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April 17, 2023 | In this issue of The Institutional Risk Analyst , we ponder the key takeaway from Q1 2023 earnings. Just by coincidence, funding cost is the same takeaway our readers considered a year ago – namely the fact that interest expense for banks, REITs and other investors is rising faster than asset returns. Bank deposit rates must rise. CNBC 4/14/23 Consider the example of JPMorgan (JPM) , which reported record Q1 2023 earnings on Friday thanks to QE. Interest income rose 139% from Q1 2022, but JPM’s investor relations team decided that the 10-fold increase in interest expense was somehow not meaningful to investors. In fact, JPM’s interest expense was up over 900% YOY. Likewise, Citigroup (C) apparently decided that investors would not find the increase in the bank's funding costs of interest to investors. In fact, Citi’s interest revenue increased 88% vs Q1 2022 but funding costs increased 377% year-over-year. After our appearance on CNBC’s Squawk Box Friday, Citi’s investor relations teams decided to complain that we had incorrectly characterized the bank’s credit loss rate. In fact, we wuz wrong. Citi’s net loss rate is actually 5x higher than the same measure for all of the banks in Peer Group 1. Years ago, we learned one of the more useful lessons in finance while working at Bear, Stearns & Co . The most important call or email from an aggrieved financial professional is often the one that is not sent. Sometimes you need to pick up the phone, dial the number and then put down the receiver before the call connects. Likewise with email. Provisions for credit losses at Citi, the next shoe to drop, were up 560% YOY in Q1 2023. This was another remarkable metric that the veteran IR professionals at Citi thought was not meaningful to investors. Fortunately, they did allow that a 49% increase in credit losses since Q1 2022 was perhaps meaningful to investors. Both managers and regulators are still fighting the last war in terms of bank risk, namely market risk due to sharply rising benchmark interest rates. The gap between bank deposit rates and that 4% yield on 90-day T-bills will close over the next year, forcing up prime bank loan rates towards low double digits. The productive economy of jobs and sales funds the necessary world of secured finance off the short end of the Treasury yield curve. A year ago, Citi took $600 million out of loan loss provisions, this as part of the great rebalancing of post-COVID credit reserves. For this reason, much of the financial data from 2021 and 2022 is useless from an analytical perspective. But the simple fact is that Citi and other consumer lenders will be building credit reserves in anticipation of an extended recession through 2023. Citi’s income was up over 80% sequentially, a legacy of the familiar pattern whereby Q1 of the year is the strongest. The fourth quarter of the year tends to be light at most large banks and especially at Citi. Thus the YOY comparison is less stimulating, with net income up just 7% vs Q1 2022. The same is true with most other banks, with Q1 being the best quarter of the year in terms of income. Most observers continue to focus on deposit runoff at smaller banks as a sign of weakness, but perhaps that focus is misplaced. We remind our readers that the whole point of tightening by the FOMC is for banks to get smaller -- 10-15% smaller on average vs average assets or about $2 trillion smaller for the entire US banking industry. The issue is not whether your bank is getting smaller, but whether credit expenses are being managed as funding costs -- and loan defaults -- inevitably rise. 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.

April 12, 2023 | Premium Service | In this issue of The Institutional Risk Analyst , we provide a pre-earnings look at the top-five depositories – JPMorganChase (JPM) at $3.6 trillion in total assets, Bank of America (BAC) at $3 trillion, Citigroup (C) at $2.4 trillion on balance sheet, U.S. Bancorp (USB) at $670 billion and Wells Fargo & Co (WFC) at $1.8 trillion. As the quarter ends, there is good news and bad news, as we discussed in our previous comment (" Powell's Duration Trap, Banks and the US Treasury "). Yields on loans and securities are rising, but more slowly than hoped. LT yields are falling, in fact, because the FOMC refuses to sell securities from the system open market account (SOMA). Market analysts come up with a variety of clever explanations as to why long-term interest rates are falling, but the gorilla dancing in the center of the room is $20 trillion or so in option-adjusted duration festering, unhedged and passive, on the Fed’s sterile ledger. Imagine where the 10-year Treasury would be today if the FOMC mandated that the Fed of New