deducted from common equity tier 1 capital, such as goodwill, deferred tax assets (DTAs) that arise from net operating loss and tax credit carry-forwards, other intangible assets (except for mortgage servicing assets (MSAs)), certain DTAs arising from temporary differences (temporary difference DTAs), gains on sale of securitization exposures, and certain investments in another financial institution’s capital instruments. Additionally, management must adjust for unrealized gains or losses on certain cash flow hedges.” Of note, when adopted in 2015, CFR Part 324 allowed all non-advanced approach institutions (aka little banks) to make a permanent, one-time opt-out election, enabling them to calculate regulatory capital without AOCI . At the time, accumulated other comprehensive income was a minor entry on bank balance sheets and income statements, minor as in the footnotes. In the age of QE, however, AOCI is now a much bigger deal, but still is dwarfed by how QE has caused unrealized losses on bank balance sheets. So, let’s begin the fun with the fire-sale calculation we perform using the aggregate data from the FDIC. We start with total capital, the broadest definition of bank equity. We then subtract the goodwill and all of the intangibles. (H/T to Jake for catching error in earlier edition.) U.S. Banking Industry Source: FDIC Notice that tangible capital dropped by several hundred billion in three quarters since Q4 2021. As we’ve noted earlier, the large banks led by JPM plateaued in Q3 2022 in terms of AOCI, mostly through sales of assets and transfers into portfolio to be "held to maturity." But the risk remains. MSR prices have likewise softened since June. Regulators refer to “assets” rather than rights because sometimes mortgage servicing can become a liability, particularly in the government market. Thanks to QE and now QT, all sorts of assets have become negative return propositions for banks and nonbanks alike. If the coupon pays less than the funding costs, you’re losing money. Just ask Jerome Powell about the return on the Fed’s SOMA portfolio. Below we take the analysis through adding the net gain or loss reported in AOCI. U.S. Banking Industry Source: FDIC So just subtracting the basics for Tier 1 capital leverage, including taking out the AOCI, we have almost cut Q2 2022 industry capital in half. And we have not even arrived at the fun part, which involves estimating the mark-to-market losses on loans and securities held in portfolio caused by the rapid increase in interest rates by the FOMC. Even if the bank holds these low-coupon assets created during 2020-2021 in portfolio to maturity, cash flow losses and poor returns could eventually force a sale. This is why people who prattle on about how well capitalized are US banks are just showing their ignorance. The table below shows our conservative M2M adjustment for the last three quarters on the almost $12 trillion in total loans and leases owned by banks. We adjust Q4 2021 by 2.5%, Q1 2022 by 8% of total loans and leases, and 15% of total loans and leases in Q2 2022 to approximate the low-end of M2M losses due to the rapid increase in interest rates in 2022. U.S. Banking Industry Source: FDIC As you can see, the industry is already insolvent in Q2 2022 with the adjustment to the loan portfolio, which may be significantly underwater by next year. GAAP allows owners of assets held to maturity to ignore mark-to-market losses so long as they have the capacity and the intent to do so. So, do you sell the 2% and 3% coupon loans and securities at a loss and buy some 8% and 9% loans coupons? Yes you do, eventually. This is how M2M becomes available for sale (AFS) “gradually, then suddenly” to recall Ernest Hemingway’s 1926 novel, The Sun Also Rises . The final part of the analysis is to apply the adjustments above to the $5 trillion bank securities portfolio. The result is another $700 billion in potential M2M losses as of the end of Q2 2022 and a picture of the US banking industry that is a good bit less positive than the conventional wisdom. U.S. Banking Industry Source: FDIC The value of the FDIC data is that they track all of the AOCI even if the banks do not need to add or subtract the balance from regulatory capital. The fact that the US banking industry had $1.3 trillion more in potential M2M losses that capital at Q2 2022 should put to rest any doubts that QE was too much funny money for too long. Notice that none of the economics reporters who cover the Fed ever ask about the impact of QE on the banking system. So now if we turn to JPM, which is one of the better managed banks in the US, the results are better than the industry as a whole but the bank still had a negative capital position at the end of Q2 2022 to the tune of -$16 billion in capital. The capital deficit increased to -$58 billion when we increased the M2M adjustment to 17.5% haircut in our stressed scenario. JPMorgan Chase Source: FDIC, Edgar Don't hold your breath waiting for Fed Chairman Jerome Powell to address the issue of bank solvency at the next FOMC press conference. First QE and now QT has injected such excessive levels of volatility into the prices of assets -- all assets -- that the value of capital has been compromised. Suffice to say that if the FOMC continues to raise interest rates above current levels, then we think that the issue of bank solvency may be front-and-center by next summer. 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.