York bond desk sell sufficient MBS each month to hit the $35 billion cap for runoff. In Q1 2023 earnings, effective hedging strategy or lack thereof will feature prominently. Fed officials have no idea how to quantify their market intervention and banks likewise are left with an insoluble risk equation. To the more attentive, since Q3 2022, the trade has been long duration, as evidenced by the decline in the fair value of mortgage servicing assets (MSRs). The fact that price multiples for MSRs continue to climb even as valuations fall illustrates the pain felt by many issuers still operating in the forward loan markets. If the 10-year retraces to 3% or lower in this cycle, margin calls on negative duration MSRs and short-TBA positions in residential mortgages will start to be a concern. Source: FDIC/WGA LLC Likewise, market volatility in March was extraordinary after the twin failures of Silicon Valley Bank and Signature Bank. The VIX traded over 25 for the first time since October 2022 and for most of the month. Q3 2022 was the start of the present rally in 10s and out for the Treasury curve. Volatility fell back below peak levels by the end of the month, but it is fair to say that modeling these markets remains a challenge. How the largest banks manage their asset-liability risk is one of the more important aspects of earnings in 2023. Look for duration smart results from JPM and USB, among the larger banks, and Mr. Cooper (COOP) and, Rithm Capital (RITM) , the REITs in 1-4s. Of note, significant personnel changes at PennyMac Financial (PFSI) have caused this once leading MBS issuer to step back in terms of pricing in conventional loans. JPM managed to shrink assets in Q4 2022, but loan growth was also low and well-below the 14% growth reported for Peer Group 1. JPM actually shed non-core funding in Q4 even as banks generally saw a massive uptick in the usage of non-core funding in Q4 2022. Was this the clue that the data dependent Fed missed? We think so. The fact that Peer Group 1 averaged a 98% change in the usage of hot money is the proverbial dog that did not bark in the night. NY Fed President John Williams says that he sees no sign of credit tightening, yet the bank data gathered by the Fed suggests otherwise. Net credit losses as a percentage of average assets have been climbing for a year, as shown in the chart below. Source: FFIEC Note that Citi with its subprime consumer lending book has a loss rate 5x Peer Group 1, which is the dark blue line running along the bottom of the chart. Because of the higher credit spread, Citi is a leading indicator. Next below Citi is USB, which also tends to track above the other money center banks in terms of loss rates. Then comes JPM in the middle of the pack. BAC and then WFC have lower loss rates but also inferior operating performance, as we discuss below. The Street has JPM growing revenue by high single digits in Q1 2023, but it is important to recall that the bank’s pretax income was down more than 20% in 2022. The comparison with 2021 was muddied by the favorable GAAP adjustments to income in that year after the huge and unnecessary provisions put aside in 2020. Even if JPM hits the Street’s growth numbers, the bank will still be way behind compared to 2021. A big reason for the difficulty that JPM and other large banks will have in growing revenues has to do with the yield on the loan book, which is only starting to recover from QE. Source: FFIEC Observe that Citi also leads the group in terms of gross yield because of the subprime consumer portfolio. Next is JPM at just shy of 5% followed by the average for Peer Group 1. The rest of the group is still showing yields below peer and just barely above 4% before funding costs and SG&A. Given that the US Treasury is paying 4% for 90-day T-bills, you can see how far banks have to go in terms of asset returns to become competitive. To get another perspective on banks and QE, the chart below shows the return on earning assets (ROEA) as calculated by the FFIEC. Source: FFIEC That the average for Peer Group 1 leads the pack reflects the diverse results of the 132 banks represented in the average. Smaller banks tend to get better pricing on loans than do the larger banks. Context matters, however. Today Peer Group 1 is still a point below the ROEA at the end of 2019. Notice that JPM and BAC are last among the top five banks, illustrating the huge, underperforming securities portfolios of these giants. USB, on the other hand, is competing with Citi for the leadership of the group even though it has a far lower gross spread on its loans. USB managed to grow assets and loans in 2022, albeit because in December it closed the acquisition of MUFG Union Bank's core retail banking operations. Unlike the other larger banks among the top-five