March 9, 2023 | Updated | Premium Service | On February 28, 2023, Kroll Bond Rating Agency (KBRA) put six classes of notes on Watch Developing issued from three transactions collateralized by subprime auto leases originated by an affiliate of RAC King, LLC . The rating action came following various news articles citing the fact that American Car Center (“ACC”) was ceasing all operations and closing its headquarters in Memphis, Tennessee on February 25, 2023. The shutdown came after the reported failure of an ABS securitization led by Atlas, the new vehicle created by Apollo (APO) to acquire the structured products group (SPG) from Credit Suisse (CS) . Why this first ABS deal for Atlas was allowed by APO to fail is unknown, but this is another negative development in the unwind of CS. It also confirms the poor market conditions in the ABS sector more generally. A number of readers have asked why KBRA and other agencies are not taking more aggressive action given the situation in the ABS market. There has been no bankruptcy filing as yet for ACC, but that seems a distinct possibility. Westlake is reportedly taking the servicing book from ACC. CS still has the warehouse assets apparently, but no word on how the transfer of the servicing will impact the bank. https://news.bloomberglaw.com/bankruptcy-law/westlake-to-take-over-servicing-of-american-car-centers-leases Will Silvergate Survive? Meanwhile, Silvergate Financial (SI) continues to attract more attention from short-sellers, this despite the fact that most of the supra-normal returns have been squeezed out of the stock. We profiled SI back in February of 2022 , when the bank was “only” trading at 2.4x book value vs 12x in March 2021, at the height of the crypto craze. The stock peaked at $219 in November 2021. How did we know that SI was probably a time-bomb for counterparties and investors? First obvious risk indicator was legal and regulatory risk of know-your-customer (KYC) and anti-money laundering (AML) compliance for a depository facilitating crypto transfers. At least with similar stories like Robinhood Markets (HOOD) and Interactive Brokers (IBKR) , the crypto trades occur away from the broker-dealer. Ian Katz at Capital Alpha Partners notes that “there’s now an open discussion in the industry about whether the bank and its holding company, Silvergate Capital, are more likely to file for bankruptcy or be forced into FDIC receivership.” So long as the subsidiary bank of a bank holding company (BHC) is solvent, it is possible to recapitalize the bank. If, however, the bank is insolvent or has other regulatory issues that affect solvency, then the State of California and/or the FDIC can declare the bank insolvent and place the depository into a federal receivership. In the event, the BHC loses 100% of the investment in the bank and often files bankruptcy. The reason we were suspicious of SI going back to 2020 was that the equity of this small mortgage bank was following the market progression of crypto stocks rather than banks, always a bad sign. Banks are designed and regulated to be boring underperformers. When a bank evidences market performance that is dramatically different from other banks, that is usually a sign of something being amiss. Besides SI, perhaps the greatest example of the outlier rule was Lehman Brothers Bank FSB , the non-bank affiliate of Lehman Brothers. In the years leading up to the great financial bust in 2008, Lehman Brothers Bank was the best performing bank in the US with equity returns over 50% annually. The bank was used as the conduit for MBS issuance by Lehman and was shut down in 2009. Does Ginnie Mae Threaten Government Lenders? A recent article in National Mortgage News asked a popular question: “ Are shaky nonbanks putting Ginnie Mae at risk? ” The answer to that question is no. In fact, for a number of reasons Ginnie Mae is a source of risk to independent mortgage banks (IMBs), depositories and the financial markets more broadly. The idea of IMBs as a source of risk to the US government is accepted doctrine in Washington. In fact, Ginnie Mae and the federal agencies that it serves, including the FHA, USDA and VA, take liquidity from the private financial markets and create the very liquidity problems that so vex housing agencies and the Financial Stability Oversight Counsel Chaired by Treasury Secretary Janet Yellen . Since the 2008 financial crisis and the National Mortgage Settlement in 2012, the cost of servicing residential mortgage assets soared several-fold, making it impossible for less efficient depositories to service government loans. Punitive fines and concerns about reputational risk helped further to drive virtually all large banks such as JPMorgan (JPM) out of the government market, mostly recently Wells Fargo (WFC) . As a result of the exodus of banks and even some nonbanks from the government market, a growing proportion of GNMA servicing assets are controlled by finance companies, real estate