depositories, USB is still able to pursue acquisitions. The Street has a lower revenue growth estimate for USB for 2023, but we expect that the Minneapolis-based bank will continue to perform above peer. The chart below shows the efficiency ratios (Overhead expenses/Net Interest Income + non-interest income) for our group and Peer Group 1. Source: FFIEC Peer Group 1 and JPM have the best (lowest) efficiency ratios, which you can think about as the dollar cost of revenue. USB is next, followed by BAC, Citi and WFC, which is in distressed territory above 75% efficiency. A combination of down-sizing and expenses related to remediating various regulatory problems has made WFC well-nigh distressed in recent years. Until WFC management gets that efficiency ratio down into the 60s and keeps it there, we would not take them seriously. Operating efficiency is a simple but effective proxy for the effectiveness of management. Despite the bank’s miserable performance, the Street still manages to be constructive on WFC, showing revenue growth that is seemingly in conflict with recent results. Assets fell 3.5% at WFC in 2022 while loans grew 5%, a remarkable achievement given that WFC exited correspondent lending in 1-4s last year. Only half of WFC’s $1.8 trillion balance sheet is invested in loans, yet the bank managed to keep its mark-to-market losses to less than 10% of capital in Q4 2022. Incredibly, the Street analysts are less constructive on BAC than on Wells Fargo. BAC dropped assets by single digits in Q4 and was below peer in terms of loan growth, two metrics that will not surprise readers of The Institutional Risk Analyst . BAC’s net loss rate is pedestrian, illustrating more the bank’s remarkable torpor more than a deliberate risk management choice, yet losses are rising. Historically, BAC made its earnings by keeping credit losses and funding costs down. But now interest expense is rising faster at BAC than either JPM or USB. We expect further increases in Q1 2023, even if the bank benefits from the flight to big depositories. Seeing BAC right behind JPM in terms of funding costs in Q4 makes us wonder how much different Q1 2023 will look. Source: FFIEC The fact that Citi had an overall funding cost 2x JPM and BAC at the end of 2022 is no surprise since the bank’s net non core funding dependence was over 40% vs 8% on average for other large banks. Despite the double-digit yields on its loan book, the high funding costs at C still result in a lower return on earning assets compared with the other top five depositories. On a risk-adjusted basis, the equity returns from Citi are arguably far lower than say JPM or USB. Maybe that is why the stock is trading 0.4x book. The Street has Citi growing earnings to $7 in 2023 but only $5.8 in 2024? Revenue growth is in low single digits. Given our view that credit is the next course awaiting many banks, Citi bears close attention because of its subprime credit book. In an environment of rising credit costs, Citi’s profile will not look very attractive. Even if commercial real estate exposures are among the worst pockets of risk in the banking world in 2023, banks with consumer facing exposures are likely to be punished further. The bottom line for earnings is shown in the relationship between net income and average assets. The first thing to notice is that the smaller banks are performing far better than their larger peers. This situation is likely to reverse in Q1 2023, however, as smaller banks are forced to drop loan rates and raise deposit rates in order to retain business. Source: FFIEC The good news for all banks is that the huge unrealized losses that caused the failure of Silicon Valley Bank will continue to moderate in Q1 2023. So long as the 10-year Treasury is closer to 3% than to 4% yield, the ugly disclosure of mark-to-market losses will be manageable for most banks. Capital markets activity is unlikely to rebound significantly as LT rates fall, but reduced volatility may help large bank results later in 2023. The bad news is that without active sales of securities from the SOMA, bank asset returns are unlikely to return to pre-COVID levels. As credit expenses rise in Q1 2023 and the balance of the year, banks are likely to see operating income squeezed between higher funding costs and sluggish yields on earning assets. At the end of the day, the spread between operating income and provisions for credit losses is the most important relationship in banking. The Fed's gift to banks in Q1 2023 is dismal capital markets results and constrained asset returns. The asymmetry of Fed interest rate policy between rate hikes and SOMA asset sales is going to create problems for banks until the imbalance is reversed. Source: FDIC 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.