investment trusts (REITs) and private funds, which lack internal liquidity or the ability to retain significant capital. Banks still finance government lenders, even if they are no longer willing to take direct risk lending to low-income consumers. While Fannie Mae and Freddie Mac provide liquidity and other support to conventional issuers, Ginnie Mae takes liquidity from the government market and creates other unnecessary obstacles that prevent IMBs from accessing vital bank financing. For example, due to budget snafus and internal disfunction, Ginnie Mae is unable to process requests for new acknowledgement agreements in a timely fashion. Backlogs stretch back more than a year. Meanwhile, funding requirements are growing with the level of defaults. Given that government issuers are required to fund loss mitigation activities from the buyout of the loan to resolution, a process that sometime takes years, the fact that Ginnie Mae cannot assist issuers in expanding financing arrangements to support loss mitigation is tragic. But this striking example of the disfunction and indifference of Ginnie Mae is only the beginning. Late last year, a senior HUD official, Michael Drayne , resigned suddenly, leaving members of the mortgage finance community scratching their heads. In the intervening months, more information emerged, including a lawsuit brought by a small mortgage firm against Softbank subsidiary, Fortress Investment, and its former affiliate, New Residential Investment, now known as Rithm Capital (RITM). The lawsuit ( 360 Mortg. Grp. v. Fortress Inv. Grp., 19 Civ. 8760 (LGS) (S.D.N.Y. Mar. 30, 2022 ) alleges that Fortress, which managed and controlled the RITM REIT at the time, conspired with at least one Ginnie Mae official to put 360 Mortgage out of business. 360 Mortgage and Fortress had a previous business dispute and relations between the two firms were strained. While claims made in civil lawsuits are often disproven, the US government has now seemingly confirmed the allegations made by 360 Mortgage in an official report. Early this year the Office of Inspector General (OIG) for the U.S. Department of Housing and Urban Development (HUD) posted a heavily redacted report that explains the back story to the litigation against Fortress and the departure of Drayne. https://www.hudoig.gov/reports-publications/investigation-summary/investigation-alleged-misconduct-ginnie-mae-senior-vice The complaint alleges that an official of Fortress/RITM threatened to put 360 Mortgage out of business. Subsequent to the threat, Ginnie Mae EVP Michael Drayne reportedly took the unusual step to accuse 360 Mortgage of fraud and place the firm into default. The narrative suggests an agency that is out of control, with a large issuer using the most senior civil servant in Ginnie Mae to purse a private vendetta against a smaller Ginnie Mae issuer. The names of the Fortress/RITM representatives have been redacted from the report. The ID for 360 Mortgage in the OIG report is “Issuer 1.” The complaint states: "On July 16, 2018, Defendant's in-house counsel called Plaintiff's counsel and threatened to put Plaintiff out of business if it did not pay the disputed amount, and warned that Defendant had a close relationship with GNMA and that it was meeting with GNMA the next day.” In addition, the OIG report goes on to recount other machinations by Fortress/RITM representatives and Ginnie Mae officials led by Drayne. Most significant, Fortress/RITM allegedly tried to convince Drayne to default another servicer, Ocwen Financial (OCN) , after it was sued by the CFPB in 2017. The ID for OCN in the HUD OIG report is “Issuer 2.” HUD’s OIG reports that Drayne communicated about OCN with Fortress/RITM representatives as early as 2016, sharing material non-public information about OCN and essentially discussing the sale of OCN’s assets to RITM. An excerpt from the OIG report is below. The reference to “IC” appears to be RITM: “OIG’s review of Drayne’s emails showed that Drayne solicited IC Representative’s thoughts about Issuer 2 as far back as a year prior to its April 2017 distress. Specifically, in an email dated March 1, 2016, Drayne asked IC Representative if he could get his “thoughts about [Issuer 2] sometime in the next couple of days. Drayne told the OIG that Issuer 2 serviced a “pretty substantial amount of [Investment Co.’s] assets,” that IC Representative was in a position to “take steps that would have . . . somewhere between harmed .. . or . . . ended [Issuer 2’s] business, really,” and therefore “we would have been strategizing about . . . what might happen here and is there anything we can do to be prepared.” The passage above suggests that the Ginnie Mae official and Fortress/RITM were discussing the termination of OCN’s status as a Ginnie Mae issuer. Given that RITM was seeking a Ginnie Mae issuer license from Drayne at the very same time these discussions occurred makes the situation even more conflicted. Of note, HUD took the unusual step of making an appearance in the 360 Mortgage litigation as an "interested party," apparently because Drayne and perhaps other parties as yet unnamed clearly acted outside the scope of their employment at HUD. For the same reason, the redacted OIG report was subsequently made public by HUD. One industry CEO who reviewed the OIG report told The IRA that “I have lost all confidence in Ginnie Mae and their ability to protect non-public, confidential information. This is a huge problem for the industry." Of note, representatives of the Department of Justice, 360 Mortgage, HUD, Ginnie Mae, and RITM did not respond to written requests for comment. Fortress responded but had no comment. We suspect that this incident and the lawsuit are going to get greater attention, both from investors and also in Washington, in the weeks and months ahead. More than six years have gone by and HUD and Ginnie Mae have yet to resolve the matter or to formally notify Congress of these disturbing events. Ginnie Mae officials learned of Drayne’s action in May 2017, but the HUD OIG was not notified until January of 2018. Drayne did not leave Ginnie Mae until the end of 2022. Incredibly, Ginnie Mae officials have refused to confirm that Drayne has left the agency and have made no comment despite several requests. It is SOP at The Institutional Risk Analyst to take allegations from lawsuits with ample seasoning, but in this case the complaint brought by 360 Mortgage against Fortress/RITM appears to be largely confirmed by the report from the HUD OIG. We suspect that this incident and the lawsuit are going to get greater attention, both from investors and also in Washington. Five years have gone by and HUD Secretary Marcia Fudge has yet to resolve the matter or to notify Congress of these events. More, there is no mention of this lawsuit in the latest RITM 10-K. 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.

February 27, 2023 | Watching the debate over interest rates and the economy, it is a point of fascination to The Institutional Risk Analyst that virtually nobody in the economic profession or media talks about the Fed’s balance sheet. Indeed, by expanding its balance sheet via quantitative easing or QE, the Federal Open Market Committee arguably lost control of monetary policy and has placed America's banks in grave risk. Since the start of the Fed’s tightening, the nominal size of the system open market account or SOMA has declined, but the duration-adjusted value of the portfolio and the entire mortgage finance complex has exploded several-fold. Mortgage-backed securities (MBS) with sub-5% coupons have seen loan prepayments slow to low single digits, extending the effective maturity of the Fed's mortgage hedge fund by 3-4x. The chart below from FRED shows Treasury debt and MBS on the left scale and reverse RPs on the right. By facilitating the mortgage lending boom in 2020-2021 during the Fed’s most extreme period of open market operations, the Fed has captured and effectively sequestered more than $12 trillion in duration represented by the $2.8 trillion notional in MBS held by the SOMA portfolio. The chart below shows the distribution of Ginnie Mae MBS by coupon: The effective duration of all outstanding MBS from 2020-21 is roughly 3x the original duration when these securities were created. This upward surge in duration represents the extension in the average life from low single-digit years to more like 12-15 years. And the duration of the entire mortgage market, including whole loans owned by banks, also expanded by a similar amount. The fact that 75% of all MBS are now between 2% and 4.5% coupons shows how the Fed’s actions have concentrated risk on the balance sheets of banks. Since the Fed does not hedge the market risk on its vast securities portfolio, the long MBS position is essentially isolated from the market. Selling pressure on 10-15 year Treasury paper and swaps is reduced. Likewise the Volcker Rule prohibits trading by large banks around their massive Treasury, MBS and corporate bond positions, thus selling pressure on long-term yields is reduced. In effect, the long-MBS position in the SOMA is in direct conflict with the FOMC’s desire to raise the cost of credit, especially long-term interest rates. But does the Fed really want long-term rates to go up and stay up? The lack of selling pressure from the MBS owned by the Fed also tends to impact the swaps market and the dollar. Thus we come to the real question: Would the negative spread in dollar swaps that has existed since 2008 remain if the Fed were to start actively selling its long MBS position? In June of 2022, we asked whether it wasn’t time for the Fed to engage the Federal Housing Finance Agency (FHFA) under Director Sandra Thompson to fix the growing duration trap facing the Fed, the GSEs (all three, btw), many REITs and the banking industry (“ The Fed and Housing ”). Thompson, who has extensive experience at FDIC and Resolution Trust