April 10, 2023 | In the next Premium Service issue of The Institutional Risk Analyst to be published this Wednesday, we’ll provide a pre-earnings look at the top-five depositories – JPMorganChase (JPM) at $3.6 trillion in total assets, Bank of America (BAC) at $3 trillion, Citigroup (C) at $2.4 trillion on balance sheet, U.S. Bancorp (USB) at $670 billion and Wells Fargo & Co (WFC) at $1.8 trillion. But first we make a couple of general market comments for all of our readers about the state of the banking industry and the Fed itself after a year of tightening by the FOMC. America’s largest bank, JPMorgan, actually shrank in size 2% in 2022, after growing average assets 10% in 2021 and 25% in 2020 during the “go big” period of QE. In that year, the Federal Reserve Board decided to double the size of its balance sheet without considering the now apparent down-side risks. As a result of the Fed’s ill-considered actions, several large banks have failed and hundreds of billions of dollars of private equity and debt have been destroyed. The total cost of QT to investors and also the US Treasury, however, is likely to be far larger as the tightening process continues. Before the bank liquidity crisis in March of 2023, our expectation was that JPM would continue to shrink in Q1 2023, but now it's likely that the largest bank in the US actually grew in 2023. Even as the size of the money center banks increased during the period of massive bond purchases by the FOMC, the book value multiple of these stocks has declined, a grim testament to the negative impact of QE on banks and investors generally. Notice that subprime lender Citi has been punished by investors, while JPM and USB lead the group. In that sense, nothing has changed in five years. Source: Yahoo, Bloomberg A couple of general observations about the group are in order. First, the Fed’s quantitative easing (QE) policy seems to have retarded lending even as banks grew in size. As banks now shrink in the world of post-QE and higher short-term interest rates, it is unlikely that we shall see significant loan growth or spread expansion. Total loans and leases held by all US banks rose 7% in 2022, but loan portfolios actually fell over the past five years vs total assets. Source: FDIC In March 2023, the Fed expanded its balance sheet by several hundred billion dollars to accommodate the cash needs of scores of smaller depositories following the collapse of Silicon Valley Bank and Signature Bank, as shown in the chart below. This extension of credit to banks was far smaller than that provided in 2008-2009, however, and the system open market account (SOMA) is already starting to decline, at least in nominal terms. Source: Board of Governors Since the Fed’s balance sheet is theoretically running off around $90 billion per month, including $60 billion in Treasury debt and an uncertain amount of mortgage-backed securities , the Treasury will eventually need to issue new bills and notes to refinance these redemptions. Because prepayments on MBS generally are very low , the redemptions from the SOMA are running well-below the $35 billion cap. The Fed’s projections for portfolio runoff are as shown in the chart below. Notice that the MBS barely declines. The green area shows MBS and CMBS held by the SOMA. The residential MBS have a weighted average coupon (WAC) around 3%, These same MBS have a weighted average maturity (WAM) in excess of 15 years or 5x the WAM at the time of issuance in 2020-2021. As a result, we think projections of the rate of runoff of MBS from the SOMA are still too optimistic. Actual compounded prepayment rates (CPRs) are running in low single digits vs the 6% CPR minimum assumed in most commercial prepayment models. "There is absolutely no way that homeowners are going to give up those 3% mortgages that went into UMBS/GNMA 2% 30r bonds," notes reformed mortgage banker and entrepreneur Alan Boyce . "The Fed will have to actively sell the MBS at a big loss to make the QT goals. All the regional banks have the same issue, you will lose the money now by selling or over time via negative carry," says Boyce. Boyce notes that there is almost 100bp spread between the WAC on the mortgage loan and the bond coupon. "Half is a forever annuity held by the GSEs and the rest is massively undervalued as a mortgage servicing right (MSR) held by a mortgage bank," he observes. "Ironically, Basle III treats the MSR as an intangible in the same category as tax loss carryforwards. MSRs trade at a lower CAP rate than commercial real estate! The Fed screwed the financial system, forcing them to stuff their balance sheets with low Risk Capital Weighted assets like MBS while eschewing the best cash flows." Simply stated, US banks are caught in a vice between rising short-term interest rates and the Fed’s $16 plus trillion effective long duration position in Treasury debt and MBS. How can SOMA be approaching $20 trillion in effective, duration adjusted size when the Fed’s own data show a nominal value just shy of $9 trillion today? Because of the extension risk of the MBS, risk that now resides inside every mortgage portfolio in the US. The mortgage bonds owned by the Fed, which had an effective average life of 2-3 years at the time of issuance during QE, are now closer to 20 years when measured against actual prepayment rates. CMBS, which are generally interest-only affairs, where principal is rarely repaid and refinancing is assumed, are also extremely sensitive to changes in interest rates. The cool chart below from the Bloomberg terminal shows the index of modified duration of Ginnie Mae securities over the past five years. In one striking image, we can see the true idiocy of QE and now QT as formulated by the FOMC. The huge manipulation of the duration of mortgage exposures by the FOMC caused the failure of Silicon Valley Bank and has badly damaged dozens of other banks. Source: Bloomberg Notice that after the market break in December 2018, the FOMC under Powell started to flood the markets with reserves based on the untested idea that this would preclude further market mishaps. This judgment turned out to be badly wrong, however, and forced the FOMC to spawn various band aids such as Reverse Repurchase Agreements to keep the money markets from imploding. The FOMC pushed down the effective duration of MBS from the LT average of 6 (think of duration as the average time required to recover principal) down to three by the end of 2019 via massive market purchases of Treasuries and MBS. With the onset of COVID, the FOMC doubled down, driving the effective duration of Ginnie Mae MBS further down to 1 from Q1 2020 through Q1 2021. In March of 2020, T-bill rates were effectively zero. Between Q1 of 2020 and Q1 of 2021, the US mortgage market originated over $5 trillion in new, low coupon mortgages with an average duration of say 1.5 at the time of issue. That's 40% of the entire residential mortgage market in 12 months. Those 2% and 3% MBS are now trading on average durations closer to 6 with weighted average maturities closer to 15-20 years. The average index value for new production MBS, securities with 5.5-6% coupons, is now back to a duration of 6. Let's consider the example of Silicon Valley Bank (SVB). At the end of 2019, SVB, has about 25% of assets invested in MBS with a duration of ~ 6 and a WAM of 5-6 years. By the end of 2020, SVB had taken its MBS position up to 33% of total assets, but half of the MBS portfolio had prepaid during that first big year of QE. Now the SVB MBS portfolio had a duration of ~ 3 and a WAM of perhaps three years. Source: FFIEC By the end of 2021, another 50% of the SVB mortgage portfolio had prepaid, but the bank's management had purchased even more, lower coupon MBS, to take the total position up to over 45% of total assets. This MBS position had sharply lower cash flows, duration now approaching 2 and a WAM of perhaps 2 years. The volatility of the SVB MBS portfolio had now doubled compared to the end of 2019 and the cost of hedging had likewise increased dramatically. Q: Did the management of SVB realize that they had killed the bank a year before it actually failed? It seems not. Of note, the Federal Reserve Bank of New York states in a February 2022 staff paper : “Because MBS pay fixed coupons to investors and typically have 30-year maturities, duration is high and prices are very sensitive to interest rates. A key distinguishing feature of MBS is that the duration of the security is not fixed but rather uncertain because borrowers can prepay their loans at any time.” The problem now for banks and the Fed itself is that virtually no borrowers are prepaying COVID era mortgages. The MBS that were being priced off of the 5-year Treasury note in 2021 are now priced off of the 15-year portion of the Treasury yield curve and extending. And even as the rally in the 10-year helps the mark-to-market on Treasury bond portfolios, the prepayment behavior of low coupon MBS may not change very much. The 3% jumbo we have sitting in a Fannie Mae high balance pool vintage March 2020 is not going anywhere, thank you. The table below illustrates the SOMA holdings as of April 3, 2023 and the crude adjustment by WGA LLC to illustrate the market impact of the Fed’s MBS and commercial mortgage holdings. Fed Chairman Jerome Powell told Congress in his recent testimony that the SOMA portfolio is running off, yet in duration adjusted terms, the SOMA is actually growing and is now 2x the notional amount. Source: Board of Governors, WGA LLC The 10-year T-note closed on a yield of 3.3% on Friday. The passive, unhedged portfolio of Treasury and mortgage debt on the books of the Fed is a dead weight on private markets and banks that holds yields down. QE took banks and the bond investors short duration to a massive degree. This has negative implications for bank loan yields and earnings going forward. Until the FOMC decides to actually sell MBS outright from its portfolio, it is unlikely that long-term benchmark interest rates such as the 10-year Treasury note will rise and remain above 3.5%. We see little indication that the Powell FOMC is willing to change policy. First and foremost, the Fed is already losing so much money on its own duration mismatch that it dares not entertain outright asset sales from the SOMA. Yet the markets remain short duration, so much so that even the prospective sale of almost $100 billion in Treasury securities and MBS by the FDIC Receivership is unlikely to impact market yields. New MBS origination volumes are so low that $100 billion barely moves the needle in terms of market supply. As a result, bank loan yields are unlikely to expand sufficiently to keep pace with funding costs unless the FOMC begins to sell MBS from the SOMA. The final thought is credit, the one thing that nobody has needed to worry about over the past decade because of QE. The Fed’s purchase and sequestration of trillions in duration forced asset prices up and net loss rates down, resulting in negative credit loss rates for much of secured finance. Now everything from auto loans to CMBS and C&I loans and residential MBS are rapidly reverting to long-term average loss rates. The illusion that credit had no cost, created by QE in 2020-2021, is now fading from view. Note in the chart below that net-charge off expenses for prime auto loans owned by banks bottomed out at zero in Q2 2021. Source: FDIC Cost of