Corp dealing with bad assets and troubled depositories, understands why time is the most precious aspect of managing risk. In simple terms, the financial world has been massively long bonds (a/k/a duration) in a rising rate environment, a troubling scenario that has left many banks insolvent on a mark-to-market basis. Note that nonbanks and broker-dealers like Goldman Sachs (GS) don’t have this problem. We urgently need to find a way for banks to sell this low-coupon paper, reinvest at a higher rate and buy the time needed to repair the damage to bank capital done by QE and now QT. Last week, the Financial Times profiled Silicon Valley Bank (SIVB) , one of our favorite specialty lenders focused on the technology space. When we worked years ago banking some of the suppliers in the world of semiconductor capital equipment, SIVB was the key relationship for startups and venture investors. But what the bank has in credit sense for lending to early-stage companies it lacks in capital markets expertise. The FT notes that the bank’s market capitalization has been cut in half over the past year: “But some analysts, shareholders and short sellers point to another problem of its making: a move to put $91bn of its assets into a poorly performing bond portfolio that has since amassed an unrealized $15bn loss.” At year-end SVB had negative accumulated other comprehensive income (AOCI) of only $1.8 billion, representing available for sale (AFS) loans and securities, and the net mark-to-market on hedges and other market facing exposures. Yet like the Fed, the GSEs and the banking system, the negative mark-to-market on the retained portfolio at SVB are 10x the AFS book and now threatens to wipe out the bank's actual capital. Remember, the agency and government MBS with 2% and 3% coupons are trading in the low 80s today or 20 points below where they were valued 18 months ago. And these securities are far-beyond the point of being underwater in terms of net carrying cost. Nobody wants to own a Ginnie Mae 2% MBS. This cash negative reality affects most of the banking industry and represents a ticking time bomb that Chairman Powell need defuse pronto. Under GAAP, if a bank buys an MBS and marks it as “held to maturity” or HTM, it can account for the security at cost. However, when an investor loses the 1) ability and/or 2) intention to hold an asset to maturity, it is forced to mark all such HTM securities to market . This is the danger that is approaching the GSEs and many banks, which may eventually be forced by rising short-term interest rates to sell assets that were once meant to be held to maturity. The FHLBs hold hundreds of billions in seasoned low-coupon loans that are underwater vs the 5% coupons on new system debt. The Fed, the prudential regulators, the FHFA and the GSEs need to sit down together and fashion a comprehensive program that will allow banks, REITs and the GSEs themselves to repackage low-coupon loans and MBS into CMOs and sell this paper into the market. The FHFA needs to re-open the doors of the GSEs to securities and seasoned loans older than six months. Once the selling process begins, prudential regulators will need to give banks forbearance in terms of the recognition of losses and the impact on capital. We need to buy time so that banks and the GSEs are not forced into involuntary sales. The good news is that by using the power of the GSEs as underwriters, we can restructure the cash flows from the existing MBS and create attractive “AAA” rated income producing securities and deep-discount zero coupon securities. Banks and other investment grade investors can buy the relatively short-duration front tranches of these CMOs, while long-term investors and insurers will find the longer-duration paper attractive. Since new issue activity in the bond market is dropping, the Fed and banks should create some new duration to offset the market shortfall. If we take a page from the playbook of Jesse Jones , Chairman of the Reconstruction Finance Corp in the 1930s, we should use the superior credit of the federal government to solve a massive duration problem created by the FOMC via QE. The solution to the problem, as it was a century ago, is to buy time. If you don’t have time, then there is no liquidity and no deliberate action possible. Deflation then ensues. Federal Reserve Board Chairman Jerome Powell needs to lead a process to help banks and the GSEs extend maturities and timelines for loss realization. We need to do this before banks are forced to explain to investors later this year why they are reporting gigantic losses on assets they once intended to hold to maturity . And after we get the process started, the Fed itself should engage the GSEs to help slowly sell the SOMA MBS and return this duration to private hands. The GSEs need the business. Once the Fed sells its MBS portfolio, it will once again have control over the size of its balance sheet. 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.