QE & QT to the Treasury As we’ve noted previously, both US banks and investors, and the Federal Reserve System, have two problems. The first problem is the ugliness of unrealized losses on securities that were bought during 2020-2021 and after. Even though the rally in the Treasury bond market off the lows of Q3 2022 has reduced the size of the negative mark-to-market for many banks and the Fed itself, this is more of a disclosure issue than an immediate concern. The second and more serious problem, however, is cash flow. Many banks and investors, and the Fed itself, are losing money because the coupons from those Ginnie May 2s and 2.5s from the period of QE are several points below the cost of funding in today’s market. The Fed is paying 5% on reserves and reverse repurchase agreements with cash from a portfolio of low coupon Treasury, agency and mortgage securities. Our friend Allex Pollock reflects on the Fed’s growing cash operating losses in his latest column in the New York Sun : “The Federal Reserve’s new report of its balance sheet shows that in the approximately six months ended March 29 it has racked up a remarkable $44 billion of cumulative operating losses. That exceeds its capital of $42 billion, so the capital of the Federal Reserve System has gone negative to the tune of $2 billion — just in time for April Fools’ Day. This event would certainly have surprised generations of Fed chairmen, governors, and, we’d have thought, newspapermen. The Fed’s capital will keep getting more negative in April and for some long time to come, at least if interest rates stay at anything like their current level. The Fed in the first quarter of 2023 reported losses running at the rate of $8.7 billion a month.” It is worth noting that the actual cash operating losses incurred by the Fed are, in fact, losses to the US Treasury. There are many people in Washington and particularly in the national Congress who naively assume that the remittances from the central bank represent “revenue” to the United States. In fact, much of the Fed’s revenue is merely the return of the Treasury’s own funds – less the Fed’s operating expenses. The interest and principal payments made on Treasury debt are clearly the assets of the United States held by the central bank. The Fed's confiscation of tens of billions in private interest and principal payments on MBS merely confirms the fact that the Treasury was the primary beneficiary of QE. We discussed this issue of the relationship between the Fed and Treasury with Robert Eisenbeis of Cumberland Advisors in a 2017 interview (“ Bob Eisenbeis on Seeking Normal at the Fed ”): Eisenbeis: When you look at the research on QE, the opinions are all over the map both inside and outside of the Fed. I think there is a consensus that there were diminishing returns in the additional QEs that were engaged in after QE1. Then it’s a question of what are the costs and benefits of getting out of the program. Those who suggest that QE has been a huge success are premature in my view. You don’t really know until we are completely out. It looks to me like we are going to be OK on balance, but what really bothers me is this constant drum beat inside the Fed and by some outsiders about the huge “profit” earned from QE. They have the accounting all wrong. The IRA: Well, the board is aligning itself with the idiocy on Capitol Hill, where the interest earned by the Fed is viewed as “income” for budget purposes. Most members have not read your 2016 testimony on the Fed's fiscal relationship with Treasury . But Bob, really, is it possible that PhD economists don’t understand the financial relationship between the Treasury and the central bank? We always like to remind people that the US Treasury issued the original $150 million in greenbacks directly into the market to help President Abraham Lincoln fund the Civil War. The Fed is the Treasury’s alter ego and is an expense to the government, which is subtracted from the earnings on the portfolio and then returned to the Treasury. Eisenbeis: Correct. The Fed almost by definition cannot make a profit. It baffles me how people inside the system can fail to see the accounting reality here. The Fed issues short term liabilities to buy Treasuries taking duration out of the market. The Treasury makes interest payments to the Fed who takes out its operating costs, including interest payments on reserves and returns the remainder to the Treasury. If this intra governmental transfer were settled on a net basis like interest rate swaps, there would always be a net payment from the Treasury to the Fed. It is too obvious, yet I am not privy to the sidebar conversations on this issue.” So given the costs to the banking sector and investors more generally of the Fed’s policies of QE and now QT, and given the Fed’s growing operating losses, should we worry about the Fed running out of cash? Will cash operating losses force the FOMC to sell securities to raise cash? In this vein, we have a suggestion for a question at the next FOMC press conference. Here goes: "Mr. Chairman, historically the Federal Reserve System has not presented a Combined Statement of Cash Flows as required by GAAP because, to quote the 2022 financials, “the liquidity and cash position of the Reserve Banks are not a primary concern given the Reserve Banks' unique powers and responsibilities as a central bank.” Given the Fed’s mounting cash operating losses and the cost this implies to the US Treasury as a result, will the Federal Reserve Board commit to release statements of cash flows for the years from 2020 forward?" 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.

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.